Unit 7

T or F Advisers with discretion of customer assets have a higher net worth requirement than advisers with custody authority?

False

13f Securities (big name securities)

$100m or more in discretion, 45 days after the end of each quarter

FinCEN Form 112

$10k

The requirement for reports of beneficial ownership is that anyone who becomes the owner of more than 5% of a security registered under the Securities Exchange Act of 1934 must file a report within

10 days

Matched Orders

2 accounts with different broker dealers

Which of the following practices is fraudulent? A) Marking up a security by 5%, but indicating to the client that the markup is only 2% B) Selling a security to a customer with a commission that exceeds industry standards C) Marking up a security by 10% more than industry standards with the customer's knowledge and consent D) Failing to state all the facts related to a security

A. Fraud is the willful deception of a client. Stating that the markup will be 2% and then effecting a 5% markup is a fraudulent act. Marking up a security by more than industry practices is a prohibited practice but is not necessarily fraudulent. It is not necessary to state all the facts; only those that are material are required. U7LO5

Discretion- 3As

Asset, Amount, Action

A business continuity plan should be designed to provide an investment advisory firm with policies to be followed in the event of any of the following EXCEPT A) a terrorist attack that leads to a lockdown and prevents the principal office from opening B) embezzlement by the firm's CFO C) an overload at the local public utility that causes a lack of power at the firm's principal office for at least 2 days D) a disruption caused by a tornado striking the firm's principal office

B. Although embezzlement is certainly not pleasant for the firm, it is not something that would normally lead to an interruption in the ability of the firm to service its clients. U7LO8

If having discretion over $100 million or more in 13(f) securities, which of the following would be exempt from filing a Form 13F? A) A natural person who exercises investment discretion over the account of any other natural person or entity B) A natural person who exercises investment discretion over her own account C) An investment adviser that manages mutual fund assets D) A trustee

B. An institutional investment manager is also a natural person or an entity that exercises investment discretion over the account of any other natural person or entity. For example, an investment adviser that manages private accounts, mutual fund assets, or pension plan assets is an institutional investment manager; so is the trust department of a bank. A trustee is an institutional investment manager, but a natural person who exercises investment discretion over her own account is not an institutional investment manager. U7LO6

One of the most prevalent schemes abusing seniors is one where the individual or couple receives an invitation to attend an educational seminar held at an upscale location. This scheme is commonly referred to as

Free Lunch Seminar - There is probably no other area of abuse directed at seniors that has received the attention of the "free lunch" seminars. The problem is that too many of them graduate from a few minutes of education into a hard sell without the attendees being warned. U7LO4

Which of the following statements are TRUE of a discretionary account at a broker-dealer? It must be approved by a designated supervisory individual of the firm. It must be reviewed frequently to minimize the chances that the account has been churned. A discretionary order may be placed once the customer has placed a power of attorney in the mail. It must be approved by the Administrator of the state of residence of the client. A) I and III B) II and IV C) I and II D) III and IV

C. A new discretionary account must first be approved by a designated supervisory person, and the account must be reviewed frequently for suitability and avoidance of churning. The written discretionary power must be "in hand," not in the mail, before discretion may commence. U7LO2

A federal covered investment adviser may enter into a contract with a client that provides for performance-based compensation under all of the following conditions EXCEPT A) the client must meet certain minimum financial standards B) compensation is based on gains, less losses, for a period of no less than 1 year C) disclosure that the performance compensation may create an incentive for the adviser to take greater risks D) the formula used to calculate compensation includes realized capital losses and unrealized depreciation Explanation

C. Because these types of compensation agreements may only be entered into with clients meeting minimum financial standards, the SEC assumes that clients understand the increased risks they are being exposed to. The minimum net worth requirement is over $2.1 million, or a client is qualified if he has at least $1 million under management with the adviser. Any performance fee must take into consideration gains and losses, both realized and unrealized, and the performance period must be no less than 1 year. Please note: State-registered investment advisers must make this "incentive" disclosure so if the question asked about them, there would be no exception. U7LO1

All of the following industry violations would probably constitute fraud EXCEPT A) inaccurate market quotations B) misrepresentation of the status of a client's account C) charging unreasonable commissions D) omitting material facts in the offer/sale of securities

C. Charging an unreasonable commission (or markup or markdown) is a prohibited practice, but it is not considered fraud. It would be fraudulent to make inaccurate statements regarding the amount of commission being charged, such as, when acting as a principal, telling the customer that there was no commission being charged when, in fact, there is a markup or markdown built into the price. U7LO5

Why does matched trading result in painting the tape? A) Matched orders will appear on the OTC Link. B) Matched orders generally result in meaningful profits for such traders. C) The phony trades make the stock appear more frequently on stock tickers. D) Matched orders are generally executed outside of normal trading hours.

