Final Exam 4
broker-dealer has been unknowingly selling unregistered, non-exempt securities through non-exempt transactions without the permission of the state securities Administrator. If the broker-dealer becomes aware of this issue, what is its best course of action? A) The broker-dealer should offer a letter of rescission to the customer. B) The customer should sue the broker-dealer in criminal court. C) The broker-dealer and customer should agree to use arbitration. D) No action should be taken since there is no violation.
A) The broker-dealer should offer a letter of rescission to the customer. **This is not a case that involves fraudulent (criminal) activity; however, selling non-exempt securities in a state in which they are not registered is a violation (civil). The best course of action is for the broker-dealer to offer the customer a letter of rescission. In the letter, the broker-dealer offers to repurchase the securities at their original cost, plus interest, minus any of the investment income that has been received by the client. **
Which of the following statements is FALSE regarding an investment adviser's contract? A) The contract may stipulate that the adviser will receive a share of the gains and appreciation that are generated in the account as long as the time period is disclosed to the customer B) Contracts may allow for an adviser to be compensated based on the value of the assets under management between designated dates C) Contracts may not be assigned without customer consent D) If the investment adviser is a partnership, advisory clients must be notified of any change in partners
A) The contract may stipulate that the adviser will receive a share of the gains and appreciation that are generated in the account as long as the time period is disclosed to the customer **The regulators consider sharing in the gains of a customer's account to be a form of performance-based fee. These fees are generally prohibited in advisory contracts unless the customer qualifies for a waiver or exemption based its status (e.g., institutional investors or officers/directors of the firm), net worth, or assets under management. Asset-based fees are not considered performance-based fees if they are calculated based on the value or average value of the assets and not the appreciation.**
According to the Uniform Securities Act, which of the following statements is NOT TRUE concerning a private placement offering? A) The offer may not be made to more than 10 retail investors in the state during any 12-month period. B) The offer may not be made to more than 35 retail investors in the state during any 12-month period. C) The offer may be made to an unlimited number of institutional investors during any 12-month period. D) Commissions may not be paid if the buyers are non-institutional investors.
A) The offer may not be made to more than 10 retail investors in the state during any 12-month period. **Under the Uniform Securities Act, a private placement offering is one that involves no more than 10 retail investors; however, there may be an unlimited number of institutional investors. The offering is considered an exempt transaction if the following conditions are met: The seller believes that all of the retail (non-institutional) buyers are purchasing for investment purposes only and, No commission or other remuneration is being paid for soliciting retail (non-institutional) buyers Any reference to a private placement that's limited to no more than 35 retail (non-institutional) investors is a condition for a private placement being conducted under Regulation D of the Securities Act of 1933, which is a federal regulation.**
Which of the following statements BEST describes discounted cash flow? A) The total value of an investment's anticipated cash flows in today's dollars B) Purchasing power in the future will have more worth than cash today C) Discounted cash flow uses depreciation and market-adjusted cash flows D) A method used to measure the risk-adjusted return on a bond
A) The total value of an investment's anticipated cash flows in today's dollars **Discounted cash flow evaluates each coupon payment and the repayment of a bond's principal at a present value, based on a rate of return. This makes it possible to evaluate a bond's value against the investor's desired rate of return. The sum of each of the discounted cash flows, plus the present value of the bond's principal, determine the total value of the bond. By comparing this value to the current price of the bond, the adviser will be able to determine if the bond is an attractive investment for her client.**
