Chapter 10 Questions

Choose Allowed or Not Allowed. 1. _____ When meeting with a new client, agent Earnest Starr fails to disclose his past work as a commercial actor.

1. Allowed. Starr's past career endeavors are not material facts for a client considering whether or not to use his services.

1. A fiduciary is best defined as: A. Someone who works for someone else B. Someone who is expected to make a profit for someone else, to the best of their ability C. Someone who gets paid to give advice to someone else D. Someone who is placed in a position of trust and expected to act in the best interest of someone else

1. Answer: D. A fiduciary is a trusted professional expected to give advice and act in a way that is in the best interest of her client. Simply working for someone else or getting paid to give advice does not make someone a fiduciary. Rather, a fiduciary duty is a unique responsibility that is placed on financial professionals. It is defined by the fact that trust is placed in a person, regardless of how or if she is compensated. Lastly, fiduciaries are not expected to make as much profit as possible for each client, but rather, to do what is most in line with each client's objectives and risk tolerance.

1. True or false. It is not possible for churning to occur in a discretionary account.

1. False. Churning, or excessive trading, can occur in both discretionary and non-discretionary accounts.

Choose proper or improper. 1. _____ Client funds and broker-dealer funds are held in the same account.

1. Improper. Commingling of funds is a violation of custody rules.

Choose Fraudulent or Not Fraudulent. 1. _____ An investment adviser fails to disclose facts about a financial condition that is not material to its effectiveness as a firm

1. Not fraudulent. Only financial conditions that are reasonably likely to impair an adviser's ability to meet a contractual commitment to a client must be reported.

Choose permitted or not permitted. 1. _____ A client gives written permission to her investment adviser representative to make trades for her one week after the first trade was made by that adviser. She gave verbal permission prior to the first trade.

1. Permitted. Written consent for discretionary authority for an investment adviser representative must be given no later than 10 days following the first discretionary trade, and verbal permission must be given prior to the trade.

1. True or false. Broker-dealers are permitted to use customer testimonials in their advertisements.

1. True. Broker-dealers may use customer testimonials; investment advisers may only use third-party testimonials in specific instances.

1. True or false. Keeping a client's electronic data out of public view is a primary responsibility for all investment professionals.

1. True. Client confidentiality extends to data stored electronically and online. Therefore, its protection is a key responsibility for all investment professionals. The SEC has mandated policies to ensure that all firms and employees maintain high standards in order to keep this information confidential.

1. True or false. Diversification should be considered part of the prudent investor standard, as it tends to reduce potential risk.

1. True. Portfolio diversification, since it reduces overall risk, is considered to be an important aspect of the prudent investor standard.

10. An agency cross transaction performed by an investment adviser: A. Is unethical and not permitted B. Is unethical and not permitted if the adviser is receiving a fee or commission from both parties C. May be ethical and does not represent a conflict of interest D. May be ethical and requires a signed consent form from any involved clients

10. Answer: D. An agency cross transaction is one in which the broker or agent is acting on behalf of both the buyer and seller in the same transaction. For investment advisers acting as brokers, this presents a natural conflict of interest, since the adviser is supposed to work in the best interest of each individual party. However, these types of transactions are permitted if the adviser only recommends the trade to either the buyer or the seller, the adviser provides the client with full disclosure regarding the agency cross transaction and obtains the client's written consent, the adviser sends the client a written confirmation at the completion of each transaction, and the adviser annually discloses in writing how many agency cross transactions have been made on each client's behalf and the amount of commissions generated from those transactions.

11. Jack works as an agent for Big Brokerage. He has a client named Shelly. Jack has discretionary authority over Shelly's account. Shelly has suggested that Jack share in the profits and losses of the account because she thinks this compensation arrangement will be a good incentive for Jack. According to NASAA Model Rules for agents of broker-dealers: A. This is always prohibited. B. This is permissible because he has discretionary authority over the account. C. This not permissible because he has discretionary authority over the account. D. This is only permissible if Jack gets written authorization from both Shelly and his broker-dealer.

11. Answer: D. According to NASAA Model Rules for broker-dealers, agents cannot share in the profits or losses of a customer's account unless they get the written authorization of the customer and the agent's broker-dealer. Additionally, FINRA rules require Jack to only share in the profits and losses according to his original percentage of account ownership.

