Series 66: Uniform Securities Act (Business Practices)

Which of the following is an acceptable investment advisory contract provision under the Uniform Securities Act?

"The investment adviser shall receive 1% of all assets invested as annual compensation" Investment advisers can receive a fee based on a percentage of all assets under management; however, they cannot be compensated based solely on capital gains achieved. Investment advisers are prohibited from assigning contracts unless written notice is given to the client. Investment advisers must advise their clients of any management changes in writing (if the adviser is a partnership).

A wealthy investor has $400,000 of funds to invest, but will need the money in one year to pay for a house that is currently under construction. Which investment is suitable?

1-year Treasury securities Since the investor needs the funds in one year, investing in long term bonds is not suitable, nor is investing in common stocks. Both of these are subject to price volatility. The best choice is to invest in Treasury securities with 1 year maturities. The maturity matches the cash needs of the customer. They are safe since they are U.S. Government guaranteed. Also, they give competitive market yields.

A block trade is a trade of at least:

10,000 shares A trade of 10,000 shares or more is a block trade (as in a large block of stock). Such a trade is large enough to strongly influence the market price of a stock, so these are often handled outside of computerized execution systems to avoid a market price distortion.

Which of the following is NOT a "Red Flag" for securities fraud operated through social media?

A banner advertisement placed by a broker-dealer on a "stock pick" chat room E-mails received promoting stocks from unknown senders are a red flag for social media investment fraud, as are unfounded or exaggerated claims about investments made on websites and apps such as Facebook or Twitter. Banner advertisements placed by broker-dealers are not a red-flag (since they are regulated by FINRA).

Which statement is TRUE about the retention of Internet advertising by broker-dealers?

All web pages that have ever been created and displayed must be archived The Administrator can request filing of all web pages that have ever been created - so they must be retained and archived!

A long-standing customer of a broker-dealer suffered a stroke and is in a coma. Who can place orders in the client's account?

An individual named as having a durable power of attorney over the client's account in a signed letter written 15 years ago Any power of attorney must be signed by the client. A durable power of attorney means that if the customer is mentally incapacitated (as in the case), the named individual continues to have control of the account. If the power of attorney is non-durable, then that individual's ability to take actions in the account ceases upon that client's mental incapacitation.

When making a sales presentation to a new client, an IAR makes a sale of advisory services to the customer, having the customer sign a sales contract. The IAR gives the customer a glossy brochure, but does not have the customer sign it. The brochure states that the client has 2 business days to back out of the contract. Under NASAA rules, why is this considered to be unethical?

Because the customer must be given 5 business days to back out of the contract Under NASAA rules, when advisory services are sold to a new client, the client must be delivered Form ADV Parts 2A and 2B - the "Brochure" and "Brochure Supplement." The rule states that the customer must get these either 48 hours prior to entering into the advisory contract; or alternatively, the customer can sign the contract and be given the Brochure and Supplement, but then has 5 business days to terminate without penalty.

Which of the following is considered to be "churning"?

Buying and selling ABC stock on the same day in a discretionary account that has a long term growth objective Churning is the excessive trading of a customer's account with the intention of generating commissions for the agent. Engaging in an arbitrage transaction (Choice A) is not churning - this is done to capture small momentary price differences that can exist between markets. Day trading in a discretionary account for a customer who wishes to speculate would be churning only if the trading was considered to be excessive - so Choice B is not churning. Performing a municipal bond tax swap for a customer (Choice C) is not churning either. Buying and then selling the same stock on the same day in a discretionary account that has a long term growth objective is likely to be churning. In such an account, a buy and hold strategy is appropriate - not quick in and out trading of positions.

A customer has an individual account. Upon written request, the customer's account statements and confirmations may be received by whom? I The customer II One of the customer's immediate relatives III The customer's agent IV The customer's broker-dealer

I only Customer mail must be sent to the customer's home address or to a post office box designated by the customer. It cannot be forwarded to a brokerage firm branch office (nor to a relative's home), because then the customer would not know what was going on in the account.

Which statement is TRUE under NASAA rules? Within 120 days of fiscal year end, the customer must be given a copy of the:

Form ADV Part 2 only if there are material changes NASAA rules require that within 120 days of fiscal year end, the adviser must send each customer a revised Brochure (Form ADV Part 2A) and Brochure Supplement (Form ADV Part 2B) if there are material changes. Instead of sending the entire Brochure, the adviser can simply send the "Summary of Material Changes" section to the Brochure, along with an offer of the revised Brochure. Also note that this annual procedure is not required if there are no material changes to the Brochure.

An investment adviser is "bought out" by another advisory firm. Which statement is TRUE?

Each customer of the "bought out" investment adviser must give prior approval for his or her account to be moved to the acquiring firm The sale of the advisory firm is a transfer of each customer's account to another adviser. This is an assignment of the account that requires prior customer approval on each transferred account.

An investment adviser is ready to open an account for a new customer. In the advisory contract, the adviser has included a clause that the customer has 48 hours to rescind the contract. The adviser gives the customer the brochure, takes payment from the customer, but forgets to have the customer sign the contract. Which statement is TRUE under NASAA rules?

Even though the customer did not sign the contract, he or she has 5 business days to rescind the contract Under NASAA rules, the brochure is required to be delivered to clients no less than 48 hours prior to entering into a written or verbal contract to provide advisory services. As an alternative to the "2 day free look," the customer can be given the brochure at the time of contract signing, as long as the contract provides for a 5 business day period following signing where the customer can terminate without penalty. In this case, the customer was not given the brochure 48 hours prior to entering into the contract. By signing and giving the adviser a check, the customer has "entered into a contract" to buy the advisory services. So this customer has 5 business days under NASAA rules to rescind the contract.

A research report on an issuer CANNOT be published by the underwriter of that issuer's securities for the time period encompassing: I 10 days following the effective date for an initial public offering II 20 days following the effective date for an initial public offering III 3 days following the effective date for a secondary offering IV 5 days following the effective date for a secondary offering

I and III A research report on an issuer cannot be published by the underwriter of that issuer's securities for the time period of 10 days following the effective date for an initial public offering; and 3 days following the effective date for a secondary offering.

Which of the following are NOT considered to be "churning"? I Exchanging income fund shares for growth fund shares for a customer who has a capital gains investment objective II Day trading by an agent with discretionary authority in a customer margin account where the customer has a speculative investment objective III Recommending trades in a customer account with the objective of producing commissions for the agent IV Swapping a municipal bond for another municipal bond to obtain a capital loss deduction

I, II, and IV Churning is the excessive trading of a customer's account with the intention of generating commissions for the agent. Exchanging mutual fund shares for a customer (Choice I) is not churning. Day trading in a discretionary account for a customer who wishes to speculate would be churning only if the trading was considered to be excessive - so Choice II is not churning. Performing a municipal bond tax swap for a customer (Choice IV) is not churning either.

Question:Under NASAA rules, advertisements by investment advisers: I can contain testimonials II cannot contain testimonials III can unconditionally make an offer of free services IV cannot unconditionally make an offer of free services

II and III The NASAA rule on IA advertising parallels the SEC rule included under the Investment Advisers Act of 1940. The NASAA rules states that any advertisement from an investment adviser: cannot contain a testimonial (broker-dealer advertising may, however); cannot state that any report or research will be provided for free unless this is offered without condition; cannot contain false, untrue or misleading statements; can include a list of recommendations made with their performance as long as all recommendations over that period (a minimum of 1 year) are included, along with the market price at the time of the recommendation and the current price of the security. This list cannot be deliberately selective. There is no restriction on the offer of free services, as long as they are truly "free" and not conditioned on making a purchase or trade.

A customer holds 52% of ABCD Corp. common stock, a thinly traded stock listed in the OTCBB. The customer wishes to sell 1% of her holding and requests that the broker display her offering quote. Which statement is TRUE?

The dealer can enter the quote only if it is bona-fide Quotes shown in any public market can reflect either a dealer or customer position. As long as this customer is making a bona-fide offering of the shares, the quote can be displayed.

An insurance agent also prepares financial plans for customers for a fee as a sideline. The agent is registered as an investment adviser representative in the State. Which statement is TRUE?

The insurance agent may say that he is registered in the State Since this agent is registered in the State (and not with the SEC) as an investment adviser representative, he can say that. He cannot say that he is registered with the SEC, since this is not true. In order to call oneself an "investment counsel," giving advice about securities must be the principal business of the adviser - not a sideline. It cannot be stated that the Administrator or State has certified the representative's qualifications, since this is not the case.

An agent and his customer wish to open a joint account by contributing $10,000 each. All of the following statements are true EXCEPT the:

agent and his customer can agree to share profits in the account as they see fit Agents are prohibited from sharing in a customer's account unless there is a written agreement between the customer and the agent which is approved by the broker-dealer; and sharing is proportional to the capital contributed. In this case, each person contributed half the funds, so sharing must be 50/50.

Investment advisers may be compensated:

based on a percentage of the value of all assets under management Investment advisers cannot be compensated based solely on capital gains achieved. The fee arrangement can be based on a percentage of all assets under management.

A money market fund that charges .10% of annual management fees and .20% of annual 12b-1 fees:

can be called "no load" A mutual fund (money market funds are mutual funds) cannot be called a "no-load" fund if it charges 12b-1 fees of more than .25% (25 basis points) annually. 12b-1 fees are charges against net asset value that pay for the cost of soliciting new investment to the fund, and they can be used to compensate salespersons that sell the fund's shares. All mutual funds charge management fees. These have nothing to do with sales loads.

Under Uniform State Law, advisory contracts:

can be executed in writing Under Uniform State Law, investment advisory contracts must be in writing - that is, there must be a signature of each of the parties to the contract on paper. It is the signature that makes the contract legally binding.

All of the following are defenses against identity theft that must be used at a broker-dealer or investment adviser EXCEPT:

cyber insurance Data encryption, installation of anti-virus and anti-malware programs, and the use of password-protection are all defenses against identity theft, where customer account data is stolen from broker-dealers or investment advisers. Cyber insurance to protect the firm against the cost of a data breach is a good thing to have, but is not a defense against a data breach.

An investment adviser has entered into a "soft dollar" agreement with a full service broker-dealer where the broker-dealer will provide the adviser with asset allocation software for free, in return for the adviser directing its order flow to the broker-dealer for trade execution at non-discounted commission rates. A customer of the adviser objects to this and directs the adviser to send his trades to an electronic discount broker. The investment adviser should:

direct the customer's trades to the electronic broker for execution The overriding rule is to follow the instructions of the customer. Failure to follow customer instructions is an unethical practice.

An investment adviser purchases a research report from a bank's research department. This report may be distributed to the RIA's clients:

if the adviser discloses to his clients that the report was prepared by a third party The use of "third party research reports" is permitted only if it is disclosed to the recipient of the report that someone else was the report's preparer.

The person named as the executor over an estate would be found in the:

letters testamentary Letters testamentary is the legal term for the will (as in "last will and testament"). The name of the executor chosen by the person who is now deceased would be found in the will.

A customer signature is needed to open a:

margin account There is no customer signature required on a new account form - this allows cash accounts to be opened over the phone, if a firm so desires. However, a customer signature is required on the hypothecation agreement needed to open a margin account - this is the legal pledge of securities in the account as collateral for the margin loan from the broker-dealer to the customer.

Under Uniform State Law, advisory contracts:

must be in writing Under Uniform State Law, investment advisory contracts must be in writing.

Under the NASAA Statement of Policy on unethical practices, investment advisers must do all the following EXCEPT:

send quarterly account statements to all customers Quarterly account statements must be sent by investment advisers that take custody of client funds or securities; there is no such requirement for advisers that do not take custody. Investment advisers must make suitable recommendations to all customers; must disclose conflicts of interest to customers; and must act in a fiduciary capacity for all customers.

A firm holds a joint cash account for a husband and wife. The wife calls the investment adviser representative and says "Sell 500 shares of ABC out of the account immediately and send a check for the proceeds made out to my name." The representative should inform the wife that:

the trade can be performed but the check must be made out to both names on the account Any party in a joint account can enter orders. However, any checks drawn on the account must be made out to all names on the account.

Under the Uniform Securities Act, copies of order memoranda maintained by investment advisers must contain all of the following EXCEPT:

time of order execution Order ticket information required for investment advisers is different than that required for broker-dealers. The IA writes an order and sends it to a broker-dealer or bank for execution. The IA must keep a record of the order as it was sent; the IA does not keep the record of the actual execution of the order - this is the responsibility of the executing broker-dealer. The record must contain the terms and conditions of the order; name of the person at the IA who recommended the transaction; name of the person who placed the order; date of order entry; name of account for which order was entered; name of broker-dealer or bank to which the order was sent for execution; and whether the order was discretionary.

A representative is making a presentation to a married couple, ages 75 and 77, about their need for continuing income as the expected life spans of the general population have increased. The representative is strongly recommending that the couple buy an equity indexed annuity (EIA). Which statement made by the representative would NOT be misleading and fraudulent?

"EIAs provide a minimum guaranteed rate of return that is guaranteed by the issuing insurance company" Equity indexed annuities (EIAs) are an insurance product that falls somewhere between a fixed annuity and a variable annuity. They give a return linked to a well-known index, such as the Standard and Poor's 500 Index, but the return is typically capped to a maximum interest rate per year. Thus, if the cap is 10% and the S&P 500 Index grows by 15%, the customer only gets a 10% return for that year. Thus, Choice A is a misleading statement. If the contract is redeemed early, there are steep surrender charges, making Choice B misleading. There is no deduction for contributions to the contract (these are non-qualified plans) making Choice C a misleading statement. Choice D is true - the contracts have a minimum guaranteed rate of return (like around 3%) that is guaranteed by the insurance company. Of course, if the insurance company fails (which rarely happens, but it has happened), then the guarantee is worthless.

Reports of cash transactions must be made to the Department of Treasury if the amount of cash received or paid exceeds:

$10,000 The Department of Treasury requires that any deposits of cash made by a customer; or withdrawals of cash made by a customer; in the amount of more than $10,000, must be reported to FinCEN (Financial Crimes Enforcement Network).

Under the Uniform Securities Act, the threshold where a State-registered adviser is considered to have taken custody of client funds if it charges prepaid advisory fees, is:

$500, 6 months or more in advance of rendering services If a State-registered investment adviser accepts $500 of prepaid advisory fees (or more), 6 months or more in advance of rendering services, then the adviser is considered to have taken custody of client funds under NASAA's interpretation. (Also note, in contrast, that the Investment Advisers Act of 1940 sets this limit at $1,200 for Federal Covered Advisers, but this is not the rule for State-registered advisers).

Which of the following is (are) prohibited in a margin account?

A customer buying a security without the intention to pay on settlement A customer selling a security without the intention to deliver on settlement A customer selling short a security that cannot be borrowed and delivered on settlement In any account, whether it be a cash or margin account, a customer cannot buy a security without intending to pay on settlement, and cannot sell a security without intending to deliver on settlement. Short sales can only be effected in a margin account. Selling short a security means that the security to be sold is borrowed from another customer of the broker-dealer. A short sale is not permitted unless it is first determined that the security to be sold can be borrowed and delivered by settlement.

Which State-registered investment adviser MUST report that it takes custody on Form ADV?

An adviser that directly deducts management fees each quarter from client accounts Taking custody means that the adviser is holding customer funds or securities or has the ability to access customer funds or securities. If an adviser is permitted to directly deduct fees from client accounts, it meets this definition. A limited power of attorney limits the adviser to trading the customer account, but the adviser has no power to withdraw funds from the client account. Thus, a limited power of attorney is not taking custody. In contrast, if the adviser has a full power of attorney over an account which allows the adviser to withdraw funds, this is considered to be taking custody.

Which of the following statements is TRUE regarding an investment adviser taking physical custody of a customer's monies or securities?

An investment adviser is permitted to take physical custody of a customer's monies or securities if the Administrator does not prohibit this by rule; and if the adviser notifies the Administrator that he will take custody An investment adviser is permitted to take physical custody of a customer's monies or securities only if the Administrator does not prohibit this by rule; and if the adviser notifies the Administrator that he has, or will take, custody. In addition, the customer must be sent a quarterly statement of account by the adviser.

Under the NASAA Statement of Policy on unethical practices, which of the following orders may be accepted in a customer's account without a written trading authorization from that customer?

An order entered by the customer The only person who is authorized to trade a customer's account is the customer whose name (or names for a joint account) appears on the account. To have anyone else trade the account would require that the customer sign a "Third Party Trading Authorization" - naming that other person as authorized to trade the account.

Under the NASAA Statement of Policy on unethical practices, which of the following orders may be accepted in a customer's account without a written trading authorization from that customer?

An order entered by the customer The only person who is authorized to trade a customer's account is the customer whose name (or names for a joint account) appears on the account. To have anyone else trade the account would require that the customer sign a "Third Party Trading Authorization" - naming that other person as authorized to trade the account. Please note that a customer's attorney does NOT have an implicit power of attorney over a customer's account. The customer must give a written power to anyone that the customer wishes to have trade his or her account.

An established customer of yours has a joint account with his wife. While on the phone with you, he discusses a specific NASDAQ stock and wants to buy shares of that stock when it declines to a certain price. The customer leaves for a 2-week vacation where he cannot be contacted. During this time, the stock declines to the level at which the customer wanted to buy the shares. What is an appropriate action to take?

Attempt to contact the customer's wife, and if this is possible, obtain authorization from her to buy the shares Since this is a joint account, both the customer and his wife can trade in the account. Thus, after obtaining authorization from the customer's wife, you would be able to buy the shares of stock.

Obtaining the 4 critical pieces of information from a customer at account opening is part of the company's policies and procedures covering:

Anti-Money Laundering When a customer account is opened, the customer must provide identifying information that must be verified promptly after account opening. The 4 critical pieces of information that must be verified are: Name, Street Address, Date of Birth and Social Security number. This is part of the "Know Your Customer" requirement. This is done to stop "bad actors" such as terrorists from opening accounts from which they can wire money to co-conspirators either within or outside the United States. Privacy of customer information is covered under Regulation SP. Customer account information is considered to be "private" and cannot be divulged to others unless the customer consents. A copy of the firm's privacy policy must be given to the customer at account opening and annually thereafter. Cybersecurity covers policies and procedures to stop the theft of customer account information. This includes protecting against unauthorized access and requiring strong customer password protection. Business continuity covers the procedures that the firm would follow to maintain customer access to accounts if there is a significant business disruption or if key personnel were compromised.

