Examkin

Question

Difficulty: MediumProhibited Market Manipulation and Fraudulent Practices

An investor opening a cash account purchases 500 shares of a corporate stock. Prior to paying for the purchase by the settlement deadline, the investor sells the stock at a profit and attempts to use the sales proceeds to pay for the initial purchase. Which of the following statements correctly describes this activity and its regulatory consequences under Federal Reserve rules?

  1. This practice constitutes prohibited freeriding, and the broker-dealer must freeze the customer's account for 90 days, requiring cash upfront for future purchases.Answer
  2. B
    This practice constitutes wash trading because the purchase and sale of the stock occurred within the same trading window without a net change in cash investment.
  3. C
    This practice is permissible as long as the broker-dealer executed the transaction as a principal from inventory rather than acting as an agent.
  4. D
    This practice is enforced solely by self-regulatory organizations (SROs) like FINRA, as the SEC lacks statutory authority over Regulation T settlement violations.

Answer

This practice constitutes prohibited freeriding, and the broker-dealer must freeze the customer's account for 90 days, requiring cash upfront for future purchases.
Freeriding occurs when an investor purchases a security in a cash account and subsequently sells that security before depositing sufficient funds to pay for the initial purchase. Under Federal Reserve Board Regulation T, if freeriding takes place, the broker-dealer is required to freeze the customer's account for 90 days. During this restriction period, the customer may still trade, but must have full cash deposited in the account before any buy orders can be executed.

Step-by-Step Solution

1
Identify the trading activity performed by the customer.
The customer bought securities in a cash account and sold them before paying for the purchase.
Under Regulation T, customers must pay for securities bought in a cash account by settlement.
2
Determine the prohibited practice category.
Buying and selling securities without paying for the original purchase is defined as freeriding.
The customer is using the proceeds of the sale to cover the cost of the purchase, which is prohibited.
3
Apply the regulatory consequence required by Regulation T.
The broker-dealer must place a 90-day freeze on the customer's account.
During the 90-day freeze, the customer must deposit full cash before any buy order can be executed.

Key Concept

Freeriding Prohibition and Regulation T 90-Day Account Freeze
Estimated Time:1m 0s
Rate this question

Topics

Prohibited Market Manipulation and Fraudulent Practices