Unit 14: Quiz 1
Which of the following statements regarding the handling of discretionary accounts are true? I. Discretionary accounts must be reviewed frequently by the designated supervisory person. II. An investment adviser representative may decide, without discretionary authority, the security to buy or sell and the amount to buy or sell. III. A husband or wife may, at any time, exercise discretionary authority in the spouse's account without specific written authorization. IV. An investment adviser representative may decide, without discretionary authority, the time at which to execute a trade. A) I and IV B) I and III C) II and IV D) II and III
A) I and IV Discretionary accounts must be reviewed frequently by the designated supervisory person, and an investment adviser representative may decide both the time and the price at which to execute a trade without discretionary authority. Only if he is to decide action (whether to buy or sell), asset (what to buy or sell), or amount (how much to buy or sell) is discretionary authority required.
In cases of fraudulent sales practices or advice with respect to securities, which of these are true? I. State securities Administrators may not take enforcement action against federal covered investment advisers. II. State securities Administrators may take enforcement action against federal covered investment advisers. III. State securities Administrators may not take enforcement action against state-registered investment advisers. IV. State securities Administrators may take enforcement action against state-registered investment advisers. A) I and III B) I and IV C) II and III D) II and IV
Ans: D) State securities Administrators have jurisdiction over any securities transaction or investment advice that involves fraud, whether or not the person involved is a federal covered investment adviser. If it involves a security, there are no exemptions from the Uniform Securities Act for fraud.
If an agent has been given limited power of attorney to exercise discretion in an account by the account holder, which of the following statements is true? A) A designated supervisory individual must frequently review the account. B) Each order must receive the prior approval of the agent's manager before it is entered. C) The power of attorney must be renewed annually by the account holder. D) The account holder is not permitted to enter new orders independently.
Answer: A) Explanation All discretionary accounts are subject to frequent review by a designated supervisory individual with the firm. Each order need not receive the prior approval of the agent's manager before it is entered; orders are reviewed after execution. There is no requirement that the power of attorney be renewed annually by the account holder, although some firms make it their policy. The account holder is permitted to enter new orders independently.
An investment adviser with custody of customer funds and securities must send the customer a statement of account activity no less frequently than A) quarterly. B) monthly. C) with every transaction. D) annually.
Answer: A) Explanation An investment adviser in possession of customer assets must send a statement to the customer at least every three months. The statement must list the securities and funds held by the adviser and their location, and it must show all transactions in the account since the last statement date.
The Investment Advisers Act of 1940 addresses the issue of investment advisers (IAs) maintaining custody of client funds and/or securities. In which of the following cases would that act consider the IA to have custody? I. Possession of client funds or securities II. Any arrangement under which the IA is authorized or permitted to withdraw client funds or securities maintained with a custodian upon the IA's instruction to the custodian III. Any capacity that gives the IA or a supervised person legal ownership of or access to client funds or securities IV. Receipt of a check made out to a third party A) I, II, and III B) I and III C) I, II, III, IV D) I and II
Answer: A) One of the things that makes the federal rules on custody different from the USA is that receipt of a check made out to a third party other than the IA is not considered to be custody.
In which of the following situations has the investment adviser not violated the antifraud provisions of the Investment Advisers Act of 1940? A) Linda tells clients the time is right to convert shares of a money market fund to shares of a growth stock mutual fund in the same mutual fund family. Without telling clients, she makes a similar conversion for her own account. B) Jane is affiliated with a broker-dealer but doesn't tell clients that the investment advice she renders is outside the scope of her employment with that broker-dealer. D) Ray's financial plan uses products available through a number of different broker-dealers. Ray intends to act as an agent of a broker-dealer with whom he is associated in implementing only a portion of the plan. He does not make this intention known.
Answer: A) Explanation If advisers intend to implement a plan using only products available from a broker-dealer with which they are affiliated, this fact must be disclosed to clients. If advisers will act as agents of a broker-dealer with which they are affiliated in implementing any part of a plan, this fact must be disclosed. If the investment advice provided is outside the scope of their employment with the broker-dealer with which they are affiliated, this fact must be disclosed. However, advisers are required to disclose trades made for their own accounts only if those trades are designed to profit from the market impact of recommendations or are inconsistent with their advice. In this case, the transaction made for the adviser's own account is consistent with her advice.
