Unit 14
Which of the following statements relating to Form ADV-E are correct? 1. The form is completed by an investment adviser who maintains custody of customer funds and/or securities. 2. The form is completed by the independent public accountant who examines the funds and/or securities in the custody of an investment adviser. 3. The form is submitted by the independent public accountant who examines the funds and/or securities in the custody of an investment adviser. 4. The form may be used to amend the investment adviser's registration. A) I, III, and IV B) I and III C) I, II, and IV D) I and II
B) I and III Form ADV-E (E for Examination) must be completed by investment advisers (IAs) 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, who examines client funds and securities in the custody of the IA, in compliance with the Investment Advisers Act of 1940 or applicable state law. The independent public accountant performing the surprise examination must submit this form within 120 days of the time chosen by the accountant for the surprise examination.
Sally is an agent with a broker-dealer. She has used her degree in computer science to develop her own stock-picking software program. The program creates a model portfolio with a 70:30 ratio of equity to debt securities. Backtesting has shown that the program is likely to produce returns that beat the overall market. As a result, Sally plans to use this model portfolio for each of her clients. Sally A) must make the details of how the program works available to all who request it. B) is likely violating suitability requirements. C) is engaging in an unethical business practice. D) is going to make her clients very happy.
B) is likely violating suitability requirements. The point here is not whether Sally's program works. The point is that it would be unlikely that all of her clients have the same objectives and financial resources. In fact, some of them might be suited for a higher percentage of debt securities rather than equities. Therefore, using the software program to create the same model portfolio for every client would probably be violating the rules dealing with suitability. This would be the same if Sally were an IAR. Please note that while this might be considered an unethical business practice, the suitability choice is more to the point.
An agent may determine which securities to purchase or sell for a client when A) written or oral discretion authority has been received by the broker-dealer within 10 days of the initial discretionary transaction. B) written discretion authority has been received by the broker-dealer before executing the first discretionary transaction. C) written discretion authority has been received by the broker-dealer within 10 days of the initial discretionary transaction. D) written or oral discretion authority has been received by the broker-dealer before executing the first discretionary transaction.
B) written discretion authority has been received by the broker-dealer before executing the first discretionary transaction. No broker-dealer or any of its employees shall exercise any discretionary power in any customer's account or accept orders for an account from a person other than the customer without first obtaining written authorization from the customer. It is an investment adviser who may act with oral consent for a period of 10 days from the initial discretionary trade.
Which of the following is an example of the prohibited business practice known as front running? A) A broker-dealer publishes a strong buy recommendation for ABC common stock several days before purchasing a large block for the firm's own account. B) An analyst informs an IAR that she is going to discuss the fact that she has changed a recent buy recommendation to a sell when she appears on cable TV later that afternoon. The IAR immediately establishes a large short position in that stock. C) A broker-dealer receives a call from one of its institutional clients giving advance notice of a 50,000-share sell order for DEF common stock to be placed just before market close. The firm immediately enters a number of smaller orders to sell DEF stock short. D) An IAR purchases 10,000 shares of DEF 6% preferred stock for four 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.
C) A broker-dealer receives a call from one of its institutional clients giving advance notice of a 50,000-share sell order for DEF common stock to be placed just before market close. The firm immediately enters a number of smaller orders to sell DEF stock short. Front running is the unethical practice of causing an order to be executed when a BD or agent has material nonpublic market information concerning an imminent block order in that security prior to the time information concerning the block transaction has been made publicly available. A large sell order will likely move the stock's price down making the BD's short sales profitable. There is nothing unethical about a BD buying a block of stock after publishing a buy recommendation; doing so in advance of publishing would be unethical, but not front running. There have been SEC cases charging trading on MNPI when securities professionals have acted in a way that takes advantage of an upcoming analyst's report. They have won their case when being able to prove that the analyst's opinion is so highly thought of that a recommendation can move the market. Although allocation based on the size of client positions is a prohibited practice, it is not front running.
Under the Investment Advisers Act of 1940, for which of the following is an investment adviser required to disclose to clients the amount of compensation he will receive? 1. Commissions on recommended securities transactions 2. Commissions on insurance sales 3. Incentives from the issuer of a recommended security A) II and III B) I and III C) I, II, and III D) I and II
C) I, II, and III Advisers must disclose compensation received on sales of securities and nonsecurities products and also compensation received from the issuer of a recommended security.
Under the Uniform Securities Act, which of the following investment advisers would be required to include a balance sheet in their brochures? 1. An adviser who exercises discretion in client accounts 2. An adviser who maintains custody over client funds and securities 3. An adviser who maintains less than $35,000 in net worth 4. An adviser who, six or more months in advance, collects prepaid fees of more than $500 A) I and IV B) II and III C) II and IV D) I and II
C) II and IV The Uniform Securities Act requires that a balance sheet accompany an adviser's brochure when the adviser maintains custody of client assets or accepts substantial prepayments of fees.