C. Entered for the purpose of (1) creating a false or misleading appearance of active trading in any publicly traded security or (2) creating a false or misleading appearance with respect to the market for any such security. U7LO5

Regulation SP

Customers have ongoing relationship, Consumers have initial contact and then no more.

The Securities Exchange Act of 1934 requires written authority for a discretionary account, unless the securities professional's discretionary authority is limited to determining the price of the stock the amount of the stock the time of the order

D. The securities professional's ability to determine the time or price at which a specific customer order will be executed does not constitute discretionary power and, therefore, does not require written authorization. U7LO2

Pay to Play (Political)

If you can vote $350/if you can't vote $150, 2 years, 6 months, $350 max, returned within 60 days

How often does institutional investment managers file reports (13F) if they exercise discretion over accounts valued at $100 million or more of 13(f) securities?

Quarterly

Wash Trades

Single person selling back and forth in same account

T or F Advisers with custody of customer assets have a higher net worth requirement than advisers with discretionary authority?

True

Form ADV-E

Used as the cover page for the annual surprise audit performed by the independent accountant on all IAs who maintain custody of customer assets. U7LO2

James Jones, quarterback for a National Football League franchise team, deliberately misstated material information in the private sale of securities he owned. Jones claims he is not subject to the antifraud provisions of the Uniform Securities Act because he is not a registered agent and, secondly, the securities involved are exempt from registration requirements of the act. Which of the following statements is TRUE? A) Jones's failure to accurately state material facts does not constitute fraud because the securities he sold were exempt from registration. B) The antifraud provisions of the USA apply to any person who acts fraudulently in connection with the offer, sale, or purchase of a security. C) The antifraud provisions of the USA do not apply to Jones because he is not suitably trained nor does he have a securities license. D) As a professional athlete, Jones is not in the securities business and is therefore not subject to the antifraud provisions of the act.

B. The antifraud provisions of the USA apply to any person who acts fraudulently in connection with the offer, sale, or purchase of a security, even in the case of an isolated nonissuer transaction like this. While Jones, as a private individual, is not subject to the registration provisions of the act, he is liable for fraud when selling securities, whether registered or not. The fact that Jones is not trained in the securities business does not exempt him from the prohibition against fraud when engaged in the sale of securities. U7LO5

In which of the following situations is an agent committing a prohibited practice? A) Buying a security on one exchange and simultaneously selling it on another to take advantage of a price disparity B) Using discretion to purchase a security in a discretionary account while awaiting written receipt of trading authority C) Allowing the customer to place an order to sell 100 shares of ABC in the client's discretionary account D) Buying a security on behalf of a customer and then reselling it before the customer has paid for it

B. Written receipt of trading authority is required before conducting any trade on a discretionary basis. Oral authorization is not sufficient; it must be in writing. It is not a prohibited practice to sell a security before the customer has paid for it (day trading), and arbitrage (buying securities on one exchange and selling them on another to take advantage of temporary price differences) is also an acceptable practice. Although the agent may have trading authority in a discretionary account, nothing prohibits the client from making his own trades.

Your friend is a licensed life insurance agent whose client wants to purchase a variable annuity. You are a licensed securities and insurance agent, and your friend wants you to sell the policy and split commissions with him. Splitting commissions A) is an unethical trade practice B) in variable annuities is allowable only if the agents involved are both licensed to sell life insurance and maintain their securities licenses at the same or affiliated broker-dealers C) would be allowable if the securities representative receives at least 60% of the commission and the insurance agent receives no more than 40% D) in variable annuities is allowable only if the agents involved are both licensed to sell life insurance and maintain securities licenses with broker-dealers registered with the Administrator

B. You must be licensed in both insurance and securities to sell variable annuities or to split commissions. Commissions on securities transactions may only be split with registered agents of the same or affiliated broker-dealers. U7LO4

An adviser has custody of a client's securities or funds if the adviser A) accepts prepayment of advisory fees or has discretion over a customer's account B) uses a broker-dealer to hold the customer's funds and securities and has limited trading authority over the account C) has authority to withdraw funds from a client's account for the benefit of the adviser for the payment of the quarterly advisory fees D) maintains the customer's funds and securities in a joint account with the registered investment adviser

C. Custody is the physical possession of the asset. Discretion is the authority to make decisions independent of the authorization of the account holder on a trade-by-trade basis. Authorization is in a blanket form in the existence of either a limited trading authority or full trading authority. Acceptance of prepayment of adviser's fees or discretionary authority does not constitute custody. The ability to withdraw funds for the purpose of paying quarterly advisory fees from a customer's accounts is deemed to be custody of the funds. A broker-dealer holding a customer's funds and securities would have custody, but the adviser who has trading authority over the account would only have discretion. If the funds and securities of the client are held with the funds and securities of the adviser in a joint account, the adviser would be involved in commingling (or theft), not custody.