When it comes to borrowing and lending money, NASAA's Model Rules prohibit activity that would compromise the objectivity of securities professionals. Which of the following are not prohibited practices? I. A broker-dealer lending money to a client to purchase additional securities II. An agent taking out a car loan from a bank whose branch manager is a client of that agent III. An investment adviser borrowing money from an affiliated broker-dealer IV. An investment adviser lending money to a client to enable that client to maintain the minimum required asset level in the account A) I, II, and III B) I, II, III, and IV C) I and III D) II and IV
Answer: A) Borrowing and lending is generally permitted when the lender is in the business of lending money and when the borrower borrows from someone in the business of lending money. Banks are the most common lenders, but broker-dealers are also in that business. When a client has a margin account, the broker-dealer is lending money to that customer to purchase additional securities. The fact that the bank branch manager is a client of the agent who is borrowing money does not change this situation because the loan is from the bank, not the manager. Loans are also permitted between affiliates.
The Uniform Securities Act prohibits broker-dealers from engaging in activity that has the effect of manipulating stock market prices. These would include: A) churning B) matched orders C) selling unregistered nonexempt securities D) higher than reasonable commissions or markups
Answer: B) Explanation Although all of these practices are prohibited, only matched orders are an attempt to manipulate market prices.
An agent is assisting a prospective client in opening an account. The individual refuses to provide his net worth and annual income. The agent should A) refuse to open the account. B) in the absence of company policy to the contrary, open the account but limit transactions to unsolicited orders. C) seek permission to consult with the client's fiduciary team, including accountants and attorneys, to obtain the financial information. D) proceed with opening the account but limit recommendations to conservative investments.
Answer: B) Explanation An agent must attempt to obtain client financial information. The broker-dealer, through its principals, may decide whether to accept business from a client refusing to provide financial information. In the absence of financial information, neither the firm nor the agent has the means to determine client suitability. Thus, the firm may only accept unsolicited orders from this client.
A customer in a low tax bracket is retired and living on a fixed income. An agent constructs a portfolio consisting of high-yield bonds and small-cap stocks for this customer. If this came to the attention of the Administrator, under the Uniform Securities Act, the Administrator would probably A) force the agent to offer rescission. B) take action against the agent for selling unsuitable investments. C) suspend the agent's license until the bonds mature. D) not take action against the agent.
Answer: B) Explanation: Selling high-yield bonds—bonds with a speculative rating—would not be suitable for an investor with this profile. Nor would small-cap stocks, because their risk level is certainly more than what this investor can accept. Rescission is only an option when a sale is made in violation of the act. No such violation is apparent here. If action was taken and a suitability violation was proven, revocation or suspension could not take place without a hearing.
Under the rules of the Securities Exchange Act of 1934, trading in a client's account would be considered excessive if the agent receives a commission from trading trading is conducted without considering the client's investment objectives trading is inappropriate in view of a client's resources A) II only B) II and III C) I only D) I, II, and III
Answer: B) Trading is considered excessive if the agent induces a client to trade securities in transactions that are excessive in size or frequency in view of the financial resources, investment objectives, and character of the client's account. There is no problem with an agent earning commissions. Churning is when the trading is excessive and leads to unreasonably high commissions.
According to NASAA's Statement of Policy on Unethical or Dishonest Business Practices of Broker-Dealers and Agents, all of the following practices are considered unethical for an agent except A) receiving written discretionary authority from a client within 10 business days of first executing a discretionary trade with oral authority from the client. B) selling 3,000 shares of ABC as directed by a client at a price that the agent determines, without oral or written discretionary authority. C) selling 3,000 shares of ABC at a price the agent determines is the best the client can get, without oral or written discretionary authority. D) determining the quantity of a specific security to purchase once the client has designated that security and the action to be taken.
Answer: B) t is not unethical for an agent to choose time and price of a trade as long as the client has determined the asset, the action, and the amount. Discretionary authority must be received by agents in writing prior to any discretionary trading taking place in the account. Please note that it is investment advisers and their IARs, not broker-dealers and their agents, who are allowed to use oral discretion for the first 10 business days after the initial discretionary trade.