Under NASAA rules, within 120 days of year end, the customer of an investment adviser must receive:

Form ADV Part 2A if there are material changes NASAA rules require that within 120 days of fiscal year end, the adviser must send each customer a revised Brochure (Form ADV Part 2A) and Brochure Supplement (Form ADV Part 2B) if there are material changes. Instead of sending the entire Brochure, the adviser can simply send the "Summary of Material Changes" section to the Brochure, along with an offer of the revised Brochure. Also note that this annual procedure is not required if there are no material changes to the Brochure.

Which of the following are prohibited practices under NASAA guidelines? I An investment adviser lending money to a customer II An investment adviser lending money to a customer that is a relative III An investment adviser lending money to a customer through a bank affiliate IV A broker-dealer lending money to a customer where securities are collateral under Regulation T

I and II Loans to a customer by an investment adviser or broker-dealer is a prohibited practice, unless the provisions of Regulation T are met. Since nothing is said about Regulation T, it must be assumed that Choice I is prohibited. In addition, NASAA takes the stance that lending to customers that are relatives is also prohibited. Loans made by an affiliate that is a bank are OK, since the affiliate must comply with the banking laws. Similarly, lending a customer money where securities are collateral in compliance with Regulation T is fine as well.

Under the Uniform Securities Act, an investment adviser is prohibited from taking custody of a client's funds if the: I Administrator prohibits this by rule II firm fails to notify the Administrator that it has custody or may take custody III firm is registered as a broker-dealer as well as an investment adviser

I and II The fact that a broker-dealer can also be registered as an investment adviser has no bearing on whether an investment adviser can take custody of a customer's securities. An investment adviser can take custody of a customer's securities, if the firm notifies the Administrator that it has custody or may take custody. However, if the Administrator prohibits taking custody, then obviously the firm cannot do so.

An agent is soliciting customer orders for a new non-exempt issue that has been registered. The top officers of this company were previously associated with XYZ Company, a highly successful firm in the same industry. That firm's success was attributed to these individuals. Under the Uniform Securities Act, which statements by the agent are permitted? I "The top officers of this new firm were previously at XYZ Company" II "These top officers were responsible for the rapid growth of XYZ Company over the past 3 years" III "The top officers are experts in the field who made XYZ Company, their previous firm, into a gold mine"

I and II The use of flamboyant or exaggerated language to induce a sale is prohibited. It is perfectly acceptable to state that the officers were associated with the other company and were responsible for its growth, as long as the statements are true.

Changes to the terms of advisory contracts must be: I filed with the Administrator on Form ADV within 30 days II filed at year end with the Administrator III approved by the customer IV approved by the Administrator

I and III Any changes to an advisory contract are a material change that must be filed with the State Administrator within 30 days. In addition, since this is a contract between the customer and the investment adviser, both parties must agree to any changes.

An agent of a broker-dealer publishes a web page that offers a free suitability determination to each customer that fills out a form electronically. Furthermore, if the customer agrees to open an account, the site states that: "The first 10 trades will be free." Which statements are TRUE regarding this communication? I To publish this web page, the broker-dealer must be registered in each State where a customer completes the suitability determination II To publish this web page, the broker-dealer is not required to be registered in each State where a customer completes the suitability determination III To publish this web page, the agent must be registered in each State where a customer completes the suitability determination IV To publish this web page, the agent is not required to be registered in each State where a customer completes the suitability determination

I and III Because this is not a "general" Internet Communication and the communication is being followed-up with specific client interaction, this is considered to be an offer of brokerage services in each State where a customer completes and submits the electronic suitability form. As such, the maker of the offer (the broker-dealer) and its agents must be registered in each State where this occurs. The fact that the first 10 trades will be free has no bearing. The broker-dealer will charge for its trades thereafter.

An Investment Adviser Representative (IAR) has been employed by a Registered Investment Adviser (RIA) for the past 12 years and has accumulated $18,000,000 of customer assets under management in accounts for 47 different customers. The IAR has experienced a personal economic decline and has been trading these customer accounts with ever-increasing frequency to generate the commissions necessary to meet his personal debt obligations. Which statements are TRUE? I The IAR has regulatory liability II The IAR has no regulatory liability III The RIA has regulatory liability IV The RIA has no regulatory liability

I and III This representative is churning his customer accounts, which is an unethical business practice. Not only does the investment adviser representative have liability, but his employing firm has liability for failing to supervise this individual.

Which information is required to be on an order ticket prior to entry of the order? I Customer name or account number II Customer address III Customer social security number IV Registered representative name or number

I and IV Prior to entry of an order, the information required to be noted on the order ticket includes the customer name or account number; registered representative name or number; buy or sell; number of shares or bonds to be traded; description of the security to be traded and execution price. The time that the order was entered must be stamped on the order ticket (this can also be done electronically). There is no requirement for a customer address or customer social security number on an order ticket.

The Uniform Securities Act prohibits which of the following? I Guaranteeing of customer accounts II Discretionary customer accounts III Soliciting customer orders for unregistered exempt securities IV Soliciting customer orders for unregistered non-exempt securities

I and IV The Act prohibits the guaranteeing of customer accounts and the solicitation of customer orders for unregistered non-exempt securities (such as common stock). There is no prohibition on discretionary accounts or the solicitation of customer orders for unregistered exempt securities (such as government bonds).

Under Uniform State Law, investment advisory contracts: I must be in writing II cannot allow for payment to the adviser based upon capital gains in the account III cannot allow for prepaid advisory fees IV cannot be assigned to another investment adviser without customer approval

I, II and IV Under the Uniform Securities Act, advisory contracts must be in writing; and must base the advisory fee as a fixed dollar amount or as a percentage of assets under management. Compensation based upon gains in the account is not allowed unless the customer is very wealthy. Prepaid advisory fees are allowed (it is common to have up to ½ year's fee paid in advance). Finally, the contract must provide that if the account is assigned to another adviser, the customer must give prior approval for the transfer.

An investment adviser may be compensated with which of the following? I Wrap fees charged to customers for all services rendered by the adviser II Soft dollars paid by an executing broker to the adviser in return for trades sent to the broker by the adviser III Bid-Ask spreads earned when position trades are executed IV Commissions paid to an affiliated broker-dealer on trades recommended by the adviser

I, II, IV Investment advisers can collect wrap fees. This is a flat annual fee covering all services rendered, including recommendations, asset allocation and trade execution - so all services are "wrapped" into a flat annual fee. Investment advisers can receive "soft dollar" compensation. In return for directing full commission trades to an executing broker, the executing broker gives the adviser research, recommendations, trading algorithms, and similar items of value. The SEC permits these "soft dollar" items to be given by the broker-dealer to the adviser as long as they ultimately benefit the adviser's investors. Investment advisers cannot take commissions on trades that they do, but they can direct their trades to an affiliated broker-dealer for execution. The affiliated broker-dealer is permitted to charge commissions. Also note that such an arrangement is a conflict of interest that must be disclosed to the customer at the time of entering into the advisory contract. Bid-ask spreads are earned by securities dealers that buy securities into their inventory and sell securities out of their inventory. These are called "position trades" because the broker-dealer is taking positions in its inventory account. Broker-dealers earn these; investment advisers are prohibited from receiving these.

Which of the following are "critical" pieces of information that MUST be collected from a customer to open a new account? I Name II Date of Birth III Telephone Number IV Social Security Number

I, II, IV There are 4 critical pieces of information that must be collected to open a new account: Customer Name Address Date of Birth Social Security Number These 4 pieces of information must be used to independently verify the customer's identity (a requirement put in place after September 11th, 2001). There is no requirement for a customer phone number, though, honestly, how would an account be opened without a way to reach the customer? Actually, there might be a situation where a phone number is not needed - for example, an account opened for a military serviceman who is stationed overseas.

Arrange the following in proper sequence when opening a new account for a customer: I Completing the new account form II Executing the first transaction III The manager signing the new account form IV Completing the order ticket for first order

I, IV, III, II The procedure to open a new account is to complete the new account form, qualifying the customer and then completing the first order ticket. The manager receives both of these and must approve the opening of the account prior to the first trade. It is prohibited for the agent to execute the trade before the manager approves the account's opening.

A customer has previously signed a durable power of attorney giving his spouse power of attorney over his individual brokerage account. Which statements are TRUE? I The power of attorney continues upon the customer's death II The power of attorney ceases upon the customer's death III The power of attorney continues upon the customer's incapacitation IV The power of attorney ceases upon the customer's incapacitation

II and III A durable power of attorney continues in effect if the grantor is incapacitated. A non-durable power of attorney ceases if the grantor becomes incapacitated. Note, however, that any power of attorney ceases if the grantor dies (the power of attorney dies with the customer!)

Which of the following are unethical practices by an investment adviser under the NASAA Statement of Policy? I An adviser exercising discretion under verbal authority from a customer given 5 business days ago II An adviser placing an order to sell a position that is dropping rapidly in price without discretionary authority III An adviser selling all of a security position when the customer authorized the sale of only part of the position IV An adviser selecting the best time to sell a position when the customer authorized the sale

II and III A representative can exercise discretion over the time or price of a securities transaction without needing a discretionary authority from the customer. A representative cannot exercise discretion over the size of a trade or the security to be traded without discretionary authority from the customer, making Choice II unethical. Verbal discretion may be accepted from a customer under NASAA rules for up to 10 business days, at which point a written power of attorney must be obtained from the customer - so Choice I is permitted. Deliberately failing to follow the customer's instructions is also unethical - making Choice III unethical.

An agent of a broker-dealer may: I charge a fee for investment advice in addition to any commission charged if a recommendation performs well II not charge a fee for investment advice in addition to any commission charged if a recommendation performs well III charge for clerical services where the charge is not based on performance IV not charge for clerical services

II and III The only fee that can be accepted for executing a transaction is the original commission charged. A broker-dealer cannot charge separately for investment advice; any charge for investment advice is included in the broker's commission charge. Charges for clerical services are permitted as long as the charges are fair and reasonable and do not discriminate among customers.

A salesperson is offering promissory notes for a company selling coffee at drive-through kiosks. The notes pay a 13% interest rate and mature within 9 months. The salesperson tells a potential investor that the notes are "risk-free" and that the kiosks are collateral that secure the note. The salesperson is not registered in the State and the notes are not registered in the State. Which statements are TRUE? I There is no requirement for the promissory notes to be registered in the State because they are exempt securities due to the fact that their maturity does not exceed 9 months II The offer is a violation of State law because the salesperson must be registered or licensed in the State and the promissory notes must be registered in the State III The offering is fraudulent because the notes are not "risk-free" and promissory notes are not backed by collateral IV The offering is a violation of State law because the promissory notes are an unsecured obligation that cannot be backed by collateral

II and III Legitimate promissory notes are marketed to sophisticated, corporate investors that have the ability to thoroughly research the company issuing the notes and determine whether the issuer will be able to repay principal and interest. However, there have been many instances of "promissory note fraud" where unlicensed individuals push bogus promissory notes that are sold as investments that offer above-market fixed interest rates and safeguarding of principal - and most of these are frauds. This is a major concern to State regulators. To offer a promissory note, both the salesperson and the note must be registered in the State. Only promissory notes that have maturities of 9 months or less, that are investment grade, and that are sold in minimum increments of $50,000 are exempt from State registration. Thus, smaller note offerings (under $50,000 amount) to smaller investors are non-exempt and must be registered; and unrated note offerings or non-investment grade rated note offerings must also be registered in the State. Finally, the tell-tale signs of fraud in promissory note offerings are: Statements that the notes are "guaranteed" or "insured" - especially by bogus foreign entities Promises of above-market rates of return (an above-market rate of return is not offered by a "low-risk" investment, but rather by a high-risk investment) Statements that the notes are "risk-free" (these are corporate issues that have risk of default) The labeling of a start-up company's notes as "prime" (since only established companies with a history of operations and earnings can be called "prime") Offers of promissory notes from a stranger who does not know the customer's financial situation

An individual that has not yet passed the appropriate State licensing examination for agent registration in a State would be permitted to: I call existing customers of the firm to solicit orders II call existing customers of the firm to invite them to seminars III make cold calls to potential customers and respond to their questions IV call other agents of the firm and offer them recommendations made by the firm

II and IV only Prior to being licensed as an agent, an individual can only perform clerical functions. The individual cannot solicit existing or potential customers ("make cold calls"), cannot make recommendations, cannot perform a suitability determination and cannot write order tickets. These are promotional activities. Unregistered individuals can basically only perform clerical functions. They can call existing customers to invite them to seminars; and they can call other agents of the firm, since the agents should know what they are doing!

If an adviser is suspicious about a customer's account activity and believes that there may be illegal activity, then the adviser: I must file a CTR report with FinCEN II must file an SAR report with FinCEN III in 15 days IV in 30 days

II and IV If an adviser is suspicious about a customer opening an account, then a "Suspicious Activities Report" must be filed with FinCEN (Financial Crimes Enforcement Network - part of the Department of Treasury) within 30 days. The customer cannot be told that the report is being filed.

Which statements are TRUE? I Referral fees can be paid by an investment adviser to an unlicensed individual II Referral fees cannot be paid by an investment adviser to an unlicensed individual III Commissions can be shared by an agent of a broker-dealer with an unlicensed individual IV Commissions cannot be shared by an agent of a broker-dealer with an unlicensed individual

II and IV Investment advisers do not earn commissions, and the prohibition on sharing commissions with unlicensed persons is not applicable. Investment advisers are permitted to pay referral fees to individuals who solicit business for the adviser, however the State defines the solicitor as an investment adviser representative that must be registered (licensed) with the State. So a referral fee can only be paid to a licensed solicitor; not to an unlicensed solicitor.

Which of the following information MUST be recorded on an unexecuted order ticket where the trade has been canceled? I Time of execution II Time of receipt III Time of cancellation IV Solicited or unsolicited

II, III, IV Time of order receipt is recorded on the order ticket, as is time of order cancellation, if the trade is canceled. Since the trade was not executed, there can be no time of execution recorded. The account name and/or number must be on the order ticket and it must be recorded whether the trade was solicited or unsolicited.

Which of the following information MUST be included on a customer confirmation? I Whether the transaction was solicited or unsolicited II The exchange where the transaction was effected III The customer name and account number IV The price of execution

III and IV Whether a trade is solicited or not is required on an order ticket, but not on a trade confirmation. The exchange where the trade was effected used to be required on the confirmation, but this is no longer the case because all markets are linked and trades must be done at the best price in a given market or routed to the better-priced market for execution. The customer name, account number, size of the trade, price of execution, and any commission charged must all be on the confirmation.

A broker-dealer is offering an IPO to the public. The broker-dealer is permitted to sell the shares to: I its unregistered employees II its registered employees III prospective customers IV its existing customers

III and IV only Broker-dealers and their employees (whether registered or unregistered) are prohibited from buying IPO shares at the offering price in the underwriting. They can, however, purchase the shares in the secondary market. A broker-dealer buying IPO shares for its own or for employee accounts is "withholding the issue from sale to the public" with the intention of taking a "free ride" on the likely upward price movement once the issue opens for trading in the market. This is a violation called "free riding and withholding."

A Chinese Wall must be maintained by a broker-dealer between all of the following EXCEPT:

Investment Banking and Mergers and Acquisitions Chinese Walls to stop information flow must be maintained between: Investment Banking and each of the following: Trading, Sales and Research Trading and each of the following: Research and Sales. The intent of the information barriers around investment banking is to stop the flow of information on upcoming underwritings, mergers or takeover deals being done by the underwriting department to others that might trade on the information for a profit before the public knows about the upcoming deal. Regarding the Chinese Wall required between investment banking and research, the intent is to make sure that research is truly independent and not influenced by the investment bankers at that firm that might demand a "favorable" research report on an issuer so that they can curry favor with that issuer to get future underwriting business. The M & A department and the underwriting department are usually one and the same at investment banking firms. There are no barriers required between these two groups. The intent of the information barrier between research and trading is to stop a trading desk from getting advance knowledge of a research report that the firm will issue and trading on that information before it is publicly released. The intent of the information barrier between trading and retail sales is that if retail brokers know in advance of a broker-dealer's trading strategy, they could use the information to front-run those trades.

What is the best way to ensure that customer account information held at a broker-dealer is not stolen due to cyber theft?

Maintain customer information in a secure website in encrypted form To stop individual customer information from being stolen, the firm must have in place procedures to verify who is accessing the customer account information and must verify that it is the actual customer doing so, typically by having the customer use a strong password and having the customer answer questions before allowing access. To stop broad based cyber theft, all customer data must be maintained in a secure website, with the data encrypted.

Which of the following is NOT a qualified custodian under NASAA rules?

National Securities Clearing Corporation Qualified custodians under NASAA's Custody Rule are: FDIC insured deposit taking institutions; Registered broker-dealers holding customer assets; Registered futures commission merchants holding customer assets; and Foreign financial institutions holding financial assets for customers. National Securities Clearing Corp. (NSCC) is not a retail institution that deals with the public - its customers are broker-dealers. An investment adviser cannot open an account with NSCC. An investment adviser can open an account with a broker-dealer that belongs to NSCC.

The Prudent Investor rule prohibits investments in: I Futures II Options III Speculative Stocks

None of the above The Prudent Investor Rule does not detail the types of investments to be made, nor does it specify that only securities are permitted investments. When investing under the rule, investments must be managed in the way that a prudent investor would.

An agent of a broker-dealer is opening a new client account. The agent has completed the new account application and the suitability determination. The customer has an investment objective of safety of principal and income. The agent makes an initial recommendation of a conservative blue chip stock with a track record of paying a consistent cash dividend. The customer accepts the recommendation. When must the commission charged on the transaction be disclosed to the customer?

On the confirmation of the transaction There is no requirement to disclose the commission charged to customers at the time of the trade or at the time of account opening. The only requirement is that the commission be disclosed on the trade confirmation. Also remember that any commission charged must be "fair and reasonable."

