3- Federal and State Regulation of Investment Advisers and Their Representatives
What is the appropriate procedure to follow when a customer fails to sign the form provided by the investment adviser stating that he has received a copy of the investment adviser's brochure? A) Proceed with the account, but make a supervisory person aware of this. B) Proceed with the account; the signature is not required. C) Don't do anything with the account until the customer's signature acknowledging receipt of the brochure is received. D) Only unsolicited orders may be accepted until the signed receipt is received.
Answer: A Although it is true that there is no legal requirement for a client to sign acknowledging receipt of the brochure, if it is the adviser's practice, the account may proceed, but only with notice to the appropriate supervisory person.
Under the NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, advisory contracts must: prohibit assignment of the contract without the client's consent. contain information on the adviser's performance for at least the most recent 12-month period. describe the amount of any prepaid fee that will be returned to the client in the event the contract is terminated. A) I and III. B) I, II and III. C) II and III. D) I and II.
Answer: A An advisory contract must prohibit assignment without the client's consent and must describe the amount of any prepaid fee that will be returned to the client if the contract is terminated. In addition, it must describe the fee or the formula for computing the fee. Contracts would never contain information regarding the adviser's past performance.
Under the Uniform Securities Act, an investment advisory contract must contain (in writing) all of the following provisions EXCEPT: A) on the departure or death of a majority shareholder of an investment advisory corporation, the advisory agreement must be renewed to prevent an unlawful assignment of the account. B) the adviser, if a partnership, must notify the client of any change in the partnership's membership. C) the investment adviser's compensation shall not be based on capital gains in client accounts. D) no assignment of the investment advisory contract may be made without the client's consent.
Answer: A Investment advisers organized as corporations are under no obligation to inform their clients of changes to shareholders. However, if an investment adviser is a partnership, clients must be notified of any change in the membership of the partnership. Keep in mind the distinction between notification and assignment. Investment partnerships must notify clients of any change in the partnership's membership, no matter how insignificant the partner's position in the firm. However, the death of a minority partner does not constitute an assignment (transfer) of the account although the information must be communicated to clients. A change in a majority interest in the partnership would be an assignment of the account that requires client consent.
An investment adviser compensated for a client's participation in a wrap fee program must provide the client with a written disclosure statement containing: A) only the services and fees of the program. B) at least the information required by Appendix 1 of Form ADV Part 2A, but not if another adviser has already furnished such a statement on the program to the client. C) at least the information required by Appendix 1 of Form ADV Part 2A, even if another adviser has already furnished such a statement on the program to the client. D) at least the information in Form ADV Part 2A.
Answer: B B) at least the information required by Appendix 1 of Form ADV Part 2A, but not if another adviser has already furnished such a statement on the program to the client. The required disclosure statement for wrap fee programs must contain at least the information in Appendix 1 of Form ADV Part 2A, but duplicates need not be provided to clients who have already received the required disclosure on that program from another adviser.
Although the regulations permit a number of different methods of investment adviser compensation, it would not be considered proper for an IA to: A) charge an annual fee equal to 1% of the first $250,000 in assets under management and 1/2% for all assets above that amount. B) tell clients that the fee will be 5% of the profits that exceed a stated benchmark, but nothing if the benchmark is not reached. C) charge $2,500 for developing a financial plan for a client. D) charge an annual fee equal to 1% of assets under management.
Answer: B Performance-based fees are not allowed except under certain specified conditions, none of which exist in this question.
An agent opening a wrap account for a wealthy client may tell the customer that: A) wrap fees generally result in higher costs than separate charges for advice, management, and transactions. B) wrap account managers will generally outperform index funds. C) wrap fees always result in lower costs than separate charges for advice, management, and transactions. D) wrap fees may result in higher costs than separate charges for advice, management, and transactions.
Answer: D When prospecting for new wrap accounts, agents are required to disclose to customers that wrap fees may result in higher costs than separate charges for advice, management, and transactions if the client is not able to use all of the services included. For those clients that are able to make use of all of the services provided, the costs will generally be lower than the cost of buying them piecemeal. Future performance of managed accounts may not be stated or implied.