12. Kevin is a representative for Top Notch Investment Advisory Services. He has a client named Rodney. Rodney has a ranch in Montana and a net worth of $2.5 million, excluding his primary residence. He has $500,000 assets under management with Top Notch. Rodney would like to pay Kevin an extra 20% of all gains above the performance of the S&P 500. He thinks it will be a good incentive for Kevin. Which of the following is true about this situation? A. Rodney would never be able to pay Kevin in this way—in other words, this type of payment is always prohibited. B. Rodney could have paid Kevin this way if Rodney had over $1 million assets under management with Top Notch instead of $500,000. C. Rodney can pay Kevin in this way, as long as Kevin provides Rodney with a disclosure document about the terms and risks of this type of compensation contract. D. Rodney could have paid Kevin in this way if the performance was on a percentage of the gains in the account, not as gains above a benchmark.

12. Answer: C. Investment advisers and their representatives are generally prohibited from sharing in a percentage of a customer's gains and losses unless the client is a qualified client, and the adviser makes certain disclosures in the advisory contract. Individuals with over $1.1 million in assets with the professional's firm or at least $2.2 million in documentable net worth (excluding the person's primary residence), such as Rodney, are considered qualified clients. Thus, performance-based compensation would be acceptable in this case.

13. Which of the following is not required in an investment adviser client contract? A. Language specifying that the client will be notified of any change in partnership B. Language that a client's account cannot be assigned to another IAR C. A term for the contract D. Whether someone is granted discretionary authority

13. Answer: B. Investment adviser contracts must include several pieces of information. They must outline all services to be provided, contain a term (time limit) for the contract, contain the advisory fee, include the formula for calculating the fee, specify the amount of the fee to be returned if the client terminates early, and specify whether the contract grants the adviser discretionary authority over the client's portfolio. They must also state that the investment adviser will not be compensated on the basis of capital gains or capital appreciation, unless the client meets certain specifications. They must include language specifying that the client will be notified of any change in partnership. They must include specific wording that the contract may not be assigned to another investment advisory firm or IAR without the client's consent. However, investment adviser contracts do not have to include language stating that the client's account cannot be assigned to another IAR.

14. According to NASAA Model Rules regarding compensation, which of the following is true of sharing in the gains of a customer's account? I. It is never permissible for agents of broker-dealers. II. It is prohibited unless the agent obtains the customer's permission and the permission of the agent's broker-dealer. III. It is never permissible for investment advisers. IV. It is prohibited for investment advisers and investment adviser representatives, unless the customer is a qualified client and receives a disclosure from the adviser. A. I and III B. II and IV C. I and IV D. II and III

14. Answer: B. According to NASAA Model Rules for broker-dealers, agents cannot share in the profits or losses of a customer's account unless they get the written authorization of the customer and the agent's broker-dealer. Investment Advisers and their representatives are generally prohibited from sharing in a percentage of a customer's gains unless the client is a qualified client and the adviser makes certain disclosures in the advisory contract.

15. Which of the following is not true regarding an investment adviser that has custody over its clients' accounts? A. It must have the clients sign hypothecation agreements if it plans to use their securities as collateral on a loan. B. It must segregate the clients' securities. C. The clients' accounts and records must be audited at least once per year by an independent third party, and the audit must be unannounced. D. The qualified custodian or adviser must provide clients with account statements on a quarterly basis or more frequently.

15. Answer: A. Investment advisers may not use their customers' securities as collateral on a loan. They must segregate their clients' securities. They must make sure clients are sent account statements at least quarterly. Client accounts are subject to an unannounced annual audit.

16. Which of the following is true regarding anti-fraud regulations? A. Transactions in municipal securities are not subject to anti-fraud regulations because municipal securities are considered exempt securities. B. Exempt transactions are not subject to anti-fraud regulations. C. Unregistered individuals can be prosecuted for fraud. D. An investment adviser who is registered with the SEC cannot be the subject of an anti-fraud investigation by a state securities administrator.

16. Answer: C. Unregistered individuals can be prosecuted for fraud. Exempt transactions and transactions involving exempt securities are also subject to anti-fraud regulations. Federally registered investment advisers can be subject to state anti-fraud investigations.