Under the Uniform Securities Act, an agent may engage in which of the following transactions?

Performing investment advisory services for customers as long as they are solely incidental to his work as a broker and no fees are charged An agent can perform advisory services for clients as long as they are incidental to his work and no compensation is taken for the advisory work. Agents cannot effect trades in a State where they are not registered; or where their broker-dealer is not registered. Agents cannot solicit orders for unregistered non-exempt securities (but they can solicit orders for unregistered exempt securities such as U.S. Governments or Municipals).

A customer wishes to buy 1 share of Dreamworks Animation stock, which she intends to frame and give to her son as a present because it includes a color image of Shrek, her son's favorite ogre. The stock is trading for $16 per share; however the commission for executing the trade will be $100, since the brokerage firm has a minimum ticket charge. Which statement is TRUE?

Prior to buying the share, the fact that the commission will be unusually high must be disclosed If there will be unusual charges for effecting a transaction, these must be disclosed to the customer. While this 1 share of stock only costs $16, the commission will be $100 - this is very high relative to the cost of the share and must be disclosed. Also note that in this scenario, the $100 charge seems reasonable, since it costs more to buy an "odd lot" than to buy a round lot of stock.

Under the NASAA Statement of Policy on unethical practices, the release of customer information to which of the following would be "unethical"?

Registered broker-dealers Under the NASAA Statement of Policy, information about a customer account cannot be divulged to anyone other than that customer, unless the customer gives authorization. The only exception is if the information request comes from a governmental authority such as the SEC, IRS or a self-regulatory organization like FINRA.

A customer enters a bank branch where he has a savings account and is approached by the branch manager who asks: "Are you interested in earning a higher rate of return than we offer on our savings accounts? Let me introduce you to our securities representative." If the customer opens a securities account, which disclosure is NOT required to be made?

Securities products are subject to taxation of income and capital gains When a customer enters a bank that has a securities "kiosk," this is called a securities branch in a bank setting. Any salesperson selling the securities in the branch must be properly registered and licensed. Note that this person can be both a bank employee and an employee of a broker-dealer, usually owned by the bank, at the same time. When a customer wishes to buy securities in that location, the sales representative must comply with the "Not-Not-May" Rule. The salesperson must inform the customer verbally and in writing (this is done by giving the customer a written brochure) that: Securities are NOT FDIC insured; Securities are NOT bank deposits; and Securities are subject to investment risk and MAY lose value. In addition, the representative must attempt to get the customer to sign a statement that he or she understands this. There is no requirement to disclose the tax consequences of the investment.

An agent holding a State securities license may share commissions with a(n):

State-licensed securities agent at the same firm Licensed securities agents may only share commissions with other licensed securities agents working at the same broker-dealer. Commissions may not be shared between individuals that do not hold securities licenses; nor can they be shared with licensed individuals working at other broker-dealers.

An agent hears from a friend who works at a publicly traded company that the Chairman is being sent to the Betty Ford Clinic and may be relieved of his responsibilities. The agent calls each of his clients with a position in that company and tells them to sell. Which statement is TRUE?

The agent has used a rumor to induce customer trading, which is a violation under the Act Because the agent has "heard" that the Chairman is being sent to a detox clinic, this is a rumor, not inside information. The use of rumors to induce customer trades is a prohibited practice under the Act.

An investment adviser's research department is going to issue a report, changing its recommendation from "Buy" to "Hold" on XYZZ stock. The analyst that prepared the report wants to sell his XYZZ holding that he has in his personal account. Which statement is TRUE?

The analyst is prohibited from selling the stock until the report is released Until the research report is released, the analyst that prepared the report is treated as an "insider" and cannot trade that stock. Once the report is released, rules for broker-dealers prohibit the analyst from trading that stock until 5 days after the release of the report. There is no such rule for analysts at investment advisory firms, so once the information is disseminated, the analyst could sell his position.

An investment adviser representative receives a written complaint from a client about the handling of the client's account. Under the NASAA Statement of Policy on unethical practices, which statement is TRUE?

The complaint must be forwarded to a manager for resolution Under the NASAA Statement of Policy on unethical practices, all written customer complaints must be forwarded to a manager for resolution.

An Investment Adviser has obtained written discretion from a client. If the IA wishes to assign the advisory contract to a Sub-Adviser, which statement is TRUE?

The transfer can be effected if the client is notified in writing and gives written consent to the transfer Just because a customer has given an Investment Adviser discretionary authority in writing does not mean that this gives the IA the power to assign the customer's contract. Discretionary authority only gives the IA the power to make investment decisions in the account without needing the customer's advance consent to each transaction. To assign the contract to a different adviser requires that the customer's signature, consenting to the transfer.

An investment adviser based in Beverly Hills, California whose clientele consists of wealthy entertainment celebrities, invests its clients' monies with the objectives of growth and income, along with safety of principal. The adviser allocates customer monies across various equity funds, bond funds, REITs and RELPs, and collects an annual advisory fee equal to 1% of assets. The adviser is recommending to its clients partnership units in rental condominiums being built in Las Vegas, Nevada. The developer of the condominiums will pay a 6% commission to the adviser for each real estate partnership unit sold. Which statement is TRUE?

The investment adviser must disclose the potential conflict of interest to any customer prior to the sale of the partnership unit to that customer Investment advisers are normally compensated by advisory fees. Normally, the adviser cannot take advisory fees for management of assets and commissions on recommended transactions, since this is a conflict of interest. However, if the conflict of interest is disclosed to the customer in advance of the purchase, and the customer still wishes to buy that security, then this is permitted. There is no regulation requiring advisers to rebate part of commissions received on recommended transactions to customers; nor is there any prohibition on offering "out-of-state" investments, as long as the security is registered in the State where offered (or is exempt from registration in that State).

An investment adviser has placed a block trade for 100,000 shares of ABCD stock. The trade is filled in 2 separate lots of 50,000 shares each, with one lot filled at $50.01 per share and the other lot filled at $50.03 per share. How should the investment adviser allocate the shares among clients that participated in the trade?

The investment adviser should allocate the shares at an average price of $50.02 per share and distribute them equally among clients participating in the trade on a pro rata basis The typical procedure for handling trades executed in a single block is to allocate the securities equally among clients at a uniform price on a pro rata basis. This is the typical disclosure made to clients. Depending on market conditions, the adviser may not be able to purchase the security for all clients at the same price. Instead, it may have to purchase the security over several days at different prices. In such a case, each client should receive a pro rata allocation at the weighted average price.

An agent is selling a new issue of a non-exempt security to a customer. In order to make it easier for the customer to understand the risks of the investment, the agent highlights the "Important Risk Factors" section of the prospectus before giving it to the customer. Which statement is TRUE about this action?

This action is a violation of the Uniform Securities Act A prospectus cannot be altered or highlighted. It is a legally prepared document that cannot be changed before it is delivered to the purchaser of a new issue security. Note that the SEC does not approve new issue offerings, nor does it approve the documents filed in connection with the sale of those offerings, making Choice C incorrect.

An Investment Adviser Representative has started a blog on the Internet to promote her services to interested parties. The blog discloses that the IAR is associated by DEF Advisers, an RIA registered in the State where the IAR is also registered and conducts business. Which statement is TRUE about this?

This action is prohibited because the RIA must approve the content of the blog and authorize its distribution If an agent of a broker-dealer or an investment adviser representative wishes to publish any content on the Internet, either as a website or on a blog, the Agent or IAR: must disclose his or her affiliation with the Broker-Dealer or Investment Advisory firm; the Broker-Dealer or Investment Adviser (the firm) must approve the content of the Internet Communication; the Broker-Dealer or Investment Adviser (the firm) must authorize the distribution of the Internet Communication; and the Agent or IAR must act within the scope of authority granted by the Broker-Dealer or Investment Adviser (the firm).

An Investment Adviser prepares a 4-color glossy brochure to be given to potential customers instead of the ADV Form Part 2A. The brochure includes all of the information found in the ADV Part 2A, but is much livelier in its presentation. An Investment Adviser Representative uses the brochure to solicit a new client, who signs a contract with the firm that includes a clause giving the customer 2 business days to back out of the contract without incurring any penalty. Which statement is TRUE?

This procedure violates NASAA rules because the customer must be given 5 business days to back out of the contract without penalty NASAA requires that new customers be delivered the investment adviser brochure. It is OK to prepare a customer brochure that includes all of the ADV Part 2 information. The rule on delivery of the brochure is that either: the brochure must be delivered 48 hours prior to entering into either a verbal or written contract with the customer to provide advisory services; or if the brochure is delivered at the time that the contract is signed, the customer has 5 business days to terminate the agreement without penalty. In this case, the customer signs a contract that gives him or her 2 business days to rescind the deal. The rule requires that the customer be given 5 business days to rescind the deal when the customer is receiving the brochure at the time that the contract is signed. Note that the wording of the brochure delivery rule states that it applies to "oral or written" contracts and we know that NASAA requires that advisory contracts be written, so this appears to be inconsistent. The use of the term "oral" covers the scenario where a customer does not sign an advisory contract, but writes a check to the adviser - which legally means that there is now a contract!

Under the NASAA Statement of Policy on Dishonest and Unethical Business Practices, which of the following is considered to be a manipulative and prohibited practice?

Wash trades Rapid-fire buying of a security on one exchange and simultaneously selling it, just to create the appearance of trading activity is a manipulative and prohibited practice known as "wash trading" (also known as "painting the tape"). Hypothecation occurs when a customer opens a margin account and he or she pledges the securities to the brokerage firm. In return for the pledge of securities, the brokerage firm loans the customer a portion of the purchase price. Rehypothecation occurs when the brokerage firm takes the pledged customer securities and goes to the bank to secure a loan which is essentially for the customer's benefit. Buying a security on one exchange and simultaneously selling it on another exchange for profit is a common trading technique known as "arbitrage" and is perfectly legal.

When can an agent represent that a mutual fund is "no load"?

When the fund does not impose an up-front sales load, a contingent deferred sales charge or annual 12b-1 fees in excess of .25% Under both FINRA and NASAA rules, a mutual fund can be called "no load" only if it has no up-front sales charge; no contingent deferred sales charge; and annual 12b-1 fees of no more than .25%. (Note, in contrast, that a "pure" no load fund cannot impose any annual 12b-1 fees.)

An investment adviser that claims that it is a "fee only" adviser could be compensated based on:

a flat annual or hourly fee for all work performed Advisers that are "fee only" can charge hourly fees, fees based on a percentage of assets under management, and can charge performance fees - but only for wealthy investors (those with either at least $1,000,000 under management or a net worth of $2,100,000 as permitted under the Investment Advisers Act of 1940). An adviser that advertises itself as a "fee only" adviser cannot be compensated from the sale of products that it sells. It cannot charge commissions on transactions, nor can it receive 12b-1 fees, which are basically annual commissions paid by a mutual fund to the broker-dealer or advisory firm that placed the customer into the fund. In both of these cases, the adviser has an incentive to either actively trade the customer's account in order to receive higher commissions or to place the customer only in those mutual funds that will pay 12b-1 fees to the adviser. A "fee only" adviser is supposed to be completely unbiased in its selection of securities for the customer and the frequency with which it trades the customer's account. Finally, fee-only advisers cannot accept "soft dollar" compensation from broker-dealers, since, again the adviser is supposed to be completely unconflicted when making recommendations to the customer.

If the Administrator prohibits investment advisers in that State from taking custody of customer funds or securities, then the investment adviser would NOT be permitted to:

accept securities from a customer that are registered in customer name A customer giving an adviser a check or cash to pay the advisory fee is not "taking custody." Those funds belong to the adviser, not to the customer. Broker-dealers are permitted to take custody of funds and securities - it is part of their regular business operations. Regarding investment advisers, if the Administrator, by rule, prohibits the taking of custody, then the adviser could not accept funds or securities from customers to be held by the adviser for that customer.

Under the NASAA Statement of Policy, an investment adviser cannot borrow funds from a(n):

accredited investor Investment advisers are prohibited from borrowing from customers - but they may borrow from affiliated or unaffiliated banks or broker-dealers (since these are Federally regulated lenders). An accredited investor is simply a customer for this definition, and an investment adviser cannot borrow from a customer.

A Registered Investment Adviser that trades securities on the behalf of customers is required to keep a record of the transaction that includes all of the following information EXCEPT the name of the:

agent at the broker-dealer who executed the transaction NASAA states that Investment Adviser order tickets must contain: Name of the person at the IA who recommended the transaction;Name of the person who placed the order;Date of order entry;Name of account for which order was entered;Name of broker-dealer or bank to which the order was sent for execution;Whether the order was discretionary.

Under NASAA rules, within 120 days of fiscal year end, each customer must be sent a(n):

an updated brochure and brochure supplement NASAA rules require that within 120 days of fiscal year end, the adviser must send each customer a revised Brochure (Form ADV Part 2A) and Brochure Supplement (Form ADV Part 2B) if there are material changes. Instead of sending the entire Brochure, the adviser can simply send the "Summary of Material Changes" section to the Brochure, along with an offer of the revised Brochure. Also note that this annual procedure is not required if there are no material changes to the Brochure.

All of the following are unethical practices on the part of an investment adviser EXCEPT:

appointing the adviser as trustee for a customer's trust account at the direction of the customer Choices A and B are clearly prohibited under the Uniform Securities Act - investment advisers cannot assign advisory contracts without customer consent; and investment advisers cannot have broker-dealer affiliates execute recommended transactions for a commission unless the customer is made aware of the arrangement. Choice C is also unethical - the adviser cannot alter an estate tax plan - only the customer can do so, using an attorney to ensure that the plan is valid. Choice D is not unethical - if the customer wishes to appoint the adviser as trustee over a trust account, so be it. The adviser has a fiduciary responsibility to the customer, as does a trustee - so this is not improper.

A married man opens an individual account at a brokerage firm. The customer places his first trade. The confirmation is received by the customer's wife, who calls the broker and informs him that her husband doesn't have the money to pay for the transaction by settlement date and that the stock should be sold immediately. The agent should:

attempt to contact the customer but otherwise do nothing Since the customer opened an individual account, and there is no mention of the husband giving the wife trading authorization, the wife has no say in what happens in the account. The representative should contact the customer to find out what is going on!

All of the following are requirements for an internet communication (a website) posted by a broker-dealer, agent, investment adviser or investment adviser representative EXCEPT the communication must

attempt to effect securities transactions or the rendering of personalized investment advice for compensation in the State Since the internet can be viewed from anywhere, Uniform State Law gives a safe harbor to having to register in a State if the following legend appears on the site: "The broker-dealer agent or investment adviser representative may only transact business in the State if registered in the State or if exempted or excluded from registration;" and "Follow ups or individualized responses to persons in the State by the broker-dealer agent or investment adviser representative that involve either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made absent compliance with State registration requirements or an applicable exemption or exclusion." So, basically, the disclaimer required is that anyone who views the site cannot be solicited by persons associated with the site unless those persons are registered in that State (or are excluded or exempt from registration). The internet communication cannot be overtly promotional - specifically, it CANNOT attempt to effect securities transactions or the rendering of personalized investment advice for compensation and the broker-dealer or investment adviser must put in a firewall or procedures that make sure that viewers of the site are not contacted by agents or investment adviser representatives to buy securities or advisory services unless the agent or IAR is appropriately registered in the State.

An investment adviser has placed a block trade for 100,000 shares of ABCD stock. The trade is filled in 2 separate lots of 50,000 shares each, with one lot filled at $50.01 per share and the other lot filled at $50.03 per share. The adviser has developed a methodology of allocating shares purchased at the lowest price to clients with a history of referring other clients and to clients with more assets under management and has been doing this unknown to staff and clients for many years. The investment adviser is guilty of:

breach of fiduciary duty The SEC has initiated fraud charges against investment advisers based on their undisclosed trading practices. The typical procedure for handling trades executed in a single block is to allocate the securities equally among clients at a uniform price on a pro-rata basis. This is the typical disclosure made to clients. Depending on market conditions, the adviser may not be able to purchase the security for all clients at the same price. Instead, it may have to purchase the security over several days at different prices. In such a case, each client should receive a pro rata allocation at the weighted average price. However, if the adviser favors one client over another in the allocation of the block, the adviser has violated its fiduciary duty (if it fails to disclose this conflict of interest to its clients).

Investment advisers are prohibited from doing all of the following EXCEPT:

charging a retainer fee Investment advisers cannot assign (transfer) an advisory contract without the customer's permission. Charging commissions on trades effected for the client is prohibited since the adviser is compensated based on a percentage of assets under management. However, if the adviser has a separate broker-dealer, the broker-dealer entity can handle the trades and earn the commissions, as long as this conflict of interest is disclosed to the client when the contract is signed. Investment advisers are obligated to notify clients if the management of the investment adviser changes (when the investment adviser is structured as a partnership). There is no prohibition on an investment adviser charging a retainer fee.

All of the following actions by an investment adviser are violations of the Uniform Securities Act EXCEPT the adviser:

discloses the risks of the investment, but the client loses as a result of the advice This is a common sense question. Making misleading statements to a customer is an unethical practice. Choice C is a fine, ethical practice - a client should be informed of the risks of an investment; and if the investment results in a loss - oh, well, - the customer knew what he or she was getting into!

An agent receives material inside information about a publicly held company. All of the following actions by the agent are violations of the Uniform Securities Act EXCEPT:

discussing the information with the principal of the broker-dealer Agents are prohibited from effecting transactions based on material inside information, either for their own account or for customer accounts. Thus, Choices A, C, and D are incorrect. If an agent receives material inside information, he should report it to his manager or principal, who then would report it to the exchange where that security trades.

A broker-dealer is a syndicate member in a best efforts underwriting of ABC Common stock. The issue is oversubscribed. The broker-dealer may allocate sales of the issue to all of the following EXCEPT:

employees of the broker-dealer When a broker-dealer does a new issue offering, it must make a "bona-fide" sale to the investing public and cannot retain part of the issue for itself or for its employees. If this were permitted, the broker-dealer would have the incentive to "underprice" the issue and then buy it for itself; intending to turn around and resell it for a profit. This would be in addition to any underwriting fees earned by the broker-dealer. Thus, broker-dealers in the underwriting group, their officers and their employees cannot buy the issue. There is nothing stopping the employees and officers of the issuer from buying the issue (they are likely to be large purchasers!).