When must the Annual Update Amendment to Form ADV be filed? A) Within 120 days of the calendar year-end. B) Within 90 days of the adviser's fiscal year-end. C) Only when an action is pending against the adviser. D) Within 90 days of the calendar year-end.
View Answer and Explanation Answer: B The Annual Update to Form ADV must be filed by a registered investment adviser no later than 90 days following the adviser's fiscal year-end (which may happen to be a calendar year).
Under the Investment Advisers Act of 1940, which of the following is TRUE about the use of the term "investment counsel" by investment advisers? A) Advisers may use the term only if their principal business is acting as an investment adviser and a substantial part of their business consists of providing continuous advice based on a client's individual needs. B) Advisers may use the term without restriction as long as they are registered. C) Advisers may use the term only if they are attorneys. D) The use of the term is prohibited under any circumstances.
A) Advisers may use the term only if their principal business is acting as an investment adviser and a substantial part of their business consists of providing continuous advice based on a client's individual needs. Advisers may use the term "investment counsel" only if two conditions are met: rendering investment advice must be their principal business, and a substantial part of that business must be providing investment supervisory services-that is, continuous advice based on the individual needs of each client.
Rule 206(4)-1 of the Investment Advisers Act of 1940 regulates advertising by investment advisers. It would be prohibited under that rule for any adviser: I. to place an advertisement in a newspaper with photos of clients accompanied by statements claiming the adviser helped them meet their financial goals. II.to advertise past, specific investment recommendations that were or would have been profitable, unless the advertisement fully disclosed all recommendations for at least the past year (including the security recommended, the date, price, and nature of the recommendation—buy, sell, or hold—the price triggering the recommendation, and the most recent price) and included a mandated cautionary legend that past performance is no assurance of future results. III. to advertise any graph, chart, formula, or other device that consumers can use to determine when to make investment decisions while prominently disclosing the device's limitations and difficulties in its use. IV. to offer a free subscription to the adviser's quarterly market review once the subscriber has completed a detailed financial profile. A) I and IV. B) III and IV. C) I and II. D) II and III.
A) I and IV. Testimonials of any kind are prohibited. Offers of free service must be totally free, not only free of cost but also free of any obligation.
Under the Investment Advisers Act of 1940, advertising done by investment advisers prohibits: the use of testimonials. reference only to specific past recommendations. untrue statements. A) I, II and III. B) I only. C) III only. D) I and III.
A) I, II and III. SEC Rule 206(4), issued under the Investment Advisers Act, prohibits untrue statements of material fact; testimonials; reference only to specific past recommendations; references to charts, formulas, or devices used to forecast securities prices without setting forth the difficulties or limitations in their use; offerings of free services without the intent or ability to perform; and guarantees of future performance.
Under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, an investment adviser who has custody of clients' securities or funds must: keep funds deposited in accounts containing only client funds. be subject to a surprise audit performed at least annually by an independent accountant. send clients' statements at least once every three months showing balances. A) II and III. B) I and II. C) I, II and III. D) I and III.
C) I, II and III. 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.
According to the Investment Advisers Act of 1940, which of the following statements regarding registration of investment advisers is TRUE? State registration is a requirement for federal registration. An investment adviser must be registered with the SEC to be registered at the state level. A) Both I and II. B) II only. C) Neither I nor II. D) I only.
C) Neither I nor II. A critical point to remember about investment advisers is that, if required to register, they register with either the state or the SEC, never with both. This is unlike broker/dealers who invariably register with both the SEC and the state(s) in which they do business.
An investment adviser structured as a partnership lends money to a customer to buy recommended securities. Under NASAA's Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, this activity is: A) acceptable, provided the securities are used as collateral for the loan and the loan conforms to the provisions of Regulation T. B) acceptable, provided the loan is made under the provisions of Regulation T of the Federal Reserve. C) unethical. D) acceptable, provided the securities are used as collateral for the loan.
C) unethical. An investment adviser cannot lend money to a customer unless the loan is made through a regulated lender such as an affiliated broker/dealer or an affiliated bank.
