STC Series 63 Chapter 1, 2, 3, and 4

Regarding registering securities in a state, describe: Filing Fees?

Issuers are required to pay filing fees at both the time of initial registration and at annual renewal. If either of these fees is not paid, the Administrator may issue a stop order, which suspends the sale of the security. The fee will vary from state to state, so there's no specific dollar amount that will be tested on your exam.

Both broker-dealers and investment advisers need records regarding transactions in their customers' accounts. These are known as Order Memorandums /Order Tickets and must include...?

Order Memorandums /Order Tickets and must include: - Account number, date of entry, date of execution - Instruction, modification, or cancelation - Terms and Conditions (e.g., limit price, time restrictions) - The person who recommended the order or that it was unsolicited - If the order was executed on a discretionary basis - The broker-dealer or bank that executed the order

Regarding exempt securities, describe: Securities Issued Pursuant to Regulation D—Rule 506?

Private offerings of securities that are not sold to the public are exempt from federal registration. Issuers using the Rule 506 private offering exemption are able to raise an unlimited amount of money; however, restrictions are imposed on the types of investors that may purchase the securities. Generally, the securities may be sold to an unlimited number of accredited investors, but no more than 35 non-accredited investors. If the issuer publicly advertises the securities or solicits investors without prequalifying them, then only accredited investors may actually purchase the securities.

Regarding the laws governing state and federal registration and the person responsible for enforcing these requirements, describe: State Administrator?

State Securities Regulator, aka State Administrator, is the person responsible for not only administering and enforcing the securities laws in a state, but for educating investors as well. The fundamental mission of a state securities regulator is to protect the consumers who purchase securities or pay for investment advice within the state. In some states, a special official, such as the Securities Commissioner, may carry out the Administrator's duties, while in other states these functions may fall under a more comprehensive office such as the Secretary of State. The powers of the Administrator will be discussed in more detail later in this Study Manual.

Are securities professionals permitted to solicit and sell unregistered, exempt securities?

The exam may get creative with language and may reference a security as being unregistered, exempt. It may seem that because the security is unregistered, its sale would be prohibited. However, the reason the security is unregistered is because it's exempt. Although securities professionals are permitted to sell unregistered, exempt securities, it's a violation to solicit the sale of unregistered, non-exempt securities.

EXAMPLE: HCI Company's public offering of securities became effective on January 14, 20XX. When will the registration expire?

The registration of a security expires one year after its effective date—NOT on December 31.

Regarding exempt securities, describe: Exchange-Listed Securities?

These are securities that are currently listed on an exchange, or will be listed on an exchange once the offering is completed. These include securities that trade on the New York Stock Exchange, Nasdaq, and the Chicago Stock Exchange. The exemption extends to securities that are equal to or higher in seniority to the listed security, as well as to rights and warrants to purchase the subject security. These securities were previously exempt under a provision referred to as the blue-chip exemption.

How do we identify whether an investment is defined as a security according to state and federal authorities?

To identify whether an investment is defined as a security, state and federal authorities often use a four-part test described in the U.S. Supreme Court decision of SEC versus W.J. Howey Co. The four required elements are: 1. An investment of money 2. In a common enterprise 3. With the expectation of profits 4. Solely from the efforts of others

Define & describe: Viatical Investments?

Viatical investments, also referred to as life settlements, represent the purchase of the rights to the death benefits from individual life insurance policies. Typically, a policyholder who is ill or in need of cash will sells the right to the death benefit from his life insurance policy to a viatical company. The company then resells these interests to investors. An investor may purchase a whole interest in an individual death benefit or a fractional interest. Investors may also purchase interests in pools of viatical settlements that have been put together by the company For exam purposes, an important consideration is whether viatical investments are considered securities? The answer is yes, according to NASAA, viatical investments are securities under state laws and must be registered in the states in which they're sold. The agents and broker-dealers who sell them must also be registered in these states. Under the NASAA Guidelines Regarding Viatical Investments, viaticals are not suitable investments for the average retail investor. Since death is unpredictable, the rate of return that the investor will receive cannot be calculated until the policyholder dies. The investor will not have access to her capital in the meantime and also there's no secondary market for viaticals. If the policy owner lives longer than expected, investors may need to contribute additional money to pay the policy's premiums. Investors may not receive anything if either the viatical company or the life insurance company that issued the policy goes out of business.

What are responsibilities of claiming a Registration Exemption?

When an exemption for a security or a transaction is claimed, the burden of proof rests with the person requesting it! When a security is not required to be registered, it's classified as an exempt security. Issuers often prefer to offer securities under an exemption because it's more timely and cost-effective than going through the formal registration process. Under the USA, provisions exist for exempt securities and exempt transactions that are based on the method by which the security is offered or sold. Both exempt securities and exempt transactions are exempt from registration requirements. However, there's no exemption from the antifraud provisions of the Uniform Securities Act. A security may be exempt from registration under federal law, but not state law, and vice versa. When the rules overlap, the most restrictive rule applies. Once again, an exemption from registration doesn't exempt a security from federal and state antifraud provisions. All securities and persons are subject to the antifraud provisions.

EXAMPLE: Al, Bob, and Charlene are the founders of a brokerage firm and were named senior officers when the company was formed. Al is responsible for handling the finances, but doesn't participate in securities transactions in any way. Bob and Charlene are responsible for managing the brokerage business. Two years after the firm was founded, Elsie replaced Bob as a senior officer. In this situation, how do the rules regarding the registration of agents apply?

When the firm's registration as a broker-dealer became effective, Bob and Charlene were automatically registered as agents. Al's responsibilities didn't involve effecting securities transactions, so he was not required to register as an agent. Since Elsie was not a partner, officer, or director at the time of the firm's initial registration, she didn't receive the benefit of automatic registration. Elsie was required to register and follow the same procedure as any other agent.

EXAMPLE: Rocksolid decides to expand and open a branch office in Colorado. It has yet to open accounts with non-institutional clients. Therefore, its only clients are institutional. Since Rocksolid has no retail clients in Colorado, is it required to register as a broker-dealer in Colorado?

Yes. Although Rock Solid has no retail clients in Colorado, it now has a place of business in Colorado and is required to register there.

EXAMPLE: Jim is an agent with a broker-dealer in Canada. Sally, one of Jim's long-term clients, spends every winter in Florida. Both Jim and his broker-dealer are registered in a limited capacity in Florida since they have many senior clients who spend every winter there. Is Jim able to contact Sally about some new investment opportunities while she's in Florida?

Yes. Jim may contact Sally in Florida since she's an existing client who is in the U.S. temporarily.

In addition to meeting the general registration requirements, each state securities registration must be completed using one of which three methods?

1. Notification (Filing) 2. Coordination 3. Qualification All registration statements are effective for at least one year from their effective date.

Regarding the General Registration of Financial Professionals, describe: Effective Date and Expiration?

A person's registration becomes effective at noon on the 30th day after the filing of the application (or on the 30th day after the filing of an amendment). If Administrators consider it appropriate, they have the authority to grant registration earlier. Issues that impact a person's registration include denial orders or pending proceedings regarding denial, revocation, suspension, cancellation, or withdrawal. For financial professionals, all registrations expire on December 31. The annual renewal process is as simple as updating the application and paying a new fee. However, Administrators retain the right to suspend or revoke a registration whenever they feel it's necessary and in the public's best interest. ** Similar application ... Although the following example involves a broker-dealer, the same scenario and effective date applies to the registration of an agent, investment adviser, or investment adviser representative. Remember, Administrators may choose to grant registration earlier **

Describe the state registration method: Registration by Coordination?

A security may be registered by coordination if the same offering is being registered under the Securities Act of 1933. While the state registration statement is coordinated with the federal registration, the two statements don't need to be filed at the same time. Under coordination, a registration statement must be filed with the Administrator along with three copies of the latest prospectus that were filed with the SEC. The Administrator may also request a copy of the articles of incorporation, any underwriting agreement or indenture related to the security, or other information or documents the Administrator deems appropriate. Any amendments to the federal prospectus must also be forwarded to the Administrator promptly. Registration by coordination becomes effective at the same time as the federal registration, provided no stop order has been entered by the SEC or the Administrator. The registration statement must be on file with the Administrator for at least 10 days. Furthermore, a statement of the minimum and maximum offering prices, maximum underwriting discounts, and commissions must have been on file with the Administrator for at least two business days. If the federal registration becomes effective prior to the satisfaction of all the requirements of previous paragraph, the state registration will become effective once the requirements have been met, unless otherwise waived by the Administrator.

When CANNOT Administrators deny, suspend, or revoke a registration?

Administrators may not deny, suspend, or revoke a registration based solely on an issuer's weak financial condition. In addition, Administrators may not institute a stop order proceeding against a registration based on facts of which they were aware when the registration became effective, unless the proceedings are instituted within 30 days. An Administrator may summarily postpone or suspend a registration pending a final determination of any proceedings being conducted under this section. If administrative action is taken, the registrant must be provided with prior written notification and be allowed to submit a written request for a hearing, which must be held within 15 days of the request.

Differentiate between an Agent of a Broker-Dealer & Agent of an Issuer?

Agent of a Broker-Dealer= a non-clerical individual who represents a broker-dealer in effecting securities transactions. Without exception, salespersons of broker-dealers who effect securities transactions are considered agents and must be registered. However, not every employee of a broker-dealer is considered an agent and subject to registration. An individual who simply performs clerical tasks, such as filing paperwork or answering the phone, is not considered an agent. Consider the following example to determine whether an individual is defined as an agent of a broker-dealer. ** Registered Representatives and Agents ... While your firm may have a different title for you, such as registered representative or financial adviser, the Series 63 Examination refers to individuals representing a broker-dealer in effecting securities transactions as agents.** Agent of an Issuer= a non-clerical individual who represents an issuer in effecting securities transactions with the public involving the issuer's securities. Let's analyze the following examples to determine whether the individuals described are considered agents of the issuer.

EXAMPLE: Lucy and Jim work for a newly formed company that's in the process of conducting an initial public offering (IPO) of stock. Jim is a director and is currently soliciting commitments from public investors for which he will earn compensation based on the number of investors who agree to purchase the securities. Once the shares are publicly traded, Lucy, the Director of Human Resources, as part of her regular duties, will administer a plan that permits company employees to purchase registered common shares of the company. Who's required to register as an agent of the issuer?

Although Lucy and Jim are both directors, their responsibilities are different. Jim is considered an agent of the issuer since his activities involve effecting transactions with the public in the issuer's securities. Furthermore, Jim will be compensated based on the number of investors who purchase shares. Therefore, he must register as an agent. Lucy is not considered an agent since her responsibility (handling the distribution of shares to employees) is one of her regular functions in the Human Resources Department. Since she's not compensated for sales, Lucy is not required to register as an agent.

Define & describe: Exempt Transactions?

Another way for securities to avoid state registration is through one of the various exempt transactions. Under the USA, an exempt transaction is a method through which an exemption is provided based on how the security is offered or sold. For transactions, the exemption must be established on a trade-by-trade basis.

Describe characteristics of: Transfer on Death (TOD) Accounts?

Both individual and joint accounts may have a Transfer-on-Death (TOD) or Pay-on-Death (POD) provision. If the account owner dies, the account passes to the designated beneficiary. Generally, the only document that's required to transfer the assets into the beneficiary's name after the account owner dies is a copy of the death certificate. A TOD or POD account may have more than one beneficiary, with each receiving a specified percentage of the account or certain securities. Only the account owner may change the beneficiaries. If the account owner becomes incapacitated prior to death and the courts appoint a guardian, that person may not change the beneficiary.

Identify the appropriate form and system used for the registration of the following different securities professionals: - Broker-Dealer - Agents - Investment Adviser - Investment Adviser Representative

Broker-Dealer - Form: Form BD - System: Central Registration Depository (CRD) Agent - Form: Form U4 - System: CRD Investment Adviser - Form: Form ADV (Parts 1 and 2) - System: Investment Adviser Registration Depository (IARD) Investment Adviser Representative - Form: Form U4 - System: IARD through the CRD

How do Broker-Dealers handle changes in a clients name and address?

If there's a change in the account name or the customer's address, a letter must be sent to the client notifying her of the change at both her former and current addresses. This is to prevent unscrupulous individuals from changing the client's address so that they can intercept her confirmations and account statements and then raid the account before the client knows what's happening.

In most circumstances, agents must be registered in a particular state before engaging in securities transactions in that state. However, there are two situations in which agents may conduct business with an existing client without being registered in the state. Describe the Two Agent Exemptions from State Registration?

In the first situation, if an agent's application for registration is pending in a state, the agent may engage in transactions for up to 60 days with an existing client who has moved to that state. This provision is contingent on the Administrator not denying the agent's application during this period and the following conditions being met: 1. The agent must be eligible to register in the state. 2. The agent's broker-dealer must be registered in the state. 3. The agent must be registered with a national securities association (e.g., FINRA). 4. The agent must be registered in at least one other state. The second situation allows an agent to engage in securities transactions with an existing client who is temporarily visiting a state in which the agent (and the broker-dealer) is not registered.

Regarding the laws governing state and federal registration and the person responsible for enforcing these requirements, describe: Securities Act of 1933 ('33 Act)?