An agent for a broker-dealer member of FINRA may exercise his judgment regarding which of the following without written authorization from the customer? I. Quantity II. Time III. Security IV. Price A) III and IV B) I and III C) II and IV D) I and II
Answer: C) Agents (or any of the other securities professionals) have the authority to decide the timing and price of a trade. Under prevailing securities law, time or price does not constitute discretion. Decisions involving the quantity and security require written trading authorization from the client.
Which of the following would most likely be considered a prohibited practice under the Uniform Securities Act? I. Recommending tax shelters to low-income retirees II. Stating that a state Administrator has approved an offering based on the quality of information found in the prospectus III. Soliciting orders for unregistered, nonexempt securities IV. Employing any device to defraud A) I, II, and III B) I and II C) I, II, III, and IV D) I only
Answer: C) All the choices are prohibited. Recommending tax shelters to low-income retirees is an example of an unsuitable transaction. Stating that an Administrator has approved an offering based on the quality of information in the prospectus, soliciting orders for unregistered nonexempt securities, and employing a device to defraud are all prohibited practices under the USA.
A customer asks an agent for a valuation of his securities portfolio. Because the agent does not want to cause the customer to panic and sell his shares at a loss, the agent inflates the value of the stock. Under the Uniform Securities Act, this action is A) permitted because the agent determined that selling the securities was not suitable B) not permitted because the agent must not attempt to influence the market value of a security C) not permitted because the agent must not deceive the customer by misstating a material fact D) permitted because the agent was not recommending a transaction
Answer: C) An agent must not deceive a customer by misstating a material fact. Furthermore, ethical behavior is not limited to the recommendation of actual trades. However, misinforming the customer does not constitute market manipulation.
If having discretion over $100 million or more in 13(f) securities, which of the following would be exempt from filing Form 13F? A) An investment adviser that manages mutual fund assets B) A natural person who exercises investment discretion over the account of any other natural person or entity C) A natural person who exercises investment discretion over her own account D) A trustee
Answer: C) An institutional investment manager is also a natural person or an entity that exercises investment discretion over the account of any other natural person or entity. For example, an investment adviser that manages private accounts, mutual fund assets, or pension plan assets is an institutional investment manager; so is the trust department of a bank. A trustee is an institutional investment manager, but a natural person who exercises investment discretion over her own account is not an institutional investment manager.
Under both federal and state law, the concept of a discretionary account is defined. It would be considered discretion when an agent A) can decide the specific time at which the transaction will be made. B) makes the decisions in the account once the client assures the agent that the proper authorizations are in the mail. C) picks the specific security that is the subject of a transaction. D) can decide the specific price.
Answer: C) Discretion is the ability to pick the asset (the specific security), the action (buy or sell), or the amount (the number of shares or bonds). Time and price are not discretionary, and nothing can take place until the proper papers have been received and documented.
Which of the following does NOT constitute market manipulation under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents? A) Engaging in transactions that would cause an appearance of increased market activity when no beneficial change of ownership actually occurs. B) Entering numerous buy orders at the close of the trading day to prevent a stock from closing lower. C) Excessive trading in a client's account for the sole benefit of increasing commission income. D) Deliberately responding to a request for a quote with inaccurate information.
Answer: C) Excessive trading for the purpose of increasing commissions is the prohibited practice known as churning, but it is not a form of market manipulation. Intentionally providing inaccurate quotes, creating fictitious volume, and entering orders to prevent a stock from moving up or down are forms of market manipulation.
One business succession issue that applies to virtually all investment advisers is A) permanent disability of a member of the board of directors. B) departure of a partner holding a majority interest. C) loss of the designated regulatory contact person. D) death of the sole proprietor.
Answer: C) Explanation All investment advisers must have a designated regulatory contact person. Only sole proprietorships are affected by the death of that sole person. Disability or death of a member of the board of directors will probably have no effect on succession, and only partnerships are concerned with a partner (of any size) leaving.
Which of the following is true regarding the antifraud provisions of the Uniform Securities Act? A) They prohibit fraud only in connection with securities transactions. B) They apply only to investment advisers who are registered under the act. C) A failure to adequately disclose material information to a client would violate these provisions. D) They prohibit the receipt of both fees and commissions on transactions that result from advisory recommendations.
