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Series 65 > 2 - Investment Advisers & Ethics > Flashcards

2 - Investment Advisers & Ethics Flashcards

This deck focuses on the registration requirements for investment advisers and investment adviser representatives, as well as rules and regulations that detail how securities professionals can conduct themselves in a just and ethical manner.

1
Q

What three activities define an investment adviser?

A

An investment adviser must:

  1. provide securities advice;
  2. as a part of a regular, ongoing business; and
  3. receive compensation for such services.

This includes financial planners, pension consultants, and sports & entertainment representatives if the above criteria are met.

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2
Q

Who is excluded from the definition of investment adviser, even if the three investment adviser criteria are met?

A
  1. an investment adviser representative;
  2. a bank, savings institution, or trust company;
  3. a lawyer, accountant, teacher, or engineer (“LATE”) who gives investment advice that is solely incidental to the practice of his profession; but, if any of these professionals hold themselves out as offering investment advice the exclusion is lost;
  4. a broker dealer or its agent whose advisory services are:
    a. solely incidental to the conduct of its brokerage business and
    b. who receives no special compensation for them;
  5. a publisher of any bona fide media publication, in whatever form, that renders general investment advice (i.e. does not take into account the specific investment situation of any client);
  6. any person that is a federal covered adviser;
  7. an adviser to a family office; or
  8. such other persons as the Administrator may by rule or order designate
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3
Q

Define investment adviser

A

An investment adviser:

  1. provides investment advice,
  2. as part of an ongoing business, and
  3. receives compensation for such advice.
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4
Q

Define investment adviser representative

A

An investment adviser representative is an individual who solicits or renders advice regarding securities or manages the accounts or portfolios of clients.

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5
Q

An investment adviser has an office in the state. Does it have to register in the state?

A

Yes. An investment adviser with a physical office in the state must register in the state.

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6
Q

Do federal covered advisers register in any state?

A

No. Federal covered advisers register with the SEC.

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7
Q

Do investment advisers under contract to manage an investment company register with the state or the SEC?

A

The SEC. Investment advisers under contract to manage an investment company are federal covered investment advisers and register with the SEC.

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8
Q

What four professionals are excluded from the definition of investment adviser, provided the advice is rendered incidentally to their profession?

A

Lawyers, accountants, teachers, and engineers (LATE). The exclusion is lost if any of these professionals charges specifically for investment advice. Note: the exclusion is NOT available to economists.

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9
Q

Do supervisors of investment adviser representatives need to register as investment adviser representatives?

A

Yes. Supervisors of investment adviser representatives must register even if the supervisor never speaks with clients.

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10
Q

Do investment adviser representatives register at the state or federal level?

A

Investment adviser representatives always register at the state level, even if the investment adviser they work for registered at the federal level.

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11
Q

When does the registration of federal covered investment advisers expire?

A

The registration of a federal covered investment adviser does not expire. The registration remains effective until withdrawn, cancelled, revoked, or suspended by the SEC.

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12
Q

When does the registration of state covered investment advisers expire?

A

The registration of a state covered investment adviser expires each December 31.

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13
Q

What is the state de minimis exemption for investment advisers?

A

Investment advisers are exempt from registering at the state level if it has no office in the state, solicits business from five or fewer retail clients in the state, and is registered in another state.

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14
Q

What is consent to service of process as it relates to the registration of securities professionals?

A

Consent to service of process allows the Administrator to accept legal documents on an individual’s behalf.

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15
Q

At the state level, when does an investment adviser’s application for registration become effective?

A

At the state level, an investment adviser’s registration becomes effective at noon on the 30th day after the application is filed.

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16
Q

At the federal level, when does a federal covered investment adviser’s application for registration become effective?

A

Within 45 days after the application is filed a federal covered investment adviser’s registration will be granted or proceedings will be instituted to determine whether the application should be denied.

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17
Q

How many reasons must an Administrator have to take disciplinary action against an investment adviser?

A

An Administrator must have at least two reasons to take disciplinary actions against an investment adviser. One of these reasons must be that the disciplinary action is in the public’s best interest.

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18
Q

Is lack of experience a proper ground for an Administrator to deny a registration?

A

No. A lack of experience alone is not grounds for denial of a registration.

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19
Q

Is a lack of qualification a proper ground for an Administrator to deny a registration?

A

Yes. A lack of qualification, including not having passed the Series 63 examination, is a valid reason to deny a registration.

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20
Q

What are the notice, hearing, and written findings requirements when a state securities Administrator subjects an individual to disciplinary action?

A

The Administrator must provide notice and give an opportunity for a hearing. If a hearing is held, the Administrator must provide written findings that support the disciplinary action.

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21
Q

Under what circumstances must an individual subject to disciplinary proceedings be given a hearing?

A

An individual subject to disciplinary actions must be given a hearing if the individual requests one. A hearing must be held within 15 days of such request.

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22
Q

When can an Administrator cancel the registration of an investment adviser?

A

An Administrator can cancel the registration if the investment adviser is:

  1. no longer in business;
  2. no longer in existence;
  3. a court finds the investment adviser to be mentally incompetent; or
  4. the investment adviser cannot be located after a reasonable search.
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23
Q

When does a withdrawal of state registration occur?

A

A withdrawal of state registration occurs 30 days after filing with the Administrator, unless disciplinary actions are pending. An individual cannot withdraw to avoid disciplinary actions.

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24
Q

After a registration is withdrawn, for how long may an Administrator initiate disciplinary actions?

