Midterm Exam (Units 1-14)
An agent employed at First XYZ Securities produces his own research reports and provides them to a select group of personal clients. The agent has written permission from his employer to engage in this activity, provided the time spent on the project is conducted after working hours. Under the Investment Advisers Act of 1940, if the agent does not charge fees for the research but receives commissions from his employing broker-dealer for trades executed through the firm, A) neither the agent nor his employing broker-dealer need register as an investment adviser. B) the agent must register as an investment adviser because the research is being done after hours. C) the agent must register as an investment adviser representative. D) the broker-dealer must register as an investment adviser and the agent as an investment adviser representative.
a
An investment adviser that has custody of customer funds and securities discovers that its net worth has dropped below the required minimum under the rules of the state Administrator. Under NASAA rules, the adviser must do which of the following? I. Notify the Administrator by the close of business on the day after discovery II. File a report of its financial condition with the Administrator no later than the close of business on the day after notification III. Cease doing business A) I and II B) I and III C) II and III D) I, II, and III
a
Federal and state securities laws deem certain conduct by investment professionals to be criminal in nature. Included in those activities are certain practices designed to manipulate the market prices of securities. An activity that would fall within the spectrum of the prohibitions would be A) wash trades. B) front running. C) guaranteeing customers against loss. D) churning customer accounts.
a
Which of the following types of investments requires the longest commitment and has the least short-term liquidity? A) Private equity fund B) Class B mutual fund shares C) REIT D) U.S. Treasury bonds
a
The Uniform Securities Act requires that investment advisers maintain certain records relating to their business operations. If the firm wishes to upgrade to a modern system, such as disk storage, A) it can do so if the system meets certain requirements, including that the information on the disk cannot be altered. B) it must keep its records in paper form. C) it must obtain approval from the Administrator prior to determining its method of record retention. D) the most modern form currently permitted is microfilm or microfiche.
a Computer disk storage is acceptable provided a printed copy can be readily obtained and the information on the disk cannot be overwritten
Which of the following firm's earnings are likely to exhibit the greatest degree of sensitivity to the business cycle? A) Furniture producer B) Telecommunications provider C) Entertainment producer D) Food and beverage producer
a Consumers buy fewer durable goods, such as furniture, during recessions and buy more during expansions. As a result, producers of these goods tend to have cyclical demand, revenues, and earnings. People do not decide to go to a movie (or rent one) based on the economy. Food and beverages is the stereotypical defensive industry, and people use their phones regardless of the economic cycle.
NASAA has a Model Rule dealing with investment adviser brochures. If an advisory client wanted information about each individual providing investment advice and having direct contact with clients in the state, that information would be found in A) Form ADV Part 2B. B) Form ADV Part 2A. C) Form ADV Part 1A. D) Form ADV Part 1B.
a Form ADV Part 2B is called the brochure supplement and includes information about the specific individuals acting on behalf of the investment adviser who actually provides the investment advice and interacts with the client. Part 2A is the brochure itself, and Parts 1A and 1B are used when initially registering and when amendments are necessary.
The consumer price index is best described as A) a weighted average cost for a basket of goods and services. B) the inflation rate for a given period of time. C) an unbiased estimate of changes in the cost of living. D) a measure of transactions between a country and the rest of the world over a period of time, usually a year.
a The CPI is the average cost of a basket of goods and services. The inflation rate is a percentage change in a price index such as the CPI.
Under the SEC's marketing rule for investment advisers, A) testimonials are given by clients while endorsements are given by promoters. B) testimonials are given by promoters while endorsements are given by clients. C) a written agreement must be in effect between the adviser and any promoter when compensation exceeds $100. D) an investment adviser may compensate a bad actor for an endorsement as long as the person's status and compensation are disclosed.
a The written agreement is not required as long as the compensation does not exceed $1,000 over a 12 month period.