17. Which of the following is true regarding the brochure rule for investment advisers? A. The brochure must provide the same information as both Parts 1 and 2 of Form ADV. B. The brochure has to be given at least 48 hours in advance of a contract being signed. C. Clients must also receive a brochure supplement, which gives disclosure information on the specific people who will be advising them on their investments. D. Existing clients must receive a new copy of the brochure every three years.

17. Answer: C. The brochure must provide the same information as Part 2 of Form ADV. If the brochure is not provided at least 48 hours prior to the time that the client signs the contract, the client is allowed to terminate the contract free of penalties for five business days. However, it is not true to say that the brochure must be given to the client at least 48 hours before the contract is signed. Instead, the brochure must be delivered before or at the time that an advisory contract is signed. Clients must also receive a brochure supplement that gives disclosure information about the specific people who will be advising them on their investments. Existing clients must receive a new copy of the brochure annually.

18. Which of the following would an investment adviser not need to disclose to a customer? A. The fact that a recommendation that was given to a client was prepared by a third-party B. The way that the investment adviser will be compensated C. The fact that there are immaterial omissions in the advisory contract D. Disciplinary actions against the adviser

18. Answer: C. Only material omissions need to be disclosed to a client. Investment advisers need to disclose if a report or recommendation was prepared by a party other than the investment adviser. The investment adviser needs to fully disclose compensation information and disciplinary actions against the adviser.

19. Which of the following is not true when an investment adviser wishes to pay a third-party solicitor to attract business for the firm? A. The investment adviser is responsible for supervising the solicitor's activities. B. The solicitor must present the investment adviser brochure and the documentation of solicitor disclosure in the same document. C. The investment adviser must be registered. D. The solicitor cannot have willfully violated any securities laws.

19. Answer: B. If an investment adviser wishes to pay a third-party solicitor to attract business for the firm, the investment adviser must be registered. The solicitor cannot be subject to any outstanding orders from the SEC barring his activity or have willfully violated any securities laws or been convicted of a felony or securities related misdemeanor in the past 10 years. The solicitor must present the investment adviser's brochure and the solicitor disclosure document as two separate documents. The solicitor disclosure document must contain the compensation arrangement between the investment adviser and the solicitor, including the amount or percentage of the advisory fee that the solicitor will receive.

2. All of the following would be considered clear conflicts of interest except: A. Recommending a security for purchase that is owned by the adviser's other clients B. Recommending a security also owned by the adviser C. Recommending securities from an issuer that employs the adviser's spouse D. Receiving a free Wall Street Journal subscription from a mutual fund company whose products you sell to your clients

2. Answer: A. Simply recommending a good thing to multiple clients is not a conflict of interest, but is more likely an expectation of a good investment adviser. However, recommending securities that the professional owns does create a conflict of interest, as does receiving a Wall Street Journal subscription paid for by a mutual fund vendor or recommending securities issued by a spouse's employer. It's important to note, however, that conflicts of interest do not by themselves prohibit a professional from acting, but rather require the professional to offer proper disclosure to the client or prospect.

2. True or false. Investment adviser representatives can never use references or past recommendations as part of their advertising efforts.

2. False. An investment adviser representative can use references and past recommendations as long as she provides a list of all recommendations she has made for at least the past 12 months.

2. True or false. Under the suitability rule, securities professionals should always try to remove any potential for client risk.

2. False. Suitability involves making sure clients are taking enough risks to meet their goals just as much as it does ensuring they are not subject to unnecessary risk.

Choose Fraudulent or Not Fraudulent. 2. _____ An adviser purchases a security for his own account in advance of purchasing a large block of the same securities for a client. He makes this purchase because he expects the price of the security to get a boost from his client's purchase.

2. Fraudulent. An adviser who uses his knowledge to purchase the same securities ahead of a client (hoping to gain from a bump in the price of the security) is called front-running, and this practice is not allowed.

Choose proper or improper. 2. _____ Client funds are audited by an independent accountant on a scheduled date at least once a year.

2. Improper. Although an annual audit by a third party is required, it must be unannounced.

Choose permitted or not permitted. 2. _____ A client gives written permission to his agent to make trades one week after the first trade was made by that agent. The client gave verbal permission prior to the first trade.

