Unit # 7: Ethical Practices and Fiduciary Obligations
The Administrator may, by rule, A) forbid investment advisers registered in that state from taking custody of client funds B) suspend the registration of a federal covered adviser because the contract did not meet the requirements for a state-sanctioned investment advisory contract C) suspend federal law if the Administrator believes it to be in the public interest D) allow an agent to waive provisions of the USA
A) forbid investment advisers registered in that stated from taking custody of client funds. *The Administrator has considerable discretion to make rules or issue orders. Specifically, the USA allows the Administrator to prohibit custody by rule. However, the USA does not allow the Administrator to waive provisions of the USA, nor can the Administrator suspend federal law. The NSMIA took away the power of the states to regulate federal covered advisers except in the case of a violation of the antifraud statutes.
Under the Investment Advisers Act of 1940, it is legal for an investment adviser to 1. rebate the commission on a mutual fund sale to a client who has already paid a fee for investment advice 2. keep the commission on a mutual fund sale when the client who purchased the shares has already paid for investment advice 3. reduce a client's advisory fee by any commissions earned on mutual fund sales to that client A) I and III B) II and III C) I and II D) I, II, and III
B) 2 & 3 *Rebating commissions on mutual fund sales is prohibited. However, because mutual fund commissions are not negotiable (as are secondary market transactions), the adviser may reduce the client's advisory fee by the commission or, with appropriate disclosure, keep the commission.
Without prior authorization from the client, an investment adviser could release information relating to the client's account 1. in order to comply with the brochure delivery requirements of the USA 2. when requested by the IRS as part of litigation against the client 3. for the purpose of furnishing information for a statistical survey being compiled by the Administrator 4. upon the receipt of a subpoena from a court of competent jurisdiction A) I, III, and IV B) II and IV C) II and III D) I, II, III, and IV
B) 2 & 4 *Without the prior consent of the client, an IA may disclose information relating to specific accounts only when requested by the IRS or by court order.
Why do matched orders result in painting the tape? A) Matched orders will appear on the OTC Link. B) The phony trades make the stock appear more frequently on stock tickers. C) Matched orders are generally executed outside of normal trading hours. D) Matched orders generally result in meaningful profits for such traders.
B) The phony trades make the stock appear more frequently on stock tickers *A matched order is an order to buy or sell securities that is entered with knowledge that a matching order on the opposite side of the transaction has been or will be entered for the purpose of (1) creating a false or misleading appearance of active trading in any publicly traded security or (2) creating a false or misleading appearance with respect to the market for any such security.
As long as properly disclosed, a broker-dealer would be permitted to charge a fee for all of these EXCEPT A) wiring funds to the client's bank B) issuing a stock certificate C) solicitation of proxies D) annual maintenance fees
C) solicitation of proxies *Broker-dealers are not permitted to charge for soliciting proxies—the issuer is responsible for reimbursing the broker-dealer for any of its expenses. All of the other charges are permitted if fully disclosed to clients. This is a case where you answer the question correctly because you know the other choices are permitted charges.
If an agent recommends the purchase of a technology company with an impressive growth record, but fails to inform the client that the company's technology will become obsolete pending the approval of a competitor's patent, the agent has A) not committed a prohibited business practice B) committed a prohibited business practice by selling an unsuitable investment C) violated the NASAA Statement of Policy of Dishonest or Unethical Business Practices of Broker-Dealers and Agents D) not violated the NASAA Statement of Policy of Dishonest or Unethical Business Practices of Broker-Dealers and Agents because no untrue statements were made
C) violated the NASAA State of Policy of Dishonest or Unethical Business Practices of Broker-Dealers and Agents. *The agent has violated the NASAA Statement of Policy of Dishonest or Unethical Business Practices of Broker-Dealers and Agents by failing to inform the client of the potential downside in the sale of a security.
It would not be considered a prohibited or unethical business practice for an investment adviser to A) pay a nominal fee, based on account size, to certain professionals as a form of thanking them for client referrals B) charge a performance-based fee to an individual who meets the SEC's accredited investor standard detailed in Rule 501 of Regulation D C) use a testimonial from a bona fide client with the proper caveat that this individual's results may not be typical and it is possible they may not be reproduced in the future D) pay a nominal fixed fee to certain professionals as a form of thanking them for client referrals
D) Pay a nominal fixed fee to certain professional as a form of thanking them for client referrals. *Referral fees (not cash fees for full-time soliciting) may be paid to certain professionals (lawyers, accountants, insurance agents, and so forth) as long as the fee is both a nominal amount (up to several hundred dollars) and is the same amount for any referral. That is, it is not based on the size of the account. In order to charge a performance-based fee, investors must have a net worth in excess of $2.1 million while they can meet the accredited investor standard when their net worth exceeds only $1 million. Finally, under both state and federal law, investment advisers may never use testimonials from clients, even with disclaimers.
If an agent misrepresents the price of a customer's stock by $10 per share to encourage the client to sell, this activity is A) allowed if the agent views the difference as a service charge B) a misrepresentation but not a fraudulent act C) allowed if the customer ultimately makes a profit in the account D) a misrepresentation and a fraudulent act
D) a misrepresentation and a fraudulent act. *The agent has committed a fraudulent act by willfully misrepresenting the value of the stock to encourage the customer to sell a security.
