Chapter 3 — Trading, Accounts & Prohibited Activities

3.1Orders & Trading Strategies

Every trade starts as an instruction, and the exam wants precision about what each instruction actually promises. A market order guarantees execution but not price — it fills immediately at whatever the best available price is. A limit order guarantees price but not execution — it only fills at the specified price or better, and may never fill at all if the market doesn't cooperate. A stop order sits dormant until the market hits a trigger price, at which point it becomes a market order — useful for limiting losses on an existing position.

Who's deciding, and who's on the other side

A discretionary order lets the registered representative choose the security, the amount, or the action without checking with the client first (within limits set by a signed discretionary authorization). A non-discretionary order requires the client's explicit instruction for every element of the trade. Separately, an order is solicited if the rep recommended it, or unsolicited if the client initiated it entirely on their own — a distinction that matters heavily for suitability obligations, since a firm bears more responsibility for trades it actively recommended.

On the firm side, a broker-dealer can act in one of two capacities: as principal, trading from its own inventory (buying from or selling to the customer directly, and typically marking up or down the price instead of charging a commission), or as agent, simply arranging the trade between two other parties and charging a commission for the service.

Position types

Being long means you own the security outright — your maximum loss is capped at what you paid. Being short means you've sold a security you don't own (borrowed to sell, with an obligation to buy it back later) — a bet that the price will fall, but with theoretically unlimited loss potential, since there's no ceiling on how high a price can rise. Bullish describes an expectation that prices will rise; bearish describes an expectation that prices will fall.

3.2Investment Returns

Return isn't one number — it's the sum of several distinct components, and the exam expects you to recognize each piece separately. Interest and dividends are income paid out along the way. Realized gains are profits locked in by an actual sale; unrealized gains are paper profits on something still held — real on paper, but not yet taxable or spendable. Return of capital is a distribution that isn't profit at all — it's simply the investor's own original money being handed back, which is why it isn't taxed as income.

Dividends: cash, stock, and the dates that matter

A cash dividend pays shareholders actual money. A stock dividend pays shareholders in additional shares instead — it doesn't add real value on its own, since the same company value is now split across more shares, but it's a common tool for signaling confidence or increasing share liquidity. Every dividend moves through three key dates in sequence:

Measuring return

Yield to maturity (YTM) and yield to call (YTC) (covered in Chapter 2) express a bond's total return under different holding assumptions. Total return is the broadest measure — it captures income plus price appreciation (or depreciation) over the full holding period, for any security. A basis point is simply 1/100th of one percent (0.01%) — a precise way to express small rate or yield changes without the ambiguity of saying "a small increase."

Cost basis is what an investor originally paid for a security (plus certain adjustments), and it's the number used to calculate a gain or loss when the position is eventually sold — a foundational input for tax reporting. Benchmarks and indices (the S&P 500, the Dow) exist to give a return context: a 6% gain looks very different in a year the benchmark returned 15% versus a year it returned -10%.

3.3Trade Settlement

A trade "happening" (execution) and a trade actually finalizing (settlement) are two different moments in time. Most equity and corporate bond trades today settle on a T+1 basis — one business day after the trade date — meaning ownership and payment officially change hands the next business day, even though the trade itself was agreed today (T).

Settlement also happens in one of two mechanical forms: physical delivery, where an actual paper certificate changes hands (increasingly rare), or book entry, where ownership is simply recorded electronically at a depository like the DTCC — the overwhelming majority of trades today settle this way, since it's faster and eliminates the risk of a lost or stolen certificate.

3.4Corporate Actions

A corporate action is any event, initiated by the issuer, that changes the security itself or investors' relationship to it. The exam cares most about splits, buybacks, and the mechanics of how shareholders get informed and get to vote.

Corporate actions come with formal notices and deadlines — shareholders must be informed in time to act (tendering shares, exercising rights) before a window closes. And shareholders who can't attend a shareholder meeting in person can vote by proxy — assigning their voting rights to someone else (often company management) to cast on their behalf.

3.5Account Types

3.6Account Registrations

Registration describes who legally owns the account, which is a separate question from what kind of trading it permits.

Retirement accounts

Qualified plans (like an employer-sponsored 401(k)) also carry specific rules on contributions and RMDs, generally following the same tax-deferred logic as a traditional IRA while adding employer-specific features like matching contributions.

3.7Anti-Money Laundering (AML)

Money laundering is the process of disguising illegally obtained money to make it appear legitimate. It moves through three classic stages, and the exam expects you to recognize each by name:

Every broker-dealer must maintain a written AML compliance program. Two specific reports drive detection: a Suspicious Activity Report (SAR) is filed confidentially whenever a transaction looks suspicious, regardless of dollar amount; a Currency Transaction Report (CTR) is filed for cash transactions over a specific reporting threshold, suspicious or not. FinCEN is the Treasury bureau that collects and analyzes this reporting. The Office of Foreign Asset Control (OFAC) maintains the Specially Designated Nationals (SDN) list — firms must screen customers against it and are prohibited from doing business with anyone on it.

3.8Books, Records & Privacy

Firms must retain specific records for specific periods — confirmations of every trade, periodic account statements, and correspondence — creating the audit trail regulators rely on. A business continuity plan (BCP) is a firm's documented plan for staying operational (or recovering quickly) through a disruption like a natural disaster or system outage. Firms may hold customer mail only under specific conditions (such as the customer traveling), and must safeguard customer assets under strict custody rules.

Regulation S-P governs how firms handle nonpublic personal information (NPI) — a customer's financial and personal details. It requires firms to keep that information confidential, provide customers with privacy notifications explaining what's collected and how it's used, and maintain safeguards (technical and procedural) to prevent unauthorized access.

3.9Communications & Suitability

Communications with the public are classified by audience and reach, with different levels of review required depending on how broadly a message is sent. Telemarketing carries its own layer of restriction, including honoring a customer's placement on the firm's or the national do-not-call list.

Know-Your-Customer and suitability

Know-your-customer (KYC) is the foundational obligation to actually understand who you're dealing with — their financial situation, objectives, and risk tolerance — before recommending anything. Suitability obligations then build on that foundation in three layers: reasonable-basis suitability asks whether a recommendation is suitable for at least some investors, based on reasonable diligence into the product itself; customer-specific suitability asks whether it's suitable for this particular customer, given what KYC revealed; and quantitative suitability asks whether the volume and frequency of recommended trades, taken together, are excessive for the customer's profile — even if each individual trade looked fine in isolation.

What counts as a recommendation in the first place matters too — a general market commentary isn't the same as a specific call to buy or sell a particular security, and the suitability obligation attaches specifically to the latter.

3.10Market Manipulation

Market manipulation is any deliberate attempt to interfere with the free and fair operation of the market — artificially inflating, deflating, or maintaining a security's price rather than letting genuine supply and demand set it. The SIE tests a specific glossary of named manipulative practices:

3.11Insider Trading

Insider trading is trading a security based on material nonpublic information (MNPI) — information significant enough that a reasonable investor would consider it in making a decision, and that hasn't yet been released to the public. It's not limited to corporate executives: anyone who receives and trades on MNPI can be liable, including someone who simply passed the tip along (a "tipper") and the person who acted on it (the "tippee").

Penalties are severe and layered — they can include steep fines (often a multiple of the profit gained or loss avoided), permanent expulsion from the industry, and criminal incarceration. This is one of the areas where the exam expects you to understand that ignorance of a tip's origin doesn't automatically excuse trading on it, if the circumstances made it reasonably clear the information wasn't public.

3.12Other Prohibited Activities