SIE Practice Exam 10

Answer: Record a customer's non-binding indication of interest

During the cooling-off period under the Securities Act of 1933, a representative MAY distribute the preliminary prospectus (red herring), record non-binding indications of interest, and rely on permitted announcements such as tombstone ads under SEC Rule 134. What is prohibited: making sales, taking orders (even 'contingent' ones), accepting money, or sending research and other promotional material about the issue — restrictions often described as the quiet period. An indication of interest binds no one; the customer can walk away and the firm is not obligated to allocate shares. Orders and payment can be accepted only after the SEC declares the registration effective and the final prospectus, including the public offering price, is available.

The Trap: cooling-off period — indications of interest allowed; orders, money, and research prohibited

• Send customers the firm's research report recommending the new issue: Quiet-period trap: circulating research or promotional material touting the issue during registration is prohibited — only the preliminary prospectus and permitted announcements may be used.
• Accept a check from a customer so the customer can lock in shares at the offering price: No-money trap: no funds may be accepted before the effective date — a heavily tested cooling-off prohibition.
• Take a firm order contingent on the final offering price: No-orders trap: no sales or binding orders may be taken before effectiveness, no matter how the order is worded or conditioned.

Verified against: quiet-period concept)

Answer: Has cleared the registration for sale but does not approve, endorse, or pass on the merits or accuracy of the offering

Under the Securities Act of 1933, the SEC's role is disclosure, not merit review. When a registration becomes effective, it means the issuer's disclosure obligations have been satisfied and sales may begin — nothing more. Every prospectus must carry a disclaimer stating that the SEC has neither approved nor disapproved the securities and does not pass on the accuracy or adequacy of the document; telling a customer otherwise is a violation. The SEC also does not guarantee the prospectus is truthful — liability for misstatements rests with the issuer and the underwriters. And FINRA, a self-regulatory organization for broker-dealers, plays no role in 'approving' an issuer's securities.

The Trap: SEC effectiveness vs. SEC approval/endorsement

• Has approved the issue after determining it is suitable for public investment: Merit-approval trap: the single most-used distractor in this area — the SEC does not judge investment quality or suitability; it requires full and fair disclosure.
• Has verified the prospectus and guarantees that its contents are accurate: Guarantee trap: the SEC does not certify or guarantee accuracy; responsibility for the truthfulness of the registration statement stays with the issuer and underwriters.
• Has delegated the approval of new issues to FINRA: Regulator-confusion trap: FINRA is an SRO for broker-dealers; it does not approve issuers' securities offerings, and no one 'approves' new issues on the merits.

Verified against: no-approval disclaimer)

Answer: A firm commitment underwriting, in which the bank acts as principal

In a firm commitment underwriting, the underwriter buys the whole issue from the issuer and resells it to the public, acting as a principal. The issuer is assured of receiving its money, and the risk of unsold shares falls entirely on the underwriter — exactly the arrangement described. In a best efforts underwriting the underwriter is merely an agent: it sells what it can, returns the rest, and the issuer keeps the risk. All-or-none is a contingent form of best efforts in which the entire offering is cancelled (and escrowed investor funds returned) unless every share is sold; a mini-max deal works similarly around a minimum threshold. A standby commitment is specific to rights offerings — the underwriter agrees in advance to purchase whatever shares existing shareholders do not take.

The Trap: firm commitment (principal, underwriter risk) vs. best efforts (agent, issuer risk)

• A standby commitment, because the bank stands ready to hold unsold shares: Standby confusion: a standby commitment backstops a RIGHTS offering — the underwriter buys only the shares existing shareholders fail to subscribe for.
• A best efforts underwriting, because the bank will make every effort to sell the shares: Agent-vs-principal trap: in a best efforts deal the underwriter acts only as AGENT and returns unsold shares to the issuer — the issuer, not the underwriter, bears the risk.
• An all-or-none underwriting, because the bank has taken the entire issue: AON confusion: all-or-none is a contingent best-efforts variant — if the whole issue is not sold to investors, the offering is cancelled and escrowed funds are returned; the underwriter never owns the shares.