An agent made written disclosure to his employing broker-dealer that he intends to execute a series of private securities transactions with clients who do not have accounts with his broker-dealer. The agent did not acquire express written permission from the broker-dealer and did not receive compensation for executing the transactions, but did receive written acknowledgment of receipt of the agent's notice. In this case, the agent A) engaged in an agency cross transaction B) performed a matched trade as permitted under the rules C) is required to register as a broker-dealer D) is guilty of selling away
D)is guilty of selling away *When selling securities, agents are prohibited from enacting transactions that are not recorded on the broker-dealer's books unless the transactions are authorized in writing by the broker-dealer prior to execution. Failure to do this is known as selling away. Receipt of notification is not the same as authorization.
Unless an exemption applies, under the Investment Advisers Act of 1940, an investment adviser is required to A) furnish a statement of the total dollar amounts of securities bought and sold each year to customers B) furnish an audited balance sheet each year to customers for whom the advisor maintains custody C) maintain a bond for an amount based on the assets under management D) provide each advisory client with a brochure or a summary of material changes within 120 days of the end of its fiscal year
D)provide each advisory client with a brochure or a summary of material changes within 120 days of the end of its fiscal year *When the same security is recommended to all or most of an IA's clients, the regulators considered this to be an unethical practice known as "blanket recommendations" because the same security will almost never be suitable for everyone.
When it comes to safeguarding confidential information pertaining to the account(s) of an individual customer or family, the rules deal primarily with what is called a covered account. A key factor in determining if an account meets the definition is A) that the account is in the name of an institutional customer B) the ability of the customer to make a one-time wire to a foreign bank account owned by a family member C) if the customer owns the underlying security on which the call option is sold D) the ability of the customer to move funds out of the account on multiple occasions
D)the ability of the customer to move funds out of the account on multiple occasions *A covered account is an account, primarily for personal, family, or household purposes, that involves or is designed to permit multiple payments or transactions. Where the money goes is less of a factor than the frequency of transactions. The only time when a single transaction account might be covered is if there is reason to believe that the identity of the customer is at risk—not likely when wiring to a family member. Institutions are not included in the definition and owning the stock underlying the sale of a call option means the option is covered—totally different from the topic here.
Under the Investment Advisers Act of 1940, an adviser who has custody of a client's funds must 1. notify a client when the client's funds are moved to another location 2. segregate client's funds and keep them identified by client 3. not move the client's funds without prior notification and specific written authority from the client A) I and II B) I, II, and III C) I and III D) II and III
A) 1 & 2 *Advisers who have custody must segregate a client's securities and keep them in a safe place, deposit client funds in bank accounts that contain only client funds (may be combined in one account, but complete records must be kept), report to clients at least every 3 months with a statement, and annually arrange for an unannounced audit by an independent accountant that will report the audit results to the SEC. All clients must be notified in writing of the location of their securities or funds and of any changes to the location. It is not necessary to notify the client before the move to obtain the client's specific written authority to move the fund. The original custodial agreement includes that authority at the discretion of the adviser.
As an investment adviser, you feel that RAN common stock is an appropriate addition to the portfolio for several of your clients. You enter an order to purchase 1,000 shares and receive two 500-share confirmations, but they are not at the same price. Which of the following is the proper procedure for you to follow? A) Allocate using the average of the two prices B) Allocate using the random selection method C) Allocate the lowest price shares to those clients with the greatest amount of assets under management D) Allocate the lowest price shares to those clients who have been with you the longest.
A) Allocate using the average of the two prices. *This is the only fair thing to do.
Section 28(e) of the Securities Exchange Act provides a safe harbor for certain soft dollar compensation extended from broker-dealers to investment advisers. Which of the following is most likely to be included in that safe harbor? A) Bespoke software designed to give clients access to asset allocation programs B) Use of vacant office space in the broker-dealer's facilities C) Desks remaining after the broker-dealer re-designed its office D) Meal expenses to attend an investment seminar sponsored by the broker-dealer
A) Bespoke software designed to give clients access to asset allocation. *Among the items generally in the safe harbor are those items designed to assist the firm's customers. Customized software that helps clients would be acceptable. Although seminar registration expenses are in the safe harbor, travel and transportation expenses, such as meals and lodging, are not. Rent and office furniture are specifically listed as out of the safe harbor
All of the following industry violations would probably constitute fraud EXCEPT A) charging unreasonable commissions B) omitting material facts in the offer/sale of securities C) inaccurate market quotations D) misrepresentation of the status of a client's account
A) Charging unreasonable commissions *Charging an unreasonable commission (or markup or markdown) is a prohibited practice, but it is not considered fraud. It would be fraudulent to make inaccurate statements regarding the amount of commission being charged, such as, when acting as a principal, telling the customer that there was no commission being charged when, in fact, there is a markup or markdown built into the price.
Centripetal Investment Advisers (CIA) has its principal office in State X and is also registered in States Y and Z. CIA would be considered to be maintaining custody of client assets in all of the following cases EXCEPT A) checks made out to 3rd parties are forwarded within 3 business days B) CIA's advisory contract calls for the automatic deduction of advisory fees C) CIA has a power of attorney granting authority to withdraw funds from the custodian D) checks made out to CIA are deposited within 3 business days
A) Checks made out to 3rd parties are forwarded within 3 business days *When a check made payable to a 3rd party is received by the investment adviser, it will not be deemed to be custody under the Uniform Securities Act if the check is forwarded within 3 business days. When a check is made payable to the investment adviser, it must be returned to the sender within 3 business days or it will be considered maintaining custody. Authority to withdraw funds or securities from the custodian or automatic deduction for fee payments are forms of custody.
