1-2. Regulatory and Ethical Considerations

Question 1

1. The Investment Advisers Act of 1940 applies to persons who sell securities.

Answer 1

False

1. The Investment Advisers Act of 1940 applies to persons who sell securities.

Rationale: The Investment Advisers Act of 1940 applies to persons who give investment advice. Persons who sell securities must register with the NASD.

Question 2

2. NASD Notices to Members 94–44 and 96–33 are applicable to insider trading.

Answer 2

False

2. NASD Notices to Members 94–44 and 96–33 are applicable to insider trading.

Rationale: NASD Notices to Members 94–44 and 96–33 are applicable to “selling away.”

Question 3

3. The U.S. Supreme Court, as well as the SEC, has ruled that an investment adviser is a fiduciary with respect to his or her clients.

Answer 3

True 3.

The U.S. Supreme Court, as well as the SEC, has ruled that an investment adviser is a fiduciary with respect to his or her clients.

Question 4

4. A registered investment adviser does not have to disclose to clients limitations in the scope of his or her recommendations and any ties with broker/dealer firms.

Answer 4

False

4. A registered investment adviser does not have to disclose to clients limitations in the scope of his or her recommendations and any ties with broker/dealer firms.

Rationale: SEC Release IA–1092 specifically requires such disclosure.

Question 5

5. The Investment Advisers Act of 1940 definition of a security is confined to stock, bonds, and certificates of deposit.

Answer 5

False

5. The Investment Advisers Act of 1940 definition of a security is confined to stock, bonds, and certificates of deposit.

Rationale: A security is defined by the Act in very broad terms and includes many other types of investments.

Question 6

6. Just because someone holds himself or herself out as an investment adviser or as one who provides investment advice does not mean that he or she is required to register as an investment adviser.

Answer 6

False

6. Just because someone holds himself or herself out as an investment adviser or as one who provides investment advice does not mean that he or she is required to register as an investment adviser.

Rationale: Generally, any person holding himself or herself out as an investment adviser or as one who provides investment advice would be required to register as an investment adviser.

Question 7

7. Anyone who meets the three-pronged test must register with the SEC.

Answer 7

False

7. Anyone who meets the three-pronged test must register with the SEC.

Rationale: Prior to the National Securities Markets Improvement Act of 1996, this was true. The 1996 Act established rules for where an adviser needs to register.

Question 8

8. Lawyers, accountants, engineers, or teachers whose advice is solely incidental to the practice of their respective professions qualify for an exemption from registration as an investment adviser.

Answer 8

False

8. Lawyers, accountants, engineers, or teachers whose advice is solely incidental to the practice of their respective professions qualify for an exemption from registration as an investment adviser.

Rationale: These groups of professionals are one of the six exceptions to the investment adviser requirement—not one of the exemptions.

Question 9

9. Those who qualify under one of the six exceptions to the investment adviser registration requirements are not considered advisers and, therefore, do not have to comply with the anti-fraud provisions of the 1940 Act.

Answer 9

True

9. Those who qualify under one of the six exceptions to the investment adviser registration requirements are not considered advisers and, therefore, do not have to comply with the anti-fraud provisions of the 1940 Act.

Question 10

10. Form ADV, Part II, is required to disclose whether the adviser has any felony convictions or specified types of current injunctions.

Answer 10

False

10. Form ADV, Part II, is required to disclose whether the adviser has any felony convictions or specified types of current injunctions.

Rationale: This information is required by Form ADV, Part I.

Question 11

11. Form U-4 must be submitted on behalf of every IAR seeking to be employed by the IA.

Answer 11

True

11. Form U-4 must be submitted on behalf of every IAR seeking to be employed by the IA.

Question 12

12. A registered investment adviser may refer to himself or herself as an RIA.

Answer 12

False

12. A registered investment adviser may refer to himself or herself as an RIA.

Rationale: Use of RIA is specifically prohibited by SEC rules.

Question 13

13. A registered investment adviser may fulfill the brochure rule by providing clients and prospective clients with a copy of his or her Form ADV, Part II, or a separate narrative statement containing all the entries that appear on Part II.

Answer 13

True

13. A registered investment adviser may fulfill the brochure rule by providing clients and prospective clients with a copy of his or her Form ADV, Part II, or a separate narrative statement containing all the entries that appear on Part II.