Investor Jones begins the year with a portfolio of high-grade bonds and blue-chip stocks valued at $300,000. During the year he receives dividends and interest amounting to $11,345, all of which is reinvested. At year-end, the portfolio is valued at $325,435. The percentage return for the year for this portfolio is: A) 8.5% B) 12.3% C) 7.8% D) 3.7%
A) 8.5% **The portfolio increased in value by $25,435, of which $11,345 represents interest and dividends. If the portfolio was valued at $300,000 at the beginning of the year, the return is 8.5% ($25,435 / $300,000).**
Which of the following communications would be exempt from the sales literature and advertising filing requirements of the Uniform Securities Act? A) A brochure on U.S. Treasury securities B) A form letter used to prospect for small business retirement plans C) An ad espousing the tax advantages of condominium investments D) A group e-mail sent to several existing clients explaining the advantages of annuity investing
A) A brochure on U.S. Treasury securities **The Administrator may require the filing of sales literature and advertising for nonexempt securities. Ads concerning exempt securities (such as Treasuries) are not subject to the filing requirements under the USA. Individual correspondence is not subject to filing with the Administrator, but form letters and group e-mails that are considered sales literature, must be filed. **
Under the Investment Advisers Act, the form that is filed annually with the SEC and determines an adviser's continued eligibility for federal registration is called: A) Annual Updating Amendment B) Consent to service of process C) ADV Part 2 D) ADV-W
A) Annual Updating Amendment **The Annual Updating Amendment is submitted to confirm that an SEC registered investment adviser is still eligible for federal registration. The form must be filed within 90 days after the end of the adviser's fiscal year.**
Randy inherited his father's IRA. If his father died at the age of 69 and Randy did not choose to take a lump-sum distribution, he must withdraw the entire account: A) By no later than the fifth year following the owner's death B) And rollover the funds into this own IRA C) By no later than the 10th year following the owner's death D) By the time Randy reaches the age of 70 1/2
A) By no later than the fifth year following the owner's death **According to IRS rules regarding inherited IRAs, a non-spouse who inherits an IRA and the decedent had not yet reached the age of 70 1/2, may take a lump-sum distribution, have the funds distributed over his expected lifetime, or have the funds distributed by the end of the fifth year following the IRA owner's death.**
The rate of return that a mortgage company may earn over the life of a loan to a customer is the: A) Holding period rate of return B) Real rate of return C) Risk-free rate of return D) Expected rate of return
A) Holding period rate of return **The return that is earned over the life of an investment and/or a loan is referred to as the holding period rate of return. Since the question asks for the return over the life of the investment (i.e., the loan), the holding period rate of return is the best answer. **
Stephen Gigs is about to retire and is concerned about having enough income to supplement his Social Security retirement savings. He would like to buy a conservative investment that can help offset inflation. Mr. Gigs takes the advice of his agent and purchases Treasury Inflation-Protected Securities (TIPS) with a face value of $100,000 and a coupon rate of 2 3/4%. Six months later, he reads that the CPI is up 3 1/2%. What is the approximate amount of Mr. Gigs' next interest payment? A) $1,375 B) $1,423 C) $2,750 D) $3,500
B) $1,423 **The CPI rose 3 1/2% and, therefore, the principal of the TIPS will increase by 3 1/2% ($100,000 + [$100,000 x 3.5%]) = $103,500. Mr. Gigs' interest will be calculated by multiplying the new face amount by the coupon rate of 2 3/4%, then dividing by two since interest is paid semiannually. ($103,500 x 2.75%) / 2 = $1,423.13. Remember, the stated rate is an annual rate and will not change.**
An equity-indexed annuity is linked to the S&P 500 Index and has a spread of 2.5%. If the S&P returns 7.5% in one year, the annuity's rate of return will be: A) 2.5% B) 5.0% C) 7.5% D) 10%
B) 5.0% **Some equity-indexed annuities have a spread, margin, or asset fee. These represent the amount that will be deducted from the returns generated by the underlying index to determine the contract's returns. If the annuity had a spread of 2.5% and its underlying index returned 7.5%, then the annuity would be credited with 5% that year (7.5% - 2.5% = 5%).