** When the SEC is referenced, the question is referring to federal law, not state law** The Securities Act of 1933 was passed in reaction to the stock Market Crash of 1929. Before then, state law primarily regulated the issuance, offer, and sale of securities. This federal law requires that certain securities be registered with the SEC in order to be offered or sold to the public. The purpose of the act is to prevent fraud in the sale of new issues of securities (primary distributions) by requiring that investors be provided with enough relevant information about the offering to make an informed decision. This information is contained in the registration statement, which is a public document that an issuer files with the SEC. The registration statement is designed to provide full and fair disclosure of all material information about the issuer and the offering. Issuers are also required to prepare a prospectus for distribution to potential purchasers. The prospectus is essentially an abbreviated version of the registration statement.

Administrators have the authority to issue a stop order to deny, suspend, or revoke a registration. These actions may be taken if they find it to be in the public interest and if any of the following conditions apply...?

- A registration statement is incomplete, false, or misleading in any material respect. - A provision of the Uniform Securities Act or any rule or order imposed by an Administrator has been willfully violated in connection with the offering by the issuer, any partner, officer, director, or control person, or underwriter. - Any officer of the issuer or underwriter has been convicted of a crime involving securities. - The security is already subject to a stop order or an injunction by a federal or state court. - The issuer's enterprise or method of business includes activities that are illegal. - The offering is fraudulent, or is made on terms that are unfair, unjust, or inequitable. - The seller's compensation is unreasonably large. - The registrant fails to pay the proper filing fee. (The Administrator may enter a denial order that will be vacated when the deficiency is corrected.)

The application for registration by the Filing method must contain the following information...?

- A statement of eligibility - The issuer's name, address, and form of organization - A statement describing the offering - A copy of the prospectus that has been filed with the SEC If all or part of the offering is for the benefit of someone other than the issuer (a non-issuer distribution), the statement must also contain the name, address, and amount of securities held by that person, and the reasons for making the offering. Registration by filing becomes effective at the same time as the federal registration, provided no stop order has been entered by the SEC or the Administrator. In addition, the required information and documents must have been on file for at least five days and the registration fee must have been paid. If the federal registration became effective at an earlier time, the state registration becomes effective when all required conditions are met. This method of registration is rarely used anymore since NSMIA was enacted in 1996. As we will see later in this chapter, the securities of large issuers that trade on the major stock exchanges are usually federal covered securities that are considered exempt from state registration. However, there could be questions about registration by notification (filing) on the Series 63 Examination, which is the reason that this registration method is described in this course. ** Be careful ... Some test-takers confuse registration by notification (filing) with notice filing. Although both use the word filing, notice filing is not a registration method. Notice filing will be examined shortly **

Describe some investment instruments that are NOT defined as securities?

- Insurance, endowment policies, or annuity contracts under which an insurance company promises to pay a fixed sum of money either as a lump sum or periodically for life or other specified period (i.e., term, universal, or whole life insurance policies, and fixed annuities) - (Any insurance product that doesn't include the word variable) - Art - Individual retirement accounts (IRAs) or Keogh plans - Currencies - Commodities - Futures - Collectibles - Condominiums (as primary residences)

Firms must collect information from each individual opening a new account and must create a record of this information. These records include...?

- Name - Address (other than a P.O. Box) and telephone number - Tax identification number - Date of birth (for individuals) - Occupation - Whether the customer is an associated person of another broker-dealer - Financial/Suitability information (net worth, annual income, tax status, investment objectives and experience, risk tolerance, liquidity needs, and other investments) Agents must always obtain at least the customer's name, address, tax identification number (Social Security or Employer Identification Number), and date of birth to open an account. Additionally, they must make a good-faith effort to obtain the rest of the information that's cited in the last three bullet points. If the client refuses to provide all the information, agents should explain in the account record why this data was not collected. The account record should also indicate the name of the agent who opened the account and the principal (supervisor) who approved it. Brokerage firms must keep all these records for six years after the account information is updated or replaced, or the account is closed.

Define the following terminology for the Series 63: - State - Security - Person - Issuer - Broker Dealer - Agent

- State: Uniform Securities Act includes a state, commonwealth, territory, or possession of the United States, including the District of Columbia and the Commonwealth of Puerto Rico. - Security: common stock, bonds, option contracts, and variable annuities. If securities are non-exempt, they must be registered in order to be offered or sold in a state. In addition to recognizing the securities that are exempt or non-exempt, it may be necessary to determine the basis for an exemption. - Person: A person is defined as any legal entity that's not deceased, is not a minor, and is not mentally incompetent. Under the Uniform Securities Act, the term person may include individuals, corporations, partnerships, sole proprietorships, issuers, and state Administrators (both the office and the individual). So, keep in mind, the definition of a person is very broad—including individuals as well as organizations. - Issuer: any person who issues or proposes to issue any security. The term issuer includes the U.S., state, local, or foreign governments, corporations, and partnerships. - Broker Dealer: a person in the business of effecting securities transactions for the accounts of others or for its own account. A firm is acting in the capacity of a broker when it effects securities transactions on behalf of its clients. In other words, a broker will locate the other side of the trade—finding the buyer when representing the seller, or finding the seller when representing the buyer. A broker charges its customers a commission for providing this service. A firm is acting in the capacity of a dealer when it effects securities transactions for its own account. A dealer stands ready to take the other side of any transaction—buying for its own inventory with a markdown or selling from its own inventory and charging a markup. A dealer providing liquidity by publishing quotes in the Nasdaq marketplace is also referred to as a market maker

Describe a general list of investments that ARE considered securities?

- Stocks (including treasury stocks), rights, warrants, transferable shares, or certificates of deposit for a security (e.g., American Depositary Receipts) - Notes, bonds, debentures, collateral trust certificates, or other evidence of indebtedness - Interest in any profit-sharing agreement - Variable annuities and variable life insurance contracts - Voting trust certificates, certificates of interest in an oil, gas, or mining title or lease, preorganization certificates or subscriptions - Investment contracts, including interests in oil and gas drilling programs, real estate condominiums and cooperatives, farm lands or animals, whiskey warehouse receipts, multilevel distributorship arrangements, and merchandising marketing schemes - Stock options or options on commodity futures contracts

Under the USA, it's unlawful for any person to offer or sell a security in a state unless the security is either registered or exempt from registration. State Administrators require registrants to provide general information about the securities being offered, such as...?

- The amount of securities to be offered in the state - Any adverse ruling entered in connection with the offering by a state regulatory authority, a court, or the SEC - Other states in which a registration statement has been or will be filed ** Watch out ... While the Administrator will want to know the other states in which a security will be offered, disclosure of the number of shares being offered in each and every state is not required** Often the issuer must also provide the Administrator with financial information and its articles of incorporation, charter, or the equivalent organizational documents. Any document that was filed with the Administrator during the last five years may be incorporated in its state registration materials by reference.

An issuer is considered to be "doing business" in a state as long as it meets just one of the following four new requirements...?

1. At least 80% of its consolidated gross revenues are derived from the operation of a business or of real property that's located in the state or territory or from the rendering of services within the state or territory; 2. At least 80% of its consolidated assets are located within the state or territory at the end of its most recent semiannual fiscal period prior to the first offer under the exemption; 3. At least 80% of the net proceeds from the offering are intended to be used by the issuer, and are in fact used in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within the state or territory; or 4. A majority of the issuer's employees are based in the state or territory (this fourth requirement was not included in the original Rule 147) - An issuer must utilize a reasonable belief standard when determining the residency of the purchaser at the time of the sale of securities. This standard is supported by the requirement that the issuer obtain a written representation from all purchasers as to their residency. - Resales to persons who reside outside of the state in which the offering is conducted are restricted for a period of six months from the date of the sale by the issuer to the purchaser (formerly nine months). **A legend requirement applies to notify offerees and purchasers about the resale restriction**

The process of registering a security by method of Qualification is much more involved than both the filing and coordination methods. The following disclosures are required under registration by qualification...?

1. Information about the issuer and any significant subsidiary including its name, address, form of organization, the state or foreign jurisdiction in which it operates, and the general competitive conditions in the industry or business in which it is or will be engaged 2. Information on all officers or directors of the issuer including their names, addresses, principal occupations for the last five years, and the amounts of securities they're holding within 30 days of the filing of the registration statement 3. Information on any person who owns 10% or more of any class of the issuer's outstanding shares 4. For any non-issuer distributions, the name and address of the person on whose behalf the offering is to be made, the amount of securities owned, and a statement of the reason for making the offering 5. A description of the issuer's capitalization and long-term debt 6. The type and amount of securities to be offered, the price of the securities, estimated selling fees, and underwriting agreements 7. The estimated cash proceeds to be received and the purposes for which the proceeds will be used 8. A copy of every prospectus, letter, advertisement, or other literature to be used in connection with the offering, and a legal opinion if it's a debt offering 9. A recent balance sheet and a profit-and-loss statement for each of the last three years 10. Any additional information required by the Administrator One of the unique characteristics of registration by qualification is that the registration becomes effective only when determined by the Administrator. ** Remember ... Although the effective date for securities registered by notification (filing) and coordination is based on the effective date of the issuer's federal registration, this is not the case for registration by qualification **

According to NASAA, the following investors are suitable candidates for viatical investments...?

1. Investors with a minimum net worth of $150,000 and an annual income of more than $100,000, or a minimum net worth of $250,000. The net worth calculations may not include the value of the investor's home. No more than 10% of each person's net worth should be invested in viatical investments. 2. Accredited investors, according to Regulation D of the Securities Act of 1933. Generally, accredited investors are financial institutions and individuals with an annual income of at least $200,000, or a minimum net worth of $1 million (again, the net worth excludes the value of their residence). More detail regarding accredited investors and Regulation D will be provided later in this chapter.

Although it's similar to Rule 147, the new Rule 147A will allow for multi-state offers (not sales), which means what?

1. Issuers are permitted to use general solicitation and publicly available websites to locate potential instate investors. Although offers are able to be made outside of the state, all sales must still be limited to in-state residents. 2. Companies are able to be incorporated or organized outside of the state in which they conduct the offering as long as they have their principal place of business in that state. Principal place of business is defined as the location from which the principal officers, manager, or partners primarily direct, control, and coordinate the activities of the issuer. ‒ For example, ABC is incorporated in Delaware, but its principal business is conducted in New Jersey. Under Rule 147A, ABC will be allowed to sell securities to residents of New Jersey. Both the amended Rule 147 and the new Rule 147A include the following provisions: 3. For an issuer to sell securities in a state, it must have its principal office (under Rule 147) or principal place of business (under Rule 147A) in that state and satisfy one of four "doing business" requirements. By satisfying one of the four new requirements, the issuer can avoid having to comply with all three of the 80% tests for assets, revenue, and proceeds of the offering. ‒ If a Rule 147 or 147A issuer subsequently changes its principal place of business after issuing securities, it will not be able to conduct another intrastate offering under these rules in another state for a period of six months from the date of last the sale in the previous state. ‒ An issuer is considered to be "doing business" in a state as long as it meets just one of the following four new requirements:

Are there any registration exclusions for broker-dealers?

A broker-dealer must be registered with the SEC as well as any state in which it's defined as a broker-dealer. Under the USA, if a person is defined as a broker-dealer in a state, it must register in that state. However, if a person is excluded from the broker-dealer definition, it's not required to register with the state Administrator. What's the process for determining whether a firm or individual is defined as a broker-dealer? First, look at the activity in which the firm is involved. Next, look at where the firm is doing business. And finally, identify the types of clients with whom the firm is doing business. In Chapter 1, the term broker-dealer was defined as any person in the business of effecting securities transactions for the accounts of others or for its own account. The USA excludes the following persons from the broker-dealer definition: - Agents (the employees involved in securities transactions) - Issuers - Banks, savings and loan companies, savings institutions, and trust companies (Bank holding companies and broker-dealer subsidiaries of banks are not excluded from the definition.) ** Helpful hint ... There are patterns in the USA. For example, banks are provided an exclusion from the broker-dealer and investment adviser definitions. Another consistent exclusion is a situation where firms limit their business to institutional clients** The next two exclusions from the broker-dealer definition require more explanation: 1. A person that has no place of business in the state AND only transacts business with issuers, other broker-dealers, banks, savings institutions, trust companies, insurance companies or other financial institutions, or institutional clients - While the USA provides the framework for states to create their own specific state securities laws, it's also concerned with protecting individual or retail investors. Institutional investors are often treated differently since they're more sophisticated and often have the expertise and ability to make independent investment decisions. Typically, institutions are able to assume greater risks and have a better understanding of those risks than individual (non-institutional) investors. For this reason, a firm that doesn't have an office in a state is allowed to deal exclusively with institutions without meeting the broker-dealer definition. 2. A person that has no place of business in the state AND is registered where the person maintains its place of business and only conducts business with existing retail clients who are not residents of the state (e.g., clients on vacation, attending school, or working in another state) - The bottom line is that if a broker-dealer has an office in a state, it must register in the state. However, if the broker-dealer doesn't have an office in a state and its non-institutional clients don't live in the state, then it's not required to register there.

Describe: Option Derivatives?