Question 14

14. Advisers who have less than $25 million under management, and are therefore required to register with their respective states, are still subject to SEC jurisdiction for anti-fraud violations.

Answer 14

True

14. Advisers who have less than $25 million under management, and are therefore required to register with their respective states, are still subject to SEC jurisdiction for anti-fraud violations.

Question 15

15. For a willful violation of the 1940 Act, the SEC may impose fines of up to $25,000 and/or imprisonment of up to 10 years.

Answer 15

False

15. For a willful violation of the 1940 Act, the SEC may impose fines of up to $25,000 and/or imprisonment of up to 10 years.

Rationale: For a willful violation of the 1940 Act (as amended), the SEC may impose fines of up to $10,000 and/or imprisonment of up to five years.

Question 16

16. SEC rulings IA–770 and IA–1092 have the force of law.

Answer 16

False

16. SEC rulings IA–770 and IA–1092 have the force of law.

Rationale: These rulings do not have the force of law, but they do indicate the thinking of the SEC.

Question 17

17. To maintain more control over their representatives, large organizations become registered investment advisers rather than having each individual adviser in the organization register independently.

Answer 17

True

17. To maintain more control over their representatives, large organizations become registered investment advisers rather than having each individual adviser in the organization register independently.

Question 18

18. If an individual needs to register as an investment adviser, it is generally preferable to register as an individual rather than set up some other form of business, such as a corporation or limited liability company.

Answer 18

False

18. If an individual needs to register as an investment adviser, it is generally preferable to register as an individual rather than set up some other form of business, such as a corporation or limited
    liability company.

Rationale: Because audited financial statements may be required and because of potential conflicts of interest, most individuals would be better off operating as a registered investment adviser through a business entity such as a corporation or an LLC rather than maintaining a sole proprietorship.

Question 19

19. If an adviser has fewer than 12 clients in a state that is not his or her state of business, there is no need to register in that state.

Answer 19

False

19. If an adviser has fewer than 12 clients in a state that is not his or her state of business, there is no need to register in that state.

Rationale: If an adviser has fewer than five clients in a state that is not his or her state of business, there is no need to register in that state.

Question 20

20. Whenever an investment adviser who is also a registered representative with a securities broker/dealer provides any advice regarding investments that are not offered by his or her broker/dealer, he or she needs to obtain the broker/dealer’s approval in each and every case.

Answer 20

True

20. Whenever an investment adviser who is also a registered representative with a securities broker/dealer provides any advice regarding investments that are not offered by his or her broker/dealer, he or she needs to obtain the broker/dealer’s approval in each and every case.

Question 21

21. A person who is registered with FINRA to sell securities is exempt from registering as an investment adviser.

Answer 21

False

21. A person who is registered with FINRA to sell securities is exempt from registering as an investment adviser.

Rationale: Registration with FINRA permits an individual to sell securities. Whether he or she has to register as an investment adviser depends on whether they meet the three-pronged test or can rely on one of the exceptions or exemptions.

Question 22

22. Before 1981, anyone who wanted to sell securities had to meet the standards of the state in which he or she wanted to sell, and there were no consistent national standards.

Answer 22

True

22. Before 1981, anyone who wanted to sell securities had to meet the standards of the state in which he or she wanted to sell, and there were no consistent national standards.

Question 23

23. It is acceptable under the Investment Advisers Act of 1940 to accept both fees and commissions from clients.

Answer 23

True

23. It is acceptable under the Investment Advisers Act of 1940 to accept both fees and commissions from clients.

Question 24

24. If an adviser collects both fees and commissions from a client, and does not point out that he or she is able to sell only products that are offered by his or her broker/dealer, the adviser may be in violation of the anti-fraud provisions of the Investment Advisers
    Act of 1940.

Answer 24

True

24. If an adviser collects both fees and commissions from a client, and does not point out that he or she is able to sell only products that are offered by his or her broker/dealer, the adviser may be in violation of the anti-fraud provisions of the Investment Advisers Act of 1940.

Question 25

25. If an adviser normally charges a fee for advice but waives it if a client purchases insurance or securities from the adviser, the adviser is guilty of rebating. This is generally considered to be unethical, and it is illegal in most states.

Answer 25

True 25. If an adviser normally charges a fee for advice but waives it if a client purchases insurance or securities from the adviser, the adviser is guilty of rebating. This is generally considered to be unethical, and it is illegal in most states.