Provided a broker-dealer has written procedures allowing for an agent to borrow or lend money to a customer, the agent may do so in all of the following situations, EXCEPT: A) A customer is a member of the agent's immediate family B) A customer is registered with a different broker-dealer than the agent C) A customer is a financial institution engaged in the business of making loans D) A customer has a personal relationship with the agent that exists outside their brokerage relationship
B) A customer is registered with a different broker-dealer than the agent **An agent may make loans or borrow money from their immediate family members, or if the client is a financial institution—a bank—or the agent and the customer have a personal or business relationship outside their brokerage relationship. However, in order for an agent to borrow from another registered person, they both must be registered with the same broker-dealer.**
Which of the following is dissolved when an owner dies? A) A corporation B) A general partnership C) An S Corporation D) A trust
B) A general partnership **General partnerships generally dissolve when an owner becomes mentally incapacitated or dies. All of the other entities listed have continuity of life. **
Under the Investment Advisers Act, which of the following forms must be filed if an investment adviser has custody of customer funds and securities? A) ADV-H B) ADV-E C) ADV-NR D) ADV-W
B) ADV-E **Submission of Form ADV-E with the SEC is required if the adviser has custody of client funds and securities. The form is filed by an independent public accountant hired by the adviser who has audited the adviser's records. Form ADV-H is filed by an adviser seeking an exemption for a temporary or continuing hardship. Form ADV-NR is filed by a nonresident general partner or nonresident managing agent of a U.S. registered investment adviser. Form ADV-W is filed by an adviser that is either seeking a partial or full withdrawal from registration.**
To cut costs, a broker-dealer hires some college interns. The firm allows the interns to make calls to potential clients to market investment opportunities in stocks, bonds, and mutual funds. This action would be: A) Unacceptable because even if they are registered, the interns must finish college to perform phone solicitation B) Acceptable if the interns are registered C) Unacceptable under any conditions D) Acceptable since full-time registered agents will manage any of the accounts that are opened
B) Acceptable if the interns are registered **Since the interns are attempting to effect transactions, they must be registered. There is no requirement that an agent of a broker-dealer have a college degree. If they are properly registered, any employees of a broker-dealer may solicit securities transactions.**
Kate is an agent at Leopold Securities and works in the firm's New York office. She uses the telephone to contact a client in New Jersey. She recommends buying stock in Tomato Garden Industries, a company located in New Jersey. Which of the following statements is TRUE? A) Since the company is located in the same state as the client, this would be considered an exempt transaction B) Both the New York and the New Jersey Administrator may have authority over the offer C) She is not permitted to make this type of offering using the telephone D) An offer exists only if a sale is made
B) Both the New York and the New Jersey Administrator may have authority over the offer **The Administrator has authority over any offer to buy or sell that is originated, accepted, or directed in the Administrator's state. A sale need not be made in order to meet the definition of an offer to sell.**
Which of the following transactions would NOT be considered an unethical business practice by a broker-dealer? A) Effecting a transaction in a security that does not involve any beneficial change of ownership B) Effecting a transaction in a security on behalf of clients for the purpose of acting as an agent for both buyer and seller C) Effecting a transaction in a security on behalf of clients for the purpose of increasing the trading volume of that security D) Effecting a transaction in a security with other broker-dealers for the purpose of increasing or decreasing the price
B) Effecting a transaction in a security on behalf of clients for the purpose of acting as an agent for both buyer and seller **It is considered an unethical business practice for a broker-dealer to effect transactions in a security for manipulative or deceptive purposes. A broker-dealer may effect an agency transaction with two clients whereby the firm represents both the buyer and the seller.**
A Suspicious Activity Report (SAR) should be filed: A) For transactions of more than $2,000 B) For transactions of $5,000 or more C) Only for transactions of more than $10,000 D) Only for transactions of more than $25,000
B) For transactions of $5,000 or more **A firm must file an SAR whenever a transaction (or group of transactions) equals or exceeds $5,000 and the firm suspects any of the following wrongdoing: The client is violating federal criminal laws. The transaction involves funds that are related to illegal activity. The transaction is designed to evade the reporting requirements (structured transactions). The transaction has no apparent business or other legitimate purpose and the broker-dealer cannot determine any reasonable explanation after examining all the available facts and circumstances surrounding the transaction.**
Which bonds would have the greatest sensitivity to interest rate changes? I) Bonds with long durations II) Bonds with short durations III) Bonds with high coupons IV) Bonds with low coupons A) I and III B) I and IV C) II and III D) II and IV
B) I and IV **Duration is a measure (expressed in terms of years) of a bond's price sensitivity to small changes in interest rates. The longer a bond's duration, the greater its price sensitivity. Also, bonds with low coupons are more sensitive to interest changes than bonds with high coupons. Therefore, a change in rates will result in a greater percentage change in a bond's value if it has a low coupon**
Sally is self-employed and has established a Keogh plan for her retirement. She has one full-time employee, Tom, who is 25 and has worked for her for 7 months. When is Tom eligible to participate in the Keogh plan? A) Immediately B) In 5 months C) In 17 months D) Never, since he is not self-employed