As a form of derivative, an option contract is considered a security. Options derive their value from the movement of an underlying instrument (e.g., a stock, index, currency, etc.). There are two types of options— calls and puts—and these contracts provide the owner with the ability to buy (if it's a call) or sell (if it's a put) the underlying instrument at a preset price. However, the owner of an option doesn't have the ability to vote. An important concept with options is determining whether an option is in-the-money (i.e., has intrinsic value). The option's type will influence how the intrinsic value is determined: - Call options have intrinsic value if the value of the underlying instrument is UP above the option's strike price. - Put options have intrinsic value if the value of the underlying instrument is DOWN below the option's strike price.

Describe Post-registration Requirements for Agents?

As described earlier, Form U4 requires registrants to provide information about themselves and their employment history. Additionally, if a registrant is currently engaged in any other businesses, he must answer a series of questions about whether he's ever: - Violated the federal or state securities laws or SRO rules - Been the subject of a regulatory proceeding or investigation - Been involved in any legal proceedings (civil or criminal) - Been the subject of a customer complaint Been terminated by a previous employer - Declared bankruptcy, had a lien placed on your property or any unsatisfied judgments By signing Form U4, a person agrees to amend this form promptly—generally within 30 days—if the information that's been submitted on this form changes. This includes both minor changes (e.g., change of address) and more important matters. Failure to report changes promptly may result in the person being fined, censured, or even barred from the industry, if the regulators determine that the oversight was deliberate. Insurance license suspensions, unsatisfied judgments and liens, and outside business activities are some of the items that must be disclosed on the Form U4.

EXAMPLE: Harrison Investment Advisory Services employs several individuals who sell the firm's portfolio management services to institutional and non-institutional clients. Last month, Marti led the team in sales. Based on Marti's activities, is she considered an investment adviser? What role does Harrison play in this scenario?

As with certain employees of a broker-dealer, an employee of an investment adviser whose job is solely clerical or ministerial (administrative) is not included in the definition of an investment adviser representative. Since Marti is involved in soliciting the investment advisory services that Harrison offers, she's considered an investment adviser representative. Harrison (the firm) is considered an investment adviser.

Describe: Whiskey Warehouse Receipts?

Clearly, the preceding list of investments that are considered securities contains some strange entries. For example, what's a whiskey warehouse receipt? Before answering that question, it may help to know that many of these instruments were added to the definition of a security in response to specific instances of investment fraud encountered by states. Including them as securities allowed Administrators to regulate them and potentially stop investment scams that were not originally envisioned by state law. By the way, whiskey warehouse receipts represent a share in a quantity of whiskey being aged for future sale—perhaps 10 or 12 years before bottling. If investors did not want to wait for the product to be sold before cashing out, they might sell their warehouse receipts to other investors. Under state law, the transfer of a whiskey warehouse receipt is equivalent to the delivery of the property it represents and, therefore, it constitutes a security

Describe Supervision of Broker-Dealer Agents and Branch Office Audits?

Every broker-dealer must have written supervisory procedures (WSPs) and must ensure that they're updated periodically and enforced. WSPs are a vital element in a broker-dealer's supervisory system—they explain what the firm's employees must do in order to comply with the securities regulations. Branch Office Audits A firm must conduct internal audits of its offices to make sure that its supervisory procedures and systems are being enforced. The firm must inspect all offices of supervisory jurisdiction and all branch offices that supervise other offices at least once a year. All other branch offices must be inspected at least once every three years, and non-branch offices on a regular basis. According to NASAA, an effective branch audit program should include unannounced visits, a method of conveying feedback, and procedures for following up so that any deficiencies discovered by the auditors are corrected.

EXAMPLE: Heritage Securities, a California broker-dealer, purchased GST Investments, a small New York-based broker-dealer. Heritage completed the purchase of GST in March and will now operate as Heritage Investments. The new firm will have offices in California and New York. What are the requirements for Heritage Investments to operate as the successor firm for the remainder of the year?

Heritage Investments will be required to file a new application with the Administrator in California and New York. However, since Heritage Securities and GST Investments were properly registered, including having paid their filing fees, the successor firm (Heritage Investments) will not be required to pay another fee until it's registration is required to be renewed.

Define & describe: Agents of Broker-Dealers?

If an individual represents a broker-dealer in effecting securities transactions, without exception, he's an agent of the broker-dealer. For a person to solicit business in a state as an agent, he must be registered under the Uniform Securities Act by filing Form U4 (the Uniform Application for Securities Industry Registration or Transfer) through the CRD. A broker-dealer may not employ an agent who is not properly registered. The registration of an agent is only in effect while she's associated with a registered broker-dealer. If an agent's employment is terminated or she chooses to leave her job, that broker-dealer is responsible for filing Form U5 (the Uniform Termination Notice) with its self-regulatory organization and the Administrator to disclose the termination of the relationship. The agent must also receive a copy of this form. If the agent doesn't join another firm within two years, her registration will lapse. If this happens, she's required to re-qualify by examination to reenter the industry. ** Good to know ... Form U4 is the form that both agents and IARs use to register. As was just mentioned, broker-dealers must file Form U5 when an agent leaves the firm. The regulators use Form U6 to report disciplinary actions against broker-dealers and agents **

What steps do you take if you're asked to identify whether a firm is considered a broker-dealer in a state?

If asked to identify whether a firm is considered a broker-dealer in a state: (1) Identify the activity in which the firm is involved (2) Determine whether the firm has an office in the state - If YES, the firm must register - If NO, identify the type of client If all clients are institutional clients, the firm is NOT required to register. If one or more clients are retail clients who are residents of the state, then the firm must register.

Describe characteristics of: Individual Accounts & Accounts for Minors?

Individual Accounts An individual account is opened by and for one person. That one person acts purely on her own behalf and not for any other person or entity. She's also the only person who's able to initiate activity in the account unless she has provided another person with written third-party authorization. For example, if a married person opens an individual account, that person's spouse may not trade in the account unless the owner has formally granted the spouse with written third-party trading authorization. Accounts for Minors Minors are not permitted to open accounts in their own names. This prohibition is due to the fact that they're not legally responsible and could refuse to accept transactions once they reach the age of majority. Although most states consider the age of 18 as the age of majority, each state is able to set its own standard. There are two approaches to opening accounts for minors—UGMA and UTMA accounts. According to the Uniform Transfers to Minors Act (UTMA), the securities in a UTMA account are the property of the minor. The custodian, who is typically a family member, makes the investment decisions; however, the assets are owned by the minor.

Regarding the laws governing state and federal registration and the person responsible for enforcing these requirements, describe: The National Securities Markets Improvement Act of 1996 (NSMIA)?

Initially, there were no regulations in place that prohibited states from demanding the registration of persons and securities that were in the process of being registered or were already registered at the federal level. Eventually, in 1996, Congress officially enacted the National Securities Markets Improvement Act (NSMIA) to eliminate the duplication of state and federal regulation of securities and advisers. NSMIA created a specific category of securities that are exempt from formal state registration. These securities are classified as federal covered securities and include: - Securities listed on the U.S. exchanges (NYSE, Nasdaq, etc.) - Certain Regulation D offerings (private placements) - Municipal securities issued outside the state - Securities issued by registered investment companies (e.g., mutual funds) These federal covered securities are no longer regulated by the states or required to register at the state level. Keep in mind, if the state doesn't require registration, it may neither deny nor revoke that registration. However, Administrators will want to know what's being offered or sold in their state. Therefore, states may require the issuers of federal covered securities to file copies of the documents that have been submitted to the SEC and may also require the issuer to pay a fee to the state. This process is referred to as notice filing. In order to prevent the duplication of regulation of advisers, NSMIA further created a specific category of investment advisers called federal covered advisers. The federal covered adviser determination is often based on either the adviser's assets under management (AUM) or the types of clients it services. Consequently, advisers are only subject to regulation at one level—either state or federal. Further details regarding the registration requirements of investment advisers will be described in subsequent chapters. Regarding broker-dealers, NSMIA prohibits states from enforcing requirements that are more restrictive than existing federal requirements. Some of these requirements relate to minimum net capital, bonding, and the maintenance of books and records. ** Remember ... Although federal covered securities are not required to be registered at the state level, some issuers may be required to notice file and pay a filing fee. Among the most common securities that fall into this category are mutual funds**

Differentiate between an Investment Adviser & Investment Adviser Representative?

Investment Adviser (IA)= any person (usually a firm, rather than an individual) that, for compensation, engages in the business of providing others with securities-related advice, reports, or analysis. To meet the definition of an investment adviser, a person must satisfy all 3 parts of the A-B-C test: 1. Providing Advice about securities 2. Providing these services as a Business 3. Receiving Compensation for these services Investment Adviser Representative (IAR)= any partner, officer, director, or other individual who is associated with an investment adviser that: - Makes recommendations or gives advice regarding securities - Manages accounts or portfolios of clients - Determines which recommendations or what advice should be given - Solicits, offers, or negotiates the sale of investment advisory services - Supervises employees who perform any of these functions ** Good to know ... Investment advisers and investment adviser representatives are also referred to as registered investment advisers (RIAs) and registered investment adviser representatives (RIARs)**

Regarding exempt securities, describe: Investment Companies?

Investment company securities (e.g., mutual fund shares) are registered under the Investment Company Act of 1940 and are also required to be registered with the SEC under the Act of 1933.

Describe characteristics of: Joint Accounts?

Joint accounts are established when two or more persons have ownership rights to an account. Since any recommendations an agent makes in a joint account must be suitable for all joint owners, he's required to obtain information from each owner of the account. In addition, all parties involved in the account must sign the account documents. Once the joint account is opened, any owner may buy or sell assets without the consent of the co-owners. However, checks and securities must be issued in the same manner as the account is titled. Any tax events will be recorded under one tax ID number. There are two basic types of joint accounts—Joint Tenants with Right of Survivorship (JTWROS) and Joint Tenants in Common (JTIC). In an account established as JTWROS, the owners are typically a married couple. In this type of account, if one owner dies, the survivor will individually own all of the assets in the account. With JITC accounts, if one owner dies, that person's portion of the account reverts to her estate. If a person wants to leave her share of an account to someone other than the co-owner, this account structure should be used. Although the assets in a JTIC account are usually evenly split, the account assets may be divided in any way specified by the tenants. The individual investments in the account are not designated to a specific tenant since each tenant is assumed to have an ownership interest in the entire portfolio.

Define & describe: Unregistered Personnel?

Keep in mind that not every employee of a broker-dealer who deals with clients is effecting securities transactions. Broker-dealers may employ unregistered individuals to perform the following functions: - Extending invitations to firm-sponsored events at which presentations and account or order solicitation will be conducted by registered personnel - Inquiring whether a prospective customer wishes to discuss investments with a registered person - Determining whether a prospective customer wishes to receive investment literature from the firm The firms that employ unregistered persons to perform these functions must ensure that these employees don't solicit new accounts or orders, discuss general or specific investment products or services offered by the firm, or prequalify customers as to their financial status, investment history, or objectives. Remember that any persons who are employed by a broker-dealer must be registered if they're authorized to receive either solicited or unsolicited orders, open customer accounts, or service accounts.

EXAMPLE: LJ Securities has completed all of its requirements for registration as a brokerdealer and filed its application with the Administrator on May 1. Provided the Administrator doesn't deny LJ's application, when will it become effective?

LJ Securities' registration becomes effective at noon on May 31 and will remain effective until December 31. However, since the 30-day wait delays LJ's ability to initiate business, the Administrator may grant registration earlier. Therefore, if the Administrator notified LJ on May 8 that its registration is effective, LJ may begin acting as a broker-dealer without waiting the full 30 days.

Regarding State Registration of Broker-Dealers, describe: - Net Capital - Advertising and Sales Literature - Sales Seminars - Correspondence

Net Capital= The Administrator may require broker-dealers to maintain a specified minimum amount of net capital (essentially a broker-dealer's liquid net worth). However, the state Administrator may not set a level that exceeds the requirement established by federal (SEC) rules. Advertising and Sales Literature= All advertising, sales literature, and other written materials (prospectuses, pamphlets, circulars, form letters, etc.) intended for distribution to current or potential clients must be filed with the Administrator. For materials relating to exempt securities, exempt transactions, or federal covered securities, filing with the Administrator is not required. Any communication or correspondence must be fair and balanced. Materials prepared for retail investors must be approved by an appropriate qualified principal in writing prior to being distributed to the public. Sales Seminars= A principal must approve all written seminar materials and guest speakers beforehand (including advertising or notices for the seminar itself). If an agent regularly conducts sales seminars, then a supervisor should attend occasionally in order to fulfill the firm's supervisory responsibilities. Correspondence= includes e-mail, instant messages and texts, as well as letters. The broker-dealer must be able to effectively monitor all incoming and outgoing correspondence (electronic and paper-based). This process must include a way of detecting potential client complaints.

EXAMPLE: Norm and his broker-dealer are registered in New York. One of Norm's New York clients is on a business trip and calls him from the airport in Kansas to place an order. Is Norm required to register in Kansas to be able to accept the order?

No. Since the client is only in Kansas temporarily, neither Norm nor his broker dealer is required to be registered in Kansas.

EXAMPLE: The XYZ Corporation files financial statements with the state at the end of the quarter and then files a registration statement a few weeks later. Does it need to include these financial statements with the registration documents?