A customer that buys a non-exempt new issue must be delivered a prospectus at, or prior to, the time of:

entering into the contract to purchase the new issue The rule for prospectuses is that they must be delivered at, or prior to, confirmation of sale. The generation of the confirm is the time that the customer is legally entering into the "contract" to buy the security, so this is the best answer. Settlement is the date (typically 3 business days after the confirm is generated) when the customer actually makes the payment for the purchase. This is when the transaction is legally "complete."

A 75-year old investor calls his securities agent, wanting to buy 1,000 shares of a high risk stock. To fund the investment, the customer is going to liquidate some certificates of deposit that he uses for current income. The registered representative should:

explain to the customer that the trade is not suitable and get a signed non-solicitation letter from the customer before accepting the order Clearly the trade is unsuitable for the customer, and he must be told this. If the customer still insists that the trade be performed, follow the customer's instructions but get a signed "non-solicitation" letter from the customer for this trade. If the investment turns sour, the agent is protected from customer complaints since he has a written statement from the customer that the agent did not solicit this trade.

If a customer of a broker-dealer fails to pay for a securities purchase by the 4th business day from trade date, the customer's account must be:

frozen The Federal Reserve sets the rules for payment of customer securities purchases in both cash and margin accounts. Payment is required "promptly," but no later than the 4th business day past trade date. If payment is not received, the unpaid position must be sold and the account must be frozen for 90 days. Many firms call this "putting a CUF" on the account - with CUF standing for Cash Up Front. A customer can make purchases in a frozen account, but must deposit the cash amount in advance. If the customer behaves for 90 days, the freeze comes off the account, and the customer is again expected to pay for purchases "promptly," but no later than 4 business days from trade date.

Under the NASAA Statement of Policy, discretion may be exercised in a customer account without first receiving a written power of attorney from that customer:

if it relates only to the price of the trade or the time of the trade The definition of "discretion," where a written power of attorney is needed from the customer, is if the agent is selecting either the security to be traded or the size of the trade. No written power of attorney is needed for an agent to select either price of execution or time of execution in a transaction. For example, if a customer says "Buy me 100 shares of ABCD when you think the time is right," the agent can choose the price and time of that trade execution without needing a written power of attorney.

An Investment Adviser Representative (IAR) wants to take a part-time job giving SCUBA lessons. This is permitted:

if the Investment Adviser that employs the IAR says that it is allowed If an agent of an IAR wishes to take outside work, he or she must give notice to the firm and must follow the instructions of the firm. There is no prohibition on being compensated for outside work, making Choice C incorrect. Choice D is potentially true as well. The individual could not give investment advice to students in his or her job as a SCUBA instructor. The individual could give investment advice if these students became clients of the investment adviser. So here we have another question with 2 potentially correct answers - which is typical of the NASAA question writing style. However, Choice B is the better answer.

If an agent of a broker-dealer is also an agent of an affiliated investment adviser, disclosure must be made to any customer:

if the agent will receive a commission for executing trades for that customer that are directed to it by the affiliated advisory firm This agent is registered with both an investment adviser and a broker-dealer that are under common control (so-called "affiliates" of the same parent company). It is very common for the larger financial firms to have both broker-dealer and separately registered investment adviser entities. If the agent will receive a commission from the broker-dealer for executing trades through the broker-dealer that are recommended by the adviser, this is a conflict of interest that must be disclosed to customers. Choice A does not require disclosure - it is a prohibited practice. Customers cannot be charged advisory fees that are materially higher than those charged by other advisers for similar services under NASAA rules. There is no requirement for disclosure of an agent's financial condition to a customer (this is required, however, for broker-dealers under Federal rules; and for investment advisers under both Federal and State rules). Finally, there is no requirement for disclosure of the registration status of the agent.

All of the following statements are true regarding investment advisory contracts EXCEPT:

if the investment adviser is a partnership, the death or withdrawal of a minority of the partners constitutes an assignment It is true that assignment of an investment advisory contract is not permitted unless the customer consents (after all, the customer hired a specific firm as the adviser for that firm's expertise; he does not want someone else to manage his funds unless he approves!). If the investment adviser is a partnership, the death or withdrawal of a majority of the partners constitutes an assignment. However, the death or withdrawal of a minority of the partners does not constitute an assignment. Finally, if the investment adviser is a partnership, the customer must be notified of any change in the membership of the partnership within a reasonable time.

A wrap account:

includes management fees, advisory fees, and commission charges "wrapped" into a single fee assessed against the account A "wrap" account charges an annual fee, either as a fixed dollar amount or as a percentage of assets under management, for all services provided. Thus, all services are "wrapped" into a single fee. There is no separate charge for investment advice, research, brokerage commissions, etc. in a wrap account.

Under the NASAA Statement of Policy on unethical practices, all of the following investment advisers would be able to loan monies where securities are collateral for the loan EXCEPT an investment adviser that:

is a partnership that lends money to a customer under the provisions of Regulation T of the Federal Reserve Board An investment adviser is not permitted to lend money to a customer, unless the investment adviser does so through an affiliated "regulated lender." An affiliated broker-dealer is regulated under Regulation T and can lend money to a customer; as can an affiliated bank. An adviser can lend monies to its officers or employees because they are not customers.

A broker-dealer offers 4 summer passes to an amusement park to each of its agents who sell at least $10,000 of bonds during the month of June. This action:

is allowed There is no prohibition on a broker-dealer compensating its agents with prizes for meeting a sales contest requirement. The broker-dealer will have to report the compensation value as taxable income to the IRS, but this is not part of the question. "Pay to play" refers to the illegal investment adviser practice of "hiring" a third party solicitor (for "pay") who works for, or who has recently left, a government entity such as a government, state or municipal pension plan. For "pay," this person steers that pension plan's advisory business to the adviser (the "play" part of the term). Soft dollar compensation is where a broker-dealer offers "free" services to a mutual fund or investment adviser in return for "directed brokerage" (which is the mutual fund or investment adviser directing its portfolio trades at full commission rates to that broker-dealer). The SEC requires that mutual funds can only accept soft dollars if the services benefit all shareholders of the fund. The SEC requires that investment advisers that accept soft dollars disclose this on Form ADV and the disclosure must be specific.

An investment adviser is considered to "take custody" of funds or securities from a customer if it:

is appointed as trustee for a customer's trust account under a legally binding trust document Taking custody means that the adviser is holding customer funds or securities. The securities must either be held in customer name, or held in adviser name, with the adviser being the trustee for the customer. Thus, if the adviser is appointed as trustee over the customer's account, custody has been taken. Exercising discretionary authority limited to trading only and accepting commissions are not "taking custody." Accepting a check to buy a mutual fund made payable to the fund custodian is not taking custody because the check is not being deposited to the adviser's account. It is sent directly to the fund custodian by the adviser. Such third party checks, as long as they are forwarded to the third party within 3 business days of receipt, are not considered to be in "custody."

The Prudent Investor Act requires that fiduciaries manage the assets of their beneficiaries based upon:

modern portfolio theory The Prudent Investor Act, adopted in most States, is a modernization of the "prudent investor rule" restricting the investment authority of fiduciaries. Instead of setting forth a list of "approved" securities (a "legal list") for investment, the Prudent Investor Act allows fiduciaries to use modern portfolio theory for investment decision making. Thus, instead of just investing in securities that have minimal risk, the fiduciary can apply risk-return analysis to choose the "best" investments for the level of risk assumed. Investment performance is not measured on each individual investment, but rather by looking at the overall portfolio return.

A representation by an investment adviser that a performance chart, in and of itself, can be used to determine which securities to buy or sell:

must be accompanied by a statement that there are limitations and difficulties in using performance charts alone to judge results If an investment adviser advertises that a performance chart, in and of itself, can be used by a customer to measure performance, or to decide which investments to make, it must be accompanied with the disclosure that there are limitations and difficulties in using performance charts alone to judge results. There is no requirement for a performance chart to be accompanied by a comparison to the Dow Jones Industrial Average's performance over the same period. The only rule is that if a comparison is made to an index, the index used must be comparable to the investment style of the adviser.

Under the Prudent Investor Act, a fiduciary is:

obligated to maximize overall portfolio return consistent with the level of risk assumed The "Prudent Investor Act" gives fiduciaries much broader latitude in terms of their ability to allocate trust assets to various investment classes, as compared to the obsolete "prudent man rule" that simply required that investments be of low risk. The concept is that modern portfolio theory can be used to diversify assets and to achieve a greater return that justifies any extra "risk" assumed by the strategy - as long as the strategy is consistent with the investment objectives and needs of the beneficiaries. The fiduciary is judged by overall portfolio performance - not by the performance of each single investment. Since a higher level of expertise may be needed to manage trust assets in this manner, the Act allows the fiduciary to contract with an outside investment adviser to provide asset management. There is no requirement for the trust to be registered with the State Administrator - this is only required for broker-dealers, investment advisers, and their agents.

The amount of commission charged to a customer to effect a securities transaction must be disclosed:

on the trade confirmation There is no requirement to disclose the amount of commission charged on a trade prior to executing the trade for the customer. The amount of commission must be disclosed on the trade confirmation and it must be "fair and reasonable." The only requirement for disclosure of commission costs is that if a transaction will result in unusually high commission costs, this must be disclosed to the customer prior to executing that trade. There is no disclosure of commissions on account statements; nor is there disclosure of commissions on Form 1099s (reports of dividends and interest paid to the security holder for tax reporting).

An investment adviser has been in business for the past 10 years. During this time period, the adviser has produced average annual returns of 28% while the Standard and Poor's Index has increased by only 15% over this period. The adviser currently charges an annual fee equal to 3% of assets and wishes to raise it to 5% of assets. This action is:

permitted only if other advisers that provide similar services to customers are charging a 5% annual fee NASAA requires that advisory fees be comparable to those charged by other advisers that provide similar services

An investment adviser wishes to charge a "2 and 20" management fee, consisting of a management fee equal to 2% of annual average net assets and a performance fee equal to 20% of the asset appreciation. This fee arrangement is:

permitted only if the clients invest at least $1 million or have a net worth, exclusive of residence, of $2.1 million Investment advisers cannot charge fees based on asset appreciation under both NASAA and SEC rules. However, if the adviser limits its clientele to very wealthy investors (a client who invests at least $1 million or has a net worth, exclusive of residence, of $2.1 million), then a performance fee can be charged under SEC rules and because of "federal supremacy," NASAA rules cannot override this exemption.

An investment adviser has 3 managing partners and 3 investment adviser representatives. All of the partners have completed the Certified Financial Planner (CFP) program and received the designation. The 3 IARs have been enrolled in a CFP preparation course and are scheduled to take the next CFP exam. The IA publishes an advertisement that states: "All of our partners are Certified Financial Planners." This advertisement is:

permitted since it is true Since the 3 partners of the firm all have their CFPs, this is a true statement and is not misleading.

If an agent opens a joint account with a customer, the agent is permitted to:

place a trade in the account without having a written power of attorney from the customer An agent can open a joint account with a customer, as long as sharing is proportional to capital contributed and sharing occurs in both gain and loss. In addition, the employing firm must approve of the arrangement. Regarding the operation of any joint account, any single owner can enter a trade (this would be either the customer or agent, in this case). There is no requirement for joint agreement to accept a trade. Any single owner of a joint account can demand that a check be drawn, but checks must be drawn to full account name (this would be the names of both the agent and the customer, thus both would need to endorse the check in order to cash it).

An IAR discusses a trading strategy with one of her clients, who tells the IAR to sell her ABC stock position whenever you see an opportunity. After this conversation, the client leaves the IAR's office for a vacation. Two days later, the IAR sees that ABC stock has risen in price and believes that this is an opportune time to sell the position. The IAR should:

place the trade and get written discretionary authority from the customer within 10 business days Unlike the rule for broker-dealers written by FINRA, where a written power of attorney is required prior to exercising discretion, the NASAA rule for investment advisers is that verbal discretion can be exercised, as long as the written power of attorney is obtained from the customer within 10 business days.

An investment adviser has placed a block trade for 500,000 shares of ABCD stock. The trade is filled in 5 separate lots of 100,000 shares each, at prices ranging from $13.56 to $14.04 per share. The adviser must allocate the shares to customers on a:

pro-rata basis across all customers participating in the block The SEC has initiated fraud charges against investment advisers based on their undisclosed trading practices. The typical procedure for handling trades executed in a single block is to allocate the securities equally among clients at a uniform price on a pro-rata basis. This is the typical disclosure made to clients. Depending on market conditions, the adviser may not be able to purchase the security for all clients at the same price. Instead, it may have to purchase the security over several days at different prices. In such a case, each client should receive a pro rata allocation at the weighted average price.

A firm's market making desk, aware that the firm is about to publish a bullish research report on ABCD stock, purposefully increases its long position in order to satisfy anticipated retail demand. This action is:

prohibited "Trading ahead of research" is prohibited. A member firm cannot alter its inventory position in anticipation of a research report that it is about to release. In essence, the member firm is treated as an "insider." Once the favorable report is released, this may cause the general public to become more bullish and buy the stock, pushing the price up. If the firm were to increase its inventory position prior to the release of the report, it could make a nice profit based on the stock's upward movement once the report is disseminated. This is prohibited.

To get a customer to open an account, an agent tells a client that she will have the manager of any mutual fund that the customer purchases call each month to explain the fund's performance. This statement is:

prohibited It is a prohibited practice to make promises to customers that the agent cannot reasonably expect to honor. In this case, the agent has promised to have the mutual fund manager call the customer each month for any fund that the customer purchases. This is a promise that cannot be kept.

A registered securities agent solicits a customer to buy shares of stock that the agent personally owns. The customer buys 100 shares of the stock and sends a check made out to the agent. The agent does not record the trade on the books of the broker-dealer. This action is considered a(n):

prohibited private securities transaction Private securities transactions are a prohibited business practice under the Act. All trades effected by an agent must be recorded on the books of the broker-dealer and must be supervised by the broker-dealer.

A new customer is opening an account with a broker-dealer. The customer tells the agent to "decide which investments are best." Prior to opening the account, the agent MUST:

receive a written power of attorney from the customer If an agent chooses more than price and time of execution for a customer, the trade is considered to be "discretionary." Prior to opening a discretionary account, a written power of attorney must be obtained from the customer.

Under NASAA rules, any recommendation made to a client by a broker-dealer is permitted only if the:

recommendation is based upon the client's investment objectives, investment experience, financial situation and financial needs In order to make a recommendation to a customer, it must be determined that the investment is suitable for the customer, based on investment objectives, investment experience, financial situation and financial needs. Because a broker-dealer is not a fiduciary, unlike an investment adviser, it is permitted to sell securities out of its inventory to customers that wish to buy that security. If a broker-dealer has a control relationship with an issuer whose securities it is recommending, this fact must be disclosed to the customer. There is no rule requiring that recommendations come from a broker-dealer's research department or a third party research firm.

An investment adviser representative is preparing a comprehensive investment plan for a customer. After completing the plan, the representative finds out that, unless precautions are taken, implementation of the plan could have severe tax consequences for the client. The first step that the investment adviser representative should take is to:

refer the client to a tax consultant for plan review This question is very judgmental. There are really 2 correct answers and you must pick the "better" of the choices. The question states that the investment plan prepared by the representative could have severe tax consequences for the client "unless precautions are taken." So if precautions are taken, then this plan is OK. The first step would be to have a tax professional review the plan to make sure that the "proper precautions" are taken (remember, IARs cannot give tax advice). If, in the opinion of the tax professional, there is no way around the adverse tax consequences, then a new plan would have to be created that avoids this tax consequence. Therefore, this would be the second step that would be taken, if this occurred.

An investment adviser representative is asked by his customer for a small loan. The IAR should:

refuse the customer's request Investment advisers cannot lend money to customers or borrow money from customers. The only exception is if the customer is a bank, broker-dealer, or affiliated company of the adviser.

A client of an investment adviser brings his father to a consultation with his investment adviser representative to discuss investment alternatives for the father. The meeting is concluded. Two weeks later, the parent telephones the investment adviser representative, inquiring about the tax status of the client. The investment adviser representative should:

refuse to disclose any information about the client Customer account privacy rules require that customer information not be disclosed to others unless the customer so authorizes. It makes no difference that the person requesting the information is the father of the customer. In order to give out the information to the father, the customer must approve.

A customer submits a written complaint to your broker-dealer. Later, he changes his mind and asks that the complaint be returned. You should:

return a copy of the complaint to the client and retain the original complaint in the firm's files This is very judgmental. SEC Rule 17a-3 (which NASAA follows) allows firms to keep complaint records in either of 2 ways: The firm may keep a written record of each customer complaint and its resolution, including customer name, address, account number, date of receipt of complaint, name of associated person identified in the complaint and disposition of the complaint; or Instead of the record, the member may maintain a copy of each original complaint in a separate file of the associated person along with a record of the disposition of the complaint. So the SEC states that if complaint copies are retained, the firm must retain the "original." Thus, Choice C is the best answer.

An agent is contacted by a new client that is moving his account from another broker-dealer because he suffered a large loss. The new customer is 80 years old, has $25,000 of annual income and has $117,000 of equity in his home. The customer's investment portfolio consists of $25,000 in a speculative stock mutual fund. This holding was originally worth $140,000. The BEST recommendation to the customer is to:

sell that fund and buy another fund in the same family of funds This is an 80-year old customer. He has already lived beyond his life expectancy and is not insurable. So Choice D is incorrect. This customer is currently invested in a speculative stock mutual fund that has collapsed in value. Since this customer only has $25,000 of annual current income, the best choice is to redeem that holding and buy a "safer" fund within the same family that gives income. Then the customer will not be hit with a sales charge on the new purchase. If the shares were to be redeemed and shares bought of a fund in a different family, then the customer would have to pay a sales charge on that purchase.