Decoction Medical Supplies (DMS) has issued $100 million of $50 par 6% preferred stock convertible at $10. The stock is callable in eight years at $50.50. The major beneficiary of a call feature is generally agreed to be A) the issuer. B) the preferred stockholder. C) the common stockholder. D) the broker-dealer delivering the called stock.
a There are two common cases where the call feature is a benefit to the issuer (1) interest rates decline. DMS can call the outstanding stock and issue new stock at a lower rate. (2) Note that this is also a convertible preferred. Should the underlying common stock price rise significantly, the market price of the preferred will follow suit. If DMS wishes to save the cost of the preferred dividend, it can call in the stock at the call price rather than paying the much higher market price.
A transaction in which an investment adviser acts on behalf of both the advisory client and another person on the other side of the transaction is known as A) a discretionary trade. B) an agency cross transaction. C) an illegal and unethical activity. D) an exempt transaction.
b
HKBH Creations is a global manufacturing company that has issued common and preferred stock. Among the differences between the two securities is that the preferred stock A) generally pays dividends on a quarterly basis. B) may be convertible. C) is considered an equity security. D) has preference in voting on the payment of the dividends
b
The devaluation of a country's currency to improve its trade deficit would most likely benefit A) a domestic producer of an export good that represents a relatively small proportion of consumer expenditures. B) a domestic producer of luxury goods for export. C) a foreign producer of luxury goods for export. D) a domestic producer of export goods that have no close substitutes.
b
What procedure would a limited partnership follow to register with the state as an investment adviser representative (IAR)? A) A limited partnership would submit the initial application for registration on Form ADV Parts 1A and 1B. B) A limited partnership cannot register as an investment adviser representative. C) A limited partnership would submit the initial application for registration on Form U4. D) Unless granted a waiver, qualification by examination is required as a condition of registration.
b
An investment adviser representative may share in the profits and losses of a customer's account A) as long as both the customer and the representative's employer give written consent. B) under no conditions. C) if the investment adviser representative deducts the advisory fee charged the customer from any profits earned. D) provided a written contract is executed between the investment adviser and the client.
b Agents can
One of your clients purchased several units in a real estate limited partnership offering. If the enterprise in unsuccessful and files for bankruptcy, which of the following have a claim on the entity's assets ahead of your client? I. Fellow limited partners II. The bank that holds the mortgage on the property III. The bank that holds the unsecured loans on the property IV. The general partner A) I and II B) II and III C) III and IV D) I and III
b Creditors, both secured and unsecured, have priority over partners (owners). The general partner is last in line.
If a customer holds certificates of beneficial interest in a real estate investment trust (REIT), all of the following statements regarding this investment are true except A) a mortgage REIT represents pooled capital for real estate financing. B) the issuer must redeem certificates on shareholder request. C) the certificates are publicly traded. D) investors may receive dividends periodically.
b REITs are not redeemed by the issuer, they are publicly traded units.
A majority vote of the outstanding shares of an open-end investment company is needed in order to approve a change A) from the old to a new custodian bank. B) from being an open-end to a closed-end investment company. C) in the maximum load charged for Class A shares. D) regarding the selection of specific securities to be added to the fund's portfolio
b Some of the changes that require a majority vote of shares outstanding include changing subclassification (open to closed, diversified to nondiversified) and changing investment policy (income to growth). The selection of service providers (like a custodian bank) and sales charge schedules are set by the board of directors.
The Investment Advisers Act of 1940 requires that investment advisers make certain disclosures to their customers through the delivery of the adviser's brochure. However, the act grants an exemption if the client is which of the following? I. A broker-dealer II. An insurance company III. An investment company IV. A person receiving impersonal advice for which the annual fee is less than $500 A) I and II B) III and IV C) I, II, and III D) I, II, III, and IV
b There are two exemptions to the brochure rule. The first is if the client is an investment company. The other is if the advice being rendered is impersonal and the charge is less than $500 ($500 as well under the USA) per year
It is correct to state that on the day they are issued, warrants have A) intrinsic value but no time value. B) time value but no intrinsic value. C) time value and intrinsic value. D) no time or intrinsic value.
b Warrants are always issued with an exercise (strike) price above the current market value. That means there is no intrinsic value. Because they have an expiration date that is often several years in the future, they have time value.