B) In 5 months **Employees of self-employed persons with a Keogh plan must be covered by the plan if they have worked for the employer for one year and are at least 21.**
Although an exempt reporting adviser (ERA) is not required to register, it must still satisfy which of the following requirements? A) File Form ADV Part 2 with the SEC B) Notice file with the Administrator C) Amend its ADV within 90 days if material information changes D) Prepare an annual brochure
B) Notice file with the Administrator **Exempt reporting advisers are required to file Form ADV Part 1A with the SEC and must notice file with the Administrator. Any material information changes must be reported promptly. As is the case with other investment advisers, an ERA is required to amend its Form ADV within 90 days of its fiscal year end.**
Under the Uniform Securities Act, all of the following are exempt from registration as an investment adviser EXCEPT an IA: A) That is owned by a fraternal nonprofit organization B) That has five or fewer clients in the state, but is actively soliciting for more clients C) That limits its advice to clients that are insurance companies in the state D) That owns an accounting practice and occasionally provides advice that is an incidental part of its accounting practice
B) That has five or fewer clients in the state, but is actively soliciting for more clients **If an investment adviser actively solicits more than five individual customers in a state, registration is required there. There are a number of situations in which a person may provide advice and yet not be required to register as an investment adviser. Some examples include professionals (e.g., the CPA in this question) whose advice is incidental, advisers whose only clients are insurance companies or other institutions, and firms that do not receive compensation (i.e., nonprofits). **
In which of the following situations does the registration of a broker-dealer result in an Administrator automatically registering an individual of the firm as an agent? A) The individual is an attorney who represents the firm B) The individual is a director of the broker-dealer and is actively engaged in the business of the firm C) The individual is an agent of the broker-dealer and is registered in another state D) The individual had been previously employed by the broker-dealer
B) The individual is a director of the broker-dealer and is actively engaged in the business of the firm **The registration of a broker-dealer in a state will automatically constitute the registration of an individual as an agent if this person is actively engaged in the business of the firm and is a partner, director, officer, or occupies a similar status.**
Which of the following statements is TRUE concerning the posting of a bond by a broker-dealer? A) The bond may be waived if the broker-dealer has been in business for at least 10 years B) There is no bond requirement if the broker-dealer does not have custody or discretionary authority over client funds or securities C) The Administrator may not waive the bond requirement for any broker-dealer D) There is no bond requirement if the broker-dealer is registered in another state
B) There is no bond requirement if the broker-dealer does not have custody or discretionary authority over client funds or securities **The Administrator may require broker-dealers to post bonds if they have custody of or discretionary authority over client funds or securities. The bond may be waived if the broker-dealer's net capital exceeds a specified amount. The Administrator may determine this amount. **
A broker-dealer has summer interns who are involved in sales and solicitations, but they are not paid. Are these interns considered agents and subject to registration? A) They are not, since there is no compensation involved B) They are, since anyone who represents a broker-dealer in effecting securities transactions is defined as an agent C) They are not, since they are not considered employees of the broker-dealer D) They are not, since they are only working during the summer, are considered temporary employees, and not subject to registration
B) They are, since anyone who represents a broker-dealer in effecting securities transactions is defined as an agent **Anyone who represents a broker-dealer in effecting securities transactions is defined as an agent and must register with the state, regardless of whether compensation is paid or not.**
XYZ Inc. is an investment adviser. One of its institutional clients would like to sell 1,000 shares of ABC stock. XYZ believes that this would be a suitable investment for another institutional client. XYZ proposes to arrange a trade between the two clients and would charge each customer a small fee for its services. This would allow each client to receive a better price than either could obtain in the open market. Which of the following statements is TRUE in this situation? A) This is permitted since the two clients are institutional investors, but would be prohibited if they were not B) This is permitted if XYZ discloses to each client that it is acting as a broker for both parties and receives each client's written consent C) This is permitted if XYZ discloses to the buyer that it is representing the seller in the transaction and receives the buyer's written permission D) This is not permitted under any circumstances unless XYZ waives any fee for arranging the transaction
B) This is permitted if XYZ discloses to each client that it is acting as a broker for both parties and receives each client's written consent **An investment adviser that wishes to act as a broker for both parties to a transaction must: Disclose the capacity in which it is acting prior to the completion of the transaction and Obtain the client's written consent. Since both parties to the trade are clients, the disclosure and consent requirements apply to both.**
Under the Investment Advisers Act of 1940, when is a firm's registration required to be renewed? A) Within 30 days of the calendar year-end B) Within 90 days of the adviser's fiscal year-end C) Within 30 days of the adviser's fiscal year-end D) Within 90 days of the calendar year-end
