Chapter 4 Practice Questions
Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, an agent may not use the term "no-load" to describe a mutual fund if A) it does not offer breakpoints B) the minimum initial investment is $10,000 C) it has a 12b-1 charge in excess of .25% D) it has service fees in excess of .10%
Any mutual fund with a 12b-1 charge or service fee in excess of .25% cannot use the term, "no-load".
An investment adviser structured as a partnership lends money to a customer to buy recommended securities. Under NASAA's Model Rule dealing with Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, this activity is A) unethical B) acceptable, provided the loan is made under the provisions of Regulation T of the Federal Reserve C) acceptable, provided the securities are used as collateral for the loan D) acceptable, provided the securities are used as collateral for the loan and the loan conforms to the provisions of Regulation T
A) An investment adviser cannot lend money to a customer unless the loan is made through a regulated lender such as an affiliated broker-dealer or an affiliated bank.
With regard to the Uniform Securities Act, which of the following statements regarding the omission of a material fact by an agent is NOT true? A) It is not a violation if the security is exempt from registration under the Uniform Securities Act. B) It is a violation even if material facts were unknowingly omitted. C) It is a violation even if the client failed to make a transaction. D) It is a violation because it is a unethical or fraudulent practice.
A) Deliberate omission of material facts is a fraudulent practice under the Uniform Securities Act, whether securities are exempt or nonexempt or even if the transaction was exempt. If done unknowingly, then it is a unethical business practice (fraud requires deliberate action) and is still a violation.
Under the Uniform Securities Act, all of the following must be disclosed in an investment advisory contract EXCEPT A) other states in which the adviser is registered B) a provision prohibiting the adviser to assign the contract without client consent C) a provision prohibiting the adviser from being compensated based on a share of capital gains D) the manner in which the advisory fee will be computed
A) There is no requirement to advise clients of any other states in which the adviser is represented. Assignment may never occur without client consent. Unless the question specifically refers to the rare cases when performance fees are permitted, always read the question as if they are prohibited.
An investment adviser would be exempt from registration under the Uniform Securities Act if it had no place of business in this state and its only clients were banks insurance companies registered investment companies other investment advisers A) III and IV B) I and II C) I, II, III and IV D) I, II and III
As long as the investment adviser does not maintain a presence in this state and its only clients are broker-dealers, other investment advisers, or institutional clients, it is exempt from registration in this state.
According to the Uniform Securities Act, all of the following are violations of suitability requirements EXCEPT failing to A) determine the customer's ability to assume risk B) know the terms and conditions of the customer's will C) make reasonable inquiry of the customer's security holdings D) identify customer objectives
B) Failure to identify objectives or to obtain corresponding financial information is considered contrary to the know-your-customer rule. Agents should ask if the customer has a will but failing to do so is not a violation of suitability requirements.
Which of the following firms would be a federal covered adviser? A) DEF Fund Managers, a corporation managing an unregistered hedge fund with $20 million in assets B) ABC Money Managers, a partnership with $112 million under management C) GHI Consultants, a sole proprietorship managing $15 million belonging to high net worth individuals D) XYZ Broker-Dealer with custody over $50 million of clients' invested assets
B) The structure of the adviser is irrelevant; if assets under management equal $110 million or more, SEC registration is required. If the investment company is registered under the Investment Company Act of 1940, the adviser must be registered regardless of size. The hedge fund is an unregistered fund, so the rule does not apply. A broker-dealer is excluded from the definition of investment adviser if investment advice is incidental to its business. Custody has nothing to do with giving advice.
An investment adviser maintains custody of customer's funds and securities. In order to comply with the Uniform Securities Act, the adviser must, at least quarterly, send written notice to each custodial client stating the location of the assets under custody changes to the location of the assets under custody amount of prepaid fee to be refunded upon early termination of the contract value of the assets under custody A) II and III B) I and II C) I and IV D) III and IV
C) Under both state and federal law, investment advisers maintaining custody of customers' funds and securities must notify their clients no less frequently than quarterly of the location of the assets and their value. If there should be a change to their location, it must be communicated promptly.
According to the Uniform Securities Act, market manipulation includes all of the following EXCEPT A) pegging B) giving a false quote C) buying and selling intentionally to show market activity D) buying on one exchange and selling on another
D) Buying on one exchange and selling on another is called arbitrage, not market manipulation, and it is an accepted business practice.