An investment adviser has been asked by many of his customers to help with preparation of their tax returns. The adviser does not have much experience with tax preparation. The adviser:

should refer the client to a qualified tax preparer This adviser is not qualified to do tax returns. He should refer the clients to a qualified tax preparer. He or she can accept referral fees from the tax preparer for this, as long as this is disclosed to the clients. The wording in Choice B makes it almost a good choice, but "educating" yourself about the tax laws is not the same as being qualified. If Choice B said instead that this adviser studied and passed the CPA exam, then this would be a good choice.

All of the following actions by an agent are prohibited during a sales presentation EXCEPT:

showing past performance of the investment An agent can show past performance in a sales presentation, since this has a direct bearing on the customer's decision to invest. An agent cannot predict specific future investment results, since he has no basis for knowing what will happen in the future. Omitting facts that can influence an investment decision (essential facts) is prohibited, since these facts are "material."

An investment adviser directs its trades to a broker-dealer paying non-discounted rates. In return, the broker-dealer is permitted to give the investment adviser:

software that compares asset allocation models used by the IA The SEC and State Administrators permit so called "soft dollar" arrangements. An adviser may direct its portfolio trades to a brokerage firm that charges a higher commission (as opposed to the lowest-cost broker) in return for the adviser getting something of value from the broker-dealer, such as research reports, asset allocation software, stock screening software, etc. The "idea" is that the value of the broker-dealer "give-back" is much higher than the "extra commission" amount paid to the broker-dealer by the adviser and will enhance the adviser's investment returns, which will benefit the adviser's clients. Note that the "give-back" under a soft dollar arrangement cannot benefit the IA - it must benefit the IA's clients.

Attaching any of the following to a prospectus delivered to a customer in connection with the purchase of a new non-exempt securities offering would be a violation of the Uniform Securities Act EXCEPT a(n):

supplement that presents the issuer's most recent audited financial statements Prospectuses cannot be altered or summarized by anyone - to do so would change the content and disclosures made to investors. Prospectuses are legal disclosure documents that are non-promotional, so copies of company advertisements cannot be attached. Similarly, reports showing the prospects of increasing sales for the company cannot be attached because they are promotional. A supplement attached to the prospectus of the company's most recent audited financial statements is non-promotional and can be attached. This is valuable unbiased investment information.

A Registered Investment Adviser (RIA) tells his customers that they can analyze his performance by reviewing charts that he has presented. The RIA must:

tell the customers that charts can be difficult to interpret and there may be hazards in viewing only charts Using performance charts alone is not the best way to analyze an adviser's performance. In their financial statements, advisers also disclose their investment methods, investment objectives, expenses, etc. and these should be considered as well. If an adviser tells a customer to just look at his or her charts to analyze performance, the adviser should also disclose that charts alone do not give the "full" picture, and that making decisions solely on this basis is not really in the customer's best interest.

Under the Uniform Securities Act, an "Internet Communication" by a Broker-Dealer will not be deemed to be "transacting business" in the State where the communication was received if all of the following conditions are met EXCEPT:

the communication must prominently disclose, with a link, the name of the State Administrator to whom complaints can be forwarded by the recipient of the communication In order for an "Internet Communication" to NOT be considered an offer of securities brokerage or investment advisory services in a State, 4 conditions must be met: The communication must be limited to general information on products and services and does not involve effecting securities transactions, attempting to effect securities transactions, or the rendering of personalized investment service for compensation; The communication must contain a legend that the Broker-Dealer, Investment Adviser, BD Agent or IA Agent may only transact business in the State if first registered in that State; or if that "person" is excluded or exempted from registration; Any follow-up individualized responses to persons that involve effecting securities transactions; or the attempt to effect securities transactions; or the rendering of investment advice for compensation; cannot be made unless that "person" has complied with the State's registration requirements (or is exempted or excluded); and The Internet Communication must contain a "firewall" or other procedure designed to ensure compliance with the above requirements.

A broker-dealer has a marketing agreement with a local bank and has located offices in each of the bank's branches. If a bank customer makes an inquiry about mutual funds offered by the broker-dealer in the branch, all of the following are true EXCEPT:

the customer's signature must be obtained on a document acknowledging receipt of the appropriate risk disclosures When a broker-dealer has a branch location in a bank office, any customers who wish to effect securities transactions must be told orally and in writing that securities products are not FDIC insured; are not deposits; and are subject to risk of loss of principal. In addition, at the time that an account is opened for a customer in such a location, NASAA requires that the member make reasonable efforts to get the customer's written acknowledgment of receipt of these disclosures.

If an investment adviser is also a registered broker-dealer and will effect recommended trades to customers through that broker-dealer:

the relationship must be disclosed to the client, at, or prior to, the signing of the advisory contract If an investment adviser will effect its recommended portfolio transactions through an affiliated broker-dealer that will charge commissions for each trade, this is a conflict of interest that must be disclosed, in writing, to the client at the time that the advisory contract is signed.

All of the following are relevant considerations when determining if a customer account has been churned EXCEPT:

transactions that are within the financial resources of the client Transactions that are within the financial resources of the client are not an indicator of churning - they are an indicator of proper trading. What is relevant is: whether the active trading is in line with the customer's investment objective; the character of the customer's account - that is, the types of investments that have been made in the account and the frequency of trading and size of each investment type; and the financial condition of the agent (e.g., is the agent not making enough money to pay his bills, so he or she has an incentive to churn?).

Under the Uniform Securities Act, an investment adviser may share in the profits of a client's account:

under no circumstances Investment advisers are prohibited from sharing in the gains of a client's account. Advisory fees are based on a percentage of assets under management.

An agent recommends that a customer should "Send $10,000 of cash to the agent, which he will personally keep in a safe place to pay for any purchase orders placed by the customer." This recommendation is:

unethical and prohibited Agents and broker-dealers are prohibited from commingling customer funds and securities with their own funds and securities. The agent cannot take customer cash or securities into his possession - this is a violation. He can have the customer send cash directly to the broker-dealer for credit to the customer's account, however.

All of the following information is required on an order ticket EXCEPT:

whether the order was placed verbally or in writing Time of order receipt is recorded on the order ticket, as is time of order execution. Both of these are required to permit regulators to be able to detect "front running" violations. They are also needed to resolve customer complaints about possible execution errors. The account name and/or number must be on the order ticket. It must be recorded whether the trade was solicited or unsolicited. There is no requirement to record the manner in which the order was received.

Michael Michaelson has an MBA in finance and has taught classes at a local college for the past 15 years. He has decided to use his knowledge and acumen in the private sector and registers in the State as an investment adviser. His business will be creating financial plans and implementing them for clients. Michael requests a waiver from the State Administrator from having to pass the Series 65/66 exam based on his educational and teaching background and receives it. He registers as an IA in the State. He wishes to publish an advertisement for his new business. Michael can state which of the following in the advertisement?

"My fee schedule, which is non-negotiable, is comparable to that charged by other advisers that do not have my extensive finance background" In Choice A, Mike cannot say that he was "approved" by the Administrator, nor can he say he was "certified" (Choice C) by the Administrator. Choice B is a reasonable and true statement. Choice D is misleading because Mike has 15 years' experience as a teacher of finance; not as an investment adviser.

Which of the following statements may be made by an agent about a new securities issue that is being registered by filing?

"The security is being registered in the State" Making untrue or coercive statements is a violation of the Act. Stating that the security is registered with the State is true. Stating that "you are guaranteed" or "Administrator approved" are either untrue or coercive and are prohibited.

Which customer could be charged an advisory fee based on account performance?

A customer with a $2,500,000 net worth Because the Investment Advisers Act of 1940 permits the charging of performance fees to qualified customers (those with either $1,000,000 invested or a net worth of $2,100,000), NASAA cannot prohibit the charging of a performance fee for this customer who has a net worth of $2,500,000. (Remember that Federal law supersedes State law; in the absence of a Federal law, then only that State law applies.) An annual account fee, or an hourly fee arrangement, would always be acceptable.

An Investment Adviser has adopted an external Business Succession Plan. Who is responsible for servicing the IA's client accounts if the managing director of the Investment Adviser suddenly dies?

Another Investment Advisory Firm to which investment management has been transferred NASAA has a model rule on "Business Continuity and Succession Planning" for Investment Advisors. The rule requires IAs to draft a plan for the actions to be taken in the event of an unexpected major negative event occurring at the IA firm. One of the issues that must be addressed in the plan is the death or disability of key personnel. To continue servicing client accounts in such an instance, the IA can adopt either an "internal" or "external" Succession Plan. In an "internal plan," the Adviser transfers the advisory responsibilities to another IAR currently in the firm. With an "external" Succession Plan, the Adviser transfers client management to another firm.

An Investment Adviser has developed a proprietary investment selection program that is based on a statistically validated and proven algorithm. The algorithm minimizes buy and hold investment strategies, and uses multiple data points to determine when to buy and sell the same security position intraday. The program has been tested and shown to produce consistent 20% returns. The Investment Adviser has a client base of around 100 individuals, with an average account size of $1,000,000. The clients range in age from 35 to 75. The Investment Adviser has discretion over these accounts and puts all of its clients into the automated trading program that it has developed. Why is this a violation of NASAA rules?

Because the automated trading strategy has not been shown to be suitable for each of the Investment Adviser's clients Because the clients range in age from 35 to 75, they probably have very different investment objectives - and putting all of the clients into the same strategy without regard to each one's investment objective is the biggest violation here. Rapid-fire automated trading programs are most often based on using very low-cost executing brokers, so trading commissions are not as big a cost - but we don't know this from the question. Whether there is a churning violation would depend on the level of commissions charged. This could be another violation, but putting all the customers into the automated investment program without regard to suitability is the bigger violation.

Which of the following is NOT market manipulation?

Commingling customer funds Commingling customer funds with broker-dealer funds is prohibited, but is not market manipulation. Giving fictitious quotes, spreading rumors of a sensational nature, and effecting trades at the close of the market to affect the closing price, are examples of manipulative practices.

A customer has an individual account. Upon written request, the customer's account statements and confirmations may be sent to the:

Customer mail must be sent to the customer's home address or to a post office box designated by the customer. It cannot be forwarded to a brokerage firm branch office, because then the customer would not know what was going on in the account.

Which of the following is considered to be non-public information about a customer?

Customer medical information collected by a physician to be used by a life insurance company selling a variable annuity contract to that customer Non-public personal information about a customer cannot be disclosed to a third party unless the customer permits such disclosure. Information obtained from a public source is "public" information and can be disclosed to others. Public sources of information include telephone listings and tax records. Aggregated customer account information is excluded from the definition of "non-public" information, since a specific customer cannot be identified. Note, as well, that medical information obtained by a physician examining a customer is "non-public" information that cannot be disclosed to others unless the customer permits.

Which form(s) MUST be signed by the customer in order to open a margin account?

Hypothecation Agreement There is no customer signature required on a new account form - this allows cash accounts to be opened over the phone, if a firm so desires. However, a customer signature is required on the hypothecation agreement - this is the legal pledge of securities in the account as collateral for the margin loan from the broker-dealer to the customer. There is no legal requirement for the customer to sign a loan consent agreement (where the customer agrees to permit the lending of the securities held in the account to someone else who wishes to effect a short sale). The customer can choose to sign the loan consent; or can choose not to sign.

An agent of a broker-dealer puts up a website that promotes the benefits of dollar cost averaging, including the caveat that it is suitable for investors only if they can maintain their periodic payments regardless of economic conditions and that it requires a long-term investment time horizon. If the website is viewed by an individual in another State where both the broker-dealer and agent are not registered, which of the following disclosures are required on the site in order not to be in violation of the Uniform Securities Act in that State? I "The broker-dealer or agent may only transact business in the State if registered in the State or if exempted or excluded from registration" II "Follow ups or individualized responses to persons in the State that involve either effecting or attempting to effect transactions in securities will not be made absent compliance with State registration requirements or an applicable exemption or exclusion" III "The services being offered do not represent an offer to sell securities or a solicitation of an offer to buy the securities in the State unless the subject securities are registered or are subject to an applicable exclusion" IV "The Securities and Exchange Commission has not approved, nor has it disapproved of offering made in this advertisement"

I and II only Since the internet can be viewed from anywhere, Uniform State Law gives a safe harbor to having to register in a State if the following legend appears on the site: "The broker-dealer agent or investment adviser representative may only transact business in the State if registered in the State or if exempted or excluded from registration;" and "Follow ups or individualized responses to persons in the State by the broker-dealer agent or investment adviser representative that involve either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made absent compliance with State registration requirements or an applicable exemption or exclusion." So, basically, the disclaimer required is that anyone who views the site cannot be solicited by persons associated with the site unless those persons are registered in that State (or are excluded or exempt from registration). There is no requirement to give a disclaimer regarding whether securities being offered are registered or exempt in the State; and the SEC has nothing to do with State law, so Choice IV does not apply (it does apply to prospectus disclosure on new issues of non-exempt securities registered under the 1933 Act, however).

An agent is prohibited from: I making an offer of a non-exempt unregistered security to a customer II making an offer of an exempt unregistered security to a customer III soliciting a customer to make an offer to buy a non-exempt unregistered security IV soliciting a customer to make an offer to buy an exempt unregistered security

I and III Agents are prohibited from offering or selling unregistered non-exempt securities in the State. Non-exempt securities (such as common stock) must be registered to be offered or sold in the State. The agent cannot attempt to get around this by having the customer make an offer to buy those securities, calling the transaction "unsolicited" and therefore exempt. The way the law reads is that making an offer to sell, or soliciting an offer to buy, both constitute an "offer to sell" securities under the Uniform Securities Act. Note, however, that it is perfectly acceptable to make an offer to sell; or solicit an offer to buy; unregistered exempt securities, such as government or municipal bonds, in a State.

An investment adviser is opening that day's mail and receives a check from a customer made out to the "Jones Cleaning Service" - the check was mailed in error to the adviser. 5 business days later, the investment adviser mails the check back to Jones Cleaning Service. Under NASAA rules, the investment adviser: I is deemed to have taken custody of the customer's funds II has not taken custody of the customer's funds III must keep a record of the check received IV is not required to keep a record of the check received

I and III If a client inadvertently gives securities or funds to an investment adviser, as long as they are returned within 3 business days, then the adviser has NOT taken custody. If the adviser inadvertently receives a check made out to a third party (as is the case here), as long as the adviser mails the check to the third party within 3 business days, then the adviser has NOT taken custody. Regardless, the adviser must keep a record of the receipt of the check.

An investment adviser is opening that day's mail and receives a check from a customer for $8,000, however the adviser shows no balance due from the customer - the check was mailed in error to the adviser. 5 business days later, the investment adviser mails the check back to the customer. Under NASAA rules, the investment adviser: I is deemed to have taken custody of the customer's funds II has not taken custody of the customer's funds III must keep a record of the check received IV is not required to keep a record of the check received

I and III If a client inadvertently gives securities or funds to an investment adviser, as long as they are returned within 3 business days, then the adviser has NOT taken custody. Since the adviser mailed the check back 5 business days later, it is defined as having "taken custody." If the adviser inadvertently receives a check made out to a third party, as long as the adviser mails the check to the third party within 3 business days, then the adviser has NOT taken custody. Regardless, the adviser must keep a record of the receipt of the check.

A Registered Investment Adviser is also a registered representative that manages a client's account. The customer is paying a fixed annual advisory fee and is paying a commission for each execution of a recommended trade, both of which have been disclosed to the customer. Which statements are TRUE? I The account may be charged both the advisory fee and a commission on each trade II The account may not be charged an advisory fee and a commission on each trade III This is an unethical practice IV This is not an unethical practice

I and IV An investment adviser can charge advisory fees to a client for recommending securities; and then can charge commissions to that client on trades performed, as long as both of these fees are disclosed to the customer. The overriding theme here is that all charges to customers must be disclosed. Note that 2 fees are permitted because the firm is acting in 2 capacities - for recommendations it is acting as an adviser; while for trade executions it is acting as a broker. Also note that if disclosure was not made of the 2 fees and "double capacity," then this would be an unethical practice.

For an adviser to charge a performance fee, the Investment Advisers Act of 1940 requires which minimum financial standards from customers? I A customer that deposits $1,000,000 or more with the adviser II A customer that deposits $2,100,000 or more with the adviser III A customer with a $1,000,000 or higher net worth IV A customer with a $2,100,000 or higher net worth

I and IV Because the Investment Advisers Act of 1940 permits the charging of performance fees to qualified customers (those with either $1,000,000 invested or a net worth of $2,100,000), NASAA cannot prohibit the charging of a performance fee for these customers. Remember that Federal law supersedes State law; in the absence of a Federal law, then only that State law applies.

Which statements are TRUE about lending money to a customer? I A broker-dealer can lend money to a customer as long as it complies with the provisions of Regulation T II An investment adviser can lend money to a customer as long as it complies with the provisions of Regulation T III A broker-dealer cannot lend money to a customer IV An investment adviser cannot lend money to a customer

I and IV Broker-dealers are permitted to make loans to customers, where the customers' securities are collateral, as long as they follow the provisions of Regulation T of the Federal Reserve Board. On the other hand, investment advisers cannot make loans to customers, unless this is done through an affiliated entity that is a regulated lender, such as a parent bank or an affiliated broker-dealer.

Under NASAA rules, an: I agent is permitted to share in the gain and loss of a customer account if a joint account is opened with the customer and sharing is proportional to capital contributed II agent is not permitted to share in the gain and loss of a customer account if a joint account is opened with the customer and sharing is proportional to capital contributed III investment adviser representative is permitted to share in the gain and loss of a customer account if a joint account is opened with the customer and sharing is proportional to capital contributed IV investment adviser representative is not permitted to share in the gain and loss of a customer account if a joint account is opened with the customer and sharing is proportional to capital contributed

I and IV Investment advisers and their representatives are held to a fiduciary standard. If they are making investments personally, they are already investing alongside their clients. Because of this, IAs and IARs cannot share in the gain or loss of a customer account. If they are making personal investments, they must be the same as those made for clients, and all will experience the same gain or loss anyway! Note that this completely differs than the rule for broker-dealers and their agents, who are not held to a fiduciary standard.