A preferred stock with which one of the following features would be most likely to maintain a relatively stable market price when interest rates are rising? A) Convertible B) Cumulative C) Adjustable rate D) Callable
c
An investment adviser may borrow from all of the following clients except A) a broker-dealer in conjunction with a margin account. B) a commercial bank in conjunction with a mortgage on the office building from which the advisory operates. C) a mortgage broker who helped the adviser negotiate mortgage terms for its office building. D) a savings and loan association that has offered to finance new computers for the adviser's office.
c
An investment adviser representative has a client for whom investment-grade bonds are a suitable addition to the portfolio. That being the case, bonds with which of the following Moody's ratings would not be considered? A) Baa B) BB C) Ba D) AAA
c
An investor interested in acquiring a convertible debenture as part of her investment portfolio would A) seek to minimize changes in the bond price during periods of steady interest rates. B) be interested in tax advantages available to convertible debt securities. C) want the safety of a fixed-income investment along with potential capital appreciation. D) want the assurance of a guaranteed dividend on the underlying common stock.
c
An investor is looking at purchasing $10,000 face of bonds. One choice is U.S. Treasury bonds priced at 104.24, and the other choice is AAA-rated corporate bonds priced at 103⅜. How much more will the Treasuries cost? A) $86.50 B) $13.75 C) $137.50 D) $8.65
c
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) CIA's advisory contract calls for the automatic deduction of advisory fees. B) CIA has a power of attorney granting authority to withdraw funds from the custodian. C) checks made out to third parties are forwarded within three business days. D) checks made out to CIA are deposited within three business days
c
If DMF Corporation issues $10 million of convertible debentures at par, all of the following balance sheet items will be affected immediately except A) the assets. B) the working capital. C) the net worth. D) the liabilities.
c
SEC Rule 204A-1 requires every investment adviser registered with the commission to prepare and maintain a code of ethics. One of the terms in that code is access person. All of the following are considered access persons except A) a supervised person who is involved in making securities recommendations to clients or who has access to such recommendations that are nonpublic. B) all of the directors, officers, and partners if they are providing investment advice as the firm's primary business. C) any supervised person of an investment adviser. D) a supervised person who has access to nonpublic information regarding any clients' purchase or sale of securities or nonpublic information regarding the portfolio holdings of any reportable fund.
c
You have a client who has shown an interest in investing in precious metals. Which of the following could be an appropriate recommendation? A) Diamonds B) Lead C) Palladium D) Tin
c
Investors in exchange-traded funds (ETFs) find they offer several attractive advantages over mutual funds. All of the following would be advantages that ETFs typically have over mutual funds except A) greater tax efficiency. B) intraday pricing for active traders. C) lower trading costs for active traders. D) the ability to buy on margin.
c ETFs, being traded on exchanges, are generally subject to commissions on buys and sells just like any other actively traded security in the secondary markets. Mutual funds are not actively traded.
One area of paramount importance to state Administrators is seeing that investment advisers make all material disclosures to their advisory clients. An example of a failure to disclose is when the adviser has a financial condition that is reasonably likely to impair the ability of the adviser to meet contractual commitments to those clients. That disclosure would not need to be made in the case where the investment adviser A) maintains custody of the account's assets. B) accepts prepayment of more than $500 six or more months in advance. C) engages in agency cross transactions. D) has discretionary power over the account.
c Numerous disclosures are required when an investment adviser engages in agency cross transactions, but this is not one of them. The potential impairment must be disclosed if the IA maintains custody, exercises discretion, or accepts a substantial prepayment of fees. For state-registered advisers, that is more than $500 six or more months in advance. For federal covered, more than $1,200. How do we know this is referring to a state-registered adviser? The question refers to the Administrator, not the SEC
One of your clients sits on the board of directors of a company whose stock trades on the New York Stock Exchange. Two months ago, the client purchased 500 shares of the stock at $50 per share. Needing some additional cash for an upcoming vacation, the client has decided to sell this stock when the market price is $48 per share. You can make this trade as long as it complies with the provisions of A) Rule 147. B) Regulation D. C) Rule 144. D) Regulation A.
