Checkpoint Exam U7

Al is an investment adviser representative for a federal covered investment adviser. Al has discretionary authority over most of his accounts and determines that shares of the RAN Corporation are a suitable investment for 7 of them. He enters a buy order for 1,000 shares of the RAN and receives 3 trade confirmations, all at slightly different prices. When allocating these shares to his clients, how should Al determine the price per share? A) Allocate the shares using the average price of all the shares combined B) Allocate the lowest-priced shares to the customers who have had accounts with the firm the longest period of time C) Allocate the highest-priced shares to the customers with the highest net worth D) Allocate the lowest-priced shares to the customers with the largest accounts

A) Allocate the shares using the average price of all the shares combined (average is the keyword & giveaway) It frequently happens that an IAR will submit an order for a large quantity of a specific security that is to be allocated among several clients. If the order is filled at different prices, the only fair treatment is to distribute the shares on an average price basis. U7LO1

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 fall under the safe harbor C) as long as the discounted rate reflected the volume of business done by Rising Tide, this would be permitted D) this would not fall under the safe harbor provisions unless the employees were those who directed the transactions to Momentum Securities

A) this would not fall under the safe harbor The use of furniture or office facilities is not included in the list of safe harbor items, regardless of the roles employees of the fund play. U7LO1

A fiduciary, acting in accordance with the UPIA, would choose investments on the basis of all of the following EXCEPT A) transaction costs B) general economic conditions C) other resources of the beneficiaries D) needs for liquidity, regularity of income, and preservation or appreciation of capital

A) 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. U7LO3

Which of the following phrases best describes a prudent investor? A) A person in a fiduciary capacity who invests in a prudent manner B) A trustee who invests with reasonable care, skill, and caution C) An investment adviser representative (IAR) handling a discretionary account D) The custodian for a minor under the Uniform Transfers to Minors Act

B) 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. U7LO3

Jonathon is employed by Frederick's Investment Advisory Service strictly to telemarket for prospective new clients. Which of the following is TRUE under the Uniform Securities Act? A) He is not subject to the antifraud provisions of the act. B) He is subject to the antifraud provisions of the act. C) He is only subject to the antifraud provisions of the act if the prospects actually utilize the firm's services. D) He is only subject to the antifraud provisions of the act if his compensation continuously increases.

B) He is subject to the antifraud provisions of the act. Remember, there are no exemptions from the antifraud provisions of either the Uniform Securities Act or the Investment Advisers Act. Fraud is defined as unlawful practices by any person involved with the purchase or sale of a security, whether registered or exempt from registration. This includes any act to defraud, untrue statements of a material fact, and omissions of a material fact. The act covers any person and there are no exemptions from the fraud provisions. U7LO5

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. U7LO7

A customer needs $10,000 to pay for a new house within the next year. His agent suggests that he invest in a stock that has been performing extremely well the past year and assures the customer that he cannot go wrong. According to the Uniform Securities Act, this is I. an unethical business practice II. an example of guaranteeing a profit III. an example of flamboyant language IV. an unsuitable investment A) II and IV B) I and III C) I, II, III, and IV D) I, II and IV

C) I, II, III, and IV All the choices listed are true. There is nothing in the LEM about flamboyant language, but there should be enough examples of what is fair and ethical for you to realize that flamboyant or exaggerated statements would be against the spirit of the law if not actually a violation. Use that kind of common sense on the real exam. U7LO4

Which of the following statements regarding brokerage and advisory activities under the USA are TRUE? I. It is not unlawful for an investment adviser or broker-dealer to employ any device, scheme, or artifice to defraud in the sales of securities to institutional investors because the USA is designed to protect individual investors. II. Under the USA, it is unlawful for an investment adviser to deceive a person when not providing advice to that person. III. Sanctions for both investment advisers and broker-dealers include administrative proceedings, judicial injunctions, and civil and criminal prosecutions. IV. It is unlawful for any person, whether technically defined as an investment adviser or not, to deceive another person for compensation as to the value of securities. A) II and IV B) I and II C) III and IV D) I and III

C) III and IV Sanctions for violations are administrative proceedings, judicial injunctions, and civil and criminal prosecutions. It is also true that any individual, whether technically defined as an adviser or not, may not deceive another person when providing investment advice if he is compensated for providing the advice. However, the Uniform Securities Act has no jurisdiction over an investment adviser when the deceitful action occurs in a nonadvisory situation, such as social interaction. U7LO5

