Series 4 Study Textbook

How To Understand Supervision Of Sales Activities On The Series 4 Exam
and become a Registered Options Principal

One of the keys to passing the Series 4 exam is to make sure that you have a complete understanding of how supervision of sales activity will be tested on the Series 4 Exam. This article which was produced from material contained in our Series 4 textbook and will help you master the material so that you pass the Series 4 exam. .


Understanding Supervision

A member firm's public customer option business must be supervised by the firm in accordance with the supervision of its overall public customer business. Registered option and security futures principals (ROSFP) designated by the firm's written supervisory procedures may supervise the member firm's option business. The ROSFP is not required to complete the security futures firm element continuing education requirement and being designated as a ROSFP does not permit the ROSFP to supervise the member's security futures business without satisfying the security futures firm element continuing education program.

What are the Duties of the ROSFP?

The registered option and security futures principal or ROSFP's duties mainly focus on the supervision of the member firm's option business. The ROSFP must supervise all of the member firm's option transactions with customers and is additionally responsible for:

  • Developing the firm's written supervisory procedures relating to option business
  • Developing the firm's training program for option business
  • Reviewing discretionary account acceptance by branch managers and other ROSFPs
  • Working with and assisting branch managers in supervising customer accounts

The ROSFP must also design and administer supervision programs to review selected option accounts to ensure proper supervision. The ROSFP may delegate most review and supervision duties to employees (usually ROSFPs) under their direct control but remains responsible for all of the areas of supervision.

TAKE NOTE! - The above duties were previously required to be supervised by the senior registered options principal or SROP. FINRA has eliminated the SROP title and replaced it with the ROSFP. You may however still see SROP used on your Series 4 exam.

Are there Additional Duties of the ROSFP?

The registered option and security future principal is also responsible for ensuring that the member firm's option business complies with all laws and industry regulations relating to option business. The ROSFP must:

  • Establish the firm's record keeping procedures relating to options
  • Review selected option accounts frequently
  • Establish guidelines and requirements for the firm's option advertising
  • Approve all option advertising and sales literature prior to first use
  • Supervise account approval procedures
  • Supervise the creation of account approval forms
  • Develop the firm's option training program
  • Review option discretionary accounts more frequently
  • Supervise the firm's procedures for allocating assignment notices
  • Audit the firm's option compliance program

TAKE NOTE!

The above duties were previously required to be supervised by the compliance registered options principal or CROP. FINRA has eliminated the CROP title and replaced it with the ROSFP. You may however still see CROP used on your Series 4 exam.

What are the keys to Option Account Compliance?

A member firm's option business requires strict supervision from the ROFSP as well as from the firm's branch office mangers. All customer option accounts must be approved in writing by a ROSFP. Not all customers will be approved to trade options and not all customers who are approved to trade options will be approved for more advanced or more risky option strategies. In order to determine if a customer should be approved to open an option account, the registered representative must collect as much financial information from the customer as possible. The registered representative must collect the following information:

  • Full name and address
  • Home and work phone numbers
  • Social security or tax ID number
  • Employer, occupation, and employer's address
  • Net worth and liquid net worth
  • Investment objectives
  • Investment experience
  • Estimated annual income
  • Whether the customer is employed by a bank or broker dealer
  • Marital status

NOTE

If the customer is employed by an NYSE member firm, an exchange or the OCC, the firm opening the account must obtain the employer's written permission for the customer to open the account, and duplicate confirms and statements must be sent to their employer.

Based on the information collected by the agent, the ROSFP must determine if option trading is suitable for the customer. Most customers will be approved to write covered calls against long stock positions. Writing covered calls is considered to be a conservative strategy. Customers must be able to demonstrate additional levels of sophistication and financial liquidity to be approved for:

  • Buying puts and calls
  • Spreads and straddles
  • Writing uncovered options

Only customers who demonstrate the highest levels of sophistication and liquidity will be approved to write uncovered options. If a firm does allow customers to establish uncovered option positions, the firm must have specific written supervisory procedures detailing suitability requirements and minimum net equity requirements for customers. Additionally, the firm must send customers who are approved to establish uncovered option positions a special risk disclosure document relating to uncovered options prior to or at the time the first uncovered option position is established. This risk document details the fact that many uncovered option positions will have the potential for an unlimited loss. If the branch office manager is not a ROSFP, the branch office manager may initially approve the account to trade options so long as a ROSFP also approves the account promptly. Each customer who opens an option account must be given the OCC's risk disclosure document detailing the risks and characteristics of standardized options at or prior to the time the account is approved for option trading. Certain customers will have to provide additional information to document that option trading is allowed. Trusts, corporations, and pension plans will be required to provide additional documents to demonstrate that option trading and, if applicable, margin accounts are permitted. Discretionary accounts will require the customer to sign a limited power of attorney. The limited power of attorney will stay in effect until the customer revokes it or dies. All discretionary option accounts must be approved in writing by two ROSFPs. The approval of the initial ROSFP must be reviewed and approved by a second ROFSP and the account should be reviewed more frequently to ensure against churning. If the agent is going to employ a systematic option program for the discretionary account, the account holder must get a detailed description in writing of the program to be used.

Regardless of the type of account, each option order must be approved on the day that the order is entered. Option orders are not required to be approved prior to being entered by an agent but must be approved promptly by a ROSFP on the day the order is entered. Firms that use electronic or computerized surveillance may review option orders in accordance with their written supervisory procedures.