Verified against: firm commitment vs. best efforts pair)

Answer: Helps sell shares to investors but makes no purchase commitment and bears no liability for unsold shares

The dividing line between the underwriting syndicate and the selling group is financial commitment. Syndicate members (led by the managing underwriter) sign the agreement among underwriters, commit capital to purchase the issue, and share liability for unsold shares. Selling group members are brought in purely to widen distribution: they sell shares for a selling concession, but they make no purchase commitment and bear no liability if shares go unsold. So a firm that wants to participate in a hot deal without capital risk joins the selling group; a firm willing to put its capital on the line joins the syndicate and earns a larger share of the underwriting spread in exchange for that risk.

The Trap: syndicate (liability) vs. selling group (no liability)

• Is liable for its pro rata portion of any shares the offering fails to sell: Liability-flip trap: pro rata liability for unsold shares belongs to SYNDICATE members under the agreement among underwriters, not to the selling group.
• Assumes the same liability as the managing underwriter once it accepts shares to sell: Everyone-shares-liability trap: accepting shares to market creates no underwriting liability — the financial commitment line runs between syndicate and selling group, not by deal participation.
• Must purchase its full allotment from the issuer as principal before reselling it: Role-confusion trap: buying from the issuer as principal describes syndicate members in a firm commitment; selling group firms only sell, they do not buy the issue.

Verified against: FINRA underwriting practice standards distinguishing syndicate members from selling group members (agreement among underwriters vs. selling group agreement)

Answer: Advertising is permitted under Rule 506(c), but every purchaser must be an accredited investor whose status the issuer takes reasonable steps to verify

Regulation D offers two paths under Rule 506. Rule 506(b) is the traditional private route: unlimited dollars, unlimited accredited investors, and up to 35 non-accredited-but-sophisticated purchasers — but no general solicitation or advertising. Rule 506(c), mandated by the 2012 JOBS Act and effective in 2013, flips the trade-off: the issuer may advertise publicly, but then every purchaser must be accredited and the issuer must take reasonable steps to verify that status — for example, by reviewing documents such as W-2s, tax returns, or bank and brokerage statements. A useful hook: 506(b) is for 'buddies' — people the issuer already knows, no advertising, 35 non-accredited allowed; 506(c) is for the 'crowd' — advertise widely, accredited-only, verified. Blanket statements that private placements can never be advertised reflect the pre-2013 rules and are out of date.

The Trap: 506(b) vs. 506(c) — which permits general solicitation, and at what cost

• Advertising is permitted under Rule 506(b), provided no more than 35 non-accredited investors purchase: Rule-mixing trap: 506(b) is the rule that PROHIBITS general solicitation; the 35 non-accredited-but-sophisticated allowance belongs to 506(b) only because it stays private.
• Private placements may not be advertised to the public under any circumstances: Stale-rule trap: this was true before the JOBS Act changes; since 2013, Rule 506(c) has expressly permitted general solicitation subject to accredited-only, verified purchasers.
• Advertising is permitted under Rule 506(c), and up to 35 sophisticated non-accredited investors may also purchase: Feature-swap trap: imports 506(b)'s 35 non-accredited allowance into 506(c); once an issuer generally solicits under (c), non-accredited purchasers are not permitted at all.

Verified against: 506(b) vs. 506(c) misconception pair)

Answer: It must use Tier 2, which requires audited financial statements and ongoing reporting

Regulation A — often called a 'mini-IPO,' though it is technically an exemption using an offering circular rather than a full registration — has two tiers. Tier 1 allows up to $20 million in a 12-month period and involves both SEC and state review. Tier 2 allows up to $75 million and preempts state registration, but in exchange requires audited financial statements, ongoing periodic reporting, and investment limits for non-accredited buyers. A $60 million raise exceeds the Tier 1 cap, so Tier 2 is the only Reg A path. Watch for stale figures: Tier 2's cap was raised from $50 million to $75 million in March 2021 (Tier 1's $20 million cap dates to 2015), so older materials showing lower numbers are out of date — and the $5 million limit belongs to Regulation Crowdfunding, a separate exemption.