All of the following practices violate NASAA's Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents EXCEPT A) 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 B) effecting a transaction with no change in beneficial ownership C) hypothecating customer securities held in margin accounts D) 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

C) hypothecating customer securities held in margin accounts 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. U7LO4

The compliance rules of the Investment Advisers Act of 1940 require all of the following EXCEPT A) written compliance policies and procedures B) appointment of a chief compliance officer (CCO) C) independent review of an advisory firm's compliance procedures D) annual compliance review

C) independent review of an advisory firm's compliance procedures While the rules require annual compliance reviews, such reviews may be conducted internally by the firm's appointed chief compliance officer rather than an independent party. The rules require written policies and procedures, an annual compliance review, and the appointment of a chief compliance officer (CCO). U7LO6

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) pay a nominal fixed fee to certain professionals as a form of thanking them for client referrals D) 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

C) pay a nominal fixed fee to certain professionals 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. U7LO1

An investment adviser affiliated with a broker-dealer would be considered to be maintaining custody when A) receiving performance-based compensation B) having the power to make buy-and-sell decisions in an account C) receiving a check made payable to that broker-dealer D) charging fees on an hourly basis

C) 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. U7LO2

Rachel is an agent registered with a broker-dealer in this state. It would prohibited for her to A) execute a transaction in a discretionary account after having received the necessary documentation B) share in the profits and losses in a client account without a financial contribution to the account C) solicit sales of a security whose registration is not yet effective D) disclose to a client that a transaction in a thinly traded stock will result in a higher-than-normal commission

C) solicit sales of a security 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. U7LO4

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) there is no violation as long as the customer signs a waiver agreeing to these terms. C) the IAR has acted in an unethical manner by giving incorrect information regarding the penalty-free withdrawal privilege D) there is a violation because the IAR failed to obtain the signed receipt.

C) 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. U7LO6

Which of the following are discretionary orders? I. A customer sends a check for $25,000 to an agent and instructs the agent to purchase bank and insurance company stocks when the price appears favorable. II. A customer instructs an agent to buy 1,000 shares of ABC Corporation at a time or price determined by the agent. III. A customer instructs an agent to purchase as many shares of XYZ as the agent considers appropriate. IV. A customer instructs an agent to sell 300 shares of LMN, Inc., when the agent deems the time or price appropriate. A) I and IV B) II and III C) II and IV D) I and III

D) I and III Discretion authorizes a representative to choose the security, the amount of shares, or whether to buy or sell. Time or price alone is not a discretionary decision. U7LO2

An investment adviser representative is required to make a disclosure to the client when I. the IAR, in preparing a recommendation, uses research provided by a third party with whom the IAR is not affiliated II. the IAR recommends a specific insurance policy for the client's overall financial plan, where a commission will be received on that sale III. transactions recommended to a specific client are inconsistent with those for other clients with objectives that are identical to that particular client IV. transactions recommended to the client are inconsistent with those for the IAR's own account A) I, II, and III B) I and III C) II, III, and IV D) II and IV

D) II and IV An investment adviser must provide full disclosure to his client if there would be even a hint of conflict of interest. This will include the case where a recommended product will generate a commission or other source of income to the adviser, as well as full disclosure, if a recommendation is not consistent with the adviser's own activity in his own account. The adviser can use any source of information to create his own analysis, disclosure of source only being required if the adviser uses the product of a third party as the presentation to the client. It would be unusual that all clients with the same objectives would purchase or have recommended for purchase the same securities. U7LO4

In the securities industry, the term "discretionary" refers to an A) account in which someone has been given custodial power over another individual's account B) account in which a person has power of attorney over an incompetent individual's account C) order that specifies the size, security, or action but leaves the choice of time or price up to the agent D) account in which the agent has the power to decide which securities to buy or sell without customer authorization for those specific trades

D) account in which the agent has the power to decide which securities to buy or sell without customer authorization for those specific trades An order is discretionary when the broker-dealer's agent places it for a customer's account without the customer's express authorization for that order. Additionally, for the order to be considered discretionary, the agent must choose at least one of the following: the security, the number of shares (or dollar amount), or whether to buy or sell. Although a person with a POA over another person's account would involve discretionary authority, that choice implies that discretion is limited only to the case where the client is mentally incompetent. U7LO2

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 must wait for the signed paperwork to be received 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 may exercise his discretion as authorized and sell the CANCO

D) 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. U7LO2