No. The XYZ Corporation may simply mention that its financial statements were previously filed with the state. Any person reading the registration statement may obtain these documents from the state if she wishes.

Define & describe: Notice Filing?

Notice filing refers to a state's demand that certain issuers of federal covered securities satisfy state requirements, such as signing a Consent to Service of Process, paying a filing fee, and possibly filing with an Administrator any copies of material that has been filed with the SEC as a part of the issuer's federal registration. Notice filing is required for issuers of investment company securities as well as issuers that distribute their securities pursuant to a Rule 506 private placement.

Define & describe: Agents of Issuers?

Occasionally, issuers use individuals to effect or to attempt to effect transactions for their own securities. These individuals are considered agents of issuers. EXAMPLE: Henry is the president of a newly formed company. In an effort to help his company raise capital, Henry has been publicly offering his company's shares to friends and other potential investors. Is Henry an agent? - Yes. Since Henry is representing the issuer in the public offering of its stock, he's considered an agent of the issuer (the company).

Describe the state registration method: Registration by Notification (Filing)?

Registration by notification, also called filing, is used by well-established corporations that meet stringent financial requirements. This method of registration was always reserved for larger issuers with securities that trade on a national exchange and have previously registered with the SEC. Not all states permit the use of registration by filing. However, in those states where it's use is allowed, the following conditions must be met: 1. A registration statement must have been filed under the Securities Act of 1933. 2. The issuer is organized under the laws of the U.S. or a state, or if not, the issuer has appointed a duly authorized agent in the U.S. for Service of Process. 3. The issuer has registered with the SEC a class of equity securities that are held by 500 or more persons. 4. The issuer has: - A total net worth of at least $4,000,000 or a total net worth of $2,000,000 and net pre-tax income for at least two of the previous three years - Not less than 400,000 units of the class of securities registered under Section 12 of the '34 Act are held by the public, excluding securities held by officers and directors of the issuer, underwriters, and persons beneficially owning 10% or more of that class of securities, and - Outstanding warrants and options held by the underwriters and executive officers and directors of the issuer in an amount not exceeding 10% of the total number of shares to be outstanding after completion of the offering of the securities being registered 5. The issuer has been in business for at least 36 calendar months preceding registration. 6. For the issuer's securities registered pursuant to the '34 Act, there must have been at least four market makers for a period of at least 30 days during the three months preceding filing. 7. The aggregate commissions or discounts received by underwriters may not exceed 10% of the aggregate offering price. 8. The issuer or any subsidiary may not have failed to pay a dividend on preferred stock or have defaulted on any bond or long-term lease since the end of the last fiscal year before it filed the registration statement. 9. In the case of an equity security, the offering price must be $5 per share or more.

Describe the state registration method: Registration by Qualification?

Registration by qualification is used when either a security's federal registration has already become effective or when no federal registration will be filed—as is the case for offerings made in one state only (intrastate offerings). Intrastate offerings are exempt from federal registration.

The following chart provides a summary of the registration and notice filing requirements for federal covered securities?

Remember, unless securities are exempt, they must be registered at the state level by means of notification (filing), coordination, or qualification.

Describe the interaction of the Federal Rule 147 vs. Rule 147A?

Rule 147 was created as a safe harbor under the statutory intrastate offering exemption which is provided by the Securities Act of 1933. The rule (also referred to as the intrastate exemption) allows companies to raise capital from their in-state investors. Typically, companies that are selling new securities are required to register their securities with the SEC; however, under Rule 147, if a company is conducting an offering and only selling its securities to its state residents, the offering is exempt from registration. Today, the strict issuer eligibility requirements and developments in both company business practices and communications technology have made Rule 147 outdated. Rule 147A- designed to update and modernize the existing intrastate offering framework and permit a company to raise money from investors who reside within its state without being required to register the offers and sales at the federal level.

EXAMPLE: Younge Securities, a Michigan broker-dealer, has both institutional and retail clients. Grace, an existing retail client of the firm, is spending three weeks in Florida house-sitting for her best friend who's traveling out of the country. If Younge Securities is not registered in Florida, will it be able to do business with Grace while she's in Florida? Will the agent that assists Grace be required to register in Florida?

Since Grace is only in Florida temporarily, Younge Securities will not be required to register in Florida. In addition, Grace's agent will not be required to register in Florida since Grace is not a resident of Florida.

EXAMPLE: Lenny and Janice are employed by High Bridge Securities. Lenny works with a team of individuals who are responsible for forwarding client calls and mailing campaign literature on behalf of the agents with whom he works. He also coordinates seminars and helps with mailing invitations. Janice is responsible for executing equity transactions for customers who open accounts after attending the seminars coordinated by Lenny. Are Lenny and Janice required to register as agents?

Since Lenny's role is clerical and doesn't involve securities transactions, he's not defined as an agent and is not subject to registration. However, in this example, because Janice is clearly representing a broker-dealer in effecting securities transactions, she's required to register as an agent.

How does the Consent to Service of Process document actually work? EXAMPLE: A client believes that her agent has taken funds from her securities account without authorization and, therefore, files a lawsuit in state court to recover her losses. However, when she files the lawsuit, her agent is no longer associated with his now former employer and cannot be located in order to serve him with legal papers. Does the client have recourse?

Since the Consent to Service of Process was filed at the time the agent was originally registered, the client may serve the papers on the state Administrator instead of the agent. Serving the Administrator is equivalent to serving the legal papers on the agent directly.

EXAMPLE: A corporation is offering its stock only in California. If the company's stock will be listed on Nasdaq, what method of state registration will the corporation use?

Since the corporation is offering its stock only in California, it may seem as though the intrastate method of registration (qualification) would be used. However, since the corporation will be listed on Nasdaq, it's not required to register at the state level as the securities are considered federal covered.

EXAMPLE: Acme Inc. is planning to expand its business and is in need of additional capital. Acme's financial advisers recommend that it offer shares of the company to the public. Are the securities being offered by Acme required to be registered? And, what role will Acme play in the offering?

Since there's no indication of an exemption, Acme is required to register the securities prior to offering them to public investors. Generally, when public investors are involved, registration is required. In this example, Acme is the issuer of the securities.

Regarding the General Registration of Financial Professionals, describe: Examinations and Surety Bond?

The Administrator reserves the right to require applicants to take an examination - which may be written, oral, or both. However, the Administrator may excuse certain categories of persons from taking an exam. Keep in mind that simply passing an examination is not sufficient for registration. Applicants must meet all requirements for registration and are not allowed to do business in a state until their registration is deemed effective by the Administrator. Surety Bond= insurance which is issued by a bonding company that agrees to pay the sum of money awarded by a court up to a certain amount. The need for a surety bond may arise as a result of a registrant's violations of the USA. The bond must be maintained for as long as the registrant is in business and for three years thereafter. The requirement to post a bond may also apply to registered broker-dealers, agents, and investment advisers if any of these securities professionals maintain custody of their clients' funds or securities, or have discretionary authority over their assets. (Discretionary authority means that the firm or one of its employees is authorized to place orders for an account without first obtaining the client's approval.) Although not always the case for investment advisers, broker-dealers generally have custody of their clients' funds and securities and must post a bond. If a broker-dealer's net capital or an investment adviser's minimum financial requirement meets specified minimum amounts, the posting of a bond will not be required. In lieu of posting a bond, Administrators allow registrants to deposit cash or securities, but not personal property. However, if depositing securities, the Administrator has the authority to determine the appropriate type and amount.

Define & describe the following systems used for the registration of different securities professionals: Central Registration Depository (CRD) System and the Investment Adviser Registration Depository (IARD)?

The Central Registration Depository (CRD) system is a computerized database that contains information about broker-dealers and their agents. Information includes the states in which a person is registered, any reported disciplinary problems with regulators, and serious complaints from investors. The Investment Adviser Registration Depository (IARD) is also an electronic filing system that facilitates investment adviser registration, regulatory review, and the public disclosure of information. Although FINRA has no regulatory control over advisers, it developed and operates the IARD. More detailed information on Form ADV and the IARD will be found in the next chapter.

Regarding the laws governing state and federal registration and the person responsible for enforcing these requirements, describe: The Securities Exchange Act of 1934 ('34 Act)?

The Securities Exchange Act of 1934 established the Securities and Exchange Commission (SEC). The SEC is the federal regulatory agency charged with enforcing the federal rules and regulations, including the registration of broker-dealers. Additionally, the Act of 1934 governs the trading (secondary) markets.

Describe Rules for Canadian Broker-Dealers and Agents?

The Uniform Securities Act contains a provision allowing for the limited registration of Canadian broker-dealers and their agents. If broker-dealers and agents are properly registered in Canada and have no place of business in a U.S. state, they will be exempt from certain provisions of the Uniform Securities Act. However, the antifraud provisions of the USA will always apply regardless of a person's registration status. Canadian broker-dealers and agents may effect transactions with a person from Canada who's temporarily in a U.S. state provided there was an existing broker-dealer/client relationship before the person entered the United States. The firms are also permitted to effect transactions with or for an existing client who's located in a state if the trades are effected in a Canadian, self-directed, tax-advantaged retirement account for which the person is the holder or contributor. However, they may not solicit new clients in a state, Canadian or otherwise.

Regarding the laws governing state and federal registration and the person responsible for enforcing these requirements, describe: The Uniform Securities Act?

The Uniform Securities Act= State securities rules and regulations are based on the Uniform Securities Act (blue-sky laws). The USA is a model law, which means that it's not the actual law of any one state, but rather a blueprint or template that each state may customize to suit its own needs. ** Keep in mind ... It may be necessary for certain persons and securities to be registered at the state or federal level. Although the Series 63 Examination expects you to understand the requirements for both, you will find a focus on the registration requirements of the Uniform Securities Act**

Define & describe: Agents Who are Affiliated with More than One Firm?

The dual registration of an agent (i.e., being affiliated with two broker-dealers simultaneously) is allowed, but only if the Administrator's direct authorization is received. Also, if an agent intends to split or divide commissions with another person, the other person must be a registered agent in the same state and be employed by the same broker-dealer or a firm that's under common control. A firm under common control includes an affiliate, subsidiary, or parent company

Regarding registering securities in a state, describe: Effective Date of Registration?

The effective date is the date on which the appropriate regulator releases the security for public distribution. If any securities of the same class are outstanding, a registration statement may not be withdrawn for one year after it's effective date, unless the Administrator determines otherwise. An Administrator may also require the filing of quarterly reports by the same person who filed the initial registration statement. The Administrator's goal is to keep registration information as current as possible and to monitor the progress of the securities offering.

Broker-dealers, agents, investment advisers, and investment adviser representatives each begin their registration process by filing an application with the appropriate regulatory authority. Describe the Application Process for General Registration of Financial Professionals?

The initial application includes the following information: - Applicant's name and aliases - Address (business or residence) for the last five years - Applicant's financial condition and history - Employment history for the last 10 years - Type of business to be conducted - Other business activities - Any charge, no contest plea, injunction, administrative order, felony conviction, or securities-related misdemeanor conviction issued by a domestic, foreign, or military court - Details regarding unsatisfied judgments or liens against the registrant - Settlements of $15,000 or more related to customer complaints, arbitration, or civil litigation - Whether a bonding company has ever denied, paid out on, or revoked a bond for the registrant - Qualifications and business history of any partner, officer, director, and other persons in a controlling position If material information that was provided to the Administrator becomes inaccurate or outdated, an amendment must be filed promptly (generally within 30 days). For purposes of announcing a person's interest in obtaining registration, the Administrator may require the registrant to publish an announcement of the application in one or more newspapers published in the state in which registration is being sought.

Why are most non-issuer transactions exempt?

The reason that most non-issuer transactions are exempt is because they represent secondary market trades that will be regulated at the federal level. On the other hand, when the issuing entity is in a position to receive the proceeds of the distribution (e.g., an IPO), it's considered an issuer transaction. Issuer transactions may be subject to state registration. The Administrator may deny or revoke any exemption upon prior written notice to all interested parties. If action is taken, the Administrator must offer the opportunity for a hearing and must provide written findings of fact and law. Pending a final determination of any proceedings, the Administrator may deny or revoke the exemptions.

Regarding exempt securities, describe: Federal Covered Securities?

These securities are not required to be registered at the state level. NSMIA eliminated a state's ability to regulate the public offerings, proxy solicitations, periodic disclosures and advertising filing requirements of the issuers of federal covered securities. Although no federal covered security is required to be registered with a state Administrator, certain securities that fall in this category are required to notice file. For now, it's important to know the characteristics of the various types of federal covered securities.

What are the two tiers for Regulation A exempt offerings?

Tier 1 - Sales of up to $20 million are permitted within a 12-month period. Of that amount, no more than $6 million may be sold on behalf of selling shareholders. ‒ The offerings are subject to both SEC and blue sky review ‒ Continuing disclosure information must be filed Tier 2 - Sales of up to $75 million are permitted within a 12-month period. Of that amount, no more than $22.5 million may be sold on behalf of selling shareholders. ‒ The offerings are subject to SEC review, but not Blue-Sky review ‒ Has stricter continuing disclosure information and filing requirements Additional Information Regarding Regulation A - Current SEC reporting companies may not use Regulation A - Both U.S. and Canadian companies are eligible - The offerings may be for either equity or debt securities ** Be careful ... Under Rule 147, the SEC exempts intrastate offerings from federal registration. However, the offering may still need to be registered with the state in which it's being sold**

An exclusion from the definition of an issuer agent exists when the individual effects what type of transactions?