2. Not Permitted. Written consent for discretionary authority for an agent must be given prior to any discretionary trade being made.

Choose Allowed or Not Allowed. 2. _____ Abel Mann, an agent, effects a transaction in a new security. He provides a copy of the preliminary prospectus on the day that the client receives a trade confirmation and then gives his client a copy of the final prospectus one day later.

2. Not allowed. A final prospectus must be delivered to the client no later than the date of trade confirmation.

2. True or false. Agents generally cannot borrow money from or loan money to customers.

2. True. Although they may borrow money from lending institutions, agents must not borrow money from or lend money to customers.

2. True or false. Under the SEC's cybersecurity regulations, firms must periodically review databases used to store client information.

2. True. Firms must periodically review databases to ensure that client information remains secure from unauthorized persons.

20. Which of the following would be least likely to fall under the principals of the Prudent Investor Rule? A. Diversification B. Delegating investment-making decisions when appropriate C. Avoiding unreasonable fees whenever possible D. Avoiding risk

20. Answer: D. The Prudent Investor Rule is based on modern portfolio theory and outlines the following principles, which must be upheld when managing assets for a fiduciary account: (1) Risk and return should be viewed in the context of the whole portfolio and in the context of the account owner's broader portfolio goals. (2) The fiduciary should diversify investments whenever possible to avoid unnecessary unsystematic risk, unless it not prudent to do so. (3) The fiduciary should avoid unreasonable fees and transaction costs whenever possible. (4) Fiduciaries have a duty, as well as authority, to delegate investment-making decisions when appropriate. (5) The fiduciary must balance the goal of preservation of capital with protection of purchasing power. It is usually prudent to take some risk in order to beat inflation and protect purchasing power, thus avoiding risk is not a core principal of the Prudent Investor Rule.

21. Which of the following would not be acceptable? A. A broker-dealer posts a glowing testimonial on its website. B. An IA posts a list of all its past recommendations in the last 12 months with a statement that past success is no guarantee of future success. C. An IA posts a graph in a brochure that shows that equity technology stocks have performed much better than equity healthcare stocks without a corresponding explanation. D. An IAR who is properly registered in Florida advertises on her website, and it is read by someone in Illinois where she not registered.

21. Answer: C. Broker-dealers are allowed to post testimonials on their websites. An IA cannot list past recommendations, unless it lists all of its past recommendations for the last 12 months with a statement that past success is no guarantee of future success. Securities professionals can post advertisements in a state where they are registered that will be seen in a state where they are not registered. IAs cannot use graphs, charts, formulae, or other devices in their advertisements that can by themselves be used to imply which securities are best to buy or sell, or when, without prominently disclosing the limitations and difficulties of doing so.

22. Which of the following is allowed in an advertisement for an investment adviser? A. Offering or selling securities that are unregistered at both the state and federal levels and that are not subject to an exemption B. Stating that an advertisement has been filed and accepted by the administrator C. A reference to one of several recommendations that a representative of the firm made to a specific customer D. Including a graph that compares the performance of equity funds, debt funds, and balance funds, and includes a detailed explanation of the limitations and difficulties of applying the figures to performance of future investments

22. Answer: D. Offering or selling securities that are unregistered at both the state and federal levels and that do not qualify for an exemption is illegal. Stating that an advertisement has been filed and accepted by the administrator suggests approval by the administrator, which is unacceptable. If an IA wishes to refer to past recommendations, it must provide a list of all the recommendations made by its representatives for at least the past 12 months. IAs cannot use graphs, charts, formulae, or other devices in their advertisements that can by themselves be used to imply which securities are best to buy or sell, or when, without prominently disclosing the limitations and difficulties of doing so. In the correct option, the advertisement does describe the limitations and difficulties, so it would be acceptable.

23. Which of the following is incorrect about an investment adviser's responsibilities regarding a principal transaction? A. The adviser must fully disclose its role in the principal transaction. B. The adviser must receive written permission from the client before the trade takes place. C. The adviser must send a client confirmation statement disclosing its role as a principal, also stating that it informed the client that it might act as a principal, and the client must give permission for the transaction. D. The adviser must describe the conflict of interest involved in a principal transaction.