B) Within 90 days of the adviser's fiscal year-end **This is a tricky question because federal regulation of IAs is based on fiscal year, while state regulation is based on calendar year. According to the Investment Advisers Act of 1940, IAs are required to renew their registration within 90 days of their fiscal year-end. On the other hand, the Uniform Securities Act requires registration renewal to be completed at the end of the calendar year.**
West Side Advisers manages several mutual funds. It uses South End Brokerage to execute many of its transactions, even though South End charges higher commissions than many other brokerage firms. West Side has access to all of South End's research reports. This is an example of: A) A quid pro quo B) Best execution C) A soft-dollar arrangement D) A revenue-sharing agreement
C) A soft-dollar arrangement **In a soft-dollar arrangement, an investment adviser sends client transactions to a particular broker-dealer even though that broker's commissions may not be the lowest ones available. In return, the investment adviser receives research or other services from the broker-dealer. In these arrangements, the clients of the investment adviser should be able to benefit by using the services of this broker-dealer as compared to a broker-dealer charging lower commissions.**
If an investor is attempting to maximize her portfolio growth over a long period, what is her strategy called? A) Investment income strategy B) Buy-and hold-strategy C) Capital appreciation strategy D) Day trading strategy
C) Capital appreciation strategy **Capital appreciation would best fit the strategy being described. Capital appreciation involves buying and selling equities in an attempt to obtain as much growth as possible and is generally considered a risky strategy. **
All of the following statements are TRUE of a 529 plan, EXCEPT: A) Withdrawals that are used for educational purposes are not subject to federal taxation. B) There are no income limits placed on contributors. C) Contributions are unlimited. D) A married couple may give a lump-sum of $150,000 without incurring federal gift taxes.
C) Contributions are unlimited. **The contribution limits for a 529 plan are quite high (much higher than those for a Coverdell Education Savings Account, which is capped at $2,000 a year), but they're not open-ended. Each state establishes the maximum amount that may be contributed to all 529 plans that are maintained for one beneficiary (typically $200,000 to $300,000). All of the other statements are correct. However, note that an investor who contributes the maximum amount allowable to a 529 plan may incur federal gift taxes. A single investor may contribute up to $15,000 per year ($30,000 for a couple) for each beneficiary without incurring gift taxes. An investor may also aggregate five years' worth of annual contributions into one and give a $75,000 lump-sum amount ($150,000 for a married couple) without incurring federal gift taxes.**
Harold has established a revocable trust. His son Stanley is the trustee and his daughter Dora and her children are the beneficiaries. The income is currently taxable to: A) Dora B) Dora's children C) Harold D) Stanley
C) Harold **Since this is a revocable trust, all the income produced by the trust must be included in Harold's (the grantor's) tax returns. The trust income would not normally be taxable to the trustee unless the trustee is also the grantor or one of the beneficiaries. Note, however, that the trustee would be responsible for making certain that the proper tax payments were made. If the trust is irrevocable, then the income is generally taxed to the trust or the beneficiaries.**
Fred works for Lasker Securities and is holding an investment seminar in Connecticut. Fred has sent 100 invitations to people located in New York. Since his firm has no place of business in New York, he has the responses returned to his office in Connecticut. Which TWO of the following statements are TRUE? I) Lasker Securities would not need to be registered as a broker-dealer in New York if it has no place of business in New York, and the seminar is to be held in Connecticut. II) Lasker Securities would need to be registered as a broker-dealer in New York, since it is conducting business in the state. III) Fred would need to register in the state of New York as an agent, since he is doing business within the state. IV) Fred would not need to be registered as an agent in New York, but must be registered in Connecticut, since the seminar will take place in Connecticut. A) I and II B) I and III C) II and III D) II and IV
C) II and III **Lasker is conducting business in the state of New York if its agents solicit securities business within that state, even though the broker-dealer has no place of business within the state. Sending invitations to attend an investment seminar is considered doing business. Fred must be registered as an agent in both states since he is acting on behalf of the broker-dealer in the solicitation of securities business in New York, and conducting an investment seminar in Connecticut.**
According to Sarbanes-Oxley, a public corporation's financial statements must be certified by the corporation's: I) Chief auditor II) Chief executive officer III) Legal counsel IV) Chief financial officer V) Compliance officer A) I only B) I and II only C) II and IV only D) II, III, and V only
C) II and IV only **Sarbanes-Oxley is a federal law that, among other things, requires a corporation's annual and quarterly financial reports to be certified by the CEO and CFO of the corporation. **
Under the Uniform Securities Act, which of the following statements is/are TRUE of exempt securities? I) Any security that is exempt under the Uniform Securities Act is also exempt under federal regulations II) Any security that is exempt under federal regulations is also exempt under the Uniform Securities Act III) federal covered securities are required to notice file with the state Administrator IV) All Canadian securities are exempt from registration A) I and III only B) II and IV only C) III only D) I, II, and IV only