Transactions in securities that are exempt, such as: − U.S. government and municipal securities − Canadian government or other specific foreign national government securities − Bank, trust company, and savings institution securities − Commercial paper that has an initial maturity of nine months or less, is issued in denominations of at least $50,000, and receives a rating in one of the three highest rating categories from a nationally recognized statistical rating organization (NRSRO) − Investment contracts for employees, such as savings plans, profit-sharing and pension plans, and stock purchase plans − Federal covered securities Transactions that are exempt (those that don't involve the public), such as: − Private placements − Sales to qualified purchasers − Transactions between an issuer and an underwriter − Transactions with a trust company or savings institution − An individual selling stock of his company to employees of the company in which no compensation is received in connection to the transactions (e.g., a clerk handling employee stock purchase plans) ** Be careful ... When an individual represents a broker-dealer in effecting securities transactions for compensation, that person must be registered as an agent, even if the security is exempt from registration **

Define & describe: Regulation A?

Under Regulation A, if an issuer offers a new issue of securities valued at $75 million or less sold over a 12-month period, the offering is exempt under the Act. However, it's not a complete exemption since the issuer must file an offering statement with the SEC and provide an offering circular to prospective purchasers. Advantages of conducting a Regulation A offering rather than a full registration include lower legal and filing fees and a shorter time needed to prepare documents.

Under Regulation D, an accredited investor is defined as...?

Under Regulation D, an accredited investor is defined as: 1. A financial institution (such as a bank), a large tax-exempt plan, or a private business development company 2. Any director, executive officer, or general partner of the issuer 3. An individual who meets either one of the following criteria: - A net worth of at least $1 million (excluding his primary residence), or - A gross income of at least $200,000 ($300,000 for a married couple) for each of the past two years, with the anticipation that this income level will continue

Since the following list is extensive, no student is expected to memorize all of the exemptions. Instead, the best approach is to focus on key terms or themes within the list. The transactions that are exempt from the registration requirements of the USA include...?

** From this list, try to focus on key words or phrases when attempting to identify whether an exemption applies. For exam purposes, remember the terms non-issuer, fiduciary, isolated, private, and unsolicited. Also, pay attention to phrases such as trades between issuer and underwriter, trades with institutional investors, directed to no more than 10 retail clients, or not involving the public.** 1. Any isolated (infrequent) non-issuer transaction, regardless of whether it's effected through a broker dealer. (This covers any secondary market transaction between parties that are not affiliated with the financial industry.) 2. Any non-issuer transaction by a registered agent of a broker-dealer provided the issuer is actually engaged in business. This means that the issuer may not be in the organizational stage, in bankruptcy, or in receivership. Also, it may not be a blank-check, a blind-pool, or a shell company whose primary purpose is to engage in mergers or acquisitions. a. The securities must be senior to the issuer's common stock. b. The securities must have been outstanding for at least three years and the issuer may not have defaulted on any of its obligations during this time. OR a. The securities have been in the hands of the public for at least 90 days AND b. The price is reasonably related to the securities' current market price AND c. The securities are not part of the underwriter's original allotment that it failed to sell AND d. Information about the issuer is publicly available either through documents filed with the SEC or through a nationally recognized securities manual designated by the Administrator AND e. The issuer's stock is traded on one of the exchanges, or the issuer is a unit investment trust registered under the Investment Company Act of 1940, or the issuer has been in business continuously for at least three years, or the issuer's total assets equal at least $2 million. 3. A non-issuer transaction in outstanding securities by a registered agent of a registered broker-dealer, provided that: a. The issuer is a reporting issuer in Canada together with its provinces and territories, or designated by rule or order of the Administrator, and has been subject to continuous reporting requirements in such foreign country for not less than 180 days before the transaction. b. The security is listed on the Toronto Stock Exchange, the TSX Venture Exchange, or designated by rule or order of the Administrator, or is a security of the same issuer, which is substantially equal to or senior in rank to such listed securities, or is a warrant or right to purchase or subscribe to any of the previously mentioned securities. 4. Any non-issuer transaction in a security of a company: a. That's subject to the registration and reporting requirements of the Securities Exchange Act of 1934, or b. Is registered under the Investment Company Act of 1940, or c. Has filed information with the Administrator that's substantially the same as that which is required for registered issuers by the Securities Exchange Act of 1934 for a period of at least 180 days prior to the transaction 5. Any non-issuer transaction effected through a registered broker-dealer on an unsolicited basis. The Administrator may require that the client acknowledge on a specified form that the order was unsolicited and that the broker-dealer maintains the form for a prescribed period. ** Remember: The language of the USA can be tricky. Soliciting the sale of unregistered, exempt securities is permitted because the securities are exempt. However, soliciting the sale of unregistered, non-exempt securities is prohibited.** 6. Any transaction between an issuer and an underwriter 7. Any transaction in a bond secured by a real estate mortgage or deed of trust, provided that the entire mortgage or deed of trust, together with the bonds, are offered and sold as a unit 8. Any transaction by a fiduciary such as an executor, administrator, sheriff, marshal, trustee in bankruptcy, guardian, or conservator 9. Any transaction by a bona fide pledgee if the sale is not for the purpose of evading the Uniform Securities Act 10. Any sale or offer to an institutional investor such as a bank, savings institution, trust company, insurance company, investment company, pension or profit-sharing trust, or to a broker-dealer 11. A private placement transaction, provided it's directed to no more than 10 retail (non-institutional) investors and the following conditions are met: a. The seller believes that all of the non-institutional buyers are purchasing for investment purposes only. b. No commissions or other remuneration is paid for soliciting any non-institutional buyer. c. Form D is filed with the SEC and the state Administrator. 12. Any sale of a preorganization certificate, provided that: a. No commission is paid for soliciting any buyer b. The number of subscribers doesn't exceed 10, and c. No payment is made by any subscriber 13. Any transaction involving existing security holders of the issuer, including persons holding convertible securities and warrants, if no commission or other remuneration is paid for soliciting buyers, or the issuer files a notice specifying the terms of the offer, and the Administrator doesn't disallow the exemption within five days 14. Any offer (but not a sale) of a security for which a registration statement has been filed under the Uniform Securities Act and the Securities Act of 1933, provided that no stop order is in effect. Sales may take place only after the registration is effective.

Regarding registering securities in a state, describe: Expiration Dates?

A security's registration expires one year after its effective date. In order to continue to offer or sell the security, it must be reregistered (which is unlikely) or sold through an exemption (which is what usually happens). Later in this chapter, a number of the exemptions from registration that are available under the USA will be examined.

Summary of Exemptions from State Registration

Pg: 39 in PDF or 31 in the book.

Describe the Maintenance Requirements of Broker-Dealers?

There are specific maintenance requirements for the different records created by broker-dealers. Depending on the type of record, the periods for record keeping include the lifetime of the firm, six years, and three years. Unless otherwise indicated by the Administrator, advertising, correspondence, confirmations, and trade tickets are examples of records that must be preserved for three years. However, for the first two years, each of these records must be kept in an easily accessible location.

For the following 3 tiers of assets under management, describe who the adviser must register with. - $110 million or more - $100 million up to $110 million - Less than $100 million Below $90 million?

- $110 million or more --> SEC Only - $100 million up to $110 million --> Either SEC or state - Less than $100 million --> State Only If a federal covered adviser's assets under management fall below $90 million, it's required to initiate state registration. **Remember ... Advisers to investment companies (mutual funds) must register with the SEC regardless of the amount of assets that they have under management (i.e., they're federal covered advisers)**

Not every person that provides securities-related advice as a business for some form of compensation is included in the IA definition. The USA specifically states that certain persons are excluded from the definition or are exempt from the registration requirements of the Act. According to the Uniform Securities Act, the following persons are excluded from the state investment adviser definition...?

- Investment adviser representatives (IARs) - Banks, savings institutions, and trust companies - Professionals whose investment advice is incidental to the practice of their professions (Remember the four letters L,A,T,E.) Lawyers Accountants Teachers Engineers - All other persons designated by the Administrator Remember, an investment adviser is defined as a person that gives securities-related advice as a regular part of its business and receives compensation for this service. The individuals who work for the adviser are considered investment adviser representatives. In the previous example, if Jim established a sole proprietorship investment advisory business, he'd be required to register it as an investment adviser and would also be required to register separately as an investment adviser representative. The following three additional exclusions from the investment adviser definition are available: - Broker-dealers and their agents - Publishers - Federal covered advisers

Firms must prepare an order ticket (order memorandum) for every order it accepts from their clients before the order is executed. Today, this is typically done electronically. All order tickets must contain which information?

- The terms and conditions of the order (e.g., limit order, market order, etc.) - Whether the order is solicited (and who recommended it) or unsolicited - The account name or designation (number) for which the order is entered - The identity of the registered representative (if any) responsible for the account - The identity of anyone else who accepted or entered the order for the client - Whether the order involved the exercise of discretionary authority - The identity of the broker-dealer or bank that received the order and the time of receipt - The time the order was entered - The time and price at which the order was executed, modified, or cancelled (to the extent possible) A supervisor does NOT need to approve every order ticket before it's entered. However, a supervisor must approve every new account before the first order for that account may be entered. A supervisor must also review all client orders after they're executed.

EXAMPLE: Rocksolid is a broker-dealer with its only office located in Wyoming, but it consistently engages in securities transactions with mutual fund managers in Colorado. If Rocksolid has not opened an office in Colorado and its only clients there are institutional investors, is it required to register as a broker-dealer in Colorado?

No. Under the Uniform Securities Act, Rocksolid is not considered a broker-dealer in Colorado because it has no place of business there and its clients are limited to institutional investors in Colorado.

Securities that qualify as exempt retain their exemption both when initially issued as well as in subsequent trading. Exempt securities include...?

1. Securities issued by the U.S. government and municipalities— including debt issued by government agencies as well as states, counties, or school districts 2. Securities issued by the Canadian government and municipalities—including debt issued by provinces or cities 3. Securities issued by other foreign governments—provided the U.S. maintains diplomatic relations with the foreign country and the securities being issued are recognized as a valid obligation of the issuer 4. Securities issued by banks, savings institutions, or trust companies 5. Securities issued by federal credit unions or industrial loan associations 6. Securities issued by insurance companies (This exemption doesn't apply to issuing variable annuities.) 7. Securities issued by common carriers (railroads) and public utility holding companies. Regulation of common carriers is performed by the Interstate Commerce Commission (ICC), while utility companies are regulated under the Public Utility Holding Company Act of 1935. 8. Securities issued by not-for-profit organizations. This includes religious, educational, fraternal, charitable, social, athletic, trade, and professional associations. 9. Any promissory notes, drafts, bills of exchange, or bankers' acceptances maturing in no more than nine months, issued in denominations of $50,000 or more, and rated in one of the three highest rating categories by a Nationally Recognized Statistical Rating Organization (NRSRO), such as S&P or Moody's. In other words, this exception covers commercial paper. 10. Any investment contracts issued in connection with an employee's stock purchase, savings, pension, and profit-sharing or similar benefit plan if the Administrator is notified in writing at least 30 days before the inception of the plan 11. Federal covered securities

Regarding the General Registration of Financial Professionals, describe: Consent to Service of Process and Substituted Consent to Service of Process?

A Consent to Service of Process is a document that irrevocably appoints the Administrator as a registered person's attorney for the service of legal papers. A registrant is required to file this document only as a part of the initial registration package. The consent then becomes a permanent document in the registrant's file and is not required to be resubmitted at the time of registration renewal. Filing the Consent to Service of Process is a convenience for customers who have complaints that they wish to pursue in court. Customers may serve notice directly on the Administrator, rather than the registrant personally. Substituted Consent to Service of Process The benefit of a Substituted Consent to Service of Process arises when a seller in one state directs an offer into a second state either in violation of the laws of the second state or fraudulently. Under a Substituted Consent, the purchaser may sue the seller in the purchaser's state and then bring an action on the judgment in the seller's state

Define & describe: Ponzi Scheme?

A Ponzi scheme is a pyramid scam where returns received by earlier investors are derived from the capital contributed by subsequent investors. As with a chain letter, the fraud typically causes a collapse and results in investors losing money. Due to the negative history of these types of programs, they're defined as securities and are regulated under the USA.

Regarding the General Registration of Financial Professionals, describe: Filing Fee?

A filing fee must be paid at the time of initial registration and annually at renewal. If an application is denied or withdrawn, the Administrator may retain all, or part, of the fee. Over the course of a year, if two or more firms combine to become one firm, the new firm (successor firm) is permitted to fill the unexpired portion of the registration term. Rather than paying a new filing fee, only the successor firm is required to file a new application. The successor firm doesn't actually need to be in existence at the time that the application is filed. Instead, it may still be in the process of being formed or incorporated

According to the Investment Adviser Act, are Solicitors and Promoters required to register as investment advisers?