23. Answer: B. Because principal transactions often involve conflicts of interest, an investment adviser must do each of the following when it engages with them: fully disclose its role in a principal transaction, describe the conflict of interest involved in a principal transaction to the client, receive written permission from the client before the completion/settlement of the transaction, and send client confirmation statements disclosing its role as a principal. The client confirmation statement should state that the adviser informed the client that it might act as a principal and that the client permitted the transaction.

24. Arthur sends stock certificates to BCD Investment Advisers, which BCD promptly returns. Bianca sends cash to BCD with instructions to deposit the cash in her account, which BCD does. Claus sends a check to BCD Investing that is payable to XYZ Broker-Dealer, which BCD forwards to XYZ Broker-Dealer. Diana grants discretionary authority to BCD, which BCD uses to purchase mutual fund shares for Diana's account. BCD Investment Advisers took custody in which of its customers' accounts? A. Arthur B. Bianca C. Claus D. Diana

24. Answer: B. If an investment adviser wants to avoid taking custody of client funds or securities, it must return any client funds or securities it receives within three business days of receiving them and must forward any checks drawn by clients and payable to third parties within three business days of receipt. The adviser must also keep records regarding any funds or securities that it receives.

25. Broker-dealers are subject to complex recordkeeping, bonding, margin, net capital, financial responsibility, and custody requirements from both the state and the SEC. What is true about these requirements? A. States may not establish requirements that exceed the federal requirements. B. Pursuant to the Uniform Securities Act, states must establish requirements that meet or exceed the federal requirements. C. A broker-dealer is subject to only the requirements of the state where it is registered. D. A broker-dealer must petition the SEC for exemption from the federal requirements it does not need to meet due to state regulations under the Uniform Securities Act.

25. Answer: A. When a broker-dealer is registered in a state and also with the SEC, the state's requirements may not exceed those of the SEC.

26. Iago has been a difficult client. He has submitted complaints to his investment adviser several times. His complaints include: (1) an investment the adviser recommended caused him to lose money; (2) the adviser forwarded a check he wrote to a third party instead of returning it to him; (3) the adviser exercised price-time discretion without having received discretionary authority; and (4) the adviser included a testimonial that was reprinted from a local newspaper in one of its advertisements. Which of the following is a prohibited activity? A. Recommending an investment that causes the client to lose money B. Forwarding a check written to a third party C. Exercising price-time discretion without discretionary authority D. Using the testimonial in its advertisement

26. Answer: D. An investment adviser may only use a testimonial under specific conditions. Use of a testimonial that is reprinted from a newspaper is not one of these conditions. Each of the other activities listed as an answer choice is allowed.

27. Vanessa wants to buy 200 ABC Company bonds. She receives firm quote of 95 from a bond dealer. Vanessa thinks this a pretty good price, so she tells the dealer she wants to put in an order. The dealer then tells her that the price is actually 97. Vanessa really wants the bonds. Should she continue with her purchase? A. No, because the dealer has committed a securities violation. B. Yes, a dealer is allowed to change a firm quote whenever he deems fit to do so. C. Yes, as long as the dealer provides a prospectus with the purchase. D. Yes, as long as she makes sure that there is a trade confirmation that includes the original quote and the revised quote.

27. Answer: A. The dealer provided a firm quote and then changed it. Thus he engaged in the prohibited practice of backing away. When a dealer makes a firm quote, he is not allowed to change it immediately; he must give the customer the chance to buy the security at that quote.

28. Justin is 20 years old and is working as a summer intern at QRST, an investment adviser firm. He isn't registered as an IAR. QRST is having him call local residents to tell them about its services and sign them up on the company's email list. Justin earns a $5 commission when he signs someone up for the list. According to the Uniform Securities Act, which of the following is true? A. Neither QRST nor Justin violated any securities regulations, because Justin is paid on a commission basis. B. Justin is under the age of 21 and IAs may only hire employees over the age of 21. C. QRST should have registered Justin before they had him start performing this task. D. Neither QRST nor Justin violated any securities regulations, because Justin is doing clerical or ministerial work, and an individual does not need to register to perform this type of work.

