Series 66 -- Investment Advisers Act of 1940

Under the Investment Advisers Act of 1940, upon entering into an advisory contract the advisor must provide the customer with the "brochure"

- which is Form ADV Part 2A. In addition, within 120 days of year end, the client must be sent a free updated brochure; or a summary of material changes that offers to provide the free updated brochure.

Excluded from Investment Adviser Definition

1. Banks or Bank Holding companies 2. Professionals: Lawyers, Accounts, Engineers, Teachers 3. Broker-Dealers and their Representative, as long as their advice is incidental and are not compensated 4. Publisher of bona fide newspapers, magazines or financial publications of general and regular circulations 5. Any person who only advises on US Government Obligations 6. Family offices

Required information in the registration application for an investment adviser includes:

1. Name the officers, directors and shareholders of the investment adviser. 2. Any disciplinary actions taken against the adviser by a self-regulatory organization must be disclosed in the registration application (there is no time limitation on this).

Under SEC Rule 202(a)(11)(G)-1 (the "Family Office Rule"), there are 3 basic requirements that must be met for the exclusion:

1. The family office must only provide investment advice to clients who are part of that family. 2. The family office must be wholly owned by family clients and exclusively controlled by family members or entities - it cannot be owned or controlled by the key employees (though key employees can make investments). 3. The family office cannot hold itself out as an investment adviser - thus it cannot advertise or market itself to non-family clients. Note that there is no asset size test for this exclusion.

IA-1092 Investment Advisers Definition

1. pension consultants 2. investment newsletters can be defined as an investment adviser that must register under Federal law if they make recommendations of securities 3. financial planners

Copies of advertising, notices and circulars be retained as a record for: 5 years if distributed to 10 or more people.

5 years if distributed to 10 or more people.

To register as an investment adviser with the SEC

A Form ADV Part 1 and Part 2 must be filed, along with a non-refundable filing fee.

IA-770 3 Prong Test

To determine who is an IA: 1. Does the person provide advice or analyses about a security? 2. Is this person "in the business" of giving advice? 3. Is this person compensated for giving advice?

IA-1092 Adds-Ons

Any person who provides advice or who issues reports or analyses concerning securities even though not necessarily relating to specific securities will be deemed an investment adviser. Giving advice does not have to be the firm's principal business to fall under the definition; it just has to be a regular activity of the firm. Any compensation received related to giving advice, whether received directly or indirectly, will meet the compensation test. Specifically excluded from the definition of an investment adviser under the Investment Advisers Act of 1940 is anyone who gives advice about U.S. Government securities. IA-1092 specifically included advisers to athletes, entertainers, and pension plans as "investment advisers" that must register.

When is an Investment Adviser obligated to deliver an updated Brochure to an existing client?

An IA is only required to provide an updated Brochure to a client annually, within 120 days of fiscal year end, if there are any material changes from the last Brochure delivered.

Under the Investment Advisers Act of 1940, the investment adviser brochure must be delivered to clients:

At, or Prior to, entering into a contract to provide advisory services. It details, among other things, the fees charged and conflicts of interest. A copy of the investment adviser's balance sheet is included in the brochure if the adviser will take prepaid advisory fees of $1,200 or more, 6 months or more in advance of rendering services.

The brochure includes:

Basic business contact information; Material changes from previous year; Description of the advisory firm and services offered including length of time in business; Fees and compensation; Types of clients; Methods of analysis; Disciplinary information; Code of ethics; Brokerage practices; Client referrals and compensation; Custody, discretion, and voting of client securities; IA financial information.

Form ADV Part 2

Part 2 is broken into 2A and 2B. Part 2A gives descriptive information about the advisory firm's business, investment style, fees, and conflicts of interest. Part 2B gives the educational and work background of the key personnel who make investment decisions or manage accounts. The Form ADV Parts 2A and 2B may be used as the document given to potential customers to satisfy the "Brochure Rule."

The records required to be retained by an investment adviser that takes custody include:

Cash receipts and disbursements ledger and general ledger Securities received and delivered ledger Purchase and sales ledger (trade ledger) Securities record (a record of each aggregate security position held, broken down by each customer owning part of the position and the physical location of that position) Confirmation copies of all customer trades Customer account statements showing all purchases, sales, securities positions, and cash debits and credits to the account Note that there is no requirement for beneficiary designations to be retained for customer accounts - in most cases, the beneficiary is named in the will when a customer dies.

Form ADV Part 1

Part I includes general information like the investment adviser's name, location, fiscal year of business, form of business, owners of the business, names of officers, number of employees, total amount of assets under management, States in which the adviser is registered, etc. NASAA rules require that State registered advisers use Form ADV Part I for their State registration. This filing must be updated annually at year end, and also must be updated within 30 days (under NASAA rules) for material changes.

Family Office

The Investment Advisers Act of 1940 excludes "family offices" from the definition of an investment adviser, so they are not required to register. Regarding the "family office" exclusion, extremely wealthy persons often set up a "family" office to manage the finances of family members. As part of its work, the family office often gives investment advice, and the employees of the family office are compensated, so they would fall into the "dragnet" of Investment Adviser registration. Because these are wealthy, "sophisticated," individuals, they are not in need of the "protection" given by SEC IA registration.