C) III only **Certain federal covered securities are required to notice file with the State Administrator. The notice filing provision applies to investment company securities and securities that are distributed through a Regulation D Rule 506 offering. A security can be exempt under federal law, but not state law, and vice versa. Only securities that are issued by some form of Canadian government are exempt from registration; the exemption does not apply to offerings made by Canadian corporations.**
Under the Uniform Securities Act, an institutional investor: A) Has more than $2.1 million of net worth B) Has a minimum of $1 million under management with an investment adviser C) May be designated as such by rule or order of the Administrator D) Is any financial institution or trust
C) May be designated as such by rule or order of the Administrator **The best answer to this question is that, by rule or order, the Administrator has the power to designate a person as an institutional investor. A client with net worth of more than $2.1 million or a client with a minimum of $1 million under management with an investment adviser is defined as a qualified client, not necessarily an institutional investor. Both financial institutions and trusts may be considered institutional investors, but there is a financial requirement that must be met.**
On Tuesday, June 3, an IA discovers its net worth has fallen below the minimum requirement. When must the IA file a report of its financial condition with the Administrator? A) On Tuesday, June 3 B) On Wednesday, June 4 C) On Thursday, June 5 D) On Friday, June 6
C) On Thursday, June 5 **If an IA's net worth is less than the required minimum, it must notify the Administrator by the close of the next business day (in this question, Wednesday, June 4). After notification is made, the IA must file a report of its financial condition by the next business (in this question, Thursday, June 5). Thereafter, the Administrator may require the IA to post a bond for the deficiency.**
According to modern portfolio theory (MPT), the expected return of an investment is the: A) Average return including realized and unrealized gains and losses, plus income over a measured time period B) Market return on the investment adjusted by the beta of the stock or the portfolio C) Possible returns on the investment weighted by the likelihood that return will occur D) Standard deviation of gains and losses over the life of the investment
C) Possible returns on the investment weighted by the likelihood that return will occur **MPT defines the expected return of an investment as the possible returns on the investment weighted by the likelihood that return will occur. **
A client purchases 1,500 shares of Bergman's Basketballs, an IPO that was underwritten by Broker-Dealer X. If the salesperson who sold the shares to the client is employed by Broker-Dealer Z, a member of the selling group, the client: A) Does not need to receive a prospectus since the shares were purchased from a member of the selling group B) Should receive the prospectus from Broker-Dealer X C) Should receive the prospectus from Broker-Dealer Z D) Should receive the prospectus from the issuer
C) Should receive the prospectus from Broker-Dealer Z **Failing to furnish a client who has purchased shares of a new issue with a prospectus is an unethical and/or dishonest business practice by a broker-dealer and/or an agent. The responsibility to furnish this document falls on the broker-dealer that sold the security to the client.**
An investment adviser charges fees based on a percentage of the assets being managed by the firm for the client. The schedule of fees reveals that the more assets the firm manages for the client, the lower the advisory fee. For customers with more than $5 million under management, the firm's advisory fees are negotiable. Which of the following statements is TRUE? A) The firm's fee structure is illegal since all customers must be charged the same rate for the same advisory services B) That part of the firm's fees that declines as assets increase is acceptable, but advisers may not negotiate different fees with different clients for the same amount of assets under management C) This fee structure is acceptable as long as the resulting fees are reasonable D) Any fee structure is acceptable as long as it is disclosed to the client and the client consents to it
C) This fee structure is acceptable as long as the resulting fees are reasonable **It is unethical for an investment adviser to charge an unreasonable advisory fee. State Administrators may conduct surveys of investment adviser fees to determine what is reasonable. Negotiable fees are acceptable as long as the resulting fee is reasonable**
Over the past 10 years, an investment adviser has developed a computerized trading algorithm that produces average returns of 30% per year. To recover the costs associated with development, the adviser now plans to charge clients an annual fee equal to 25% of their average balance. An Administrator would consider this fee: A) Unreasonable, since past performance is not indicative of future returns B) Reasonable based on average results from the past C) Unreasonable due to the significant amount of the gains being taken as compensation compared to normal fees from other advisers D) Reasonable, since the system is unique and not available from other investment advisers
C) Unreasonable due to the significant amount of the gains being taken as compensation compared to normal fees from other advisers **Performance-based fees are only available for qualified investors. Assessing a fee of 25% of the gains may be considered reasonable, but an asset-based fee of 25% would certainly be considered excessive. Generally, an asset-based fee exceeding 2% is considered excessive.**
An individual forms a broker-dealer as a sole proprietorship. Which of the following actions are required by the Administrator? I) Filing Form BD II) Submitting a Consent to Service of Process III) Maintaining a minimum amount of net capital IV) Paying a filing fee A) I, II, and IV only B) II, III, and IV only C) I only D) I, II, III, and IV
D) I, II, III, and IV **All of the actions are required by the Administrator as part of the application process for registration as a broker-dealer.**