28. Answer: C. Justin is performing a task that requires him to register. The Uniform Securities Act states that anyone who "solicits, offers or negotiates for the sale of or sells investment advisory services" must register as an IAR. Thus, QRST should have registered Justin as an investment adviser representative before having him start his internship.

29. According to NASAA Model Rules for investment advisers, which of the following is not required in an investment advisory contract? A. An outline of the advisory services B. The name of any issuers that the investment adviser is owned by, affiliated with, or under common control with C. The amount of the fee to be returned if the client terminates early D. Whether the contract grants the adviser discretionary authority over the client's portfolio

29. Answer: B. According to the NASAA Model Rules on investment advisory contracts, new and renewed investment advisory contracts must be in writing, outline all services to be provided, contain a term (time limit) for the contract, contain the advisory fee, include the formula for calculating the fee, specify the amount of the fee to be returned if the client terminates early, specify whether the contract grants the adviser discretionary authority over the client's portfolio, include specific wording that the contract may not be assigned to another investment advisory firm without the client's consent, the appropriate disclosures the investment adviser will not be compensated on the basis of capital gains or capital appreciation, if the investment adviser is a partnership, and notify clients of changes in the partnership (for example, a partner has been added or left), and no advisory contract can be entered into or can contain language that requires a client to waive any part of her rights under the Investment Advisers Act of 1940. The contract does not need to state the name of any issuers that the investment adviser is owned by, affiliated with, or under common control with.

Choose Allowed or Not Allowed. 3. _____ Cindy Redd, an investment adviser, publishes an advertisement in which she notes that she has passed all of her licensing exams and is properly registered with FINRA.

3. Allowed. It is perfectly fine to say that you are registered with FINRA as long as that is true. To state that you are "approved" or "certified" by FINRA, however, would not be allowed.

3. Which of the following is not used to determine if a trade is excessive? A. Whether the transaction is a principal or agency transaction B. Number of shares bought or sold by the client C. Client's investment objectives D. Commission generated

3. Answer: A. Generally, whether the transaction was a principal or agency transaction has no bearing on whether or not a trade is considered excessive. However, the number of shares transacted by the client, the client's investment objectives, and the amount of commission generated will all be considered when trying to decide if trading in a client's account is excessive.

3. True or false. As long as an agent discusses a client's investment needs, wants, and expectations in full detail before engaging in any trades, the suitability requirement has been met.

3. False. An initial in-depth discussion of investment needs, wants, and expectations is a requirement for suitability, but so too is a continuous evaluation of changes to a client's goals and investment situation.

3. True or false. FINRA guidelines require only a firm's management to have defined roles and responsibilities as part of a cybersecurity plan.

3. False. Both FINRA and the SEC suggest that all individuals employed by the firm have defined roles and responsibilities as part of a cybersecurity plan.

3. True or false. For a margin account with a broker-dealer, a written agreement must be in place before any trades are made.

3. False. For a margin account with a broker-dealer, a written agreement must be in place no later than promptly after the first trade is executed.

3. True or false. Graphs and charts are prohibited from advertisements for investment advisers and investment adviser representatives.

3. False. Graphs, charts, and formulas are not prohibited; however, statements or implications that would lead one to believe they are representative of a security's potential merits are not allowed.

Choose Fraudulent or Not Fraudulent. 3. _____ An employee of a firm reports his securities holdings to the firm's compliance office one week after first obtaining inside information.

3. Not fraudulent. An employee must report his securities holdings to a firm's compliance office within 10 days of becoming an access person.

Choose permitted or not permitted. 3. _____ A client gives verbal permission for time and price discretion to his investment adviser prior to any trades taking place. The client then provides written permission two weeks after the first time and price discretionary transaction took place.

3. Permitted. For a time and price discretionary trade, only verbal authorization is permitted.

Choose proper or improper. 3. _____ Clients receive account statements every three months.

3. Proper. Quarterly account statements must be provided to clients when advisers have custody of their accounts.

4. An investment adviser, IAR, or agent can borrow money from her client as long as: A. There is a written agreement in place prior to the loan. B. The interest rate is fair to the client. C. The client is in the formal business of lending money and the loan is an official loan. D. The money from the loan is not used to buy securities.