Investment Advisers Act of 1940. Testimonials are prohibited in these advertisements

The advertisement CANNOT purport that graphs, charts, computer programs, etc., CAN determine which securities to buy or sell, or when to buy or sell. If an offer is made of a list of prior recommendations, it must cover all (not just the best-performing) recommendations made over a minimum of the past 12 months.

by an investment adviser to promote the sale of the firm's advisory services is prohibited, unless the customer consents to such disclosure.

The only disclosure of customer information that may be made without customer consent is required disclosures to governmental bodies such as the IRS.

Brochure Rule

Requires investment advisers, under the Investment Advisers Act of 1940, to provide to clients a disclosure document detailing the investment adviser's business, fees, and conflicts of interest (a "brochure"), which is either Form ADV Part 2A or a separate printed brochure with the same information. Furthermore, Form ADV Part 2B (the "Brochure Supplement") must also be included - this gives the educational and work history of the key personnel who make investment decisions or manage accounts. The brochure must be delivered to clients at, or prior to, entering into an advisory contract. Note that electronic delivery of these documents is permitted

The Investment Advisers Act of 1940, under Rule 204-2 on Record keeping:

Requires that if an investment adviser sends any notice, circular or other advertisement to more than 10 persons, the adviser is NOT required to keep a record of the names and addresses of the persons to whom it was sent. But if the notice is DISTRIBUTED to persons named on any list, the adviser must "retain, along with a copy of such notice, a memorandum describing the list and the source thereof."

Investment adviser registration exemption

Investment Adviser Act of 1940: 1. Intrastate exemptions 2. Adviser to insurance companies Uniform Securities Act: For those advisers with NO office in the State that give advice to :PROFESSIONAL INVESTOR" such as: Banks Trusts Investment companies Insurance companies

The States in which an investment adviser is registered would: A. be found in Form ADV Part 1 B. be found in Form ADV Part 2 C. be found in both Form ADV Part 1 and Form ADV Part 2 D. not be found in either Form ADV Part 1 or Form ADV Part 2

The best answer is A. be found in Form ADV Part 1 The ADV Part 1 is the basic registration information filed with the SEC - such as name of firm, address, phone number, officers, shareholders, States where the adviser is registered, etc. The ADV Part 2 is broken down into 2 parts. Part 2A is the "Brochure" that must be delivered to customers. It describes the investment adviser's policies, fees, education, types of investments, types of clients, method of analysis used, conflicts of interest, etc. Part 2B is the "Brochure Supplement" which details the educational and work background of the key personnel who make investment decisions or manage accounts.

To determine if a person is "in the business" of giving investment advice under the Investment Advisers Act of 1940, which of the following are considered? I That the individual regularly gives advice on securitiesII That more than 50% of the individual's earnings are derived from making investment recommendationsIII That the individual receives compensation for giving advice on securities A. I only B. I and III only C. II and III only D. I, II, III

The best answer is B. To be "in the business" of giving investment advice, this must be a regular activity of the firm or person; and the advice must be rendered about securities; and that person must be compensated for giving such advice.

An Investment Adviser obtains a list of the 30 members of the local rotary club and sends each a letter that includes a coupon that gives a 20% discount to club members if they purchase the adviser's services. Which statement is TRUE under the provisions of the Investment Advisers Act of 1940? A. This is a fraudulent and prohibited practice B. A adviser must keep a record of the letter and a memorandum describing the mailing list C. The adviser is only required to keep a record of any rotary club members that use the coupon D. The adviser is not required to keep copies of prospecting letters

The best answer is B. The Investment Advisers Act of 1940 covers this situation under Rule 204-2. It requires that if an adviser sends any notice, circular or advertisement, it must keep a record of the names and addresses of the persons to whom the communication was sent. If the communication is sent to more than 10 persons, this detailed record is not required to be kept, however if the communication is sent to a list of individuals (as in this case), a copy of the letter, along with a memorandum describing the list and its source, must be retained.

All of the following must be disclosed by an investment adviser to a customer EXCEPT: A.the President of the advisory firm pleaded "nolo contendere" in a civil action taken by a State Administrator B.an investment adviser representative of that firm was fined $1,500 by FINRA for making unsuitable recommendations C.a partner in the firm was suspended by FINRA for 1 year from engaging in the securities business D.a partner in the firm was convicted of misappropriation of funds 8 years ago

The best answer is B. Under the Investment Advisers Act of 1940, legal and disciplinary actions taken against an investment adviser that resulted in a guilty or "no contest" plea must be disclosed to customers; as must any disciplinary actions by self-regulatory organizations that resulted in suspension, expulsion, or the imposition of fines in excess of $2,500. Convictions for misdemeanors or felonies involving securities or monies that occurred within the last 10 years must be disclosed as well.