A solicitor or promoter is a person who receives either cash (e.g., a fee) or non-cash (e.g., reduction in advisory fees) compensation for referring clients to an investment adviser, but is not directly affiliated with the adviser. For example, CPAs and attorneys may refer potential customers to specific advisers. Investment advisers can also hire marketing firms and social media influencers to act as promoters. According to the Investment Adviser Act, solicitors are generally not required to register as investment advisers. Solicitors and promoters must disclose to investors if they're paid more than $1,000 in a 12-month period as well as any material conflicts of interest. They typically do so through the use of a specific disclosure document or the adviser's brochure. According to the Uniform Securities Act, most states require solicitors to register as either investment advisers or investment adviser representatives. Under state law, advisers also need to document that their customers have received the appropriate disclosure documents and brochure from the promoter or solicitor.

Define & describe: The Antifraud Rule?

Although the Brochure Rule of the Investment Advisers Act of 1940 dictates the type of written disclosures that must be provided to clients, it generally doesn't require that specific verbal disclosures be made when discussing an adviser's services with a potential client. However, untrue or misleading verbal statements are prohibited. The antifraud section of the Act is somewhat vague since the SEC cannot define every action that constitutes a fraudulent practice. Although the SEC has created rules that specify certain practices as prohibited, it has taken action against advisers for practices that were not specifically prohibited but were considered to be fraudulent. Therefore, advisers must always consider whether the verbal representations they make to clients may be construed as fraudulent, deceptive, or manipulative.

Differentiate between the Brochure Delivery of State-Registered Investment Adviser and Federal Covered Adviser?

A state-registered investment adviser that's entering into a contract with a client must deliver its brochure: - Not less than 48 hours prior to entering into any advisory contract with the client, OR - At the time of entering into the contract, if the client has a right to terminate the contract without penalty within five business days after entering into the contract A federal covered adviser that's entering into a contract with a client must deliver its brochure: - Either before or at the time it enters into an investment advisory contract with a client Federal covered advisers are NOT required to provide a brochure to registered investment companies. Additionally, investment advisers (both state and federal) do NOT need to provide a brochure to clients whose contracts are only for impersonal advisory services for which they pay less than $500 per year. Impersonal advisory service refers to providing financial advice that's not tailored to a client's specific objectives or doesn't consist of statistical information with opinions as to the investment merits of specific securities. On an annual basis, an adviser must give all of its existing clients either an updated version of its brochure or a summary of any material changes that have been made to its old brochure. The delivery must take place within 120 days after the end of the adviser's fiscal year. Although a brochure may not be required, the fiduciary relationship between an adviser and its advisory client may still require the adviser to provide the client with any disclosures it considers necessary.

What are the 3 elements that define an investment adviser?

A-B-C Test: 1. Provides Advice about securities 2. As a regular part of its Business 3. Receives Compensation for these services

Regarding Investment Advisory Contracts, describe: Assignment and Involuntary Assignment of Contract?

Assignment is considered the direct or indirect transfer of an advisory contract by the adviser, or the transfer of a controlling block of the investment adviser's outstanding voting securities by a security holder of the advisory firm. Involuntary Assignment of Contract An investment adviser must obtain its clients' consent in order for their contracts to be assigned to another adviser. If an adviser is a corporation, the acquisition of a controlling block of the adviser's shares by another entity is considered a change of control that requires client consent. Also, if an adviser is organized as a partnership, the death or resignation of a majority of the partners is considered a change of control that requires client consent. Although the death or resignation of a minority of the partners doesn't constitute a change of control, the adviser is required to notify clients within a reasonable period.

Certain information about an advisory firm is required to be disclosed to clients and disclosure is accomplished by providing clients with specific documentation. The Administrator may require investment advisers to provide all information that would be in the public's best interest or useful for the protection of advisory clients. What are those Financial and Disciplinary Disclosures?

Advisers must disclose to their clients all material, legal, or disciplinary actions that have occurred within the preceding 10 years. Remember, any legal or disciplinary event that reflects negatively on an adviser's integrity must be disclosed. If an investment adviser experiences a financial condition that may reasonably impair its ability to meet client commitments, it must be disclosed to clients. This disclosure is specifically required when the adviser: - Has discretionary authority over client accounts - Has custody of client funds or securities - Requires prepayment of more than $500 in fees, six months or more in advance Failure to make the required disclosures is considered fraudulent. However, disclosure of SRO proceedings is required only if the fine levied against the adviser exceeds $2,500.

Describe the effect of Broker-Dealer Original Managers on Agent Registration?

All original partners, officers, and directors of a broker-dealer who are involved in effecting securities transactions are automatically registered as agents when the broker-dealer initially registers with the state.

Define & describe: Form ADV Part 2A - The Brochure Rule?

All registered investment advisers are required to provide clients with a disclosure document (brochure) to describe their overall business as well as actual or potential conflicts of interest. Since Part 2 already requires advisers to satisfy a list of disclosures as a part of the registration process, firms may use either Form ADV Part 2A or produce a brochure with substantially equivalent information. The firm brochure must include the following information: - The adviser's name, address, website, and the date of the brochure - A statement that registration doesn't imply a certain level of skill or expertise - A description of the advisory firm, the length of time the firm has been in business, its principal owners, types of services offered, amount of assets under management (both discretionary and nondiscretionary), and the method used to compute the amount of these assets - Fees and compensation, types of clients, methods of analysis used and investment strategies employed, and the fact that capital is at risk - Disciplinary information, such as criminal or civil actions in a domestic, foreign, or military court, involving the firm or its management personnel that resulted in a conviction, or plea of guilty or nolo contendere (no contest), or any proceeding involving the SEC, state, SRO, or foreign financial regulatory authority - The adviser's code of ethics - Soft-dollar arrangements - Whether the firm has been subject to bankruptcy during the last 10 years - Financial information: an adviser must disclose all financial conditions that may reasonably impair its ability to meet its contractual commitments to clients. ** You should know ... Advisers with different types of clients may create and file different brochures that are tailored to each specific client **

When is an audited balance sheet (financial information) required?

An audited balance sheet (financial information) is required if an adviser: 1. Has full discretionary authority over a client's account 2. Solicits prepayment of advisory fees - For federal-registered advisers: more than $1,200 in fees per client, six months or more in advance - For state-registered advisers: more than $500 in fees per client, six months or more in advance

Are Broker-Dealers and their Agents excluded from the Definition of a State Investment Adviser?

An exclusion is available to a broker-dealer and its agents (registered representatives) as long as the investment advice being provided is within the scope of the broker-dealer's business and there's no special compensation for the advice. Brokerage commissions don't constitute special compensation unless a clearly definable portion is for investment advice. Agents are also entitled to the exclusion if they provide advice under the knowledge and control of their broker-dealer. The one exception is when broker-dealers sponsor wrap accounts. A wrap account typically charges clients a single fee for investment advice, execution of transactions, asset allocation, and administrative services. Brokerage firms that offer wrap accounts must register as investment advisers and must treat these clients as advisory clients. In practice, most of the broker-dealers that offer wrap accounts do so through affiliates or subsidiaries that are registered investment advisers.

Are Publishers excluded from the Definition of a State Investment Adviser?

An exemption is available for publishers of bona fide newspapers, news magazines, or other financial publications provided they have general and regular circulation. To be considered general, the publication may not contain promotional material and the advice given must be impersonal. Impersonal advice is neither tailored to the specific investment needs of a particular client nor timed to specific events affecting the securities industry. Although some newsletters offer impersonal investment advice, if the publications are not of general circulation, the newsletter publishers may be required to register as investment advisers.

Describe Investment Adviser Discretionary Authority and Oral Discretion?

An investment adviser may retain the discretionary authority to manage an account, but avoid being considered to have custody of a client's funds or securities by having the assets held by a broker-dealer. However, according to the NASAA Model Rule on Custody Requirements for Investment Advisers, an adviser that has been granted full discretion is considered to have custody of the client's assets. - Limited discretion: Allows an adviser to enter orders to buy or sell securities, but not to remove money or securities from the account. - Full discretion: Gives an adviser all of the abilities acquired through limited discretion, with the addition of check-writing privileges and authority to remove other assets from the account. Oral Discretion Typically, discretion may be exercised only after receiving written authorization from the client. However, a client's oral discretion is enough to allow an investment adviser to buy or sell securities on the client's behalf without written authorization. This oral discretion provision is only available to investment advisers and only effective for a period of 10 business days after the discretion is granted. By the end of the 10-day period, the adviser must obtain the client's written authorization to continue operating in a discretionary capacity. ** Be careful ... The oral discretion provision doesn't apply to broker-dealers and their agents. To exercise discretion, broker-dealers and their agents must obtain a client's written authorization**

As a refresher, define an: Investment Adviser Representative (IAR)?

An investment adviser representative is a non-clerical employee of an investment adviser who manages accounts, provides advice to clients, solicits advisory services, or supervises the employees who perform these functions. IARs work for IAs; they're not the firm. Investment adviser representatives are not regulated by the SEC at the federal level; instead, they're regulated by state Administrators at the state level. The Series 63 Examination expects candidates to be able to distinguish the investment adviser (the firm) from the investment adviser representative (the employee). The relationship is parallel to that of a broker-dealer (the firm) and an agent (the employee) who represents the firm in effecting securities transactions.

Describe the General Registration of Investment Advisers?

Any person that meets the investment adviser definition is required to register with either the SEC or one or more states. For advisers, this is accomplished by filing a two-part application—Form ADV—with the appropriate regulator. An adviser files Form ADV electronically through the Investment Adviser Registration Depository (IARD) system. Remember, the IARD system is similar to FINRA's Central Registration Depository (CRD) system and was created to make the filing of documents faster and more convenient. If there are technical difficulties with the IARD system that prevent electronic filing or if the system will not accept the form, an adviser may file Form ADV manually. When filing electronically, the typed name of the adviser's authorized officer is considered irrefutable evidence that the appropriate person has signed the application.

Are Federal Covered Advisers excluded from the Definition of a State Investment Adviser?

As has already been mentioned, federal covered advisers are advisers that are required to register with the SEC and are regulated under the Investment Advisers Act of 1940. Although federal covered advisers will be covered in greater detail shortly, for now it's important to understand the relationship between the state Administrator and federal covered advisers. State Requirements for Federal Covered Advisers While federal covered advisers (FCAs) are required only to register with the SEC, states may require them to complete the process of notice filing. There are two situations in which an adviser is required to perform notice filing: (1) when a federal covered adviser has a place of business in a state, and (2) when an adviser has no place of business in the state, but has six or more noninstitutional clients who reside in a state. The notice filing requirement for federal covered advisers is similar to the process that issuers of federal covered securities must follow. Notice filing is not a method of registration; instead, it represents an Administrator's ability to require the FCA to pay a fee and to file the same documents that have been filed with the SEC. Since the state Administrator doesn't have the power to grant registered status to federal covered advisers, the Administrator is not permitted to revoke the federal covered adviser's registration. However, the Administrator may issue a stop order preventing a federal covered adviser from conducting business in the state due to the adviser's violations of state securities laws.

Series 63 exam requires an understanding of the differences between state-registered investment advisers and federal-registered investment advisers. Describe the State Registration of Investment Advisers?

As previously defined, an investment adviser (IA) is any person (usually a firm, rather than an individual) that, for compensation, engages in the business of advising others as to the value of securities or the advisability of purchasing or selling securities. The advice may be given directly or through publications or correspondence. To meet the definition of an investment adviser, a person must satisfy all three parts of the A-B-C test by: 1. Providing Advice about securities 2. Offering this service as a regular part of doing Business 3. Receiving Compensation for these services An adviser that's ineligible for federal registration must be registered at the state level. This includes advisers that have less than $100 million in assets under management (AUM). Unless an adviser is exempt from registration or excluded from the investment adviser definition, it may not conduct business in a state unless it's registered under the Uniform Securities Act.

Define & describe: Federal Covered Advisers (FCAs)? FCAs include the following...?

As previously described, any person that meets the investment adviser definition is generally required to register with either the SEC or one or more states. However, federal covered advisers are required to register only with the SEC at the federal level. FCAs include the following: - Investment advisers with $110 million or more in assets under management (IAs with assets under management between $100 million and $110 million may choose to register with either the SEC or one or more states.) - Advisers to registered investment companies (e.g., mutual funds) - Advisers that do business in 15 or more states - Advisers that are not regulated or required to be regulated as investment advisers in the state in which they have their principal office and place of business (With the exception of Wyoming, all states, the District of Columbia, and Puerto Rico require the registration of state investment advisers. Wyoming has no IA registration provisions. Therefore, advisers with offices in Wyoming are regulated by the SEC.) - Pension consultants that provide advice to employee benefit plans with assets of at least $200 million - Affiliates of federal-registered IAs, if their principal office and place of business is the same as that of the SEC-registered adviser - Newly formed advisers that reasonably believe that they will become eligible for federal registration within 120 days of formation Generally, if an adviser doesn't qualify as a federal covered adviser, it must be registered at the state level. If an adviser withdraws its registration, it has the right to initiate the registration process again. Any persons defined as investment advisers, even if they qualify for an exemption from registration, are subject to the antifraud provisions of the Investment Advisers Act. **Remember ... Advisers to investment companies (mutual funds) must register with the SEC regardless of the amount of assets that they have under management (i.e., they're federal covered advisers)**

Define & describe: Form ADV Part 2?