4. Answer: C. The only time an agent can borrow money from a non-family member client is when the client is actually in the business of lending money and the loan is an officially documented loan. This would most likely occur when the securities professional has a bank or other type of lender as a client. An investment adviser or IAR may only borrow money from clients who are broker-dealers, affiliates of the investment adviser, or financial institutions in the business of loaning funds.

4. True or false. An investment adviser would be allowed to enter into a performance-based arrangement if the client had a net worth of $2.5 million and a primary residence valued at $600,000.

4. False. High-net-worth individuals are allowed to enter into performance-based arrangements with investment advisers; however, to qualify for that distinction an investor must have at least $2.2 million in net worth, excluding her primary residence.

4. True or false. Until all relevant suitability information has been considered, a broker-dealer is prohibited from engaging in all securities transactions for a client.

4. False. In the case of an unsolicited transaction (one made at the request of the client), a broker-dealer does not need to meet the suitability standards.

4. True or false. As long as reasonable policies and procedures to identify the red flags of identity theft are in place, a firm has satisfied its SEC requirement to maintain an identity theft program.

4. False. While establishing reasonable policies and procedures to identify red flags is a key part of any identity theft program, there are additional requirements.

Choose Allowed or Not Allowed. 4. _____ Investment adviser Serta Nement regularly promises potential clients that if they follow her advice their investments will see significant gains.

4. Not allowed. Promising gains is considered to be a guarantee, which is prohibited.

Choose permitted or not permitted. 4. _____ A client gives written authorization for a third party to buy securities on her behalf.

4. Permitted. Trading authorization is allowed when a client acknowledges in writing that a specified third party can trade on the client's behalf.

Choose proper or improper. 4. _____ A broker-dealer receives written consent and then hypothecates a client's securities.

4. Proper. A broker-dealer with custody can hypothecate a customer's securities with previous written consent.

4. True or false. Broker-dealers operating within a bank setting should always offer their services in an area distinct from where regular banking activity takes place.

4. True. Broker-dealers operating in a bank should always make their location distinct from the place where regular banking takes place.

5. Which of the following would constitute someone sharing inside information? A. A CEO talking to his barber about his company's annual report from last year B. A securities professional sharing a stock tip with someone who is not a customer C. A CEO's spouse telling his mother about a merger that will be announced the following week D. A stockholder telling a non-stockholder what was discussed in that year's annual stockholders' meeting

5. Answer: C. Due to the fact that the merger has not been announced yet, sharing this information with anyone outside the company, even a spouse or partner, could be considered the illegal sharing of nonpublic information. A CEO talking about last year's annual report is discussing information that is already public, as is a stockholder sharing information learned in a stockholders' meeting. A stock tip from a professional is not unethical by itself, unless it is actually based on information that is considered nonpublic.

5. True or false. An investment adviser representative can only reveal confidential client information with the client's consent.

5. False. A client's consent is one of the means by which an investment adviser can share confidential information. The other is as the result of a court order.

5. True or false. As long as an agent selling shares of a mutual fund delivers a final prospectus before a given sales date, full disclosure has been provided.

5. False. A securities professional is responsible for explaining all material facts to a client. Simply handing the client a copy of a prospectus alone does not meet this requirement.

Choose Allowed or Not Allowed. 5. _____ Bill Vonn, an agent, purchases shares of A New Start for a client but does not deliver a copy of the prospectus. A New Start is listed on the NYSE, and its IPO closed 20 days ago.

5. Not allowed. The client should have received a prospectus. This is because A New Start is listed on an exchange and its offering closed within the past 25 days.

6. Which of the following clients may enter into a performance-based compensation arrangement with an investment adviser? I. Registered investment companies II. An individual with over $500,000 in net worth III. A hedge fund IV. An investment adviser's secretary A. I only B. I and III C. II and III D. I, II, and IV

6. Answer: B. Performance-based compensation contracts are available only to clients that likely have the ability to understand the risk and conflicts of interest associated with them. Those clients include registered investment companies (mutual funds) and hedge funds. An individual investor must have over $2.1 million in net worth (or $1 million in assets with the professional's company), not $500,000 to have a performance-based contract with a firm. Lastly, senior personnel and securities professionals at investment advisory firms can hire other IAs and IARs on a performance basis; however, a firm's rank and file employees, such as secretarial staff, are not allowed to do so.