If employed by a federal covered adviser, which of the following individuals would be required to register as an IAR in State A? A) A person who works at the home office located in State B B) A person who resides in State A but works at the home office located in State B C) A person who resides and works in state B, and has five retail clients who live in state A D) A person who works at the home office in state A however all of his clients are institutions located in State A and State B
D) A person who works at the home office in state A however all of his clients are institutions located in State A and State B **If an IAR is employed by a federal covered adviser, the de minimis exemption—limiting the number of retail clients—does not apply. The IAR may exceed the five-client threshold in a state as long as he does not have a place of business. However, when an IAR is employed by a federal covered adviser and has an office in the state, the IAR would be required to register in that state, regardless of the number or type of clients being serviced. Remember, IARs of federal covered advisers are required to register in the state(s) in which they maintain an office. For that reason, a person who works at the home office in State A is required to register there. This is true regardless of the type of clients that the IARs may have in State A.**
Regarding the possession of funds held by investment advisers (IAs), which of the following is FALSE? A) Client notification must be made immediately regarding the location where the firm will hold the funds B) Client funds may only be held in an account that is established for that specific purpose C) Client funds may be held by a qualified custodian that has met certain standards D) Clients must receive a statement at least annually that discloses certain details of the funds held by the firm
D) Clients must receive a statement at least annually that discloses certain details of the funds held by the firm **Client account statements are sent on a quarterly basis and must include the amount of funds in the firm's possession, a list of securities held in custody, a record of transactions, and all fees charged. If a custodian holds the assets (i.e., not the IA), the IA must have a reasonable belief that the statements are being provided**
Melissa is listening to a group of individuals discussing trends in the current market. They are saying that they are fully invested and have no purchasing power and that they believe the market will continue to rise. Melissa, however, anticipates a market peak followed by a downturn. She is most likely a follower of which style of investing? A) Momentum investing B) The Random Walk Theory C) The Sharpe Ratio D) Contrarian investing
D) Contrarian investing **Melissa is an adherent to the contrarian style of investing. She goes against the wisdom of the majority.**
According to NASAA Model Rules, an IA may be compensated on the basis of performance provided the adviser discloses all the following information in writing to the client, EXCEPT the: A) Fee arrangement may create an incentive for the adviser to make riskier or more speculative investments B) Adviser may receive a share of both realized and unrealized gains in the account C) Period used to measure performance D) Fact that the adviser has discretion as to any index to measure performance
D) Fact that the adviser has discretion as to any index to measure performance **The adviser may not use any index to measure performance, only one that is appropriate. The adviser must disclose the nature of any index and why the adviser believes it is appropriate.**
The major advantage of an S Corporation versus a C Corporation is that an S Corporation: A) Provides its owners with limited liability B) Has greater access to the capital markets C) Is exempt from state corporate income taxes D) May elect to be treated like partnerships for federal tax purposes
D) May elect to be treated like partnerships for federal tax purposes **For most businesses, the major advantage of forming an S Corporation (or a limited liability company), rather than a regular C Corporation, is that S Corporations may elect to be taxed like partnerships under Subchapter S of the Internal Revenue Code. S Corporations must meet certain restrictions in order to qualify for this special treatment. The owners of both types of corporations have the protection of limited liability.**
An agent who is registered in State A contacts an individual investor in State B. The investor agrees to open an account and buy a security through the agent. If the broker-dealer is registered in State B, but the agent is not, the agent MAY: A) Sell the security if it is registered in State B and the agent's registration is pending in State B B) Sell the security as long as the agent's supervising principal is registered in the state C) Sell the security if it is exempt D) Not sell the security
D) Not sell the security **In order to sell a security in a state, the broker-dealer and the agent must be registered in that state. Since the agent is not registered in State B, he may not sell the security to the investor. It is important to note that individual investor is a new client. If the investor was an established client who previously lived in State A, but had moved to State B, the agent could continue to service the client's account for 60 days after the client moved. However, this provision is only available if the agent's registration was pending in State B.**
According to the Uniform Securities Act, all of the following sales and advertising literature may be subject to filing with the Administrator, EXCEPT a(n): A) Prospectus for a limited partnership B) Pamphlet for an oil and gas program C) Brochure for a mining company D) Offering circular for an endowment policy
D) Offering circular for an endowment policy **The Administrator may require the filing of sales and advertising literature for securities investments. Limited partnerships, oil and gas programs, and mining companies issue securities. Endowment policies are insurance products, not securities**
Which of the following statements is TRUE regarding the taxation of qualified cash dividends? A) Qualified cash dividends are taxed at ordinary income rates in the year in which they're paid. B) Qualified cash dividends are tax-exempt. C) Qualified cash dividends are not taxed in the year in which they're paid, but the recipient will adjust his cost basis. D) Qualified cash dividends are taxed at a maximum rate of 20% in the year in which they're paid.