Under NASAA's Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, which of the following is NOT considered when determining excessive trading in a client's account? A) Length of association with the agent B) Client's financial status C) Character of the account D) Investment objectives of the client
A) Length of association with the Agent. *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, the agent has engaged in unethical conduct. Remember, the suitability provisions of NASAA's policy require that, before making recommendations, agents make reasonable inquiry as to the client's financial situation, investment objectives, and needs. The recommendation must be suitable in light of any information known to the agent. The length of association with the agent is not relevant to these requirements.
Ditherton, Wiggleman, and Jones, LLC, is an investment adviser with $2 billion in AUM. In appreciation for the large volume of brokerage transactions directed their way, Alexander Wimpton and Sons, Members of the NYSE, offer to send Mr. Ditherton on an all expense trip to Zurich to attend a seminar covering the latest developments in global investing. Under Section 28(e) of the Securities Exchange Act of 1934, A) Mr. Ditherton could attend, but only if he paid all of the expenses except for those direct costs of the seminar B) Mr. Ditherton could not attend because the safe harbor under Section 28(e) only applies to domestic events C) Mr. Ditherton could attend because attendance at a business-related seminar such as this falls under the safe harbor provisions of Section 28(e) D) Mr. Ditherton could attend, but only if he paid the direct costs of the seminar and let Wimpton and Sons take care of the transportation costs
A) Mr. Ditherton could attend, but only if he paid all of the expenses except for those direct costs of the seminar *Section 28(e) provides a safe harbor for soft dollar compensation from broker-dealers to investment advisers. Included is covering the registration fees of seminars related to the adviser's business. However, all transportation and personal expenses must be paid by the investment adviser.
An investment adviser representative, who also receives commissions as an agent at a brokerage firm, has opened an account with a client whose net worth is $200,000. The customer wants the account aggressively traded and wishes the investment adviser to be compensated based on the account's performance. In this account, payment on a performance basis is A) not permissible B) permissible if the customer's net worth is a minimum of $1 million C) permissible D) permissible with approval from the agent's supervisor and written permission from the customer at the time the account is opened
A) Not permissible *It is not permissible to trade this account on a performance basis; the investment adviser representative must be paid on commission or through a fixed-fee arrangement. Under the Investment Advisers Act of 1940, performance fees are allowed only for clients with a minimum of $1 million invested or a minimum net worth in excess of $2.1 million.
Plenitude Premier Solutions (PPS) is registered in State C. If PPS wished to maintain custody of client funds or securities, A) prompt notice would have to be given to the State C Administrator on Form ADV. B) notice is given to the State C Administrator as part of the annual updating amendment. C) prompt notice would have to be given to the State C Administrator in a private letter. D) permission would have to be obtained from the State C Administrator
A) Prompt notice would have to be given to the State C Administrator on Form ADV. *It is unlawful for an investment adviser, registered or required to be registered in a state, to have custody of client funds or securities unless the investment adviser notifies the Administrator promptly in writing on Form ADV that the investment adviser has or may have custody.
Rachel is an agent registered with a broker-dealer in this state. It would prohibited for her to A) solicit sales of a security whose registration is not yet effective B) execute a transaction in a discretionary account after having received the necessary documentation C) share in the profits and losses in a client account without a financial contribution to the account D) disclose to a client that a transaction in a thinly traded stock will result in a higher-than-normal commission
A) Solicit sales of a securities whose registration is not yet effective. *Until a security's registration is effective, no soliciting may take place. Once the proper documents have been received, discretionary trading may begin. In general, transactions in thinly traded stocks (those with little market activity) will involve higher-than-normal commissions to cover the higher costs. As long as consent has been granted by the client and the employing broker-dealer, an agent may share in the profits and losses in the client's account without the need to make a financial contribution to the account.
An income-oriented customer has a discretionary account with an agent. If the agent purchases speculative growth stock on behalf of the customer, under the Uniform Securities Act, this is considered A) an unsuitable transaction B) an acceptable transaction C) a matching activity D) a wash trade
A) an unsuitable transaction *Income-oriented clients authorize their agents to buy income-producing securities, not speculative securities. Purchasing speculative securities would be considered an unsuitable transaction and inconsistent with the account's objectives.
You are an IAR. One of your clients is a C level officer with a publicly traded corporation. When needing to relieve yourself, you are shown to the executive washroom. While cleaning up, you notice a report, stamped "Confidential" and a quick peek reveals that it is highly favorable to the company. Under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, you A) cannot buy any of the stock for personal or client accounts B) should tell your client what you saw and ask permission to act on this information C) contact the Administrator immediately D) can accept unsolicited orders from clients and buy for your personal account only
A) cannot buy any of the stock for personal or client accounts *This is a case of "accidentally" acquiring material, inside, nonpublic information. Under no circumstance are you permitted to make any use of this until the report is made public. However, you may accept unsolicited customer orders (unless they were in the washroom with you), but you can't do anything for yourself.