As with Part 1, Form ADV Part 2 must be filed with either the state(s) or the SEC through the IARD system. Part 2 consists of a series of items that contain disclosure requirements for an investment adviser's brochure as well as other required supplements. Responses to these items must be in a specific order and written in a narrative, plain English format that takes into consideration the client's level of sophistication. Plain English is generally understood to mean language that facilitates effective communication in a narrative form that avoids legal and highly technical terms as well as the use of multiple negatives.

Exceptions to the Prohibition of Performance Fees?

Congress placed a general prohibition on performance fees in the Advisers Act to prevent unsophisticated advisory customers from being subject to arrangements in which the adviser has everything to gain if successful and little, if anything, to lose if unsuccessful. However, several exceptions have been established for sophisticated investors that understand that the investment adviser may be compensated on unrealized gains and may have an incentive to make speculative investments. The types of clients that may be charged a performance-based fee include: - Registered investment companies (e.g., mutual funds) - Qualified clients that have at least $1.1 million under management with the adviser or have more than $2.2 million in net worth (A person's primary residence is excluded.) - Clients who are not U.S. residents - Knowledgeable individuals associated with the investment adviser, such as an executive officer, director, trustee, general partner, or non-clerical employee who has participated in the investment activities of the adviser for at least 12 months

To open a margin account, a client must sign a margin agreement which attests to the fact that he agrees to follow the regulations of the FRB, FINRA, and the brokerage firm. The margin agreement usually contains three separate agreements—the credit agreement, the hypothecation agreement, and the loan consent agreement. Describe these three agreements!

Credit Agreement By signing the credit agreement, a customer acknowledges that she's borrowing funds from the firm and is responsible for payment of interest and repayment of the loan amount. The agreement discloses the terms under which the client is borrowing the money. This is a required document that a customer must sign to open a margin account. Hypothecation Agreement The hypothecation agreement states that the customer hypothecates (pledges) the securities to the brokerage firm and gives the firm the right to rehypothecate (repledge) the securities to secure a loan at a bank. This is a required document that a customer must sign to open a margin account. Loan Consent Agreement The loan consent agreement gives the firm the right to lend the customer's securities. Broker-dealers typically lend these securities to clients who are seeking to borrow stock for short selling purposes. This is an optional document; a customer is not required to sign it to open a margin account.

When is an Investment Adviser considered to have Custody?

Custody is defined as having legal responsibility for, or control over, another person's assets. The USA states that an adviser is considered to have custody when it's in possession of client funds or securities. An adviser will also be considered to have custody when it has: - Legal ownership or access to its client's funds or securities within a partnership, corporation, or investment pool - Full discretionary authority over a client's account - Inadvertently received a client's funds or securities and has not returned them to the client within three business days - Accepted a third-party check from a client and has not forwarded it to the third party within three business days NASAA's Custody of Client Funds or Securities by Investment Advisers Model Rule establishes additional guidelines that advisers must follow when they're considered to have custody of client funds or securities. The model rule requires investment advisers to notify the Administrator whether they have or will have possession of client funds or securities. Ultimately, the Administrator has the power to allow or disallow any adviser from maintaining custody.

Regarding the laws governing state and federal registration and the person responsible for enforcing these requirements, describe: The Investment Advisers Act of 1940 (IA '40 Act)?

This federal law governs investment advisers that must register with the SEC. Many of its concepts have been incorporated in the USA and in the model rules that NASAA has adopted regarding investment advisers. While the provisions of the Uniform Securities Act will be a significant exam focus, the Series 63 Examination will also test a candidate's knowledge of the Investment Advisers Act of 1940. Paying close attention to this concept is important since the exam may require a person to be able to recognize state versus federal laws as they apply to investment advisers.

Describe: Real Estate Condominium?

This instrument was added to the list of securities to cover investment opportunities in which the purchaser of a condominium allows his property to be included in a rental pool that's managed by a third party. For example, the condominium may be part of a complex near a ski lodge and the buyer purchases the property for investment purposes, rather than for occupancy. In this situation, offering this type of condominium investment could be viewed as the offer of a security.

EXAMPLE: Theodore Investment Advisers (TIA)= A federal covered adviser headquartered in California. Dave: IAR who works out of the California office. All of his clients are Hollywood celebrities or professional athletes. Simone: IAR with an office in Nevada. She has 25 clients who live and own ski lodges in Colorado and has 10 clients who are barley famers in Wyoming. Alvin: IAR who lives in Arizona and splits time between TIA's Arizona and New Mexico offices. He has clients in both states as well as two mutual fund clients in Texas. He also has 14 high-networth clients in Montana.

Dave—Since Dave is an IAR and works out of the California office, he's required to register in California. Simone—Since Simone is an IAR and works out of the Nevada office, she's required to register in Nevada. The fact that Simone also has 25 clients who are business owners in Colorado and 10 clients who are farmers in Wyoming doesn't create a registration issue. As long as Simone doesn't have a place of business in either state, she's not required to register in Colorado or Wyoming. Alvin—Since Alvin is an IAR who works out of the Arizona and New Mexico offices (has a place of business in both states), he's required to register in both states. Although Alvin also has two institutional clients in Texas and 14 high-net-worth clients in Montana, he's not required to register in either state since he has no office in Texas or Montana. Theodore Investment Advisers—TIA is a federal covered adviser and is, therefore, not required to register at the state level. However, notice filing is required in any state in which TIA and its investment adviser representatives have an

Every registered investment adviser must renew its registration with either the SEC or the state Administrator(s). When should those updates or amendments happen?

Every registered investment adviser must renew its registration with either the SEC or the state Administrator(s). Advisers that are registered with the SEC must renew their registration within 90 days of their fiscal year-end. However, advisers that are registered under the Uniform Securities Act must renew their registration within 90 days of the calendar year-end (i.e., December 31). In addition, advisers must update their brochure at least once per year by filing an annual updating amendment. This amendment must be filed with at the time of the investment adviser's registration renewal. The main items that are required to be updated are the investment adviser's assets under management, the number of accounts, investment adviser representatives, other employees, and clients. If material information in an adviser's brochure becomes inaccurate, the adviser must update its brochure promptly (i.e., within 30 days), rather than waiting until the end of its fiscal year. A change in the adviser's name or location, changes to custody disclosures, changes due to successions and ownership arrangements, and the occurrence of reportable disciplinary or financial issues are all considered of material importance. In lieu of filing a new application, a successor adviser may simply file an amendment to Form ADV, provided the changes are limited to: - The form of organization - The state of incorporation or partnership

Describe Broker-Dealer Financial Reports and Special Examinations?

Financial Reports Certain financial reports must be filed with the Administrator. The filing requirement for these reports could be quarterly, annually, or as frequent as determined by rule or order. Special Examination All required records of a broker-dealer, whether located within or outside the state, are subject to periodic or special examination as determined by the Administrator. The Administrator will cooperate with the Administrators of other states and the SEC, as well as national securities exchanges and associations, to avoid the duplicate inspection of records.

Define & describe: Form ADV Part 1?

Form ADV Part 1 includes information about an adviser's business, ownership, clients, employees, business practices, affiliations, and any disciplinary events of the adviser or its employees. In addition, specific information of interest to regulators includes: - The investment adviser's name, number of employees, and form of organization - The name, address, disciplinary history, and business affiliations for the past 10 years of each partner, officer, director, or any person performing an advisory activity - The education and business background of certain employees of the investment adviser (The IA Act of 1940 sets no minimum qualifications that must be met for registration. However, some advisory firms will set their own standards regarding the education and background of any employee who advises clients.) - How the investment adviser will maintain custody of client assets - Whether the investment adviser or any person associated with the firm is subject to any disqualification that would be a basis for denial, suspension, or revocation of registration as an investment adviser - The number and size of discretionary and non-discretionary accounts - A statement as to whether the adviser's principal business will consist of investment supervisory services. Investment supervisory service is defined as the giving of continuous advice regarding the investment of funds on the basis of the specific needs of each client. Although the information found in Part 1 of Form ADV is generally not required to be disclosed to the public, the SEC makes the information available through the Investment Adviser Public Disclosure (IAPD) website.

Questions concerning the relationship between IAs and customers should be analyzed carefully since the USA has created requirements for IAs that maintain custody. If an adviser has custody, it must...?

If an adviser has custody, it must: 1. Provide immediate written notification to the Administrator using Form ADV 2. Use a qualified custodian to hold the funds and securities in a separate account (Qualified custodians include an FDIC-insured bank or savings association or a registered broker-dealer that holds client assets in customer accounts.) 3. Provide written notification to all clients of the custodian's name, address, and the manner in which the funds will be maintained 4. Send quarterly account statements to clients that indicate the amount of funds, a list of each security held in custody, a record of all transactions, and any fees deducted by the adviser: * If the account statements are sent by a qualified custodian rather than the adviser, the adviser must have a reasonable basis for believing that the statements have been provided. * If the account statements are sent by an investment adviser: - The IA must have an independent CPA verify and audit the accounts each year. - The auditor's findings are reported through the IARD on Form ADV-E within 120 days of completion of the audit. - If the auditor discovers material discrepancies, the Administrator must be notified within one business day. Most IAs avoid being considered to have custody of their clients' funds and securities by having the assets held by a brokerage firm. However, if an adviser does maintain custody, the firm will be subject to additional scrutiny.

Describe Investment Adviser Minimum Financial Requirements?

In order to identify whether an investment adviser is operating within the rules, it must furnish financial reports as required by the Administrator. If an investment adviser's net worth drops below the minimum level established by the Administrator, the adviser must notify the Administrator about the deficiency by the end of the next business day. After transmitting the notice, the adviser must file a report of its financial condition by the end of the following business day. (Note that net worth equals the adviser's assets minus its liabilities.) NASAA's Model Rule is not binding. Therefore, each state is free to set its own minimum financial requirements for advisers. However, an adviser is required to satisfy only the minimum financial requirement of the state in which its principal office is located. **Remember... If advisers are in compliance with the minimum financial requirement ($35,000 for advisers with custody and $10,000 for advisers with discretion), the Administrator may waive the obligation to post a surety bond**

An investment adviser may not employ an investment adviser representative unless the representative is properly registered. A representative's registration is effective only during the time the individual is employed by a registered investment adviser. When the representative's association with an investment adviser begins or ends, the Administrator must be notified by the investment adviser. What must an investment adviser representative do in order to register with a state? Investment adviser representatives of state-registered investment advisers are exempt from registration in any state in which they...?

In order to register with a state, an investment adviser representative must: - File an application - File a Consent to Service of Process - Pay a filing fee An IAR will be required to complete Form U4, which is filed by the investment adviser through the CRD system (which links to IARD). At the time of separation or termination of an IA representative's employment, the advisory firm will file Form U5 to notify the state Administrator of the end of the association. IAR applicants may also be required to pass an oral or written examination. However, simply passing an examination is not sufficient for registration. Applicants may not transact business in a state until all required items are filed and registration is granted by the Administrator. If the Administrator considers it appropriate, the examination may be waived for certain categories of persons. Investment adviser representatives of state-registered investment advisers are exempt from registration in any state in which they: - Have no place of business, and - Don't direct solicitations to more than five non-institutional clients who are residents of the state within 12 consecutive months This exemption applies regardless of whether the IAR or any person to whom the solicitation is directed is present in the state. ** A repeated exemption ... The previous exemption is referred to as the de minimis exemption. Both IAs and IARs are afforded the same exemption**

On a very basic level, what's the difference between state-registered advisers and federally-registered advisers?

Larger advisers and those that advise mutual funds register with the SEC as federal covered advisers. Smaller advisers must register with at least one state.

Describe characteristics of: Margin Accounts?

Margin Accounts allows a client to pay only a portion of the purchase price of the securities he purchases. The customer borrows the balance from the brokerage firm and the firm charges the client interest for the loan. The portion of a margin trade that a customer has paid for is referred to as his equity and represents the customer's ownership interest in the position. Margin accounts are governed by the Federal Reserve Board's (FRB's) Regulation T requirements and FINRA rules. Under Regulation T, customers who buy securities on margin must deposit 50% of the initial purchase price; however, brokerage firms may have more stringent internal (house) rules. Since Regulation T is 50%, a customer's gains or losses will be doubled. The easiest way to determine this is by remembering that a margin investor is able to buy securities worth two-times his invested amount. If the securities rise in value, he experiences two-times the gain; however, if the securities fall in value, he experiences two-times the loss.

Regarding the laws governing state and federal registration and the person responsible for enforcing these requirements, describe: North American Securities Administrators Association (NASAA)?

NASAA is responsible for updating the Uniform Securities Act as well as maintaining the content of the Series 63 Examination. Organized in 1919, NASAA is the oldest international organization devoted to investor protection. NASAA's current membership is comprised of 67 state, provincial, and territorial securities Administrators. These Administrators come from the 50 U.S. states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico. Additionally, NASAA has released a number of Model Rules and Statements of Policy that serve to clarify various provisions of the USA. The Series 63 Examination will test your knowledge of certain NASAA rules covering the activities of broker-dealers, agents, investment advisers, and investment adviser representatives. As with the USA, these Model Rules and Statements of Policy are not the actual law of any one state, although many states have chosen to adopt at least some of them.

