Module 2: Opening Accounts After Evaluating Customer Profiles

• Topic 01

  Account Types and Ownership

  143 questions
• Topic 02

  Customer Profile and Suitability

  141 questions
• Topic 03

  Account Documentation and Supervision

  126 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. A broker-dealer's registered representative recommends a high-yield bond to a large insurance company with $500 million in assets. Which regulatory standard governs this recommendation?

   • A
     No suitability standard applies because large institutional investors are presumed to be sophisticated and exempt from all suitability rules
   • B
     FINRA Rule 2111 (suitability), because the insurance company is an institutional customer, not a retail customer, and Reg BI applies only to retail customers
     Correct answer
   • C
     Regulation Best Interest, because Reg BI applies to all securities recommendations regardless of customer type
   • D
     FINRA Rule 2210, because the recommendation was made in writing and is classified as retail communication
   Explanation

   An insurance company with $500 million in assets qualifies as an institutional investor under FINRA's rules. Regulation Best Interest applies exclusively to recommendations made to retail customers — individuals who receive recommendations for personal, family, or household purposes. For institutional customers, FINRA Rule 2111 (suitability) governs the recommendation. The three-part analysis under Rule 2111 (reasonable basis, customer-specific, quantitative suitability) applies.

2. What is the Compliance Obligation under Regulation Best Interest, and what written policies does it require?

   • A
     The Compliance Obligation requires broker-dealers to file Form CRS with FINRA within 30 days of any material change to their business practices.
   • B
     The Compliance Obligation requires broker-dealers to test their compliance programs annually using independent third-party auditors.
   • C
     The Compliance Obligation requires broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with all of Reg BI's requirements, including the Care, Disclosure, and Conflict of Interest Obligations.
     Correct answer
   • D
     The Compliance Obligation only applies to firms with more than 500 retail customers; smaller firms are exempt from the written policy requirement.
   Explanation

   The Compliance Obligation is the overarching procedural requirement under Reg BI. It mandates that broker-dealers create, maintain, and enforce written policies and procedures designed to ensure compliance with all Reg BI obligations. These written policies must address how the firm will satisfy the Care, Disclosure, and Conflict of Interest Obligations in practice, making Reg BI compliance part of the firm's written supervisory framework.

3. A customer's profile shows moderate risk tolerance and a 10-year time horizon. Which asset allocation is generally most consistent with these parameters?

   • A
     A 100% equity allocation is most consistent because a 10-year time horizon supports maximum equity exposure regardless of risk tolerance.
   • B
     A 100% fixed-income allocation is most consistent because moderate risk tolerance means the customer cannot accept any equity market risk.
   • C
     A balanced allocation with a moderate equity-to-fixed-income ratio (e.g., 60% equities / 40% fixed income) is generally most consistent with moderate risk tolerance and a 10-year time horizon.
     Correct answer
   • D
     A 50% speculative and 50% growth allocation is most consistent because the 10-year time horizon supports aggressive investment strategies.
   Explanation

   A customer with moderate risk tolerance (willing and able to accept some but not excessive loss) and a 10-year time horizon generally warrants a balanced portfolio. The classic 60% equities / 40% fixed-income allocation is commonly associated with moderate risk tolerance and medium-to-long time horizons. The equity portion provides growth potential over the 10-year period, while the fixed-income portion provides stability and income. This is a commonly tested concept on the Series 7 exam.