An investment adviser affiliated with a broker-dealer would be considered to be maintaining custody when A) receiving a check made payable to that broker-dealer B) receiving performance-based compensation C) charging fees on an hourly basis D) having the power to make buy-and-sell decisions in an account
A) receiving a check made payable to that broker-dealer *Under the NASAA Model Rule on Custody Requirements for Investment Advisers, when an investment adviser uses an affiliated broker-dealer as its qualified custodian, the adviser is considered to be maintaining custody. Therefore, receipt of a check made payable to the BD 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—but whether the fees are hourly, performance-based, or any other method is not related to custody.
One of your very best clients introduces you to his son and then, one week later, is injured in an accident and is totally paralyzed and unable to speak. The son calls you and enters an order for his father's account that is entirely consistent with your client's trading habits. As an agent, you would A) refuse the trade without a signed power of attorney B) visit your client in the hospital and ask him to squeeze your hand if he wishes to go ahead with the trade C) follow the son's instructions D) act in accordance with the client's last will and testament
A) refuse the trade without a signed power of attorney *Nothing takes place in an account without instructions from the client or someone else with written trading authorization. Nothing in the question indicates that the son has trading authority. There is no will yet because the client is still alive.
An IAR concludes a successful meeting with a client by receiving oral authority to begin exercising discretion in the client's account. The IAR leaves the appropriate paperwork with the client and urges him to return it in the postage paid envelope as soon as possible. After returning to the office, the IAR enters the first discretionary order for this account, a purchase of $10,000 of CANCO common stock. Six days later, CANCO reports that it is going to miss its earnings estimates and the stock begins to fall. The IAR realizes that the best thing to do for the client is take the loss and get out before it gets worse, but the client has not yet returned the signed paperwork. In this case, A) the IAR may exercise his discretion as authorized and sell the CANCO B) the IAR has acted improperly from the outset by making the purchase prior to receiving the signed paperwork C) the investment adviser firm should apply to the Administrator for an extension of time D) the IAR must wait for the signed paperwork to be received
A) the IAR may exercise his discretion as authorized and sell the CANCO *Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, oral discretionary authority is permitted to be used in a customer's account for the first 10 business days after the date of the first transaction. Following that 10 days, the rule requires written authorization to be on hand for any future discretionary trading.
Following the advice of its portfolio managers, the Rising Tide hedge fund executes most of its securities transactions through Momentum Securities, a registered full-service broker-dealer. In order to compensate for the commissions charged, Momentum Securities allows employees of Rising Tide to use its furniture and facility at a discounted rate. Under the soft-dollar provisions of Section 28(e), A) this would not fall under the safe harbor B) this would not fall under the safe harbor provisions unless the employees were those who directed the transactions to Momentum Securities C) this would fall under the safe harbor D) as long as the discounted rate reflected the volume of business done by Rising Tide, this would be permitted
A) this would not fall under the safe harbor
ABC Advisers, Inc., a federal covered investment adviser is a wholly owned subsidiary of ABC Corporation, a holding company that also owns ABC Securities, a full-service broker-dealer that is a member of the New York Stock Exchange and FINRA. One of the clients of ABC Advisers calls his IAR to explain that he has just received a margin call in his ABC Securities account. Under these circumstances, it would NOT be prohibited for the IAR to use securities owned in the advisory account to obtain a loan for this client A) because the 2 firms are affiliated B) because ABC Advisers, Inc. is in the money lending business C) if the client agreed to repay the loan within 30 days D) when the client has furnished ABC Advisers, Inc., with a proper discretionary trading authorization
A)because the 2 firms are affiliated *In most cases, the only money lenders on the exam will be banks and broker-dealers. If an advisory client receives a margin call from activity in his brokerage account, securities owned in the advisory account may be used by the affiliated broker-dealer to meet the margin deficiency.
When it comes to borrowing and lending money, the Uniform Securities Act (USA) prohibits activity that would compromise the objectivity of securities professionals. Which of the following is (are) NOT a prohibited practice(s)? 1. A broker-dealer lending money to a client to purchase additional securities 2. An agent taking out a car loan from a bank whose branch manager is a client of that agent 3. An investment adviser borrowing money from an affiliated broker-dealer 4. An investment adviser lending money to a client to enable that client to maintain the minimum required asset level in the account A) I and III B) I, II, and III C) I, II, III, and IV D) II and IV
B) 1, 2, & 3 *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.
An agent for a broker-dealer member of FINRA may exercise his judgment as to which of the following without written authorization from the customer? 1. Quantity 2. Time 3. Security 4. Price A) I and II B) II and IV C) III and IV D) I and III
B) 2 & 4 *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.
Protection of the investing public is one of the major objectives of the SEC. Much of the protection comes from the disclosure requirements enveloping the industry. Among the disclosure forms used is Form 13F. To come under the SEC's requirement to file a Form 13F, an institutional manager must have discretion over A) a portfolio of at least $100 million B) a portfolio of at least $100 million of 13(f) securities C) more than 10% of the outstanding voting securities of a reporting company D) a portfolio of at least $50 million
B) A portfolio of at least $100 million of 13 (f) securities. *An institutional money manager, with at least $100 million in 13(f) securities under discretionary management, is required to file Form 13F. This form must be filed within 45 days of the end of the quarter.