Answer: C) A failure to adequately disclose material information to a client would violate these provisions. Explanation The antifraud provisions prohibit a failure to disclose material information, as well as misstatements of fact and deceptive practices. An investment adviser is not exempt from the antifraud provisions even if exempt from registration.
Which of the following statements are true of a discretionary account at a broker-dealer? I. It must be approved by a designated supervisory individual of the firm. II. It must be reviewed frequently to minimize the chances that the account has been churned. III. A discretionary order may be placed once the customer has placed a power of attorney in the mail. It must be approved by the Administrator of the state of residence of the client. A) II and IV B) III and IV C) I and II D) I and III
Answer: C) I and II A new discretionary account must first be approved by a designated supervisory person, and the account must be reviewed frequently for suitability and avoidance of churning. The written discretionary power must be "in hand," not in the mail, before discretion may commence.
Under the Uniform Securities Act, when may an investment adviser legally have custody of money or securities belonging to a client? I. If the Administrator has not prohibited this practice II. If the investment adviser has notified the Administrator that it has custody III. Only as long as the adviser does not also have discretionary authority over the account Answer: A) I only B) I and III C) I and II D) II and III
Answer: C) I and II The Administrator may prohibit advisers from having custody of client securities or funds. If no such prohibition applies, the Administrator must be notified in writing that the adviser has custody. There is no relationship between having discretion and having custody. An investment adviser can have either, both, or none.
A federal covered investment adviser would like to charge a client a performance fee based on a selected benchmark. The client has $400,000 invested with the adviser but has a net worth of $2,250,000, of which $350,000 represents an investment account, 50% of which is shared with his cousin. Which statement is true? B) Because the total of the amount invested with the adviser ($400,000) plus the individual's personal net worth ($1.8 million without counting the joint property) exceeds $2 million, this client has the necessary net worth to qualify for a performance-based compensation program. C) Because the client's 50% share of the investment account is only $175,000, this client does not qualify for a performance-based compensation program. D) Because we can allow none of the jointly held property, this client does not have the necessary net worth to qualify for a performance-based compensation program.
Answer: D) Explanation Under federal (and state) law, in order to qualify for a performance-based compensation program, the client must have either $1.1 million in assets managed by the adviser or a net worth in excess of $2.2 million. This requirement is described in Rule 205-3 of the Investment Advisers Act of 1940, and the NASAA Model Rule makes reference to the federal rule. If using joint assets, only those with a spouse are allowed. Please note that this differs from meeting the net worth standard as an accredited investor. Under Rule 501 of Regulation D of the Securities Act of 1933, one can use assets owned jointly with persons other than a spouse to qualify as an accredited investor, but only to the extent of the percentage ownership of the account or property.
An investment adviser runs an advertisement in the business section of the local newspaper. The ad describes the nature of the firm's model portfolio and indicates that it has outperformed the overall market by 800% over the past 10 years, and the firm therefore guarantees that clients will more than keep pace with inflation. At the bottom of the ad, in smaller print, is the following statement: "Results are not guaranteed. Past performance is not indicative of future results. These results are not normal and cannot be expected to be repeated." This is an example of A) a wrap fee account. B) a properly worded disclaimer. C) a violation of an investment adviser's fiduciary responsibility. D) an improper hedge clause.
Answer: D) Hedge clauses may not be used to disclaim statements that are inherently misleading.
The NASAA Model Rule on Custody Requirements for Investment Advisers requires that an adviser with custody of client funds or securities do all of the following except A) submit an audited balance sheet to the Administrator with Part 2A of Form ADV each year. B) deposit client funds into separate accounts and provide written notice to clients about the location of their assets. C) submit to an annual surprise audit conducted by an independent accountant. D) send monthly account statements to clients.
Answer: D) Investment advisers with custody must send statements to clients on a quarterly basis.
An investment adviser affiliated with a broker-dealer would be considered to be maintaining custody when A) receiving performance-based compensation. B) having the power to make buy-and-sell decisions in an account. C) charging fees on an hourly basis. D) receiving a check made payable to that broker-dealer.