D) Qualified cash dividends are taxed at a maximum rate of 20% in the year in which they're paid. **Qualified cash dividends are typically taxed at a maximum rate of 20% in the year in which they're paid. Corporate bond interest is taxed at an investor's ordinary income rate, municipal bond interest is typically tax exempt. Stock dividends, not cash dividends, will adjust an investor's cost basis.**
An investment adviser contracts with a person who is not affiliated with the firm. In fact, the contractor is not registered with any state Administrator or with the SEC. Under the Investment Advisers Act of 1940, if the IA intends to give the contractor a finder's fee for any investment advisory client that's secured through her service, which of the following statements is TRUE? A) The investment adviser is prohibited from paying the contractor. B) The investment adviser doesn't need to be registered. C) The contractor must register with the SEC as a solicitor. D) The contractor doesn't need to register with the SEC as a solicitor.
D) The contractor doesn't need to register with the SEC as a solicitor. **In this question, the contractor is acting as a solicitor for the investment adviser. Registered investment advisers are permitted to pay solicitors as long as they have a written contract. If the solicitor is only referring clients and not providing advice directly, the solicitor doesn't need to register with the SEC. However, most states do require solicitors to register as investment advisers or investment adviser representatives. In comparison, broker-dealers are prohibited from paying any fees or commissions to non-registered persons.**
Ace Financial Consulting is a registered investment adviser specializing in financial planning. Although Ace's IARs are experienced and knowledgeable, they have many clients with complex tax issues. Ace has a consulting agreement with Block & Tackle, a local law firm that specializes in taxation. Block & Tackle is paid a fee whenever Ace calls them in to consult on the tax issues in a complex financial plan. Which of the following statements is TRUE? A) If Block & Tackle is not registered as an investment adviser, it would be required to obtain a waiver from the state Administrator to operate in this advisory capacity B) If Block & Tackle receives cash compensation from Ace, it must follow the rules for cash solicitors under the Investment Advisers Act C) This arrangement is appropriate provided Block & Tackle is compensated directly by the advisory clients on whose plans it provides advice D) This is a legitimate use of a professional consultant by the advisory firm and Block & Tackle need not register as an adviser
D) This is a legitimate use of a professional consultant by the advisory firm and Block & Tackle need not register as an adviser **It is perfectly appropriate for an investment adviser to consult other qualified professionals to ensure that their advice is accurate and in the client's best interest. Block & Tackle need not register as an investment adviser as long as it does not hold itself out to the public as an investment adviser, and as long as it provides investment advice incidental to its normal law practice.**
Why would an investment adviser perform a capital needs analysis for a client? A) To determine how much income the client will need at retirement B) To determine how to best reduce the client's tax liability C) To determine how much disposable income the client has available to purchase insurance D) To determine how much insurance the client needs in order to fund future financial goals
D) To determine how much insurance the client needs in order to fund future financial goals **A capital needs analysis is used to determine the amount of insurance a client needs to purchase today in order to fund her future financial goals. For example, if the client dies prematurely and the value of her investments are not sufficient to pay for her child's college education, life insurance is needed to fund the difference.**