c Rule 144 is the SEC rule dealing with the resale of securities by control persons. (A member of the board of directors is included in that definition). The test will not deal with the specifics of the rule other than knowing the difference between a control person (affiliate) and a nonaffiliate and knowing the general holding period for restricted stock. Restricted stock is acquired in a private placement, that does not apply here because the stock was purchased on the NYSE
A consent to service of process allows the Administrator to A) verify the accuracy and completeness of registration without obtaining the registrant's prior approval. B) terminate a registrant's application. C) be the registrant's attorney to receive service of any lawful process in any noncriminal suit, action, or proceeding against the registrant or the registrant's successor. D) ensure that the legal appeal process is expedited as a result of the Administrator's access to information.
c The consent to service of process provides the Administrator with power of attorney to accept legal papers on behalf of registrants. This power of attorney does not grant the administrator the authority to terminate the registration at will nor does it empower the administrator to verify information or expedite the registration process.
The Uniform Securities Act considers which of the following to be investment advisers subject to registration in the state? I. An adviser with no place of business in the state who advises wealthy customers in the state on a fee basis only II. An adviser with a place of business in the state whose total fee income in the state amounts to $150 III. An adviser with no place of business in a state who provides advice on only fixed annuities IV. An adviser with a place of business in the state who provides advice only to open-end investment management companies registered under the Investment Company Act of 1940 A) I, II, and IV B) I only C) I and II D) I, II, and III
c Unless the adviser is federal covered, any adviser with a place of business in the state, no matter to whom the advice is sold, is required to register with the state. An adviser with no place of business in the state is exempt only if the advice is given to certain institutional-type clients, such as insurance companies and banks, not individuals, wealthy or not. If any of your clients are registered investment companies, you must be a federal covered adviser, making registration with the state nonapplicable.
Which of the following statements are true? I. When an investment adviser representative begins or terminates employment with an adviser registered under the Uniform Securities Act, only the investment adviser must notify the Administrator. II. When an investment adviser representative begins or terminates employment with a federal covered adviser, only the investment adviser representative must notify the Administrator. III. When an agent of a broker-dealer leaves the firm, only the broker-dealer must notify the Administrator. IV. When an investment adviser representative or a registered agent of a broker-dealer terminates employment, notice must be given to the Securities and Exchange Commission. A) II and IV B) I and III C) I and II D) III and IV
c When an agent of a BD begins or terminates employment, both the agent and the BD must promptly notify the Administrator. Notice to the SEC is not required.
An investor purchased 300 shares of Amalgamated Auto Parts (AAP) at a price of $60 per share. Shortly after the purchase, with the price of AAP at $62, the investor sold three AAP 60 call options when the premium was 6 points. At expiration, AAP stock was trading at $53 per share. The net result to this investor is A) a gain of $300. B) a loss of $100. C) a loss of $300. D) a gain of $100.
c the investor paid $60 per share for the stock. The premium of $6 per share reduced the cost to $54 per share. With a cost of $54 and a sale price of $53, there is a loss of $100 per contract.
A broker-dealer registered in multiple states must meet the record retention requirements of A) the state where the broker-dealer is incorporated. B) the state where the principal office of the broker-dealer is located. C) the state with the most stringent requirements. D) the SEC.
d
Following the rules of the Uniform Securities Act, an investment adviser ensures that all clients receive a written contract prior to the firm engaging in advisory activities in their accounts. The contract clearly states all of the account details, including the services to be provided, the fees to be charged, and the procedure for handling early terminations. Because the investment adviser (IA) has a tendency to pursue some rather unorthodox methods of analysis, the contract provides that the clients waive their right to sue in the event that the IA violates any provision of the Uniform Securities Act. Under the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, A) the adviser has met the requirements of providing a written contract. B) the contract is enforceable only if signed by the client. C) the contract is misleading and could lead to action by the Administrator. D) waivers of this type are never permitted.
d
Several years ago, an investor purchased $100,000 of U.S. Treasury bonds bearing a 2.80% coupon. Because of economic conditions, those bonds are now yielding 3.5% in the secondary markets. Therefore, the investor's semiannual income will A) decrease. B) Increase. C) be approximately $1,750. D) stay the same.