Which statements are TRUE about an adviser offering discounted rates? I An investment adviser is permitted to offer a discount from standard rates to selected categories of customers II An investment adviser is permitted to offer a discount from standard rates only if all customers are given the discount III The investment adviser can offer the discount as long as charges to all of the investment adviser's customers are fair and reasonable IV The investment adviser can offer the discount as long as the fact that discounts are offered is disclosed in the Form ADV Part 2A

I and IV Investment advisers do not have to offer the same rates to all their customers - they are permitted to pursue additional business by offering defined groups a discounted rate. However they must offer these discounts to all customers that qualify for the terms of the discount - for example, the discounted fee might apply only to members of a local Rotary Club; or the discount might only apply to customers that invest at least $200,000 with the adviser. The adviser must disclose the existence and terms of the discounts in the Form ADV Part 2A ("the Brochure") that is given to clients.

NASAA Model Rule 502 (c) applies to: I State registered advisers in its entirety II State Covered advisers only to the extent that the conduct is fraudulent or deceptive III Federal Covered advisers in its entirety IV Federal Covered advisers only to the extent that the conduct is fraudulent or deceptive

I and IV NASAA Rule 502 (c) sets the rules for investment advisory contracts. As a NASAA rule, it only covers State-registered advisers. Federal covered advisers are subject the rules of the Investment Advisers Act of 1940, however the rule says that it applies to Federal covered advisers to the extent that the alleged conduct is fraudulent or deceptive. The rule requires that advisory contracts provide in writing: The services to be provided, the term of the contract, the fee formula, the amount of prepaid fee to be returned for early termination and any grant of discretionary power; That no direct or indirect assignment or transfer of the contract is permitted without consent of the client; That the investment adviser shall not be compensated based on capital gains (unless the client is wealthy, with either $1MM of assets under management or $2.1MM of net worth - this is set under the Investment Advisers Act of 1940); and That if the investment adviser is a partnership, the adviser will notify the client within a reasonable time of any change in the membership of the partnership. The rule also prohibits any provision that waives compliance with the rule or with the Investment Advisers Act of 1940; and prohibits an advisory contract that is contrary to Section 205 of the Investment Advisers Act of 1940 (Section 205 prohibits compensation based on gain or loss).

The vice president of a publicly traded company casually tells a close friend over dinner that the company's results are looking very weak this quarter. The friend offers some comforting words to the vice president and does not tell anyone else about the news. Which statement is TRUE?

Neither the vice president nor the friend have violated the insider trading laws The "tipper-tippee" doctrine applies only to cases where the tipper "intentionally" gives the information to the "tippee," who then trades on it. In this case, the "tippee" never traded, so there is no violation.

Which statements are TRUE about the filing of the annual surprise audit results with the Administrator by investment advisers? I Only advisers that take custody must be audited II All advisers must be audited III Audit results must be filed with the Administrator within 60 days of completion of the audit IV Audit results must be filed with the Administrator within 120 days of completion of the audit

I and IV The NASAA custody rule requires that each adviser that takes custody be audited on a "surprise" basis annually, so the actual date of the audit is only known to the CPA. There is no audit requirement for advisers that do not take custody. After the CPA shows up for the audit and completes the examination, a copy of the auditor's report and financial statements must be filed with the Administrator within 120 days of completion.

A broker-dealer offers 4 summer passes to an amusement park to each of its agents who sell at least $10,000 of bonds during the month of June. This action is: I allowed II not allowed III considered to be "soft dollar" compensation IV not considered to be "soft dollar" compensation

I and IV There is no prohibition on a broker-dealer compensating its agents with prizes for meeting a sales contest requirement. The broker-dealer will have to report the compensation value as taxable income to the IRS, but this is not part of the question. Soft dollar compensation is where a broker-dealer offers "free" services to a mutual fund or investment adviser in return for "directed brokerage" (which is the mutual fund or investment adviser directing its portfolio trades at full commission rates to that broker-dealer). The SEC requires that mutual funds can only accept soft dollars if the services benefit all shareholders of the fund. The SEC requires that investment advisers that accept soft dollars disclose this on Form ADV and the disclosure must be specific.

Delivery of a prospectus is required if a: I new issue of corporate bonds is being offered to the public II trade in a corporate bond takes place in the secondary market III new issue of government bonds is being offered to the public IV trade of a government bond takes place in the secondary market

I only Prospectus delivery is only required for new issues being sold in the primary market. Once a company is trading in the secondary market, it is reporting its results to the SEC and this information is publicly available. Thus, an investment decision can be made from this information and there is no longer a prospectus delivery requirement. There is no prospectus requirement for exempt securities - governments, agencies and municipals (because we trust that our government won't fleece us!).

A representative is making a presentation to a married couple, ages 77 and 81, about their need for continuing income as the expected life spans of the general population have increased. The representative is strongly recommending that the couple buy an equity indexed annuity (EIA). Which statements made by the representative would be misleading and fraudulent? I "EIAs guarantee a minimum rate of return that is equal to the Standard and Poor's 500 Index" II "I do not earn any commissions when I sell you an EIA" III "EIAs are tax qualified, allowing you to reduce your taxable income by deducting any contribution that you make" IV "EIAs provide a minimum guaranteed rate of return that is guaranteed by the issuing insurance company"

I, II, III Equity indexed annuities (EIAs) are an insurance product that falls somewhere between a fixed annuity and a variable annuity. They give a return linked to a well-known index, such as the Standard and Poor's 500 Index, but the return is typically capped to a maximum interest rate per year. Thus, if the cap is 10% and the S&P 500 Index grows by 15%, the customer only gets a 10% return for that year. Thus, Choice I is a misleading statement. Technically the salesperson does not earn a commission, but he or she does earn a very steep sales charge, so Choice II is misleading. There is no deduction for contributions to the contract (these are non-qualified plans) making Choice III a misleading statement. Choice IV is true - the contracts have a minimum guaranteed rate of return (like around 4%) that is guaranteed by the insurance company. Of course, if the insurance company fails (which rarely happens, but it has happened), then the guarantee is worthless.

Under the Uniform Securities Act, an Investment Adviser MUST inform a client about: I Change of address II Addition of new partners to the advisory partnership III Change of phone number IV Addition of client accounts from another advisory firm that was "bought out"

I, II, III Investment advisers must inform their clients about a change of address or a change or phone number (this is common sense). It is also a requirement to inform clients about the addition of new partners to an advisory partnership. There is no requirement to notify customers of the addition of new advisory clients, since this has no impact on the customer.

A broker-dealer has a marketing agreement with a local bank and has located offices in each of the bank's branches. If a bank customer makes an inquiry about mutual funds offered by the broker-dealer in the branch, which of the following statements are TRUE? I Oral disclosure is required that the products offered are not FDIC insured; are not deposits; and are subject to risk of loss of principal II Written disclosure is required that the products offered are not FDIC insured; are not deposits; and are subject to risk of loss of principal III Reasonable efforts must be made to obtain the customer's signature on a document acknowledging receipt of the appropriate risk disclosures IV Reasonable efforts must be made to obtain the customer's signature on an arbitration agreement covering any claims made by the customer of not knowing that the products being offered were securities and not bank products

I, II, III When a broker-dealer has a branch location in a bank office, any customers who wish to effect securities transactions must be told orally and in writing that securities products are not FDIC insured; are not deposits; and are subject to risk of loss of principal. In addition, at the time that an account is opened for a customer in such a location, NASAA requires that the member make reasonable efforts to get the customer's written acknowledgment of receipt of these disclosures. There is no legal requirement to attempt to get the customer's signature on an arbitration agreement - though many broker-dealers do this as an internal policy.

Which of the following orders MUST be retained as a record by broker-dealers? I Executed orders II Unexecuted orders III Canceled orders IV Subscription orders

I, II, III only A subscription order arises from a rights offering, where a corporation is attempting to raise additional funds from its existing shareholders by offering them subscription rights to new shares at a discount from the current market price. These orders happen directly between the issuer and the shareholder, so there is no broker-dealer record of these. All orders placed by customers with a broker-dealer, whether executed, unexecuted or canceled, must be retained as a record by broker-dealers. The retention period for these is set under the Securities Exchange Act of 1934 at 3 years (and State Administrators must comply with the Federal rules for broker-dealers because of federal supremacy).

Under the NASAA Statement of Policy on Dishonest and Unethical Business Practices, which of the following practices are prohibited? I Guaranteeing a client against loss for non-exempt securities II Guaranteeing a client against loss for exempt securities III Borrowing money or securities from a customer IV Lending money or securities to a customer

I, II, III, IV Agents may not personally guarantee a customer's account against loss, regardless of the securities being exempt or non-exempt. Borrowing money or securities from a customer; or lending money or securities to a customer; is a prohibited practice.

In order for an investment adviser to be compensated with a performance fee, which of the following must be disclosed in writing? I The periods that will be used to measure performance and their significance in the computation of the fee II That the fee arrangement is based on both unrealized appreciation and realized capital gains III The nature and significance of any index used as a comparative measure IV The reason why the adviser believes the use of any comparative index is appropriate.

I, II, III, IV Before entering into an advisory contract that charges a performance fee, the adviser must disclose in writing: that the fee arrangement may create an incentive for the adviser to make investments that are riskier; that the investment adviser will get compensation based on both unrealized appreciation and realized capital gains; the basis for valuing any illiquid investments used in computing unrealized appreciation; the periods that will be used to measure performance and their significance to the computation of the fee; and the nature of any index used as a comparison of investment performance, the significance of the index, and the reason why the adviser believes the index is appropriate.

Which of the following must be included in an investment advisory contract under NASAA rules? I The formula for computing the advisory fee II The amount of prepaid fees to be returned if the contract is terminated early III Whether the contract grants discretionary authority to the adviser IV Disclosure that the fee for managing equity securities may be higher than for managing fixed income securities

I, II, III, IV Consider this to be a learning question. The advisory contract, under NASAA rules, must include: Description of services provided; Term of contract; Formula for computing fees; Amount of prepaid fees to be returned if contract is terminated early; Assignment of the contract is not permitted unless the customer approves; Whether the contract grants discretionary authority to the adviser; and Disclosure that the fee for managing equity securities may be higher than the fee for managing debt securities.

If an investment adviser asks a prospective customer to make a decision as to whether to hire the adviser based solely on performance charts given by the adviser to the prospect: I The adviser must disclose the difficulties and limitations of using performance charts alone to make such a decision II The adviser must disclose that past performance is not a predictor of future results III The adviser cannot be deliberately selective in choosing which customers' investment results are included in the performance charts IV The adviser cannot make a comparison of the results shown to a benchmark index unless the index chosen is of a comparable class of securities

I, II, III, IV If an investment adviser advertises that a performance chart, in and of itself, can be used by a customer to measure performance, or to decide which investments to make, it must be accompanied with the disclosure that there are limitations and difficulties in using performance charts alone to judge results. When prior performance is shown, the disclaimer that past performance does not predict future results must be made. When creating performance charts, the adviser must include the entire universe of recommendations made during that time period - he or she cannot just choose the "good" ones. If a comparison is made to an index, the index used must be comparable to the investment style of the adviser.

An investment adviser may be compensated with which of the following? I Wrap fees charged to customers for all services rendered by the adviser II Soft dollars paid by an executing broker to the adviser in return for trades sent to the broker by the adviser III 12b-1 fees paid by a mutual fund to the adviser based on annual net assets IV Commissions paid to an affiliated broker-dealer on trades recommended by the adviser

I, II, III, IV Investment advisers can collect wrap fees. This is a flat annual fee covering all services rendered, including recommendations, asset allocation and trade execution - so all services are "wrapped" into a flat annual fee. Investment advisers can receive "soft dollar" compensation. In return for directing full commission trades to an executing broker, the executing broker gives the adviser research, recommendations, trading algorithms, and similar items of value. The SEC permits these "soft dollar" items to be given by the broker-dealer to the adviser as long as they ultimately benefit the adviser's investors. Investment advisers can receive 12b-1 fees. These are flat annual fees paid by mutual funds to brokers and advisers that place customers in the fund. The 12b-1 fees are used to attract new investment in the fund. The typical fee is .50% of assets under management annually, paid by the fund to the broker or adviser. These mutual fund share purchases have no up-front sales charge. Investment advisers cannot take commissions on trades that they do, but they can direct their trades to an affiliated broker-dealer for execution. The affiliated broker-dealer is permitted to charge commissions. Also note that such an arrangement is a conflict of interest that must be disclosed to the customer at the time of entering into the advisory contract.

Which of the following information MUST be recorded on an executed order ticket? I Time of execution II Time of receipt III Account number IV Solicited or unsolicited

I, II, III, IV Time of order receipt is recorded on the order ticket, as is time of order execution, assuming that the order was filled (which is the case here). Both of these are required to permit regulators to be able to detect "front running" violations. They are also needed to resolve customer complaints about possible execution errors. The account name and/or number must be on the order ticket. Finally, it must be recorded whether the trade was solicited or unsolicited.

Under the provisions of the Prudent Investor Act, a Registered Investment Adviser should consider which of the following when investing and managing trust assets? I General economic conditions II Possible effects of inflation or deflation III Trading patterns of plan beneficiaries IV Investment tax consequences

I, II, IV The Prudent Investor Act states that the trustee should consider the following when making investment decisions relevant to the trust or its beneficiaries: General economic conditions; Possible effects of inflation or deflation; Expected tax consequences of investment decisions or strategies; The role that each investment plays within the overall trust portfolio; The expected total return; Other resources of the beneficiaries; Needs for liquidity, regularity of income, and preservation or appreciation of capital; and An asset's special value to one or more of the beneficiaries. The trading patterns of the plan beneficiaries have no bearing on this.

An agent of a broker-dealer is soliciting potential clients to buy a new issue of corporate common stock. Which of the following is the agent PROHIBITED from doing? I Using the mails or other means of interstate commerce to offer the security to a potential client who resides in a State where the agent is registered II Offering the security to a potential client in another State where the agent is not registered III Selling the security to an existing client in a State where the agent is registered and then mailing the prospectus to that client IV Delivering a prospectus to an existing client who resides in a State where the agent is registered after the client expresses interest in buying the issue

II and III only As long as the agent is registered in the State, he or she can offer the stock issue to new or existing clients in that State, making Choice I permitted, and Choice II prohibited. Choice III is prohibited because the customer cannot be "sold" the new issue security unless the customer receives the prospectus at, or prior to sale. Delivering the prospectus after the sale is made is not allowed. In Choice IV, since the agent is registered in the State, there is no reason why a prospectus cannot be given to a customer that expresses interest in buying the issue.

An investment adviser is opening that day's mail and receives a check from a customer made out to the "Jones Cleaning Service" - the check was mailed in error to the adviser. The same day, the investment adviser mails the check back to Jones Cleaning Service. Under NASAA rules, the investment adviser: I is deemed to have taken custody of the customer's funds II has not taken custody of the customer's funds III must keep a record of the check received IV is not required to keep a record of the check received

II and III If a client inadvertently gives securities or funds to an investment adviser, as long as they are returned within 3 business days, then the adviser has NOT taken custody. If the adviser inadvertently receives a check made out to a third party (as is the case here), as long as the adviser mails the check to the third party within 3 business days, then the adviser has NOT taken custody. Regardless, the adviser must keep a record of the receipt of the check

Under the Uniform Securities Act, which statements are TRUE regarding investment advisers that take custody of customer funds? I The administrator must give written approval before an adviser can take custody of customer funds II The administrator can require a higher surety bond for advisers that take custody of customer funds III Statements of account must be sent to customers whose assets are held in custody at least quarterly

II and III only There is no requirement for an investment adviser to get prior approval from the Administrator to take custody of customer funds. The Administrator may, by rule, prohibit advisers from taking custody; and can require a higher surety bond for advisers that do take custody ($35,000 instead of $10,000). If an adviser takes custody of customer funds or securities; account statements must be sent to the customer by the adviser at least quarterly.

Which State-registered investment advisers MUST report that they take custody on Form ADV? I An adviser that is affiliated with a parent bank or trust company II An adviser that directly deducts management fees each quarter from client accounts III An adviser that has discretionary authority over client accounts under a limited power of attorney IV An adviser that acts as a trustee for a client where the grantor of the trust is the client

II and IV Taking custody means that the adviser is holding customer funds or securities or has the ability to access customer funds or securities. If an adviser is permitted to directly deduct fees from client accounts, it meets this definition. Securities must either be held in customer name, or held in adviser name, with the adviser being the trustee for the customer. Thus, if the adviser is appointed as trustee over the customer's account, custody has been taken. A limited power of attorney limits the adviser to trading the customer account, but the adviser has no power to withdraw funds from the client account. Thus, a limited power of attorney is not taking custody. In contrast, if the adviser has a full power of attorney over an account which allows the adviser to withdraw funds, this is considered to be taking custody.

An investment adviser would be considered to have custody of client funds if it: I received a check from a customer made payable to the custodian that was sent inadvertently and the adviser immediately forwards it to the custodian II received a check from a customer made payable to the adviser, who deposits it and opens an account for the client III received a power of attorney from a customer authorizing it to buy and sell securities on the customer's behalf IV received a power of attorney from a customer authorizing it to withdraw client funds or securities maintained with the custodian

II and IV The adviser "custody" rules of both the SEC and NASAA state that an adviser is considered to have custody if it holds, directly or indirectly, client funds or securities or has the authority to obtain possession of them. This includes: receiving checks from clients made out to the name of the adviser (but not to the name of third parties), unless they are received inadvertently and returned within 3 business days of receipt; any arrangement under which the adviser is permitted to withdraw client funds or securities from a custodian; or any capacity, such as being a general partner, that gives the adviser access to client funds or securities. The rule also states that if an adviser inadvertently receives a check made out to a third party, as long as the check is forwarded to the third party within 3 business days, the adviser has not taken custody. Thus, in Choice I, the adviser has not taken custody because the check was made payable to a third party (the custodian) and then forwarded immediately to the custodian. In Choice II, the adviser has taken custody because it deposited the check. In Choice III, the adviser can only trade and cannot withdraw cash, so it does not have custody. In Choice IV, the adviser can withdraw customer funds and securities, so it does have custody.

A violation of the Uniform Securities Act occurs if statements made about a security are: I true, but omit non-material facts II true, but omit material facts III untrue, but include material facts IV untrue, but include non-material facts

II, III, IV Untrue statements are prohibited - it makes no difference if they contain material or non-material facts. True statements are the only ones that can be made, but remember that a true statement that omits material facts is not really true - it is deceptive and misleading.