A risk-averse investor wants to invest in Treasury securities. The investor's agent recommends Treasury notes, pointing out that federal government-backed securities are default-free securities not subject to interest rate risk. In the above situation, the agent has acted A) properly because Treasury notes are suitable for a risk-averse customer and are free of all investment risk B) fraudulently because the agent failed to disclose that the investment carries interest rate risk C) fraudulently because Treasury notes are unsuitable for a risk-averse customer D) properly because Treasury notes carry no risk of principal default
B) Fraudulently because the agent failed to disclose that the investment carries interest rate risk. *Although Treasury securities (such as T-notes issued by the federal government) do not carry default risk, the customer who buys them bears interest rate risk because the value of the notes will fall if interest rates rise. The agent has acted fraudulently in not disclosing this risk to the customer.
A fiduciary, acting in accordance with the UPIA, would choose investments on the basis of all of the following EXCEPT A) other resources of the beneficiaries B) transaction costs C) needs for liquidity, regularity of income, and preservation or appreciation of capital D) general economic conditions
B) Transaction Costs *Under the Uniform Prudent Investor Act, transaction costs are not a primary factor in a trustee's determination of which investments to choose for the trust. They may be a factor in determining where to execute the transactions. The key for the prudent investor is to use skill and caution examining all of the factors involved to meet the stated objectives.
All of the following statements concerning an agency cross transaction for an advisory client are true EXCEPT A) it is a transaction in which a person acts as an investment adviser in relation to a transaction in which the adviser or related person acts as a broker-dealer for both the advisory client and another person on the other side of the transaction B) an investment adviser may recommend the transaction to both parties to the transaction C) an investment adviser must make prior written disclosure to the advisory client that it will act as broker-dealer for, have a potential conflict of interest with, and may collect commissions from both parties D) an advisory client must provide prior written consent for the adviser to be able to engage in agency cross transactions
B) an investment adviser may recommend the transaction to both parties to the transaction *The investment adviser handling an agency cross transaction may not recommend the transaction to both parties. An agency cross transaction is a transaction in which a person acts as an investment adviser in relation to a transaction in which the adviser or related person acts as a broker-dealer for both the advisory client and another person on the other side of the transaction. An advisory client must provide prior written consent for an adviser to be able to do agency cross transactions as part of his operating plan. An investment adviser must make written disclosure to the advisory client that it will act as broker-dealer for, have a potential conflict of interest with, and may collect commissions from both parties.
The prohibited practice of an investment adviser placing the same security in the accounts of all of the firm's clients is known as A) matched orders B) blanket recommendations C) churning D) discretionary misrepresentation
B) blanket recommendations *When the same security is recommended to all or most of an IA's clients, the regulators considered this to be an unethical practice known as "blanket recommendations" because the same security will almost never be suitable for everyone.
A federal covered investment adviser may enter into a contract with a client that provides for performance-based compensation under all of the following conditions EXCEPT A) the client must meet certain minimum financial standards B) disclosure that the performance compensation may create an incentive for the adviser to take greater risks C) the formula used to calculate compensation includes realized capital losses and unrealized depreciation D) compensation is based on gains, less losses, for a period of no less than 1 year
B) disclosure that the performance compensation may create an incentive for the adviser to take greater risks. *Because these types of compensation agreements may only be entered into with clients meeting minimum financial standards, the SEC assumes that clients understand the increased risks they are being exposed to. The minimum net worth requirement is over $2.1 million, or a client is qualified if he has at least $1 million under management with the adviser. Any performance fee must take into consideration gains and losses, both realized and unrealized, and the performance period must be no less than 1 year.
One of the major differences between identity theft and physical theft is that in the case of identity theft, A) the cost of the damages is generally much less B) it might not be discovered for some time C) the victim can usually correct the problem much more quickly than with physical theft D) unless hospitalization is required, law enforcement is generally unconcerned about identity theft
B) it might not be discovered for some time *With identity theft, it might be months before you are aware that your identity has been stolen. This is unlike physical theft, where you are there at the time of the mugging or see the results when returning home to find your place has been burgled. Clearing up cases of identity theft can take a very long time, and the amount of money involved can be staggering.
If a new customer opens an account with a broker-dealer and tells the agent to buy investments at his discretion, before engaging in any transactions in the account, the agent must A) have the customer supply letter of credit from a bank B) receive a written discretionary power from the customer C) designate which investments will be purchased D) register as an investment adviser
B) receive a written discretionary power from the customer. *Because the agent will be acting with discretion, a written power of attorney must be obtained from the customer before transactions can occur. This power is called discretionary power.
Mary is a bowling buddy of Susan, a covered investment adviser. Mary refers Amanda, a wealthy widow, to Susan, and after a very pleasant meeting, Amanda places $15 million under management with Susan. If Susan were to give Mary a cash payment for the referral, A) both Susan and Mary would have to disclose the cash payment to Amanda B) she would be engaging in an prohibited practice C) only Susan would have to make disclosure to Amanda D) she would have to obtain Mary's permission first
B) she would be engaging in a prohibited practice *Although there are circumstances under which cash payments may be made to solicitors, none of the required conditions found in the Investment Advisers Act of 1940 appear to be met here. A formal written agreement must be in effect, not just a one-time reward.