EXAMPLE: The treasurer's office of the city of Metropolis frequently issues municipal notes directly to large institutional investors. Mona, a Metropolis government employee, arranges these transactions. Is Mona considered an agent and required to register?

No. Although Mona is representing the issuer (Metropolis) in effecting transactions in securities, she's not considered an agent because of the nature of the securities she's selling (municipal notes). What if Metropolis sold its municipal notes to investors through Greg, an agent of Rocksolid Brokerage? Greg would not qualify for an exception since he's an agent of a broker-dealer, not the issuer.

EXAMPLE: Sally is very excited about a new investment opportunity that Jim has just proposed and mentions it to her broker Kevin, who retired to Florida many years ago. If Kevin is interested, is Jim able to contact him?

No. Jim may not contact Kevin since is not an existing client.

EXAMPLE: A firm is registered as an investment adviser in North Dakota and has no office in Montana. Most of the adviser's clients are in North Dakota. However, due to job relocations, four non-institutional clients now live in Montana. Is the firm required to register as an investment adviser in Montana?

No. Under the USA, since the adviser has no place of business in Montana and directs communications to no more than five non-institutional clients, it's exempt from registration in Montana.

EXAMPLE: Jim is an accountant who charges clients $125 per year to complete and file their tax returns. Occasionally, Jim suggests to his clients that they make use of their employer-sponsored retirement plans and recommends certain mutual fund families. Does Jim meet the IA definition?

No. Since Jim's advice is incidental to his accounting profession and he doesn't receive specific compensation for giving that advice, he's excluded from the definition of an investment adviser.

EXAMPLE: An investment adviser is headquartered in Oklahoma, which has a minimum financial requirement of $35,000. The adviser is in the process of opening a new office in Texas, which has a minimum financial requirement of $50,000. To open the Texas office, will the adviser be required to satisfy the $50,000 Texas requirement?

No. Since the adviser is headquartered in Oklahoma, it's required to satisfy only the $35,000 minimum financial requirement for Oklahoma. The adviser is not required to satisfy the $50,000 requirement that's set by the state of Texas.

EXAMPLE: A broker-dealer and its agents regularly recommend securities through their research reports that are distributed to clients. If and when a client's trade is executed, the firm collects a commission for the service provided. Is the broker-dealer considered an investment adviser?

No. The broker-dealer is not considered an investment adviser since it's not receiving a fee for providing advice. Distributing research reports to customers is an incidental practice for a broker-dealer. The commission received is for executing transactions, not for advice.

Describe characteristics of: Option Accounts?

Option trading involves a high degree of risk and is not suitable for all clients. A customer's account must be approved by an ROP for option trading before the firm can accept an order from a customer to buy or sell options. All broker-dealers must have written supervisory procedures for overseeing and approving option accounts. A Registered Options Principal (ROP) (normally an officer or general partner) is responsible for implementing these procedures. Options Agreement An agent must gather financial and background information to see whether the customer has the ability to understand the nature of options trading and to assume the risk. Generally, the registered representative obtains this information by completing the Options Account Agreement on the client's behalf. If the client is not present when the representative fills out the Options Account Agreement, the broker-dealer must send the Agreement to the client for her to verify the information and sign it. If the customer refuses to provide information, a note to this effect must be made on the agreement. The customer must sign and return the agreement to the brokerage firm within 15 days of the time the ROP approves the account. By signing this document, the customer verifies that the financial information provided is correct and agrees to abide by the rules of the Options Clearing Corporation, the option exchanges, and the broker-dealer. The customer also agrees not to violate any exercise or position limits. If a signed form is not returned within the 15-day period, the customer may not open new option positions. Instead, only liquidating (closing) transactions would be permitted. The client must be given a disclosure document (the Options Disclosure Document, or ODD) by no later than the time the account is approved for options trading.

Regarding Investment Advisory, describe: Performance-Based Fees?

Performance-based fees are those that are based on a share of the capital gains or capital appreciation in a client's account. Fulcrum Fee One type of performance-based fee is referred to as a fulcrum fee. This is a fee that has two parts—a base fee plus a performance-based fee that increases or decreases relative to the performance of the client's portfolio as compared to a specific benchmark over a specific period (e.g., compared to the S&P 500 Index for the calendar quarter). The benchmark index must be comprised of securities with similar risks and objectives as those in the client's portfolio.

Regarding exempt securities, describe: Securities Sold to Qualified Purchasers?

Qualified purchasers, as defined under the Investment Company Act of 1940, are persons who own at least $5 million in investments. These sophisticated investors are deemed to be capable of evaluating investments and protecting themselves in a manner that renders regulation by state authorities unnecessary.

The federal requirements regarding advisers that maintain custody are very similar to the state requirements that were covered earlier in this chapter. Again, an investment adviser has custody of client funds and securities when it possesses the assets or has the ability to appropriate them. The Advisers Act requires investment advisers with custody to...?

The Advisers Act requires investment advisers with custody to: 1. Deposit the funds of each client in a separate account with a qualified custodian. The accounts must be maintained either in the client's name or in the name of the adviser as agent or trustee. Records must be kept for each account showing where it's maintained, all deposits and withdrawals, and the amount of each client's ownership in the account. 2. Provide each client with written notification of the place and manner in which the funds and securities will be maintained. Clients must also be notified of subsequent changes. 3. Send to each client, at least quarterly, an itemized statement of all the funds, securities, and transactions effected in the account, and any free credit balances. 4. Arrange an unannounced annual examination by an independent public accountant to verify the amount of funds and securities. The accountant must file Form ADV-E with the SEC promptly following the examination (within 120 days). If required, the accountant must also file this form with the state regulators.

Under the USA, there are two situations in which a person that meets the definition of an investment adviser is considered exempt from state registration. What are the Two Exemptions from State Registration?

The first exemption is a situation in which: - The adviser has no place of business in the state and the adviser's only clients are institutional investors. ** Remember ... Institutional investors include investment companies, other investment advisers, broker-dealers, banks, trust companies, savings and loan associations, insurance companies, employee benefits plans with at least $1,000,000 of assets, or government entities** The second exemption from registration is based on the following situation: - The adviser has no place of business in the state, and the adviser doesn't direct communications to more than five non-institutional clients in the state within 12 consecutive months. (This is referred to as the de minimis exemption for investment advisers.) ** Always remember ... There's no de minimis exemption for broker-dealers. If a broker-dealer has no office in a state, but intends to do business with non-institutional (retail) clients in that state, it must be registered there regardless of the number of clients**

EXAMPLE: Fletcher is in the airport and about to leave on an extended vacation with his family, but cannot stop thinking about the current state of the market and his investments. Before boarding, Fletcher calls Julie, his investment adviser representative, and tells her that she has his permission to take care of things in his account while he's gone. Although Fletcher has not signed a power of attorney, may Julie execute trades for Fletcher?

Yes. This example illustrates the oral discretion provision that's permitted for investment advisers and their representatives. Julie has discretionary authority over Fletcher's account for 10 business days. In order to retain discretionary control after the 10 days, Fletcher must provide a signed power of attorney.

Regarding registering securities in a state, describe: Amendments?

The issuer may amend its registration statement after the effective date to increase the number of shares being sold. If the issuer does amend the statement, it's not required to file a new registration statement as long as the issuer's public offering price, underwriters' discount (spread), and commission schedule are not being changed. If information in the registration statement becomes outdated or turns out to be inaccurate or incomplete, a correcting amendment must be filed with the Administrator. The effective date of the registration will then depend on the date of the amendment, not the date of the original filing.

Define & describe: Investment Advisory Contracts?

The relationship between a customer and an investment adviser typically is formalized through a contract. State law requires that contracts between clients and state-registered advisers be in writing. Although federal law doesn't require investment advisory contracts to be in written form, most federal registered advisers put contracts in writing as a matter of good business practice. In addition, SEC rules place the following conditions on all investment advisory contracts: - Advisers may not include provisions in contracts that claim to waive compliance with the Advisers Act or any of its rules. Therefore, contract language may not lead clients to believe they have waived any available right to take legal action against the adviser (i.e., through exculpatory contract provisions). This also means that advisory contracts may not contain hedge clauses that absolve the adviser from liability or mandatory arbitration provisions. (A client may be asked to voluntarily sign a predispute arbitration agreement at the time of account opening.) - An adviser may not assign its clients' contracts without their consent. - Performance-based fees generally are not permitted; however, exceptions may be made for certain types of clients.

Define & describe: Form ADV Part 2B—Brochure Supplement?

The same clients who receive the firm's brochure must also be provided with a brochure supplement. The supplement is similar to a resumé that describes the education, qualifications, and disciplinary history of all supervised persons who directly interact with clients or who have discretionary authority over client accounts. The brochure supplement must also disclose whether any of these people have other business activities or receive fees or compensation for selling financial products. Advisers must deliver the brochure supplement to their clients either prior to or at the time the person described in the supplement begins advising the clients. If an adviser experiences a material change, such as a disciplinary event involving one of its employees who manages accounts, the adviser must send the client an updated brochure supplement. If the material normally contained in the supplement is already covered in the firm's brochure, there's no need to provide a separate document. The firm is also not required to provide a brochure supplement to qualified clients (officers or directors of the adviser, or other non-clerical affiliated employees). Advisers that are registering in one or more states must file a copy of the brochure supplement through the IARD system for each supervised person doing business in the state. However, advisers that are registering with the SEC are not required to file their brochure supplements. Instead, they must retain copies for their own records. If requested by a regulator, an adviser must be able to produce the brochure supplement. **Something to consider ... Investment adviser representatives should never verbally diminish the importance of the brochure or alter its content. Any such action is considered a misleading business practice and is prohibited**

Describe Performance Fees for State-Registered Advisers?

The state and federal laws concerning performance-fees are the same. While the USA prohibits performance fees, NASAA's Model Rule (Performance-Based Compensation Exemption for Investment Advisers) allows these fees for qualified clients.

An investment adviser's registration remains in effect unless it has been withdrawn, cancelled, or revoked by the SEC. The SEC also has the authority to suspend an investment adviser's registration for up to 12 months. These actions may be taken if the investment adviser or any person associated with the adviser has...?

These actions may be taken if the investment adviser or any person associated with the adviser has: - Willfully made or caused any required report or application filed with the Commission to be false or misleading with regard to any material fact, or has omitted any material fact - Been convicted within the previous 10 years of a misdemeanor involving securities, misappropriation of funds, or a felony - Been permanently or temporarily prohibited by court order from acting as an investment adviser, underwriter, broker, dealer, or as an affiliated person of an investment company, bank, or insurance company - Willfully violated or is unable to comply with any provision of federal securities law - Willfully aided another person's violation of federal securities law or has failed to reasonably supervise a person who commits a violation - Been subject to an order of the Commission barring or suspending the person from being associated with an investment adviser

Broker-dealers must send confirmations to customers for each transaction that they execute on the client's behalf. How do clients receive these confirmations, by when do they need to receive them, and what information must be on them?

These documents (which may be delivered electronically) must be sent by no later than the date on which the transaction settles. Among other things, the confirmation must disclose whether the broker-dealer acted as a broker (agent) or as a dealer (principal), as well as the commission or markup charged. The confirmation for a bond transaction does NOT need to include the bond's rating.

State-registered investment advisers must produce and keep records as required by the Administrator. These include...?

These include account records, order tickets, original copies of correspondence, and signed copies of client contracts (particularly those concerning discretionary accounts). They must also keep copies of all advertising that's sent to two or more persons. Unless otherwise directed by the Administrator, all required records must be preserved for a period of five years in an easily accessible location. However, for the first two years (of the five), the records must be kept in the principal office of the investment adviser. All required records of a registered investment adviser, whether located within or outside the state, are subject to periodic or special examination by the Administrator. The Administrator may cooperate with the Administrators of other states and the SEC in order to avoid duplicate records inspections.

EXAMPLE: Sally is a non-producing branch manager who has no clients, but is responsible for supervising a group of salespeople who actively solicit clients for the financial services firm. Does Sally meet the IAR definition?

Yes. Although Sally doesn't have clients, she supervises employees who are performing the functions of IA representatives. Therefore, she must also become registered as an IA representative.

EXAMPLE: An investment adviser is registered in North Dakota and provides advice to numerous institutional clients in Montana, but doesn't have a place of business in that state. Is the firm exempt from registering as an investment adviser in Montana?

Yes. As long as the advisory firm has no place of business in Montana, it may continue advising its institutional clients. However, if the firm opens an office in Montana to serve its clients better, it's no longer exempt from registering as an investment adviser in Montana—even if it continues to serve only institutional clients.

Describe Registration Requirements for IARs of Federal Covered Advisers?

While investment advisers may be required to register at either the state or federal level, investment adviser representatives are required only to be registered at the state level. Therefore, all IARs, whether they work for state-regulated or federal-covered investment advisers, must be registered in at least one state. An IAR of a federal covered adviser is required to register in any state in which she maintains an office. The number of clients that an IAR has in a state is not the determinant of whether registration is required there. Instead, registration is based on the state in which her office(s) is located. Remember, federal covered advisers (the firms) are not registered in a state; instead, they're required to register only with the SEC. When an IAR's association with a federal covered adviser begins or ends, the Administrator must be notified by the IAR.