Which of the following information MUST be included on a customer confirmation? I Whether the transaction was solicited or unsolicited II Whether a payment for order flow was made III The customer name and account number IV The price of execution

II, III, IV Whether a trade is solicited or not is required on an order ticket, but not on a trade confirmation. The amount of any commission charged and whether a payment for order flow was made must be disclosed. The customer name, account number, size of the trade, and price of execution must all be on the confirmation.

Which of the following is NOT an unethical practice on the part of a broker-dealer?

Recommending the purchase of a security that is currently being held in the inventory of the broker-dealer Unlike investment advisers that have a fiduciary responsibility to customers, broker-dealers are under no such obligation. Broker-dealers can hold inventories of securities and trade them with customers. Yup, this is a conflict of interest, but it is the way that the market works. Executing trades for customers at prices unrelated to the market is unethical; as is not recording securities transactions on a broker-dealer's books and records; as is making a recommendation to a customer without first determining the suitability of such a recommendation.

Which order is NOT required to be retained as a record by a broker-dealer?

Subscription order pursuant to a rights offering A subscription order arises from a rights offering, where a corporation is attempting to raise additional funds from its existing shareholders by offering them subscription rights to new shares at a discount from the current market price. These orders happen directly between the issuer and the shareholder, so there is no broker-dealer record of these. All orders placed by customers with a broker-dealer, whether executed, unexecuted or canceled, must be retained as a record by broker-dealers. The retention period for these is set under the Securities Exchange Act of 1934 at 3 years (and State Administrators must comply with the Federal rules for broker-dealers because of federal supremacy).

An investment adviser has developed a proprietary trading system that has consistently achieved 20% annual returns over the past 5 years. During this period, the Standard and Poor's 500 Index has increased by 10% per year. Other advisers that offer similar services charge an annual advisory fee equal to 5% of annual assets under management. This adviser wishes to charge an annual fee equal to 10% of assets under management since it believes that its services are superior. Which statement is TRUE?

The 10% annual fee is unreasonable because it is not comparable to other advisers that perform similar services Fees charged by an investment adviser must be comparable to the fees charged by other advisers that offer similar services. Since other advisers that provide similar services charge a fee equal to 5% of assets annually, a 10% annual charge is excessive.

Which of the following securities, if purchased by an investment adviser for its own account but not for its client accounts at the same time, is a "red flag" indicator of a potential conflict of interest violation?

The IA buys an Initial Public Offering for its own account This is a little vague, but here's where the question is coming from. A broker-dealer can "reward" an investment adviser for sending it commission trading business by placing IPOs in the adviser's personal account. IPOs are hard to get and often jump in price because of the excess demand, so this gives the adviser a personal gain that his clients do not share in. This is clearly a conflict of interest and is also unethical. With the other choices, the adviser is putting his or her personal funds in a nice, safe, low yielding investment. These are not likely to produce gains that the adviser's other customers will not enjoy.

The financial officer of a local not-for-profit religious organization calls an agent of a broker-dealer and says that: "If you split your commission and rebate ½ of it back to our church, I will tell all of our congregants to do business with you." Which statement is TRUE?

The agent cannot accept the offer because commissions can only be split with other agents that work at the same broker-dealer NASAA's rule on sharing of commissions is quite clear - commissions can only be split or shared with registered agents that work at the same firm. Therefore, the agent could not split his commissions with the church.

A mutual fund sponsor is holding an educational seminar at the convention center at a resort hotel near Disney World. The seminar will focus on the features of different bond funds offered by the fund sponsor. Which statement is TRUE about an investment adviser representative (IAR) attending the seminar?

The IAR can attend the seminar with travel and accommodation expenses paid by the mutual fund sponsor, as long as the conflict of interest has been disclosed to clients Mutual fund sponsors often hold large conferences for registered representatives and investment adviser representatives where the travel and accommodation expenses are paid by the fund sponsor. The rules here are that the meeting must be educational, not promotional; the fund cannot pay for the travel expenses of spouses; and the conflict of interest must be disclosed to clients.

The CEO of a publicly traded company is a large client of an investment adviser representative. The CEO, who is a member of the prestigious River Rocks Country Club, tells the IAR that he will refer other club members to the IAR if the IAR will give the referred clients a discount, and will give the CEO the same discounted rate. Which statement is TRUE about this situation?

The IAR can offer the discount as long as the fact that non-club members pay a higher fee is disclosed in the Form ADV Part 2A Investment advisers do not have to offer the same rates to all their customers - they are permitted to pursue group business by offering defined groups a discounted rate. However they must offer these discounts to all customers that qualify for the terms of the discount (in this case, they must be members of the country club); and the adviser must disclose the existence and terms of the discounts in the Form ADV Part 2A ("the brochure") that is given to clients.

An IAR (Investment Adviser Representative) is employed by a Registered Investment Adviser in a State. The IAR has a young, wealthy, client with an investment objective of aggressive growth. To meet the objective, the IAR engages in active trading strategies, using an outside broker to effect the trades at a discounted rate. The IAR receives a small payment from the broker for these trades. Which statement is TRUE?

The IAR must notify the client of the payment arrangement with the executing broker Since the IAR has a fiduciary obligation to the client and is already earning an advisory fee (presumably, it is not stated in the question), it is a breach of fiduciary duty for the adviser to accept payment from an executing broker for directing the client's portfolio trades to that broker. The basis for selecting a broker must be "best trade execution" along with "lowest fees" for getting best execution. However, if the fee arrangement, along with the fact that this is a conflict of interest, is disclosed to the client in writing, then it is permitted.

A customer invests $100,000 and opens a discretionary account with an agent specifying an investment objective of long-term growth. The agent decides that it is best to diversify and spreads the monies among a number of income funds within the same fund family. Which statement is TRUE?

The agent acted inappropriately and fraudulently The customer specified an investment objective of long-term growth, not income. If the agent places the funds in a number of income funds, the action is inappropriate and fraudulent.

Which statement is TRUE about the participation of an agent of a broker-dealer in an Internet Chat room about investing?

The agent can only make general statements about investing in the Chat room BD agents and IA agents are not prohibited from participating in Internet Chat rooms as long as they limit their communications to "general" statements about investing. They are prohibited, however, from making recommendations of securities in Chat rooms and from soliciting business from other participants in the Chat room.

Sarah Sacks has an individual account at a broker-dealer. Sarah calls her agent at the broker-dealer and states that she wishes to open an account for her sister Sally in her sister's name and buy 1,000 shares of PDQ stock. Which statement is TRUE?

The agent can open the account only if the sister Sally gives authorization in writing A third party is prohibited from opening an account in someone else's name. The customer must open the account personally. Sarah cannot open an individual account in her sister's name. Sally (the customer in this case) must either sign the new account form to open the account; or can give her sister Sarah a full power of attorney, signed by Sally, that names Sarah as a person allowed to act of Sally's behalf.

An agent has an individual account for a husband. The husband calls the agent and states that he wishes to open an account in his wife's name and buy 500 shares of PDQ stock. Which statement is TRUE?

The agent can open the account only if the wife gives written authorization A third party is prohibited from opening an account in someone else's name. The customer must open the account personally. A husband (Third Party) cannot open an individual account in his wife's name (Customer). To allow the husband to trade in her account, the wife must open the account and she must sign a Third Party Trading Authorization, giving the husband power of attorney over the account.

An agent recommends that a customer buy shares of ACME Mutual Fund. The fund has a sales charge of 6%. The first breakpoint occurs at the $10,000 level, where the sales charge is reduced to 5%. The customer gives the agent a check for $8,500 to invest in the fund, which the agent forwards promptly for investment in ACME shares. Which statement is TRUE?

The agent has acted unethically because he did not make the client aware of the breakpoint If a customer is getting "close" to the purchase amount needed to qualify for a breakpoint, it is unethical under NASAA rules not to make the customer aware of the relevant sales charge discount on the purchase of shares in dollar amounts at or above the breakpoint. Thus, the agent was supposed to tell the customer that if he or she put in another $1,500, the sales charge would be reduced. Furthermore, the customer must be made aware of any letter of intent feature (if available) that can be used to reduce the sales charge.

An agent recommends that a customer buy shares of ZIZI Mutual Fund. The fund has a sales charge of 7%. The first breakpoint occurs at the $10,000 level, where the sales charge is reduced to 5%. The fund offers a letter of intent provision. The customer gives the agent a check for $9,500 to invest in the fund, which the agent forwards promptly for investment in ZIZI shares. Which statement is TRUE?

The agent has acted unethically because he did not make the client aware of the upcoming breakpoint and the letter of intent provision If a customer is getting "close" to the purchase amount needed to qualify for a breakpoint, it is unethical under NASAA rules not to make the customer aware of the relevant sales charge discount on the purchase of shares in dollar amounts at or above the breakpoint. Thus, the agent was supposed to tell the customer that if he or she put in another $500, the sales charge would be reduced. If the customer does not have the extra $500 right now, the agent must tell the customer about the letter of intent feature, which gives the customer up to 13 months to deposit the extra $500 and obtain the lower sales charge on the entire $10,000 invested. Thus, Choice D is the better answer than Choice C.

A customer sends a strongly worded written complaint to an agent, alleging that the agent made untrue statements that resulted in the customer buying a security that is now worthless. The agent believes that the letter has no merit, and places the letter in his file, with a notation that "No Action Taken." Under the Uniform Securities Act, which statement is TRUE?

The agent has violated the Act because all complaints must be reported to the broker-dealer Written customer complaints must be submitted by agents to their broker-dealers for resolution under the Act. It is prohibited for the agent to "bury" the complaint.

A customer places an order to sell 500 shares of ABCD stock at the best price possible, so that the customer can use the funds from the settlement in 2 business days to pay for a new car purchase. The agent notices that the price of the stock is dropping rapidly and decides to sell 200 out of the 500 shares that day - since he believes that the price will rebound. The next day the price rises and the agent sells the remaining 300 shares. Which statement is TRUE regarding the agent's actions?

The agent has violated the Uniform Securities Act because he or she exceeded the discretionary authority that was granted by the customer The customer ordered the sale of 500 shares "at the best price." Verbal discretion over price and/or time of execution is permitted as long as the order is executed that day. To accept discretion over price or time of execution from a customer for longer than 1 day requires written permission from the customer. Since no written permission was received from the customer, the 500 shares should have been sold the day the sell order was placed - in this case, the agent exceeded the discretionary authority granted by the customer. (However, since the customer did get a better execution, he or she might not complain! Then again, because the customer will not have all the sale proceeds to pay for the car in 2 business days as ordered, maybe he or she will complain!)

An agent is employed by First Patriot Bank and Trust Company of Connecticut as a banking representative. The agent is registered in the State with a general securities license through First Patriot Securities, a separate operating subsidiary of First Patriot Holdings - the parent company of the bank. A retired couple that is making their monthly visit to the bank to deposit their social security checks asks the agent about the appropriateness of investing in either mutual funds or certificates of deposit. Which statement is TRUE regarding the actions that the agent may take when giving a response to these customers?

The agent may give advice to the couple about the suitability of investing in either mutual funds or certificates of deposit This agent is registered with a broker-dealer in that State. The agent can recommend securities such as mutual funds in his or her capacity as an agent of the broker-dealer. There is no separate registration required in the State as an investment adviser representative to do so. Regarding the recommendation of certificates of deposit, these are a bank product. Banks are excluded from the definition of an investment adviser under Uniform State Law (they are also excluded from the definition of a broker-dealer). There is no registration at the State level required to recommend banking products.

An older customer with failing eyesight requests that his mail be delivered to the agent's brokerage firm branch office rather than to his home. He also requests that his agent be the one to read, on at least a monthly basis, his statements to him. If the agent cannot commit to this, the customer wishes that the agent's secretary be the one to read the mail. Which of the following actions may be taken?

The agent must refuse the customer's request because all mail must be sent to the customer's address or P.O. box Customer mail must be sent to the customer's home address or to a post office box designated by the customer. It cannot be forwarded to a brokerage firm branch office, because then the customer would not know what was going on in the account. The customer can arrange for someone at home to read his or her mail. The registered representative cannot be the "reader" since, if the statement shows that the account value has declined, the registered representative might omit this information (intentionally or unintentionally).

Which action on the part of an agent would NOT be a violation of the Uniform Securities Act?

The agent tells a customer that if options positions are properly used to hedge a stock position, then a loss cannot be suffered on the stock position during the option's life Backdating of transactions is a prohibited practice. Not delivering a prospectus to a customer that buys a non-exempt new issue offering is a prohibited practice. Paying a referral fee to obtain a customer account without disclosing this practice to the customer is a conflict of interest that must be disclosed. Telling a customer that options positions can hedge a stock position against loss is a true statement and is not a prohibited guarantee against loss. The difference is that the customer pays for the option that is protecting the stock position, and this is perfectly acceptable.

A customer asks an agent for the current market value of his stock portfolio. The stock market has been dropping sharply today, and the agent gives the customer the most recent valuation that he has, which is based on yesterday's closing prices. Which statement is TRUE?

The agent's action is fraudulent because he misrepresented the status of the account to the customer and gave inaccurate market quotations Giving inaccurate market quotes is a prohibited practice under the Act. In this case, the agent misrepresented the status of the account to the customer by giving yesterday's closing quotes. If the agent did not have immediate access to today's prices, then he should have told the customer that he would get today's quotes and call him back as soon as possible.

An agent of a broker-dealer is having a very busy day. Just after the agent completes a conversation with one customer and picks up another waiting call, another call comes in. The agent picks up this call and puts the other customer on hold. The caller tells the agent that he is considering selling his position in ABCD stock, a thinly traded OTCBB stock. The agent is very pressed for time and wishes to return to the customer waiting on hold. He tells the customer that the last price he saw for ABCD stock was $4.50 per share, without mentioning that this was the price about 15 minutes ago when he last accessed the OTCBB for a quote in ABCD stock. Which statement is TRUE regarding the agent's price quote to the customer?

The agent's price quote is misleading since the customer would assume that the quoted price is the most recent trade in the subject security In this situation, the agent is misleading the customer. Any reasonable person would assume that the quote received for the security is the current quote - not one from 15 minutes ago. If the agent disclosed this fact at the time that the quote was given, there would be no problem. The fact that the agent did not disclose the fact that the quote was "stale" makes the agent's statement deceptive and misleading.

An agent of a broker-dealer recommends a security to a customer. The customer buys 1,000 shares, paying the firm a commission. The stock reaches a new market high in two weeks. Under the Uniform Securities Act, which statement is TRUE?

The only compensation that can be accepted by the broker-dealer is the original commission charged The only fee that can be accepted is the original commission charged. It is prohibited to be paid based on the gains in a customer's account. A broker-dealer earns its fee for investment advice within the commission charged. It cannot charge a separate fee for investment advice, since this would be a "double charge" to the customer.

An Investment Adviser is screening companies for their investment potential and finds what he believes to be an undiscovered growth stock. The adviser puts in an order to buy 10,000 shares, which is executed in 2-5,000 share purchases at different prices. What is the most appropriate way for the adviser to distribute these shares to his client's accounts?

The shares should be distributed pro-rata across all client accounts The typical procedure for handling trades executed in a single block is to allocate the securities equally among clients at a uniform price on a pro rata basis. This is the typical disclosure made to clients. Depending on market conditions, the adviser may not be able to purchase the security for all clients at the same price. Instead, it may have to purchase the security over several days at different prices. In such a case, each client should receive a pro rata allocation at the weighted average price.

A Registered Investment Adviser has established an enviable track record and decides that it should increase its asset management fee to reflect the increased value of its services. The Adviser amends its contract to include a fee equal to 5% of assets under management, charged each month to the client. This fee structure is disclosed in the Form ADV Part 2 filed with the Administrator and each customer signs a new advisory contract. Which statement is TRUE?

This action cannot be taken because the compensation to the Adviser is excessive Charging excessive fees is prohibited and a fee of 5% of assets per month is a 60% annual fee - clearly an unbelievably high fee! The ridiculous fee cannot be justified by including it in an amended Form ADV Part 2 filed with the Administrator (Administrators do not examine the filing information routinely - they just have it on file if they need access to it - so it would likely not be picked up by the Administrator unless there was a customer complaint). The ridiculous fee cannot be justified because the customer signed an advisory contract - he or she may not have known what was being signed. Finally, the adviser can charge fees monthly, quarterly, yearly - the frequency of the payment makes no difference. Rather, it is the amount being paid for the service that is the issue.

ADAP Advisers is offered a large block of ACME stock (a NYSE-listed issue) by an institutional investor at a 20% discount to the current market price, if ADAP Advisers is willing to buy the block that day. Which statement is TRUE if ADAP purchases the block for its own account rather than for its customers?

This action is permitted if the purchased stock is not a suitable investment for ADAP's customers Investment advisers have a fiduciary responsibility to their customers and must always put their customers' interests first. Since this block of stock is being offered to the adviser at a substantial discount, the adviser must buy the stock for its customers - but only if the stock is a suitable investment for these customers. On the other hand, if the stock is not a suitable investment for ADAP's customers, then ADAP is free to buy the block of stock for its own account. (Note that Choice A is incorrect because this is the exception to the general rule.)

A Registered Investment Adviser wishes to prepare an advertisement that shows a satisfied customer stating "I made over 20% last year with my investment adviser; and I will make 20% this year." Which statement is TRUE?

This advertisement cannot be used The Investment Advisers Act of 1940 prohibits the use of customer testimonials in advertising - with no ifs, ands or buts. Because of federal supremacy, this prohibition applies at the State level.

An Investment Adviser Representative writes a blog published on the Internet about how to achieve the best returns for clients, while minimizing risk. Which statement is TRUE about this?

This can only be done if the Investment Advisory firm that employs the IAR both approves the content and authorizes the distribution of the communication If an agent of a broker-dealer or an investment adviser representative wishes to publish any content on the Internet, either as a website or on a blog, the Agent or IAR: must disclose his or her affiliation with the Broker-Dealer or Investment Advisory firm; the Broker-Dealer or Investment Adviser (the firm) must approve the content of the Internet Communication; the Broker-Dealer or Investment Adviser (the firm) must authorize the distribution of the Internet Communication; and the Agent or IAR must act within the scope of authority granted by the Broker-Dealer or Investment Adviser (the firm).