An investment adviser prepares a slick advertising piece containing the relevant information from the firm's Form ADV - Part 2. One of the firm's IARs secures a contract with a new client and presents the brochure at that time. While explaining the terms of their agreement, the IAR mentions that the client may withdraw within the first 48 hours without any penalty. Upon returning to the office, the IAR realizes that he forgot to have the client sign a receipt for the disclosure document. Under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, A) there is a violation because the brochure must be delivered at least 48 hours prior to entering into the contract. B) the IAR has acted in an unethical manner by giving incorrect information regarding the penalty-free withdrawal privilege C) there is no violation as long as the customer signs a waiver agreeing to these terms. D) there is a violation because the IAR failed to obtain the signed receipt.
B)the IAR has acted in an unethical manner by giving incorrect information regarding the penalty-free withdrawal privilege *The problem here is that the client has 5 days to withdraw, not 48 hours. Under Rule 203(b)-1 of the Uniform Securities Act, an investment adviser, or investment adviser representative must deliver the brochure to an advisory client or prospective advisory client not less than 48 hours prior to entering into any investment advisory contract with such client or prospective client; or at the time of entering into any such contract, if the advisory client has a right to terminate the contract without penalty within 5 business days after entering into the contract. A signed receipt is not necessary and waivers are never allowed.
Under the USA, all of the following statements are true regarding investment advisory contracts EXCEPT A) they must be in writing B) they cannot allow for prepaid advisory fees C) they cannot be assigned without customer approval D) they can only allow fees to be performance related under certain limited circumstances
B)they cannot allow for prepaid advisory fees *Nothing in the USA prohibits prepaid advisory fees. The contract must describe the nature of these fees and the circumstances, if any, under which any or all of the prepaid fee may be returned in the event of early cancellation of the contract. The USA requires initial and renewal contracts to be in writing and state that assignment may take place only with the client's consent. There are certain circumstances, such as an investor with a net worth of at least $2 million, where performance-based fees are permitted.
An investment adviser representative of a federal covered investment adviser that provides advisory services to State A would not trigger the "pay-to-play" prohibition against the firm receiving compensation from that state for advice as long as the IAR contributed no more than A) $500 per election cycle for a candidate that IAR was eligible to vote for B) $350 per election cycle for a candidate that IAR was ineligible to vote for C) $350 per election cycle for a candidate that IAR was eligible to vote for D) $250 per election cycle for a candidate that IAR was ineligible to vote for
C) $350 per election cycle for a candidate that IAR was eligible to vote for *There is a de minimis level that is considered an exception from the pay-to-play restriction on investment advisers for political contributions. If the covered employee can vote for the person, the maximum contribution is $350 per election cycle. If the covered employee cannot vote for the person, the maximum contribution is $150 per election cycle.
If a federal covered investment adviser intends to pay a third party solicitor to solicit clients for investment advisory services, which of the following must be TRUE? 1. The solicitor must be a registered investment adviser representative with the state. 2. The registered investment adviser must be properly registered as an investment adviser under the Investment Advisers Act of 1940. 3. There must be a separate written agreement between the solicitor and the registered investment adviser. 4. The agreement between the solicitor and the registered investment adviser is contained as part of the investment adviser's brochure. A) II and IV B) I and IV C) II and III D) I and III
C) 2 & 3 *Under federal regulations, if an investment adviser intends to pay a third party (nonemployee) solicitor to solicit clients for investment advisory services, the investment adviser must be properly registered with the SEC, there must be a written agreement between the ivnestment adviser and the solicitor, and there can be no outstanding or pending orders or disciplinary actions against the solicitor involving finance or dishonesty. The solicitor does not have to be registered as a registered investment adviser representative because he is not representing the registered investment adviser in the giving of investment advice, in the management of accounts, or in the supervision of anyone else working for the registered investment adviser in these areas. The solicitor is being paid a fee for the solicitation of business for the registered investment adviser with a requirement of full disclosure to the client of the relationship with the adviser. There is no provision in the Uniform Securities Act that permits an individual to solicit business on behalf of a state-registered investment adviser without IAR registration.
An investment adviser is a member of the board of directors of a privately held corporation that has just gone public. The adviser would like to recommend the stock to several of his advisory clients. Which of the following statements are TRUE? 1. The adviser can do so without restriction. 2. The adviser must disclose the existence of a control relationship. 3. The adviser may base his recommendation on all information at his disposal. 4. The adviser must base his recommendation on publicly available information. A) II and III B) I and III C) II and IV D) I and IV
C) 2 & 4 *As a director of a public company, the adviser is an insider and must disclose this relationship to any clients that were recommended the stock. Further, as an insider, the adviser must be careful to base his recommendations on publicly available information or there would likely be a violation of the insider trading rules.
The term "churning" means 1. switching a client's account from an income fund to a growth fund 2. excessively trading securities in the account of a client primarily for the purpose of generating commissions for the agent 3. trading unsuitable securities in a client's account 4. a bond swap in a customer's account for tax benefits A) I and II B) II and IV C) II only D) I and III
C) 2 only. *Churning is conducting excessive transactions in a customer's account for the purpose of generating commissions and is prohibited
An investment adviser making investment decisions within parameters agreed upon with the client is managing the portfolio on A) a nondiscretionary basis. B) a best-efforts basis. C) a discretionary basis. D) an advisory basis.