7. Selling away would be best defined as: A. Selling securities not offered by an agent's firm B. Selling securities to individuals who are not clients C. Selling a firm's securities at a better price than their client's securities D. Churning a customer's account

7. Answer: A. Selling securities not offered through one's broker-dealer represents an ethical violation if done without the broker-dealer's approval. Churning (making excessive trades) and getting a better price on the same securities when transacting at the same time as a customer are ethical violations, but aren't classified as selling away. Selling to individuals who aren't clients does not necessarily represent an ethical violation, since the buyers would technically become clients the moment you sell to them.

8. Market manipulation does not include which of the following? A. Intentionally entering identical and opposite trades as someone else for the same security and amount with the intention of creating a false sense of trading activity or volume B. Trading on a false rumor that you read about in the Enquirer and making money on the trade C. Painting the tape D. Posting a blog comment about an upcoming merger that is not really in the works and benefiting from an increase in the price of securities issued by one of the parties to the alleged merger

8. Answer: B. While inventing a rumor about a stock to profit from it is prohibited, trading on a rumor from a publication is not. Matched trades and painting the tape are also prohibited.

9. Client confidentiality may be broken: I. As a client instructs or gives permission II. After a client passes away III. If a court orders it broken IV. In the event that a client is out of the country A. II and IV B. I and II C. I and III D. III and IV

9. Answer: C. Client confidentiality can only be broken if the client gives permission or as ordered by a court or by law.

Match the professional to the compensation arrangement. A. Investment adviser representative B. Agent C. Solicitor 4. _____ A flat fee received for providing investment advice

A

You are a covered associate and you perform volunteer work for the campaign of an official. Would this trigger the ban?

Answer: No. Volunteering your time for an official is acceptable, but paying for any campaign expenses, such as posters, clean up, etc., will be considered a contribution. Your own personal expenses, such as your own meals or travel, will not be considered a contribution.

You are working as a covered associate and you live in an area that allows you to vote for an official who can direct business to your firm. You go door to door and solicit contributions from others. Your raise $200 in contributions. You bundle these contributions together and send them to the official. Will this trigger the ban?

Answer: Yes. Investment advisers may not coordinate any contributions to an official who can direct business to their firm. This is often called bundling. There is no de minimis exception for bundling.

While teaching at a community college, Steve contributes $400 to the political campaign of a local issuer. Six months later, he lands a job as an IAR, soliciting business for an advisory firm. His main clients are governmental entities. Will Steve's political contribution ban his new employer from providing advisory services to the governmental entity to which he made the contribution?

Answer: Yes. It doesn't matter where Steve was employed when he made the political contribution or whether he was a covered associate at the time he made it. His employer will be subject to the ban for the amount of the two-year period that remains from the time the contribution was made.

An investment advisory firm is located in a district that votes for an official that could direct business to the adviser. The firm makes a contribution of $200. Would this trigger the ban?

Answer: Yes. The de minimis exception only applies to covered associates. It does not apply to the advisory firm.

You are a covered associate who lives in a district that allows you to vote for a candidate that can direct business to your firm. You solicit a PAC to give money to the candidate, and it contributes $200. Will this contribution trigger the ban?

Answer: Yes. The rules state that no investment adviser or covered associate shall solicit any person or PAC to make any contribution to any official that has influence over directing business toward the firm.

You are working as a covered associate and you get your children to each contribute $1,000 to a candidate who you know can direct business to your firm. Would this trigger the ban?

Answer: Yes. You may not violate these rules by using indirect means.

Match the professional to the compensation arrangement. A. Investment adviser representative B. Agent C. Solicitor 1. _____ Fee based on a percentage of assets under management

Answers: 1. A

Match the professional to the compensation arrangement. A. Investment adviser representative B. Agent C. Solicitor 2. _____ Markup on the price of a security purchased from a client

B

Match the professional to the compensation arrangement. A. Investment adviser representative B. Agent C. Solicitor 3. _____ Commissions received for effecting securities transactions

B

Match the professional to the compensation arrangement. A. Investment adviser representative B. Agent C. Solicitor 5. _____ Cash payments made to a third party in return for bringing clients to a firm

C