An agent of a broker-dealer publishes a web page that offers a free suitability determination to each customer that fills out a form electronically. Furthermore, if the customer agrees to open an account, the site states that: "The first month of trading will be free." Which statement is TRUE regarding this communication?

This communication is permitted only if the broker-dealer and the agent are registered in each State where a customer completes the Web form Because this is not a "general" Internet Communication and the communication is being followed-up with specific client interaction, this is considered to be an offer of brokerage services in each State where a customer completes and submits the electronic suitability form. As such, the maker of the offer (the broker-dealer) and its agents must be registered in each State where this occurs. The fact that the first month of trading is free has no bearing. The broker-dealer will charge for its trades thereafter.

An investment adviser representative has joined the local golf club, where there are many wealthy club members. At the club, the IAR has met many individuals who are interested in having her investment advisory firm manage their money. As an inducement only available to club members, the IAR offers to reduce the annual management fee to .25% of annual average net assets from the usual fee of .35%, conditioned upon a minimum of $500,000 being invested by that club member. Which statement is TRUE about this offer?

This is a permitted fee arrangement as long as the existence of the negotiated discount is disclosed in the Form ADV Part 2A Discounted investment adviser fee arrangements are permitted only if they are disclosed in the Form ADV Part 2A (the IA brochure). The Form ADV is filed electronically with either the SEC (Federal Covered Advisers) or the State using IARD - Investment Adviser Registration Depository within 90 days of year-end. It must be given to advisory clients when an account is opened and an updated Form ADV Part 2A or a Summary of Material Changes to the form must be delivered to customers annually thereafter.

An agent promises an elderly potential customer that he will visit each weekend to discuss the customer's account performance if the customer opens an account. The agent travels extensively and is rarely in town on weekends. Which statement is TRUE?

This is a prohibited business practice It is a prohibited practice to make promises to customers that the agent cannot reasonably expect to honor. In this case, the agent has promised to personally visit the customer each weekend to go over investment results, even though the agent travels extensively. This is a promise that cannot be kept.

An agent of a broker-dealer is approached by the manager of a local bank, who tells that agent the following: "If you have any customers who want an extremely safe investment, you can sell them CDs issued by our bank and we will pay you a $50 referral fee for each completed sale." Which statement is TRUE about the agent engaging in this activity?

This is an unethical activity known as selling away unless the agent obtains written permission of his or her firm to sell the bank's CDs If an agent wishes to sell a security that is not being offered by his or her firm, the agent is "selling away" from the firm. This is prohibited under both FINRA and NASAA rules unless the agent gets written approval of the firm to engage in the transaction. All securities transactions effected by agents must be known to the employing firm and must be supervised by the employing firm. Note that selling away is not illegal - there is no law stating that selling away is prohibited. Rather, it is an unethical practice if an agent "sells away" without the permission of his or her firm.

A broker-dealer is attempting to increase its commission brokerage business by offering "free office space" in its Park Avenue office building to hedge funds in return for the hedge fund sending its trades through that broker-dealer. Which statement is TRUE?

This is an unethical practice unless it is disclosed on the Form ADV filing with the Administrator This question is based on reality. In New York City and other "high rent" locations. Broker-dealers offer so-called "hedge fund hotels," where they offer hedge fund advisers nice office space that they own (on places like Park Avenue) at subsidized or "free" rents if the hedge fund agrees to direct its portfolio trades to that broker-dealer. The SEC requires that investment advisers that accept soft dollars disclose this on Form ADV and the disclosure must be specific. Because most hedge fund advisers are set up as partnerships, hedge funds are not subject to the mutual fund soft dollar rule which requires that the soft dollar benefit accrue to the shareholders. All of the "partners" in a hedge fund may get a benefit from the reduced expenses that the hedge fund will enjoy from the subsidized rent. However, the SEC (and also NASAA, because each State uses the same ADV Form) requires that the hedge fund disclose the practice of accepting soft dollars as a line item in the Form ADV and that it disclose that, in return for getting the rent subsidy, it may be paying a higher commission rate to that executing broker-dealer.

A registered representative has a sales assistant who has helped bring in a large new customer. The representative is so pleased with the sales assistant's professional conduct and aggressiveness that he wants to journal entry 50% of the commissions resulting from the account to the assistant. The sales assistant will be sitting for the Series 7 examination within 3 weeks. Which statement is TRUE?

This is not permitted because the sales assistant is not registered Commissions can only be split with another registered person employed by the same broker-dealer. Since the sales assistant is not yet registered, commissions cannot be shared between the registered representative and the sales assistant. Note that once the sales assistant is registered, the registered representative could begin to share commissions with the assistant on trades executed by the client (but could not share commissions on trades that occurred prior to the sales assistant becoming registered).

A Registered Investment Adviser who is also a registered representative manages a client's account, charging the client both commissions on trades and an advisory fee. Which statement is TRUE?

This is not unethical as long as disclosure is made to the client An investment adviser that charges advisory fees to a client for recommending securities; and then charges commissions to that client on trades performed; would be engaging in an unethical practice if the adviser did NOT disclose the 2 sources of revenue. As long as disclosure is given to the customer (and the charges are fair), this is OK. The overriding theme here is that all charges to customers must be disclosed.

A customer telephones a broker-dealer to complain that an agent forged her signature on a document. Which statement is TRUE?

This is only defined as a complaint that the broker-dealer must document and resolve if it is put in writing and filed with the broker-dealer A complaint that must be recorded and resolved is defined as one received by the broker-dealer in writing (e-mail counts here as well), A verbal complaint does not count - even though this is a pretty serious allegation. If a complaint is truly serious and valid, the customer will put in writing.

ACME Advisers has as a client, a large broker-dealer - ACCO Brokerage. ACME wishes to open an account to buy securities on margin at ACCO Brokerage. Which statement is TRUE?

This is permitted because the broker-dealer is in the business of lending money on securities An investment adviser is prohibited from borrowing money from a customer. However, if the customer is a bank or broker-dealer (these are persons who are in the business of lending money); the adviser may borrow funds in an arm's length relationship.

A broker-dealer is a subsidiary of a company that is listed on the New York Stock Exchange. An agent of the broker-dealer believes that the parent company's stock is a good investment and wants to recommend it to her customers. Which statement is TRUE about this?

This is permitted only if the agent discloses the existence of the relationship verbally when making the recommendation and it is disclosed in writing on the confirmation This question does not address reality! As an internal policy, most broker-dealers prohibit their agents from recommending the stock of their publicly traded parent company - because of the inherent conflict of interest. For example, an agent for Merrill Lynch cannot recommend the purchase of Bank of America stock (B of A owns Merrill). However, let's move to the theoretical and, evidently, the test world. This is a conflict of interest that must be disclosed to clients when making a recommendation. The existence of the relationship must be disclosed verbally when making the recommendation; and also must be disclosed in writing prior to completion of the transaction (this is done by disclosing it in writing on the trade confirmation).

A registered representative leaves Firm A to join Firm B. She makes a written agreement with another registered representative at Firm A to get 20% of the commissions from the accounts that she is leaving at Firm A. The agreement covers a period of 6 months following her leaving Firm A. Which statement is TRUE about this arrangement?

This is prohibited because a registered representative can only share commissions with another representative at the same firm Registered representatives can only share commissions with other registered representatives at the same firm. They cannot share commissions with representatives who work for other firms; and they cannot share representatives with unregistered persons. The only exception is when a registered representative is retiring from a firm. The RRR (Retiring Registered Representative) can enter into a contract with the representative who takes over his or her accounts at his or her ex-firm to receive a portion of the commissions earned. The written agreement must be completed before retirement and must be approved by the firm.

A Registered Investment Adviser has discretionary control over 50 accounts that range in value from $200,000 to $1,500,000. She receives a free due diligence trip from a real estate limited partnership sponsor to inspect a property in Florida. She is enthusiastic about the investment potential and purchases a $50,000 real estate limited partnership unit in the property for each of her accounts. The RIA disclosed the fact that she received the free trip to each of her customers before making the purchases. Which statement is TRUE?

This is unethical because the adviser did not determine the suitability of the investment for each account It really does not seem likely that the partnership units were suitable for each and every one of the investment adviser's 50 accounts - the investment appears to have been bought for these accounts without regard to suitability.

A customer buys 1,000 shares of XYZZ stock in a margin account and pays the required 50% margin on settlement date. The customer requests that the broker-dealer transfer the securities into the customer's name and ship them to his home address. Which statement is TRUE?

This request cannot be honored because the securities must be paid for, in full, to process a transfer and ship request Securities held in margin accounts cannot be transferred and shipped - they are kept in "street" name as collateral for the customer margin loan. The customer must pay off the loan on the securities in order for the brokerage firm to transfer them into his or her name and ship them. There is no requirement for such a request to be made in writing.

A customer buys 500 shares of ABCD stock in a cash account and pays for the securities in full on settlement date. The customer requests that the broker-dealer transfer the securities into the customer's name and ship them to his home address. Which statement is TRUE?

This request should be honored as given Fully paid customer securities can either be held in custody of the firm (where they must be segregated and kept in safekeeping); or the customer may request that the securities be transferred into his or her name and shipped to the customer. Note that securities held in margin accounts cannot be transferred and shipped - they are kept in "street" name as collateral for the customer margin loan. There is no requirement for such a request to be made in writing.

A mutual fund is offered with no up-front sales charge and no contingent deferred sales charge. It charges 50 basis points of 12b-1 fees annually. The fund publishes an advertisement stating that: "This is a no-load fund." Which statement is TRUE?

This statement is misleading because a no-load fund cannot charge more than 25 basis points of 12b-1 fees A mutual fund is not permitted to advertise itself as a "no-load" fund if it charges 12b-1 fees of more than .25% (25 basis points) annually. 12b-1 fees are charges against net asset value that pay for the cost of soliciting new investment to the fund, and they can be used to compensate salespersons that sell the fund's shares.

The portfolio construction most suitable for a pension fund seeking current income and safety of principal is:

Treasury bonds, Corporate bonds and covered call writing Selling naked calls is risky; selling covered calls is a conservative income strategy with limited loss. Therefore, the best choice must either be A or B. General obligation bonds are tax-free Municipal bonds that yield less than taxable investments, such as Treasury bonds or Corporate bonds. Since the pension plan is tax-deferred, investing in these lower yielding investments is inappropriate; they are only appropriate for customers that are currently in high tax brackets. Therefore, the best choice is B - a portfolio of Treasury bonds, Corporate bonds and covered call writing.

An agent omits to state material facts which are needed by an investor to make an informed decision. Under the NASAA Statement of Policy on Dishonest and Unethical Business Practices, this action is fraudulent if the statements refer to:

U.S. Government Bonds Municipal Bonds Corporate Bonds Omission of material facts that a customer needs to make an informed investment decision is fraudulent for both exempt and non-exempt securities. Remember that fraud applies to everything.

When is an investment adviser deemed to have custody of client funds?

When the adviser holds a check payable to the client from the client's broker-dealer When the adviser holds a full power of attorney over the client's account When the adviser acts as a trustee where the client is the beneficiary of the trust NASAA has specific rules to be followed if an adviser takes custody of client funds. "Custody" does not only include accepting client funds or securities, but also includes: accepting prepaid advisory fees of $500 or more, 6 months or more in advance of rendering services (note that the IA Act of 1940 sets this at $1,200 for Federal Covered Advisers);an account that gives the adviser a full power of attorney, which allows the adviser to withdraw funds and trade (but not an account that gives the adviser a limited power of attorney where the adviser can trade only);a trustee for the client - by definition, a trustee has custody, since the trustee has full control over the assets in the account; andinadvertent receipts of customer funds or checks that are not returned within 3 business days.

An investment adviser prepares an advertisement that will be used in newspapers in a large city. Under NASAA rules, the advertisement would be permitted to contain a(n)

a toll-free number to call for more information The NASAA rule on IA advertising parallels the SEC rule included under the Investment Advisers Act of 1940. The NASAA rules states that any advertisement from an investment adviser: cannot contain a testimonial (broker-dealer advertising may, however); cannot state that any report or research will be provided for free unless this is offered without condition; cannot contain false, untrue or misleading statements; can include a list of recommendations made with their performance as long as all recommendations over that period are included, along with the market price at the time of the recommendation and the current price of the security. This list cannot be deliberately selective.

All of the following actions by a representative are violations of the Uniform Securities Act EXCEPT:

failing to state all known facts relating to a transaction It is not an unethical practice for a representative to fail to state all known facts relating a transaction; failure to state the material facts is the unethical practice. Inducing trades for the purposes of increasing commissions (churning) is unethical; commingling customer and representative's monies is unethical; and recommending unsuitable transactions to customers is unethical.

Under NASAA rules, an investment adviser representative could NOT personally borrow money from a:

family member that has an account with the adviser Investment adviser representatives cannot borrow funds from customers (unless the customer happens to be a bank, broker-dealer, or lending institution). NASAA prohibits agents from borrowing from family members that are customers; but there is no prohibition on borrowing from family members that are not customers of the adviser.

An investment adviser is marketing an unproven asset allocation program to customers that has not been validated by real-world testing. The adviser believes that the program works well and tells this to potential buyers, but has no data to support this claim. If the adviser sells this program to customers, then the adviser:

has committed an unethical business practice The key to this situation is that the asset allocation program is unproven and has not been validated. The sale of such a program is an unethical practice. The adviser's claim that the program works well is bogus - there is no supporting data.

Under the provisions of the Prudent Investor Act, all of the following statements are true regarding the management of trust accounts with multiple beneficiaries EXCEPT the fiduciary:

must manage the trust to meet the needs of older beneficiaries before considering the needs of the younger beneficiaries The "Prudent Investor Act" gives fiduciaries much broader latitude in terms of their ability to allocate trust assets to various investment classes, as compared to the obsolete "prudent man rule" that simply required that investments be of low risk. The concept is that modern portfolio theory can be used to diversify assets and to achieve a greater return that justifies any extra "risk" assumed by the strategy - as long as the strategy is consistent with the investment objectives and needs of the beneficiaries. The fiduciary is judged by overall portfolio performance - not by the performance of each single investment. Since a higher level of expertise may be needed to manage trust assets in this manner, the Act allows the fiduciary to contract with an outside investment adviser to provide asset management. In any trust with multiple beneficiaries, the fiduciary must act impartially and must consider the needs of each beneficiary. Therefore, when there are multiple beneficiaries, the trustee cannot favor any one of them.

A market maker in ABCD stock is currently quoting the stock in the OTCBB at: $42.00 Bid (500 shares); $43.00 Ask (1,000 shares) If the market maker receives a customer order to sell 800 shares of ABCD at $42.50, the market maker:

must update its quote to: $42.00 Bid (500 shares); $42.50 Ask (800 shares) Customer limit orders that are better priced than the current quote must be displayed in the marketplace. This dealer is currently offering the stock at $43.00 - this is the price at which he is willing to sell up to 1,000 shares. Since this customer is willing to accept less to sell - $42.50 for up to 800 shares, the customer's offer must be displayed in the market. Note that NYSE, AMEX (NYSE American), and NASDAQ systems automatically comply with this rule - they require all orders to be electronically submitted where the exchange systems sequence and display them. So this rule really only applies to quotes for non-listed stocks placed in the OTCBB.

A market maker in ABCD stock is currently quoting the stock at: $42.00 Bid (500 shares); $43.00 Ask (1,000 shares) If the market maker receives a customer order to buy 800 shares of ABCD at $42.50, the market maker:

must update its quote to: $42.50 Bid (800 shares); $43.00 Ask (1,000 shares) Customer limit orders that are better priced than the current quote must be displayed in the marketplace. This dealer is currently bidding the stock at $42.00 - this is the price at which he is willing to buy up to 500 shares. Since this customer is willing to pay more to buy - $42.50 for up to 800 shares, the customer's bid must be displayed in the market. Note that NYSE, AMEX (NYSE American), and NASDAQ systems automatically comply with this rule - they require all orders to be electronically submitted where the exchange systems sequence and display them. So this rule really only applies to quotes for non-listed stocks placed in the OTCBB.

A client is in the process of opening a new account at a broker-dealer. The client has told the agent that her investment objective is capital preservation. When performing the suitability determination, the client refuses to disclose net worth and previous trading experience. The client also wants the agent to enter trades in the account without specific direction from the client, but has not yet returned a signed power of attorney. The representative is:

not permitted to enter an order in the account until the power of attorney is received As is typical, there is a lot of "extra" information in the question that is not relevant. The key here is that the customer has not returned a signed power of attorney (POA), which would allow the representative to enter trades in the account at the representative's discretion. Until the power of attorney is received, the agent cannot enter orders without getting customer approval. Choice C is "not bad," but the fact is that the agent can still solicit orders from the customer and is not limited to accepting unsolicited customer orders only. Choice B gives a recommendation that is in accordance with the customer's investment objective, but the representative cannot place an order for that security unless either the POA is received or the customer gives express approval. Finally, discretionary authority cannot be exercised without a POA, regardless of whether the branch manager specifically approves the trade in advance of execution, making Choice D incorrect.

A new broker-dealer is attempting to attract clients and publishes the following advertisement: "If we do not generate an investment return of 10% within 1 year, we will happily refund your money." This statement in advertising is:

prohibited since this is a guarantee of performance, which cannot be made under State law Promising to refund a customer's money if an investment target is not reached is a prohibited guarantee of performance.

Under NASAA rules, a customer MUST sign and return the margin agreement:

promptly after the initial transaction in the account NASAA wording states that the signed margin agreement must be obtained promptly after the first transaction in account. In contrast, FINRA requires that the margin agreement be signed and returned prior to settlement of the first transaction in the account. Since this is a NASAA question, the answer is their rule!

Under NASAA rules, a customer must sign and return the margin agreement:

promptly after the initial transaction in the account NASAA wording states that the signed margin agreement must be obtained promptly after the first transaction in account. In contrast, FINRA requires that the margin agreement be signed and returned prior to settlement of the first transaction in the account. Since this is a NASAA question, the answer is their rule!