C) a discretionary basis. *When the investment adviser makes investment decisions with parameters agreed upon with the client, the arrangement is best described as being on a discretionary basis.
If a customer is upset with her agent and sends him a letter of complaint, under the Uniform Securities Act, the agent should A) tell the customer he is willing to make rescission B) call the customer, apologize, and attempt to correct the problem C) bring the customer complaint to a supervisory person immediately D) do nothing
C) bring the customer complain to a supervisory person immediately *Failure to bring customers' written complaints to the attention of the agent's supervisor is prohibited.
Which of the following would justify an investment adviser's use of a full-service broker? 1. Obtaining special reports dealing with economic projections from the broker 2. Expense-paid business trips paid for by the broker 3. The use of the research analysis provided by the broker A) II and III B) I and II C) I, II, and III D) I and III
D) 1 & 3 *Full-service brokerage firms often provide research reports, securities and portfolio analysis, and special reports without specific charges, but are usually compensated by their higher commissions. Nothing in industry rules prevents an adviser from using a full-service broker to effect customer transactions. However, it would be unethical if the adviser were to benefit personally from the direction of the client business.
Which of the following are examples of the prohibited business practice known as front running? 1. An investment adviser publishes a strong buy recommendation for XYZ common stock and then purchases a large block for the firm's own account several days later. 2. An investment adviser publishes a strong buy recommendation for ABC common stock several days after purchasing a large block for the firm's own account. 3. An analyst informs an IAR that he is going to discuss the fact that he has changed a recent buy recommendation to a sell when he appears on cable TV later that afternoon. The IAR immediately establishes a large short position in that stock. 4. An IAR purchases 10,000 shares of DEF 6% preferred stock for 4 of her income-oriented clients. It takes several separate trades to fill the entire order, and the prices range from $24.25 to $24.33. The IAR allocates the shares, giving price preference to clients taking the largest positions. A) I and IV B) I and III C) II and IV D) II and III
D) 2 & 3 *Front running is the prohibited practice of placing an order to benefit from news not yet released or orders that will impact the market. An adviser acquiring stock and then publishing a buy recommendation or an IAR benefiting from an analyst's news before public release are examples of this type of wrongdoing. Although allocation based on client positions is a prohibited practice, it is not front running.
Which of the following phrases best describes a prudent investor? A) An investment adviser representative (IAR) handling a discretionary account B) A person in a fiduciary capacity who invests in a prudent manner C) The custodian for a minor under the Uniform Transfers to Minors Act D) A trustee who invests with reasonable care, skill, and caution
D) A trustee who invests with reasonable care, skill and caution. *Although all of these may have a fiduciary responsibility, the definition, as expressed in the Uniform Prudent Investor Act of 1994, requires reasonable care, skill, and caution.
Fraud would include the willful omission of A) the public offering price in a preliminary prospectus B) any fact C) a material fact, but only one that might be pertinent to making an investment decision D) any material fact
D) Any material fact *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.
All of the following practices violate NASAA's Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents EXCEPT A) recommending the purchase of a security to a majority of the clients solely on the basis of the issuer's properly published press release regarding a likely increase in earnings per a new product branding strategy B) effecting a transaction with no change in beneficial ownership C) conducting securities transactions, with clients, that are not reflected on the books of the broker-dealer and without the knowledge and supervision of the employing broker-dealer D) hypothecating customer securities held in margin account.
D) Hypothecating customer securities held in margin account. *The normal method of financing customer margin accounts is by hypothecating their securities so there is nothing dishonest or unethical happening. According to the North American Securities Administrators Association's (NASAA) Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, agents may not recommend securities without reasonable basis. Even then, when the same security is recommended to a majority of the firm or agent's clients, it is likely going to be the prohibited practice of blanket recommendations. Effecting transactions with no change in beneficial ownership is a form of market manipulation in conflict with NASAA's Statement of Policy. Conducting securities transactions not reflected on the books of the employing broker-dealer and without the employing broker-dealer's prior written authorization is known as selling away, considered by NASAA to be an unethical practice.
Which of the following practices is fraudulent? A) Failing to state all the facts related to a security B) Marking up a security by 10% more than industry standards with the customer's knowledge and consent C) Selling a security to a customer with a commission that exceeds industry standards D) Marking up a security by 5%, but indicating to the client that the markup is only 2%
D) Marking up a security by 5% but indicating to the client that the markup is only 2% *Fraud is the willful deception of a client. Stating that the markup will be 2% and then effecting a 5% markup is a fraudulent act. Marking up a security by more than industry practices is a prohibited practice but is not necessarily fraudulent. It is not necessary to state all the facts; only those that are material are required.
Which of the following statements regarding the use of a hedge clause by an investment adviser is CORRECT? A) A properly worded hedge clause may be used to minimize the investment adviser's fiduciary responsibility. B) A hedge clause that limits liability to acts done in bad faith or pursuant to willful misconduct but that also explicitly provides that rights under state or federal law cannot be relinquished would generally be acceptable to the Administrator. C) The adviser's brochure must always contain at least one hedge clause. D) A hedge clause that limits the investment adviser's liability for losses caused by conditions and events beyond its control, such as war, strikes, and natural disasters, would generally be acceptable to the Administrator.