An individual is an agent for a broker-dealer. He takes and passes the appropriate examinations and forms a sole proprietorship investment adviser. Some time later, he terminates his registration with the broker-dealer. This action would require A) qualifying by re-examination B) terminating the IA registration C) amending the Form ADV D) affiliating with another broker-dealer within 30 days
On the Form ADV, Part 1A, the IA indicated that he was also an agent for a BD. Since that is no longer the case, the ADV must be promptly amended.
Foster Advisers operates as an investment adviser that is registered in a state where the Administrator, by rule, prohibits investment advisers from holding custody of client funds and securities. This means that Foster Advisers may not have physical custody over its clients' monies and certificates manage client accounts on a discretionary basis examine customers' stock certificates A) II only B) III only C) I only
Under the Uniform Securities Act, custody indicates that the adviser has physical possession over its clients' certificates and monies. A prohibition against custody in a given state does not prohibit the adviser from holding investment discretion over clients' accounts, provided such discretion is granted under a suitable authorization or power of attorney. Merely examining customers' stock certificates is certainly not the same as holding custody or possession of such certificates.
The NASAA Model Rule on Agency Cross Transactions requires that an investment adviser relying on the rule send a written disclosure document to affected clients including the total number of agency cross transactions during the period for the client since the date of the last such statement or summary as well as the total amount of all commissions or other remuneration the investment adviser received or will receive in connection with agency cross transactions for the client during the period no less frequently than A) semiannually B) quarterly C) within a reasonable period of time following any transaction made in reliance upon this rule D) annually
When an investment adviser is going to be performing agency cross transactions, these disclosures must be made as least annually.
Insider trading info
Whenever an agent has concerns about matters involving the broker-dealer's customers, such concerns should be shared with the agent's supervising principal. It is appropriate that the agent stop recommending XYZ stock to customers and prospects.
An investment adviser is preparing an advertisement. Which of the following would be acceptable? 1. An endorsement on radio or TV from a celebrity who is a client of the firm 2. Identifying his best investment recommendations for the past 6 months 3. Offering to provide his investment recommendations for the past 12 months 4. Promoting his system of charts and formulas while mentioning their limitations and difficulties
3,4. Any mention of investment recommendations in any adviser advertisement must always include all recommendations (not just good ones) made over the course of the last 12 months. If the adviser uses charts or formulas, any mention of them must always include a statement to the effect that they have limitations and may be difficult to use. No outside endorsements are ever allowable on the exam
Which of the following are prohibited practices? An investment advisory firm organized as a partnership failed to inform its clients of the departure of a partner with a very small interest in the partnership An investment advisory firm charges an annual fee equal to 2% of the first $250,000 in assets under management; 1% of the next $500,000; and .5% for everything in excess of $750,000 Without client consent, the majority stockholder of a registered investment adviser pledges his stock as collateral for a loan taken out by the firm to expand its services Engaging in agency cross transactions A) I and III B) I and IV C) III and IV D) I and II
A) Any change in the ownership of an investment advisory firm organized as a partnership, no matter how small, requires notification to all clients within a reasonable amount of time. If the firm is structured as a corporation, the pledging of a controlling interest in the company's stock is viewed as an assignment of the contracts. This may not occur without the approval of the clients. Agency cross transactions, where the adviser represents both sides of the trade, are permitted as long as the adviser makes the proper written disclosures and does not make the buy/sell recommendations to both parties.
An agent lives in Montana and is registered in Montana and Idaho. His broker-dealer is registered in every state west of the Mississippi River. The agent's client, who lives in Montana, decides to enroll in a 1-year resident MBA program in Philadelphia, Pennsylvania. During the 1-year period, when the client is in Philadelphia, the agent may A) conduct business with the client as usual B) not conduct any business with the client C) only accept unsolicited orders D) not deal with the client until the broker-dealer registers in Pennsylvania
A) Even though the college program is referred to as a resident program, that does not mean that the client has changed his state of residence. Although neither the firm nor the agent is registered in Pennsylvania, the agent may continue to conduct business with the client. This is because both the agent and his firm are properly registered in the client's state of permanent residence.
In which of the following situations did an agent commit fraud? A) An agent knowingly sold a nonexempt, nonregistered security to a retail client who could well afford the risk involved. B) An agent sold an excellent growth company to a client by omitting immaterial information during the discussion, so as not to distract the client from purchasing a suitable security. C) A client claims an agent sold him unsuitable securities. D) On review of his files, an agent discovered he had sold a nonexempt, unregistered security to a retail client.