d
Under the Investment Advisers Act of 1940, which of the following would not meet the criteria of persons associated with an investment adviser? A) An individual whose only connection to the firm is a position on the board of directors B) A manager in an investment advisory firm who supervises five investment adviser representatives C) The individuals responsible for bringing new clients to an advisory firm D) An individual whose only function is posting trades to client accounts
d
ABC Securities is a broker-dealer registered with the SEC and domiciled in State M. ABC Securities is not be defined as a broker-dealer in State N under the Uniform Securities Act if it has no offices in State N and if which of the following are true? I. Its only clients are insurance companies. II. It has contact with fewer than six State N residents in any 12-month period. III. Its only solicitation of State N residents is through radio advertisements originating in State M but received in State N. IV. It occasionally engages in firm commitment underwriting with issuers based in State N. A) I and II B) II and III C) III and IV D) I and IV
d A BD with no office in the state is not defined as a BD in that state if its only business is with institutions, other BD, and issuers when engaged in underwriting their securities. There is no de minimis exemption. Any solicitation of individuals into the state, whether in person or by radio, television, or any publication, requires registration in the state.
Senescent Retirement Planning (SRP) is registered as a broker-dealer with the SEC and a number of states. As such, the client relationship summary (Form CRS) must be delivered to each retail investor before or at the earliest of any of these except A) the opening of a brokerage account for the retail investor. B) placing an order for the retail investor. C) a securities transaction or an investment strategy involving securities described to a retail investor. D) entrance into an investment advisory contract with the retail investor.
d Although Form CRS must be delivered to an advisory client as stated, that does not apply here because SRP is a broker-dealer and not an investment adviser.
Which of the following qualifies under the Section 28(e) safe harbor provisions for soft dollar compensation? A) Providing access to the broker-dealer's computerized accounting system, allowing the investment adviser to prepare its financial statements B) Reimbursement for travel expenses incurred to attend a seminar on the latest compliance trends for registered investment advisers C) Rent-free use of unused space in the broker-dealer's office D) Clearance and settlement services provided by the broker-dealer
d Clearance and settlement of trades is a qualifying brokerage service. The safe harbor under Section 28(e) applies to services that benefit the customers of the investment adviser. Rent-free use of office space benefits the investment adviser (IA) not the customer. An accounting system that allows the IA to prepare its financial statements benefits the IA, not the customer. Seminar fees are permitted but not reimbursement for travel expenses.
Which of the following persons is required to register with the SEC as a federal covered adviser? A) An adviser who manages assets of $90 million or more B) An adviser who gives advice related only to U.S. government securities C) A publisher who gives incidental investment advice only D) An adviser who gives advice only to registered investment companies
d Investment Advisers who act as advisers to investment companies registered under the Investment Company Act of 1940, regardless of their size, are required to register with the SEC. Only those with at least $110 million under management are required to register with the SEC. Once that level has been reached, the investment adviser may remain SEC registered as long as his AUM does not drop below $90 million.
Under the NASAA Model Custody Rule, an investment adviser (IA) would be permitted to take or have custody of any securities or funds of any client if A) customer permission was obtained prior to entering into the contract. B) the IA maintained adequate net worth or a surety bond. C) permission was obtained from the Administrator and custody was not prohibited by that state's rules. D) notification was given to the Administrator that he has or may have custody and custody was not prohibited by that state's rules.
