Trade Confirmation

A customer buys 500 shares through her firm. The trade confirmation discloses that the firm charged a markup on the trade. In what capacity did the firm act?

1. A.As an underwriter in a public offeringUnderwriting involves distributing new issues for an issuer — this is an ordinary secondary-market trade from inventory.
2. B.As an investment adviser to the customerAdvisers charge fees for advice — they are not defined by executing trades, and a markup is trade compensation.
3. C.As a principal, selling from its own inventoryCorrect — a markup is principal compensation, charged when the firm is the counterparty to the trade.
4. D.As an agent, matching the customer with another sellerAgents earn commissions, not markups. A markup means the firm itself sold the shares.

Why: A markup means the firm sold the customer securities from its own inventory — that is principal (dealer) capacity. Agents charge commissions; principals charge markups or markdowns.

A trade confirmation typically shows:

1. A.Nothing usefulThe confirmation is a required record of the transaction and is the customer's primary check on how the trade was handled. It carries the specific terms of the trade, not filler.
2. B.Trade date, settlement date, price, and commissionCorrect - key confirmation details.
3. C.Only the customer's nameCustomer identification appears on the confirmation, but it is only one field among many. The document also reports what was bought or sold, at what price, on what dates, and at what cost to the customer.
4. D.The firm's profit margin onlyCompensation disclosure is genuinely part of the confirmation, since commissions or markups must be shown to the customer. But that is one line item on a document that also states the security, price, quantity, and trade and settlement dates.

Why: A confirmation shows trade date, settlement date, price, and any commission or markup.

A customer disputes the details on a trade confirmation, claiming the price shown does not match what was agreed to over the phone. What must the principal ensure occurs regarding this discrepancy?

1. A.Accept the confirmation as correct by default, since it was generated through the firm's standard processWrong. A disputed confirmation should be investigated against the underlying order record, not simply defended by default.
2. B.Investigate the discrepancy, including reviewing the order ticket and any recorded communications, to determine the accurate termsCorrect. A disputed confirmation should be investigated against the underlying order and communication records to resolve the discrepancy.
3. C.Dismiss the dispute unless the customer provides a written contract signed by both partiesWrong. A signed written contract is not the standard for investigating a trade terms dispute; the firm's own order and communication records are the relevant source.
4. D.Cancel the trade automatically whenever a customer disputes any confirmation detailWrong. Automatic cancellation is not the appropriate response; the discrepancy should first be investigated to determine the accurate terms.

Why: The principal must ensure the discrepancy is investigated, including a review of the order ticket and any recorded communications, to determine the accurate terms of the trade -- not simply accept the confirmation as correct by default without investigating the customer's specific claim.

A firm's confirmation system automatically populates every trade confirmation with "agent" in the capacity field regardless of how the trade was actually executed, to simplify the firm's back-office processing. A principal discovers that several of the auto-populated confirmations were actually principal transactions. What is the problem?

1. A.There is no problem, since capacity is a formality and customers are not harmed as long as the price charged was fair.Wrong. Capacity is a required disclosure element in its own right, not a formality excused by price fairness.
2. B.The capacity disclosed on a confirmation must reflect the capacity actually used to execute that specific transaction; a system default that does not track actual execution capacity produces inaccurate disclosures regardless of administrative convenience.Correct. The confirmation must reflect actual execution capacity, not a convenient default.
3. C.The problem is limited to the transactions where the firm acted as agent, since only agency trades require capacity disclosure.Wrong. Both principal and agency trades require accurate capacity disclosure, not agency trades alone.
4. D.The problem is that the system should default to "principal" rather than "agent," since principal is the more conservative disclosure.Wrong. Any fixed default is the problem; accuracy to actual execution, not a different uniform default, is what is required.

Why: The capacity disclosed on a confirmation must reflect the capacity actually used to execute that specific transaction. A system default that does not track actual execution capacity produces inaccurate disclosures regardless of administrative convenience.