Answer: D) Under the NASAA Model Rule on Custody Requirements for Investment Advisers, when an investment adviser (IA) uses an affiliated broker-dealer as its qualified custodian, the IA is considered to be maintaining custody. Therefore, receipt of a check made payable to the broker-dealer is acceptable (it does not have to be forwarded). Discretion is not custody, and the method of compensation has nothing to do with custody. Don't confuse that with the case where the IA can debit the client's account for fees—that would be custody; whether the fees are hourly, performance based, or any other method is not related to custody.
MaryBeth is an agent with QuickTrade Securities, a subsidiary of QuickLoan Bankcorp, which is a holding company that also owns QuickIssue Capital Markets, an underwriter specializing in bringing new issues to market. Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, MaryBeth would be permitted to split commissions resulting from securities transactions with any of the following individuals except A) an agent registered with QuickIssue Capital Markets. B) the principal supervising her activities at QuickTrade Securities. C) another agent registered with QuickTrade Securities. D) an agent properly registered with USATrade Securities.
Answer: D) Under the NASAA policy, in order to split commissions, both individuals must be licensed as agents with either the same broker-dealer or ones under common control (ownership). What about sharing with your principal? Why not? In fact, many managers (principals) have commission overrides as a fundamental part of their compensation package. Remember, under the Uniform Securities Act, there is no separate principal registration as there is with FINRA; all principals are registered as agents (or IARs, as the case may be), just the same as you.
Under the NASAA Model Rule on Custody Requirements for Investment Advisers, an investment adviser who has custody of clients' securities or funds must do which of these? I. Keep funds deposited in accounts containing only client funds. II. Be subject to a surprise audit performed at least annually by an independent accountant. III. Send clients statements at least once every three months showing balances. A) II and III B) I and II C) I and III D) I, II, and III
Answer: D) When advisers have custody of clients' securities or funds, they must abide by the following rules: 1. Securities must be segregated and identified by clients and kept safe. 2. Client funds must be deposited into bank accounts that contain only the client funds, and the adviser must be named trustee. 3. Records of all funds, securities, and transactions affecting clients' accounts must be kept. 4. Clients must be sent notice of the location of funds and securities and any changes that take place there. 5. Clients must receive a quarterly statement showing all funds and securities in the adviser's possession and any transactions that have taken place. 6. The adviser must arrange for a surprise audit by an independent public accountant of all securities and funds in the adviser's custody each year.
Which of the following statements regarding an agent's authority to place orders for a client's account under NASAA's Statement of Policy on Unethical or Dishonest Business Practices of Broker-Dealers and Agents is true? A) Written approval from the client authorizing a stated amount of a specified security is required before placing an order. B) The agent may, without the client's approval, place a sell order for the purpose of avoiding losses but may not place a buy order without the client's authorization. C) The agent is not required to obtain authorization to place orders for a client's account unless a conflict of interest is involved. D) The client's oral approval is sufficient for a specific order.
Answer: D) Explanation Oral approval from the client authorizing a stated amount of a specified security is sufficient to place an order. An agent must receive authority to place orders for a client, whether or not there is a conflict of interest. Written approval from the client authorizing a stated amount of a specified security is not required before placing the order. However, written authority is necessary for the agent to exercise discretion in the account.
If an agent is assigned to an account previously handled by an agent who has since left the firm, which of the following actions should the agent take first? A) Suggest the customer buy one of the stocks the firm is currently recommending. B) Liquidate the portfolio for immediate reinvestment in stocks the firm is currently recommending. C) Require the customer to sign a trading authorization naming the agent as the party with authority. D) Verify the account information.
Answer: D) verify the account information The agent must verify and update client information before recommending trades. Without knowledge of the client's needs and financial profile, the agent cannot make suitable recommendations.
Fraud would include the willful omission of A) a material fact, but only one that might be pertinent to making an investment decision. B) the public offering price in a preliminary prospectus. C) any material fact. D) any fact.
C) In order for the action to be fraud, it must be willful. But not all willful acts are fraudulent, depending on what is and is not a material fact. Material facts are those that a potential investor uses to make an investment decision. Nonmaterial facts may be omitted because they don't affect the selection process. If they are not pertinent, they are not material. The preliminary prospectus (red herring) does not include the public offering price, so there is nothing being omitted.