If an investment adviser wishes to hire an individual to solicit business for the advisory firm: I the solicitor must be registered as an agent of that investment adviser in the State II the adviser must be registered with either the SEC or the State as appropriate III there must be a written agreement between the adviser and the solicitor IV there must be a written agreement between the adviser and the SEC or the State Administrator, as appropriate A I and III B I and IV C II and III D II and IV

The best answer is C. An investment adviser solicitor must be registered in the State; however, the solicitor can be an independent third party that is not a representative of that investment adviser, making Choice I incorrect. The investment adviser (the firm) must be registered with the SEC if it has $100,000,000 or more of assets under management (a federal covered adviser). If the firm has less than $100,000,000 of assets under management, then it only is required to register with the State. To use a solicitor, there must be a written agreement between the adviser and the solicitor that spells out the work to be performed and the compensation to be paid.

Which of the following actions by an investment adviser are prohibited under the Investment Advisers Act of 1940? I Making a cash payment to a solicitor that is undisclosed to the customer for signing that customer as an advisory clientII Using an advertisement that includes a testimonial from a famous personalityIII Entering into an oral advisory contract with the customerIV Accepting a prepaid advisory fee from a client A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. I, II, III Prepaid advisory fees are permitted, though the contract must explain how much of the fee will be refunded if the contract is canceled prematurely. Making a cash payment to a solicitor for signing a customer to a contract is permitted only if the payment is disclosed to the customer; and if the customer receives a solicitor's "Brochure" as well as the adviser's "Brochure;" and the customer must sign an acknowledgment that both were received. Oral advisory contracts are not permitted under the Investment Advisers Act of 1940 - they must be in writing (Note, however that the "Brochure Rule," under the Investment Advisers Act of 1940, requires delivery of the "Brochure" at, or prior to, entering into either a verbal or written contract, which is contradictory - but this is the rule!). Testimonials are prohibited in investment adviser advertising.

An investment adviser who renders advice solely to investment companies is:I subject to State registrationII exempt from State registrationIII subject to Federal registrationIV exempt from Federal registration A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. II and III Investment advisers to investment companies are "federal covered advisers" that are required to register with the SEC only. There is no requirement for registration of these advisers at the State level. One of main intents of the Investment Advisers Act of 1940 was to register advisers to investment companies and place limits on their compensation.

All of the following are considered to be "giving advice about securities" under SEC Release IA-1092 EXCEPT a person who: A. issues reports about securities to customers B. develops an overall financial plan for customers C. advises customers on the selection of an investment adviser D. advises customers on the selection of a broker-dealer

The best answer is D. A person who advises customers on the selection of a broker-dealer to effect their recommended trades is not an investment adviser. However, a person who recommends other investment advisers to customers can be considered by the SEC to be an investment adviser that must register; as can a person who issues reports about securities (for years, the SEC has chased subscription investment newsletters to register as investment advisers - the newsletters claim that they are excluded under the "general circulation publication" exclusion; the SEC claims that they are not a "general circulation newsletter," but rather are circulated only to those buying their investment advice, and thus they should register!) Finally, anyone developing financial plans for customers for a fee, of which securities investments may be a minor part, is defined as an "investment adviser" that must register.

Oral advisory contracts are NOT permitted under the Investment Advisers Act of 1940

They must be in writing. (Note, however that the "Brochure Rule," under the Investment Advisers Act of 1940, requires delivery of the "Brochure" at, or prior to, entering into either a verbal or written contract, which is contradictory - but this is the rule!). Testimonials are prohibited in investment adviser advertising.

Which of the following persons MUST register as an investment adviser? A. An executor who recommends securities investments for an estate B. A bank trust department that recommends securities investments for its accounts C. A broker-dealer that recommends securities investments to its customers D. A newsletter publisher that makes specific securities recommendations to customers

The best answer is D. Executors of estates are lawyers, and they are excluded from the definition of an investment adviser if they take no separate compensation for rendering advice. Similarly, banks are excluded from the definition, as are broker-dealers that do not charge separately for advice. A person who issues reports about securities is considered to be an investment adviser by the SEC. For years, the SEC has chased subscription investment newsletters to register as investment advisers - the newsletters claim that they are excluded under the "general circulation publication" exclusion; the SEC claims that they are not a "general circulation newsletter," but rather are circulated only to those buying their investment advice, and thus they should register!

In the business of giving investment advice:

To be "in the business" of giving investment advice, 1. this must be a regular activity of the firm or person; 2. the advice must be rendered about securities; and 3. that person must be compensated for giving such advice. Investment advice includes recommendations, analyses, or reports about specific securities or specific categories.

Investment advisers cannot accept fees based on performance unless:

The client has at least $1,000,000 of assets under management or a $2,100,000 net worth. Fixed annual fees, wrap fees, fees based on a percentage of assets under management, and commissions on trades where the adviser has a separate broker-dealer entity, are all permitted compensation items.

Investment Advisers Act of 1940

The federal law, administered by the SEC, that requires investment advisers to mutual funds and advisers who manage $100,000,000 or more of assets to register with the SEC and file reports with the SEC. The other smaller advisers are only required to register with the State, not with the SEC.