An investment adviser wishes to engage the services of a third party to solicit new clients for the firm. To be in compliance with the Investment Advisers Act of 1940, the solicitor must be registered as an IAR compensation may not be sales related the solicitor must not be subject to statutory disqualification disclosure of the solicitation arrangement must be made to clients upon request A) II and IV B) I and IV C) II and III D) I and III

C. Third-party solicitors are not required to be registered as IARs and therefore may not receive sales-related compensation. However, they must not be subject to statutory disqualification that would prevent them from becoming registered. Disclosure is necessary, whether or not it is requested. U7LO1

Sally is an agent with a broker-dealer. She has used her degree in computer science to develop her own stock-picking software program. Backtesting has shown that the program is likely to produce returns that beat the overall market. As a result, Sally plans to use this program for each of her clients. Sally A) must make the details of how the program works available to all who request it B) is engaging in an unethical business practice C) is going to make her clients very happy D) is violating suitability requirements

D.

Under the NASAA Model Custody Rule, an investment adviser would be considered to have custody of client assets if that adviser inadvertently receives a check from a client made out to the IA and does not return the check within 24 hours a check from a client made out to a third party and does not forward the check within 3 business days stock certificates from a client and does not forward them within 3 business days stock certificates from a client and does not return them within 3 business days A) I and IV B) I, II and IV C) II and III D) II and IV

D. 2 & 4 Checks made out to a third party must be forwarded to that party within 3 business days of receipt or the IA will be considered to be maintaining custody. In the case of certificates or checks made out to the IA, return must be made within 3 business days of receipt in order to avoid custody issues; they are never forwarded. U7LO2

Under the Uniform Securities Act, which of the following investment advisers would be required to include a balance sheet in their brochures? An adviser who exercises discretion in client accounts An adviser who maintains custody over client funds and securities An adviser who maintains less than $35,000 in net worth An adviser who, 6 or more months in advance, collects prepaid fees of more than $500 A) I and II B) I and IV C) II and III D) II and IV

D. 2 & 4 The Uniform Securities Act requires that a balance sheet accompany an adviser's brochure when the adviser maintains custody of client assets or accepts substantial prepayments of fees. U7LO2

Which of the following statements regarding an agent's authority to place orders for a client's account under NASAA's Statement of Policy on Unethical or Dishonest Business Practices of Broker-Dealers and Agents is TRUE? A) The agent may, without the client's approval, place a sell order for the purpose of avoiding losses but may not place a buy order without the client's authorization. B) The agent is not required to obtain authorization to place orders for a client's account unless a conflict of interest is involved. C) Written approval from the client authorizing a stated amount of a specified security is required before placing an order. D) The client's oral approval is sufficient for a specific order.

D. Oral approval from the client authorizing a stated amount of a specified security is sufficient to place an order. An agent must receive authority to place orders for a client whether or not there is a conflict of interest. Written approval from the client authorizing a stated amount of a specified security is not required before placing the order. However, written authority is necessary for the agent to exercise discretion in the account. U7LO2

Under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, which of the following is an acceptable third-party trading authority? A) John tells his investment adviser that he has full confidence in his wife's ability to manage his money. Later, she calls the adviser to place an order for him. B) George tells his accountant that he has authority to trade for him. The accountant then calls the investment adviser for an order. C) Frank orally declares to his investment adviser that his lawyer has full authority to trade on his account. Later, the lawyer calls to place an order on Frank's behalf and properly identifies himself to the investment adviser. D) Phil sends his investment adviser written notice that his attorney has authority to execute trades on his behalf. Later, his lawyer places an order on Phil's account.

D. Placing an order for a client on the instructions of a third party is called third-party trading authority. In order to place an order for the client's account on the instruction of a third party, prior written authority must be obtained by the adviser from the client. Placing a third-party order without written authorization would not only be unethical conduct, the adviser would also incur civil liability to the client for any losses incurred. An investment adviser may not even accept orders from a client's spouse without written authorization. Only Phil's procedure was correct because he did provide written authorization for his lawyer to execute trades on his behalf. U7LO2

Under the Uniform Securities Act, it is NOT considered fraudulent if an agent A) omitted a material fact because she knew she did not have time to cover everything in a short presentation B) made an untrue statement of a material fact C) deliberately failed to follow a customer's instructions D) actively solicited orders in unregistered exempt securities

D. Securities that do not require registration under the USA are exempt securities. Although the securities are exempt from registration, thereby making the solicitation permitted, the agent who makes the solicitation and the broker-dealer must be registered. An agent may not make an untrue statement of a material fact, omit a material fact, or deliberately fail to follow a customer's instructions.