D) a hedge clause that limits the investment adviser's liability for losses caused by conditions and events beyond its control, such as war, strikes, and natural disasters, would generally be acceptable to the ADMIN. *The regulators have not objected to clauses that limit the investment adviser's liability for losses caused by conditions and events beyond its control, such as war, strikes, natural disasters, new government restrictions, market fluctuations, communications disruptions, and so forth. Such provisions are acceptable because they do not attempt to limit or misstate the adviser's fiduciary obligations to its clients. Limiting liability to acts done in bad faith might cause the unsophisticated client to fail to understand that he still has a right to take action, even when the acts are committed in good faith. Fiduciary responsibility cannot be limited by hedge clauses.
An agent's client calls on Monday to discuss the current market situation. They discuss how 100 shares of KAPCO common stock would be an appropriate addition to the client's portfolio. On Thursday, the client calls and tells the agent to place an order for the KAPCO stock at whatever price the agent feels is best. The agent waits until Friday, purchasing the stock at a price $2 per share below Thursday's low. In this case the agent acted A) properly because the agent used discretion as to price and time B) properly because the agent saved the client money C) improperly; the order cannot be placed without prior written authorization allowing discretion D) improperly; the order should have been placed on Thursday
D) improperly; the order should have been placed on Thursday *In this question, the client specified that the agent should determine the best price. Nothing other than oral permission is necessary in order for an agent to use discretion as to time and or price. However, time and/or price discretion are only good for that day—those are considered "day" orders, so the agent is able to use judgment, but the order must be placed during the day it was received.
An agent's client calls on Monday to discuss the current market situation. They discuss how 100 shares of Kapco common stock would be an appropriate addition to the client's portfolio. On Thursday, the client calls and tells the agent to place an order for the Kapco stock at whatever price the agent feels is best. The agent waits until Friday, purchasing the stock at a price $2 per share below Thursday's low. In this case, the agent acted A) improperly; the order should have been placed on Monday B) properly because the agent saved the client money C) properly because the agent used discretion as to price and time D) improperly; the order should have been placed on Thursday
D) improperly; the order should have been placed on Thursday. *In this question, the client specified that the agent should determine the best price. Nothing other than oral permission is necessary in order for an agent to use discretion as to time or price. However, time or price discretion are only good for that day—those are considered "day" orders, so the agent is able to use judgment, but the order must be placed during the day it was received.
Holly Cavendish is an IAR with Remington, Fairchild, and Hume, a federal covered investment adviser. Holly's manager tells her that he will be busy for a couple of hours working on completing the Form ADV-E. This tells Holly that her firm A) will be changing to state registration. B) is undergoing a special evaluation by its clients. C) is reporting certain errors discovered by management. D) maintains custody of customer funds and or securities.
D) maintains custody of customer funds and or securities. *The Form ADV-E (E for surprise Examination) must be completed by investment advisers that have custody of client funds or securities and that are subject to an annual surprise examination. Then the IA gives this form to the independent public accountant that, in compliance with the Investment Advisers Act of 1940 or applicable state law, examines client funds and securities in the custody of the investment adviser.
NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers deems all of the following as unethical practices for investment advisers EXCEPT A) inability or unwillingness to disclose sources of additional fees received from those other than the customer in connection with providing advisory services to that client B) recommending a security based on a rumor C) charging advisory fees that are significantly higher than those charged by other advisers for similar services in that state D) performing the initial trades in a new discretionary account with oral authorization
D) performing the initial trades in a new discretionary account with oral authorization *NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers permits an investment adviser to exercise discretion with oral authorization from the client, for a period of 10 business days after the initial discretionary trade in the account. Charging advisory fees that are significantly higher than those charged by other advisers for similar services, failing to disclose sources of compensation received by the adviser in connection with rendering advisory services, and recommending trades based on rumors are all unethical trade practices.
The duties and responsibilities of a fiduciary are spelled out in A) the Uniform Gift to Minors Act B) the Investment Advisers Act of 1940 C) the Summary Plan Document of the DOL D) the Uniform Prudent Investors Act of 1994
D) the Uniform Prudent Investors Act of 1994 *The UPIA is the legal guide for fiduciaries, who must act with skill and caution in the best interest of their clients.
Discretion is exercised when a securities professional determines all of the following EXCEPT A) dollar amount of trade B) to buy or sell a particular security C) number of shares D) time or price
D) time or price *Determining control over the time or price of an order does not constitute discretion. The selection of the number of shares or the dollar amount of a trade constitutes discretion. When a registered securities professional (BD, agent, IA, or IAR) determines what to buy or sell or the number of shares to be bought or sold, that person is exercising discretion.
An investment adviser may borrow from all of the following clients EXCEPT A) a commercial bank in conjunction with a mortgage on the office building from which the advisory operates B) a broker-dealer in conjunction with a margin account C) a savings and loan association that has offered to finance new computers for the adviser's office D) a mortgage broker who helped the adviser negotiate mortgage terms for its office building
D)a mortgage broker who helped the adviser negotiate mortgage terms for its office building *Mortgage brokers are not in the business of lending money; they help parties negotiate terms of a loan, which is why they are called brokers. The bank, brokerage, and savings and loan association are in the normal business of lending. Advisers are limited to borrowing money from clients that are in the normal business of lending or entities that are affiliated with the IA.