Emmet opened an investment advisory service 3 years ago and raised $50 million in capital from family, friends, and contacts and then closed to new investors. If Emmet's stock picks expanded assets under management to $110 million, Emmet: A) must register for the first time with the state Administrator. B) must update his registration with the state Administrator. C) is not required to take any action. D) must register with the SEC.
Answer: D When the annual updating amendment filed by a state-registered investment advisory firm indicates that the $110 million threshold has been reached, the firm has 90 days to register with the SEC.
After publishing a favorable report on a stock, an analyst was asked to appear on a television program to discuss the reasons for the bullish recommendation. Which of the following best describes how the analyst may communicate about the stock to others? A) The analyst may communicate about the stock to clients and prospective clients only if he has disclosed personal or firm holdings of that security. B) The analyst may not communicate about the stock to prospective clients but may discuss the stock with current clients. C) The analyst may communicate about the stock and is not required to disclose any positions he or his firm holds in the stock. D) The analyst may not communicate about the stock to any other parties.
A) The analyst may communicate about the stock to clients and prospective clients only if he has disclosed personal or firm holdings of that security. Because the report has been published, the analyst's assessment of the stock is already public information. Thus, the analyst may recommend the stock to clients and prospects. However, the analyst must disclose whether he or his firm holds a position in the stock.
According to the Investment Advisers Act of 1940, under which of the following circumstances is an exculpatory provision acceptable in a contract between an investment adviser and its clients? A) This provision is prohibited under all circumstances. B) The client has received written disclosure of this provision and has signed a written acceptance prior to any transaction. C) The client is a broker/dealer. D) The client is purchasing government securities only.
A) This provision is prohibited under all circumstances. An exculpatory (culpa meaning fault) provision is never acceptable in an investment advisory contract. Its purpose is to exclude officers and directors from liability for disregard of their duties. This might also be phrased as the client waiving his rights, and is also not permitted.
Which of the following investment advisers would be permitted to use the term "investment counsel"? A) A professional providing a market timing service with an annual subscription fee of $995; this service attempts to maximize profits by suggesting entry and exit points for over 100 listed stocks. B) An investment adviser who has been admitted to the bar in the state in which the firm's principal office is located. C) A firm whose exclusive business is placing clients' assets into model portfolios. D) A financial planner offering a wide range of services to his clients, including tax planning, estate planning, insurance planning, and investment advice.
Answer: C To use the term "investment counsel", two criteria must be met. First, the principal business of the adviser must be the rendering of investment advice. Second, the nature of the advice must meet the definition of investment supervisory service. That means giving continuous investment advice to clients based on their individual needs. That is frequently accomplished by selecting model portfolios most appropriate to the client's needs. The financial planner clearly is not principally in the business of offering investment advice because he describes his service as offering a wide range of services, of which advice is only a part. The exam frequently uses that wording to indicate that advice is not the principal activity. While the publisher's principal business activity may be offering advice, nothing about the description indicates that individual client accounts are being monitored.
Which of the following statements is (are) TRUE concerning wrap fee programs under the Uniform Securities Act? Wrap fee disclosure documents must be filed with the Administrator. Nonmaterial changes to wrap fee disclosure documents must be filed with the Administrator within 90 days of fiscal year end. Amendments must be filed promptly with the Administrator if the disclosure document becomes inaccurate in any material way. The disclosure document must contain the information required by Appendix 1 of Form ADV Part 2A. A) I and III. B) I, III and IV. C) I only. D) I, II, III and IV.
Answer: D Wrap fee disclosure documents must be filed with the Administrator and must contain the information required by Appendix 1 of Form ADV Part 2A. Amendments must be filed promptly with the Administrator if the disclosure document becomes inaccurate in any material way. Nonmaterial changes to wrap fee disclosure documents must be filed with the Administrator within 90 days of fiscal year end.
Under IA-1092, an investment adviser: makes advice his principal activity. makes advice his regular activity. is compensated directly for advice. is compensated directly or indirectly for advice. A) II and III. B) I and IV. C) I and III. D) II and IV.
Answer: D makes advice his regular activity. is compensated directly or indirectly for advice. Under the SEC's release, the rendering of advice does not have to be a person's principal activity. Rather, it must be a regular activity, and compensation may be received directly or indirectly.