A) Fraud requires the intent to deceive. The agent knowingly deceived the client by selling unregistered securities, therefore committing a securities fraud. An agent is not required to discuss all information, only that which is material information. The term retail client refers to individual or non-institutional clients.
If a licensed agent believed that interest rates were about to fall and contacts all of her clients and suggests they purchase high quality debt securities with long-term maturities, this action A) has probably violated the Uniform Securities Act's suitability standards B) may be acting on material inside information C) is probably not in violation of any suitability standards as long as the bonds are of high quality D) is in error as a drop in interest rates will cause bond prices to fall, leading to a loss in the client's accounts
A) If interest rates fall as the agent guesses, debt securities with long-term maturities will increase in price. However, the agent is at fault for making the same recommendation to all of her clients, as the same product cannot be suitable for everyone. This may be referred to as a blanket recommendation on the exam. Even U.S. Treasury bonds, with the highest degree of safety available, are not always suitable based upon the specific objectives of the investor.
An individual who has applied for registration as an investment adviser representative has just passed the Series 66 exam. This individual may begin soliciting advisory clients A) when informed by the investment adviser that the representative's registration is effective B) when informed by the administrator that the representative's registration is effective C) immediately D) within 48 hours
A) Passing the Series 66 exam is one of the ways to fulfill NASAA's testing requirement for IARs, but it does not automatically give one an effective investment adviser representative's license. Notice is received by the investment adviser from the appropriate state and/or federal authorities and then, in accordance with that firm's procedures, advisory activity may start. The Administrator does not have direct contact with the individual. The same applies to agents passing the Series 63 exam.
Under the Uniform Securities Act, which of the following are prohibited actions of an investment adviser? Agency cross transactions Selling securities as a principal to an advisory client without receiving consent of the client prior to the settlement date Charging a performance fee to an elderly client whose net worth is only $2 million, with $150,000 of that under the adviser's management The owner of a majority of the stock of the advisory firm pledges that stock to a bank as collateral for a loan. No notice is sent to clients as this is an operating decision, not one dealing with investment advice A) II and IV B) I and IV C) III and IV D) I and III
A) The USA prohibits an investment adviser from acting as principal or agent in a transaction with an advisory client without approval prior to completion (settlement) of the trade. Assignment of a majority interest in the company's stock is considered to be the same as assignment of client contracts; an action that may not be done without client acceptance. There is nothing wrong with agency cross transactions as long as disclosure is made and the trade is recommended to only one of the parties by the adviser. Performance fees may be charged, regardless of the client's age, to anyone with a net worth of at least $2 million or with at least $1 million under management with the firm.
Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, requirements of advisory contracts include which of the following? They must be renewed on an annual basis. They must describe the amount of any prepaid fee that will be returned to the client in the event the contract is terminated. They must prohibit assignment of the contract without the client's consent. A) II and III B) I, II and III C) I and III D) I and II
A) There is no requirement that advisory contracts be renewed on an annual basis. Contracts can be written for any length agreed upon. Advisory contracts must describe the amount of any prepaid fee that will be returned to the client if the contract is terminated and must prohibit assignment without the client's consent.
Bryan, an agent registered with a broker-dealer, buys 1,000 shares of XYZ Corp. in his own account. In recommending XYZ Corp. to his customers, Bryan informs them that he believes in the company so much that he put his own money in the stock. This practice is A) not an unethical sales practice B) an illegitimate sales tactic C) only problematic if Bryan sells his shares after informing the other investors D) only problematic if investors lose money in the investment
A) This practice is ethical providing it is accurate and not employed in a coercive manner. It would be expected that when Bryan decides to sell his position, he would not do so prior to notifying his clients with a position in that stock. Otherwise, this would be an ethical problem.
Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, in which of the following circumstances may an investment adviser representative share in profits and losses in a customer's account? A) Such sharing is never permissible under the Policy B) If the advisory fee of the investment adviser is reduced by the share of the profits earned C) If the investment adviser representative and the customer have a written contract D) If the client and the IAR's supervisor give permission and if the sharing is done in proportion to the amounts each part has invested
A) Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, investment advisers and their representatives are prohibited from sharing in the gains and losses in a customer's account. Conversely, an agent may share with a customer in a joint account with permission of the client and the broker-dealer. Unlike FINRA rules, there is no requirement that the agent have a financial interest in the account.
Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, which of the following statements regarding the distribution of reports prepared by 3rd parties that are not affiliated with the adviser is TRUE? A) An adviser is required to disclose any source of information used in making recommendations to clients. B) An adviser may use a report prepared by someone else if the source of the report is disclosed. C) An adviser need not disclose the author of any outside 3rd party report unless the client asks. D) An adviser is prohibited from basing recommendations on work that is wholly the product of someone else's efforts.
B) An adviser is not prohibited from providing clients with reports prepared by others, but when this is done, the adviser must disclose the true source of the report. However, the disclosure requirement does not apply to the research an adviser uses in rendering investment advice.
The Uniform Securities Act requires which of the following to be registered as agents of a broker-dealer? A major partner in a broker-dealer who actively manages the firm's day-to-day operations A partner who has contributed most of the capital of the firm but takes no part in its activities A broker-dealer employee whose major function is to take orders from the public on behalf of the firm's partners An employee of a broker-dealer who only trades securities for the broker-dealer's account A) II and IV B) I, II, III and IV C) I, III and IV D) I and II
C) Employees who take orders from the public on behalf of the partners of broker-dealers and who trade securities for the accounts of broker-dealers must register as agents. The USA requires any person who represents a broker-dealer in effecting securities transactions to register as an agent of their employing broker-dealer.
According to the Uniform Securities Act, which of the following must be registered as an investment adviser representative? John, who opens an investment advisory firm where he devotes his time exclusively to management responsibilities as the sole proprietor of the firm Paul, who works for a firm soliciting investment management accounts on behalf of several different investment managers Margaret, who works as a registered agent for a broker-dealer Mark, an employee of AAA Broker-Dealers, who solicits brokerage clients for commissions on the basis of research conducted by his firm's securities analyst A) II and III B) II and IV C) I and II D) I and IV
C) Paul, who works for a firm soliciting investment management accounts for several investment managers, must register as an investment adviser representative because he is acting in the capacity of a sales agent for investment advisers. John, as the owner, will be automatically registered as an investment adviser representative when his advisory firm registered as an investment adviser. Margaret need not register as an investment adviser representative because she functions as a registered agent for a broker-dealer. If she sold investment advice for the broker-dealer's investment management subsidiary, she then would have to register as an investment adviser representative. An agent of a broker-dealer, earning commissions on security sales, is not an IAR even if his primary selling tool for the brokerage business is the firm's outstanding research department.
An investment adviser representative lends $10,000 to her brother-in-law who is also an IAR with the firm. He signs an agreement to pay her back in 5 years at below market interest. This arrangement is A) acceptable if any profits and losses in the customer's account are shared in proportion to each party's financial contribution and with the firm's prior permission B) unacceptable as the interest rate is too low C) acceptable because she made the loan to a fellow employee of the firm D) acceptable because the client is considered an immediate family member
C) The April 18, 2004, NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers permits IAs or their IARs to lend money to associated persons with the same firm.
A broker-dealer is running a sales contest offering a bonus to any agent who sells a specified amount of a money market mutual fund. An agent is only a few sales short of reaching the target. Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, it would be prohibited for the agent to A) contact existing clients and suggest that they refer family members who might open accounts B) participate in this contest C) ask the members of his golf foursome to purchase fund shares to help him reach the goal D) imply that the money market fund is similar to a savings account
D) NASAA has a special Statement of Policy dealing with unethical business practices related to investment companies. One of the provisions considers it unethical is comparing money market mutual funds to savings accounts. The nature of money market funds is such that there generally would not be any suitability problems recommending friends or clients ask others to open an account with you.
An agent submits a list of recommendations to a customer that includes 5 different securities. The customer chooses to buy a round lot of 1 of the 5 securities recommended (a stock in which the agent's broker-dealer makes a market). The firm, in completing the trade, charges a markup that is larger than normal for a stock transaction. Is this allowable under the Uniform Securities Act? A) No, the markup schedule is set and cannot be changed for an individual trade. B) Yes, markup schedules are dependent upon the type of security, broker-dealer risk, services that the broker-dealer provides, and effort in acquiring the security. C) Yes, it is allowable, but proper disclosure is required. D) No, under the circumstances given, it is a prohibited practice to charge a higher than normal markup.
D) Higher than average markups or commissions are not prohibited if they are justifiable and disclosed. However, in this case, there would appear to be no justification because the customer bought a round lot, the normal trading unit of stock. The firm is a market maker, so the security is being sold from their inventory and the stock is on the company's recommended list.