The illegal business practice of purchasing and selling a security for the purpose of creating an appearance of market activity is known as A) arbitrage B) spinning C) front running D) matched orders
D) matched orders A matched order, sometimes known as "painting the tape," is defined as when trades are coordinated for the purchase or sale of a security. Essentially an order is placed with the knowledge that another order (or orders) of substantially the same size, at substantially the same time, and at substantially the same price, has been or will be entered. The effect is to cause an appearance of market activity and price movement that is not market driven.
Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, which of the following statements regarding the distribution of reports prepared by third parties that are not affiliated with the adviser is true? A) An adviser is required to disclose any source of information used in making recommendations to clients. B) An adviser may use a report prepared by someone else if the source of the report is disclosed. C) An adviser need not disclose the author of any outside third-party report unless the client asks. D) An adviser is prohibited from basing recommendations on work that is wholly the product of someone else's efforts.
B) An adviser may use a report prepared by someone else if the source of the report is disclosed. An adviser is not prohibited from providing clients with reports prepared by others, but when this is done, the adviser must disclose the true source of the report. However, the disclosure requirement does not apply to the research an adviser uses in rendering investment advice.
The NASAA Model Rule on Business Continuity and Succession Planning requires that every investment adviser (IA) establish, implement, and maintain written procedures relating to a business continuity and succession plan. The rule requires that A) all data be properly encrypted. B) the plan be reasonable in relation to the IA's business model and size. C) double authentication methods be used to protect data. D) the adviser use offsite servers.
B) the plan be reasonable in relation to the IA's business model and size. The Model Rule specifically requires that the plan be based upon the facts and circumstances of the investment adviser's business model, including the size of the firm, type(s) of services provided, and the number of locations of the investment adviser. All the other choices refer to cybersecurity requirements.
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) The power of attorney must be renewed annually by the account holder. B) Each order must receive the prior approval of the agent's manager before it is entered. C) The account holder is not permitted to enter new orders independently. D) A designated supervisory individual must frequently review the account.
D) A designated supervisory individual must frequently review the account. 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.
Under which of the following circumstances does NASAA allow an investment adviser to charge performance-based fees? 1. The client must initially have $1.1 million under management or a net worth in excess of $2.2 million. 2. Compensation paid in this way must be for gains reduced by losses. 3. Disclosure must be made that the fee arrangement may create an incentive for the investment adviser to make investments that are riskier or more speculative than would be the case in the absence of a performance fee. A) I and II B) II and III C) I, II, and III D) I only
C) I, II, and III The NASAA Model Rule permits performance-based fees if the client has at least $1.1 million in assets under management or a net worth in excess of $2.2 million, provided the compensation is based on gains and losses. Unlike the Investment Advisers Act of 1940, under the NASAA Model Rule, state-registered advisers must make additional disclosures, including the incentive to take additional risk.
Which of the following actions, if performed by a registered investment adviser representative, would not be considered inappropriate under the Uniform Securities Act? 1. Recommending suitable securities to a client 2. Lending money to a client who is a regular member of your Sunday group at the country club 3. Misappropriating client assets to benefit the client's favorite charity 4. Without having discretionary power, determining when would be the most opportune moment to sell a specific security holding the client has indicated he wishes to liquidate A) I and IV B) II and III C) II and IV D) I and III
A) I and IV Be careful of the negatives. This question is really asking for the permitted actions. We may always recommend positions that we feel are suitable, and discretionary authorization is not required if an IAR is only determining time or price. Even though FINRA rules might permit a loan to a client with whom there is a preexisting personal relationship, no such rule applies under the USA. Misappropriation of customer funds is never permitted, even if for a worthy cause.
Under the NASAA Model Rule on Business Continuity and Succession Planning, which of the following investment advisers should be most concerned about succession planning? A) Jeremy's Financial Planning and Advice, organized as a sole proprietorship B) Finest Financial Advisers, Incorporated C) Bob and Ted's Excellent Advice, LLC D) The Four Partners Advisory Service
A) Jeremy's Financial Planning and Advice, organized as a sole proprietorship Because a sole proprietorship has only one individual in the business, Jeremy's death or incapacity would likely lead to closure of the business. This could have disastrous implications for his clients unless proper succession planning is done in advance. Although this kind of planning is required for all investment advisers, the effect on the LLC, corporation, and partnership, all of which have multiple owners, is not as critical as a sole proprietorship.