d It is unlawful for any investment adviser to take or have custody of any securities or funds of any client if (1) The Administrator, by rule, prohibits custody, or (2) In the absence of a rule, the investment adviser fails to notify the administrator that he has or may have custody. It is true that there is a minimum net worth or bond required, but that is not part of NASAA's Custody Rue, but rather found in Model Rule 202(d)-1, NASAA's Minimum Financial Requirements for Investment Advisers
MT Securities is a broker-dealer registered in 42 states. MT Securities makes a market in over 100 different stocks and participates in the underwriting of approximately 22 IPOs per year. Which of the following actions would be prohibited under NASAA's Statement of Policy on Dishonest and Unethical Business Practices of Broker-Dealers and Agents? A) Adding to its inventory of a stock in which it makes a market, hoping to gain from market appreciation B) Purchasing shares of an IPO from the issuer and then reselling those shares to the public at a higher price C) Purchasing shares of a security in which it makes a market from a client at one price and then reselling those shares to another client at a higher price D) Acquiring shares of an IPO as part of the underwriting syndicate and holding a small portion for the firm's investment account, hoping to gain from market appreciation
d Members of the underwriting syndicate on an IPO are prohibited from withholding shares of that issue in their own accounts; they must make a bona fide public offering. As a market maker, the firm is permitted to adjust the size of its inventory to take advantage of market conditions. All underwriters purchase new issue shares at one price and then resell them at the public offering price (that is their underwriting compensation). Market makers buy at the bid and sell at the ask, earning the spread.
Prosperity Financial Investments (PFI) is a registered investment adviser with $85 million in total assets under management. PFI also manages the PFI Growth Fund, a registered open-end investment company with assets of $30 million. If one of PFI's investment adviser representatives (IARs) voluntarily terminates registration, the notification procedure would be which of the following? A) PFI, as a federal covered adviser, must notify the SEC. B) PFI must notify the Administrators of the states in which the individual is registered. C) PFI and the IAR must notify the Administrators of the states in which the individual is registered. D) The IAR must notify the Administrators of the states in which the individual is registered.
d Regardless of AUM, because PFI is managing a registered investment company, it is a federal covered adviser. As such, when an IAR terminates, only the IAR sends notice of the termination to the appropriate administrators.
Which of the following statements is correct regarding an unsolicited trade in an unregistered, nonexempt security? A) It is an exempt transaction only if it is an order to buy; an order to sell an unregistered, nonexempt security is not an exempt transaction. B) The Administrator may, by order, require that the customer acknowledge, upon a specified form, that the sale was unsolicited and that a signed copy of each such form be preserved by the broker-dealer for a specified period. C) The transaction is exempt if the broker-dealer does not maintain an office in the state from which the order is received. D) The Administrator may, by rule, require that the customer acknowledge, upon a specified form, that the sale was unsolicited and that a signed copy of each such form be preserved by the broker-dealer for a specified period.
d The USA specifically grants the Administrator the authority to make a rule requiring written acknowledgment of unsolicited orders be recorded on a designated form. it is important to understand the difference between a rule (applies to everyone) and an order (applies to a specific broker-dealer). The Administrator could not require one broker-dealer to keep these forms but not another.
The Investment Advisers Act of 1940 provides for an exemption from registration to investment advisers whose clients are residents of the state in which the adviser has its principal office and only place of business and who do not give advice dealing with securities listed on any national exchange (e.g., New York Stock Exchange). This exemption is denied to any investment adviser meeting all of the requirements but having as a client A) an accredited investor. B) an insurance company. C) a bank. D) a private fund.
d The intrastate exemption offered under the Investment Advisers Act of 1940 does not apply to an investment adviser (IA) with even a single private fund as a client. The insurance company exemption only applies when all of the IA's clients are insurance companies. The question is asking about the intrastate exemption, not exemptions in general. Another point is there are cases where an investment adviser without a place of business in a state whose only clients are institutions like banks and insurance companies qualifies for an exemption under state law, but this question deals with federal law. In addition, the question point out that this particular exemption (intrastate exemption) applies only when the client resides in the same state as the IA's principal office.
XYZ Securities, Inc., a FINRA member broker-dealer, is registered in all 50 states. XYZ has its principal office in State C and a branch office in State A. If the State U Administrator wishes to examine certain financial records of XYZ's, the Administrator would be able to do all of the following except A) ask the State C Administrator to perform the examination. B) ask FINRA to perform the examination. C) do so during normal business hours without prior notice. D) examine those records located in State U.
d This broker-dealer does not have a place of business in State U, so there are no records located there. How can an Administrator examine records that don't exist? All records are kept in the principal office, and those pertaining to branch operations are kept in the branch office. If a broker-dealer is registered in her state, the Administrator can examine that firm's books and records during normal business hours without prior notice.