The Trap: Reg A Tier 1 vs. Tier 2 caps and which tier carries audited financials/ongoing reporting

• It may use Tier 1, which permits offerings of up to $75 million in a 12-month period: Cap-flip trap: swaps the two tiers' limits — Tier 1 is capped at $20 million; the $75 million ceiling belongs to Tier 2.
• It cannot use Regulation A, because the regulation is limited to offerings of $5 million or less: Stale-figure/Reg CF confusion trap: $5 million is the Regulation Crowdfunding cap (and an obsolete old Reg A number) — current Reg A allows up to $75 million under Tier 2.
• It cannot use Regulation A, because offerings under the regulation are capped at $20 million: Cap-misapplication trap: treats Tier 1's $20 million limit as the ceiling for all of Regulation A; Tier 2 extends the cap to $75 million.

Verified against: current-fact warning: $20M/$75M since 2021)

Answer: Are restricted securities that generally may not be resold under Rule 144 until they have been held for six months

Stock acquired in a Regulation D private placement is restricted stock: Reg D exempts the transaction, not the security, so the shares carry resale restrictions even though the issuer's other shares trade publicly. Under SEC Rule 144, a non-affiliate holding restricted securities of an SEC-reporting issuer must generally hold them for six months before reselling — this customer, at four months, has roughly two months to go. Accredited-investor status does not shortcut the holding period; immediate resale of unregistered securities to institutions is a separate channel under Rule 144A and is limited to qualified institutional buyers. And full SEC registration is not required to exit — Rule 144 is the safe harbor that lets holders resell once its conditions are satisfied. (Affiliates face additional Rule 144 conditions, including volume limitations, even after the holding period.)

The Trap: restricted stock six-month holding period — public listing does not free private-placement shares

• May not be resold unless the issuer first registers them with the SEC: Over-restriction trap: registration is not the only exit — Rule 144 exists precisely to provide a safe-harbor path for reselling restricted stock once its conditions are met.
• May be sold immediately, because the issuer's stock already trades publicly: Restricted-status trap: the exemption covered the transaction, not the security — the shares are restricted regardless of the issuer's public listing, and the holding period still applies.
• May be sold immediately, as long as the buyer is an accredited investor: 144A/accredited confusion: immediate resale of unregistered securities is a Rule 144A privilege limited to qualified institutional buyers — accredited-investor status does not waive the Rule 144 holding period.

Verified against: restricted stock results from Reg D)

Answer: The sale is permitted: Rule 144A allows immediate resale of unregistered securities to qualified institutional buyers

SEC Rule 144A permits the immediate resale of unregistered (restricted) securities to qualified institutional buyers (QIBs) — generally institutions that own and invest at least $100 million in securities. With more than $250 million invested, the insurance company clears the QIB threshold, so the broker-dealer may sell to it today; this QIB resale channel is what gives privately placed bonds an active institutional trading market. The holding period belongs to ordinary Rule 144 resales of restricted securities — six months for SEC-reporting issuers, one year for non-reporting issuers — and Rule 144A bypasses it entirely for sales to QIBs. Note the ladder of thresholds students often blur: accredited investor is a Regulation D concept with far lower hurdles (for individuals, $200,000 income — $300,000 with a spouse — or $1 million net worth excluding the primary residence; institutions such as insurance companies qualify by entity status), and being accredited does not by itself open the 144A market — QIB status does. Regulation S is different again: it covers offshore offers and sales to non-U.S. persons and has no role in this domestic institutional trade.