An order is received from one of your clients to purchase 200 shares of GEMCO common stock at 45 GTC. Two days later, while at a luncheon meeting with a different client, you are informed by that individual that the inside scoop is that GEMCO is going to be the subject of an FBI investigation. An hour after you return from lunch, you see an execution report for the 200 shares at 44.90. Under the Insider Trading and Securities Fraud Enforcement Act of 1988, you A) are not in violation because the order was placed before you learned of the inside information B) are in violation because you should have called the client immediately and had the ordered canceled C) are not in violation because the trade was the result of an unsolicited order D) are in violation because you should have canceled the order the moment you received the tip
A) are not in violation because the order was placed before you learned of the inside information Violations of the insider trading rules can only happen when a person acts on the information. Because the order was placed on the books prior to the agent's learning of the inside information, there is no violation. There is no obligation to cancel the order, and contacting the client would be making use of the inside information.
Which of these has the SEC not enumerated as a specific item that must be included in written compliance manuals for investment advisers? A) The advisory firm should implement procedures for allocating investment opportunities such as best executions among clients. B) The advisory firm must monitor the consistency of portfolios with guidelines established by clients, disclosures, and regulatory requirements. C) The advisory firm should indicate the educational requirements necessary for employment. D) The advisory firm must review policies and procedures at least on an annual basis.
C) The advisory firm should indicate the educational requirements necessary for employment. Guidelines under SEC rules require (at a minimum) that the chief compliance officer of each federal covered investment adviser conduct an annual review of its compliance procedures. Among the duties of the compliance officer is to monitor the consistency of portfolios with guidelines established by clients, disclosures, and regulatory requirements. The firm should implement procedures for allocating investment opportunities such as best executions among clients. If the firm does have internal educational requirements, that would be found in its HR manual, not in its compliance manual.
Under which of the following circumstances can an agent conduct customer transactions without the activity being recorded on the books and records of the broker-dealer employer? A) The securities are exempt under the Uniform Securities Act. B) The customer is a member of the agent's immediate family. C) The transactions are authorized in writing by the broker-dealer before execution of the transactions. D) The agent will receive no compensation.
C) The transactions are authorized in writing by the broker-dealer before execution of the transactions. Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, it would be considered contrary to the standards imposed for an agent to effect securities transactions not recorded on the regular books or records of the broker-dealer that the agent represents, unless the transactions are authorized in writing by the broker-dealer before execution of the transaction.
Wealth Creation Advisers (WCA) is a federal covered investment adviser specializing in consulting to pension plans. WCA's principal office is located in State L. The governor of State L is running for re-election. If WCA were to make a $350 contribution to the campaign, under the SEC's pay-to-play rule, WCA A) could be subject to disciplinary action. B) could continue with business as usual, as the contribution is within the de minimis limitation because their principal office is located in State L. C) would be prohibited from receiving compensation for advisory services rendered to any agency of State L for two years. D) would be prohibited from rendering any advisory services to any agency of State L for two years.
C) would be prohibited from receiving compensation for advisory services rendered to any agency of State L for two years. The SEC's pay-to-play rule prohibits investment advisers from receiving compensation for advisory services to a government entity (any agency, authority, or instrumentality of a state or political subdivision) for two years after the advisory firm or any covered employee makes a political contribution to a public official or candidate who is or would be in a position to influence the award of investment advisory business by public retirement funds. Please note that the advisory relationship can continue, just without any compensation. The de minimis exemption of $350 applies to an individual, as long as that person is eligible to vote for the candidate ($150 if he is not), but it never applies to the firm.
Which of the following would be considered unethical under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers? A) An investment adviser varies the annual fee based upon each client's assets under management, charging less for those with higher balances and more for those meeting the account minimum. B) An investment adviser representative receives an order to buy XYZ stock from an advisory client and simultaneously recommends that another advisory client sell that stock in an agency cross transaction. C) An investment adviser discloses in its brochure that, from time to time, it may sell securities recommended to clients directly out of the firm's inventory. D) A loan is made to an investment adviser representative by one of her clients who happens to be the chief loan officer where she maintains her principal banking relationship.
D) A loan is made to an investment adviser representative by one of her clients who happens to be the chief loan officer where she maintains her principal banking relationship. It is an unethical and prohibited business practice for investment advisers (IAs) and their representatives to borrow money from clients who are not in the business of lending money. In this case, the loan officer is the one who is doing the lending, not the bank. IAs are permitted to base their fees on the amount of assets under management, generally charging a lower percentage to those with higher balances. IAs are permitted to act as principals in recommended trades, but appropriate disclosure must be made. In an agency cross transaction, a recommendation may be made to either, but not both, parties to the trade.
Rachel is an agent registered with a broker-dealer in this state. It would be prohibited for her to A) share in the profits and losses in a client account without a financial contribution to the account. B) disclose to a client that a transaction in a thinly traded stock will result in a higher-than-normal commission. C) execute a transaction in a discretionary account after having received the necessary documentation. D) solicit sales of a nonexempt security whose registration is not yet effective.
D) solicit sales of a nonexempt security whose registration is not yet effective. A nonexempt security is one that is required to register. Until that 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. You will notice that this is different from the FINRA rule; remember, this is a NASAA exam.