Question 26

26. If a financial planner who is not a licensed lawyer helps a client fill in blank forms designed to create a will or trust, the planner may be guilty of practicing law without a license.

Answer 26

True 26. If a financial planner who is not a licensed lawyer helps a client fill in blank forms designed to create a will or trust, the planner may be guilty of practicing law without a license.

Question 27

27. Principles and rules embodied in codes of ethics have the force of law.

Answer 27

False 27. Principles and rules embodied in codes of ethics have the force of law. Rationale: Codes of ethics often are based on laws, but they are not laws themselves. Failure to abide by a code of ethics is not a violation of law.

Question 28

28. Steve Maloski recommends a specific investment strategy for a client. He knows that it is not the best one for the client, but it is a good strategy, and he will make more money by having the client implement it. In this case, Steve has violated his fiduciary duty to the client.

Answer 28

True 28. Steve Maloski recommends a specific investment strategy for a client. He knows that it is not the best one for the client, but it is a good strategy, and he will make more money by having the client implement it. In this case, Steve has violated his fiduciary duty to the client.

Question 29

29. Conflicts of interest to which a financial planner may be subject can be overcome by full disclosure to the client.

Answer 29

True 29. Conflicts of interest to which a financial planner may be subject can be overcome by full disclosure to the client.

Question 30

30. New York Stock Exchange Rule 405 (the “know your customer” rule) requires a registered representative to meet with each client and get to know him or her on a personal basis.

Answer 30

False 30. New York Stock Exchange Rule 405 (the “know your customer” rule) requires a registered representative to meet with each client and get to know him or her on a personal basis. Rationale: Rule 405 requires a registered representative to gather essential information to have reasonable grounds for believing that a particular investment recommendation is suitable for the client, in terms of the client’s overall financial situation, investment objectives, and risk tolerance level. The requirement far exceeds simply meeting with the client to get to know him or her on a personal basis.

Question 31

31. If financial planners do not have expertise in a particular area of financial planning, they should nevertheless provide service in that area within the limits of their expertise.

Answer 31

False 31. If financial planners do not have expertise in a particular area of financial planning, they should nevertheless provide service in that area within the limits of their expertise. Rationale: A financial planner must be aware of his or her limitations and has an affirmative duty to consult with those who have the requisite expertise.

Question 32

32. After initial qualification as a financial planner, there is no continuing obligation to keep reasonably abreast of current practice and information in the field.

Answer 32

False 32. After initial qualification as a financial planner, there is no continuing obligation to keep reasonably abreast of current practice and information in the field. Rationale: Financial planners have a duty to keep current on how financial services industry changes may affect recommendations made to clients.

Question 33

33. CFP Board of Standards practice standard 100–1 requires the scope of the financial services engagement to be in writing.

Answer 33

False 33. CFP Board of Standards Practice Standard 100–1 requires the scope of the financial services engagement to be in writing. Rationale: Practice Standard 100–1 does not require the scope of the engagement to be in writing but acknowledges that certain disclosures to the client may be required to be in writing.

Question 34

34. Under Practice Standard 200–2, if a practitioner is unable to obtain sufficient and relevant quantitative information and documents to form a basis for recommendations, he or she should refuse to provide the requested services.

Answer 34

False 34. Under Practice Standard 200–2, if a practitioner is unable to obtain sufficient and relevant quantitative information and documents to form a basis for recommendations, he or she should refuse to provide the requested services. Rationale: In this situation, a practitioner should either (1) restrict the scope of the engagement to those matters for which sufficient and relevant information is available or (2) terminate the engagement.

Question 35

35. Practice Standard 200–1 deals primarily with gathering quantitative information and documents from clients.

Answer 35

False 35. Practice Standard 200–1 deals primarily with gathering quantitative information and documents from clients. Rationale: Practice Standard 200–1 deals primarily with mutually defining a client’s personal and financial goals, needs, and priorities.

Question 36

36. Practice Standard 300–1 states that a planner may not use any assumptions when analyzing client data.

Answer 36

False 36. Practice Standard 300–1 states that a planner may not use any assumptions when analyzing client data. Rationale: Practice Standard 300–1 states that the planner will use assumptions in at least two mutually agreed upon areas: the areas of personal and economic considerations.