The Trap: Rule 144A/QIB vs. Rule 144 holding period vs. accredited investor

• The sale is permitted only because the insurance company qualifies as an accredited investor: Accredited-vs-QIB threshold confusion: accredited status (a Regulation D concept with far lower thresholds) is not the test — Rule 144A turns on qualified institutional buyer status, generally $100 million or more invested in securities.
• The sale is permitted only if it is executed offshore under Regulation S: Reg S misapplication: Regulation S covers offshore offerings to non-U.S. persons; it is not required for — and does not govern — a domestic institutional resale under Rule 144A.
• The sale is prohibited until the bonds have been held for six months under Rule 144: 144 vs. 144A confusion: holding periods (six months for SEC-reporting issuers, one year for non-reporting issuers) govern ordinary Rule 144 resales; Rule 144A creates a separate path allowing immediate resale to qualified institutional buyers with no holding period.

Verified against: accredited vs. QIB thresholds; Reg S)

Answer: Return the check and explain that only a non-binding indication of interest may be recorded until the registration becomes effective

Until the SEC declares a registration statement effective, the Securities Act of 1933 prohibits selling the security, accepting orders, and accepting customer funds — so the check must go back, however the customer words the request. The most the representative may do is record a non-binding indication of interest, which commits neither the customer nor the firm; the actual order and payment can be taken only after the effective date, when the final prospectus with the public offering price is available. Escrow does not rescue the deposit: escrow accounts belong to all-or-none and mini-max contingency offerings, holding investor funds after the effective date pending the contingency — they are not a workaround for pre-effective payments. And the preliminary prospectus (red herring) is an information document only: it shows no final price, cannot confirm an order, and must not be marked up.

The Trap: no sales, orders, or money during cooling-off — escrow and clever order wording are not workarounds

• Deposit the check in an escrow account until the registration becomes effective: Escrow misapplication: escrow is a feature of all-or-none and mini-max contingency offerings for funds received AFTER the effective date — it does not make accepting money during the cooling-off period permissible.
• Confirm the order by sending a preliminary prospectus marked with the expected price range: Red-herring markup trap: a preliminary prospectus contains no final price, cannot be used to confirm orders, and must not be marked up or annotated.
• Accept the order but return the check, since only payments are prohibited before the effective date: Orders-allowed trap: binding orders are just as prohibited as payments during the cooling-off period; wording the order around the unknown final price does not cure it.

Verified against: AON escrow feature; red herring pair)

Answer: Only the preliminary prospectus, exactly as filed, may be sent — no highlighting, annotations, or supplemental sales material is permitted before the registration is effective.

While a registration is pending, the only offering document that may circulate is the preliminary prospectus exactly as filed — never highlighted, underlined, annotated, or bundled with the firm's sales material or research touting the issuer. Altering the red herring or attaching promotional pieces effectively creates an unlawful offer under the Securities Act of 1933 and runs headlong into the quiet-period concept that surrounds a new issue. The "fair and balanced" standard from general communications rules is beside the point here: during registration, the problem is sending such material at all, not its tone. Nor does delivering the final prospectus at the time of sale retroactively cure an improper pre-effective communication. And the inverted version has it exactly backwards — the red herring is the one document that may be sent; it is the markups and add-ons that are forbidden.

The Trap: Believing a marked-up red herring or accompanying research is permissible during registration

• The representative may send the research note but not the preliminary prospectus.: Misconception: inversion of the rule — the red herring is precisely the document that may circulate; the add-on sales material is what is prohibited.
• The mailing is acceptable as long as the research note is fair, balanced, and not misleading.: Misconception: general communications standards misapplied — during registration the restriction is on sending promotional/research material at all, not merely on its tone.
• The mailing is acceptable if the final prospectus is delivered when the customer eventually purchases.: Misconception: later delivery of the final prospectus treated as curing an improper pre-effective communication — it does not.

Verified against: quiet-period concept)