A

An Administrator has jurisdiction to initiate disciplinary proceedings for one year after withdrawal.

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25
Q

What are the requirements for an investment advisory contract?

A
  1. Must be in writing;
  2. Compensation must based on assets under management (except in limited circumstances when it can be based on percentage of capital gains, performance of the portfolio);
  3. No assignment to another investment adviser or investment adviser representative without the customer’s consent;
  4. Notification for changes in majority interests in a partnership (does not apply to corporation);
  5. No stipulations waiving compliance with the Uniform Securities Act.
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26
Q

When can an investment adviser assess a performance fee?

A

An IA can charge a performance fee only to “qualified clients”, defined as clients with at least $1 million in assets with the firm or at least $2 million in net worth.

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27
Q

What is the brochure rule?

A

A rule requiring that every investment advisory client receive a disclosure statement (an “investor brochure”) containing all information that is found in form ADV II. This rule applies to federal covered and state investment advisers.

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28
Q

What are the rules under the Investment Adviser’s Act of 1940 when an investment adviser has custody of client funds?

A

The client securities must be segregated and properly marked; client funds must be deposited in separate bank accounts; the investment adviser must notify the client as to the place and manner in which the funds and securities are being maintained; an itemized list of such funds and securities must be delivered to the client at least every three months; such funds and securities must be verified annually by an independent CPA on a surprise basis.

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29
Q

When must an investment brochure be delivered to a client entering into an investment advisory contract?

A

Clients must receive the brochure:

  1. at least 48 hours before signing the investment advisory contract, or
  2. at the time the contract is signed, provided, that the customer can cancel the contract within 5 days without penalty.
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30
Q

When must a balance sheet be included in an investor brochure (disclosure statement)?

A

A balance sheet must be included in an investor brochure if:

  1. the investment adviser has custody of client funds and securities; or
  2. the investment adviser collects pre-payment of fees ($500 at least six months in advance).

In these circumstances the balance sheet must also be included in Form ADV II.

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31
Q

What investment advisory customers are excepted from the brochure rule?

A

Certain clients are not required to receive an investor brochure. These include:

  1. investment company clients;
  2. clients for impersonal advisory services; or
  3. clients that are charged a fee of less than $200.
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32
Q

Performance fee arrangements contingent on capital gains or other appreciation in a client’s account are prohibited, except for contracts with which types of client?

A
  1. Registered investment companies; and
  2. Persons with $1 million under the adviser’s management or a net worth of at least $2 million.
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33
Q

What constitutes custody of client funds and securities?

A

Custody includes:

  1. the temporary possession of clients’ funds or securities, or
  2. when an investment adviser can dispense client funds without the client’s consent.
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34
Q

What are the criteria for an investment adviser to properly maintain custody of client funds and securities?

A

To maintain custody of client funds and securities an investment adviser must:

  1. segregate and identify all customer securities;
  2. establish a separate account for each client’s funds;
  3. notify the client of the location of its funds;
  4. send a quarterly report to the customer detailing what securities and funds the investment advisor is maintaining custody;
  5. submit to surprise annual audits by a CPA; and
  6. promptly notify the Administrator on Form ADV.
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35
Q

What is a wrap fee program?

A

A program under which a client is charged a combined fee for investment advisory services and commissions for executing securities transactions.

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36
Q

What is not considered custody of client funds and securities?

A
  1. An investment adviser with discretionary authority is not considered to have custody of client funds.
  2. The pre-payment of fees is not considered custody of a client funds or securities.
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37
Q

An investment adviser must disclose financial impairment to which of its clients?

A

Financial impairment must be disclosed if the investment adviser has:

  1. discretionary authority;
  2. custody of client funds or securities; or
  3. received pre-payment of fees ($500 at least six months in advance).
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38
Q

What are the three criteria the Uniform Securities Act uses to define fraudulent and other prohibited practices?

A
  1. Employing any device, scheme or artifice to defraud;
  2. making any untrue statement of a material fact or omitting to state a material fact necessary to make a statement not misleading; or
  3. engaging in any act, practice, or course of business that operates as a fraud or deceit on a person.
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39
Q

What are the criteria the Uniform Securities Act uses to define fraudulent and other prohibited practices for investment advisers or investment adviser representatives?

A
  1. Employing any device, scheme or artifice to defraud the other person; or
  2. engaging in any act, practice or course of business which operates or would operate as a fraud or deceit upon the other person.
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40
Q

How broad are the antifraud provisions of state securities laws?

A

Very broad. They cover any person or transaction involving a security, regardless of whether the person, security or transaction is registered, exempt or federal covered.

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41
Q

May registered agents share fees or split commissions?

A

Yes, but only if they are registered as agents for the same broker dealer or two broker dealers under common ownership or control. Clients need not be told of such arrangement so long as it does not increase the amount of commission charged.

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42
Q

May an individual register as an agent for more than one broker dealer?

A

No. But an agent may be registered with multiple broker dealers that are affiliated by direct or indirect common control. For example, an agent may register with two broker dealers that are owned by the same parent company.

43
Q

What are some examples of material facts that would constitute fraud if misstated by agents or broker dealers knowingly and willfully?

A
  1. inaccurate market quotations;
  2. misstatements of an issuer’s earnings, projected earnings or dividends;
  3. inaccurate statements regarding the amount of commissions, markups or markdowns;
  4. stating or implying that the agent has inside information when he does not;
  5. telling a customer that a security will be listed on an exchange without reliable information;
  6. informing a client that registration of a security means approval by the SEC or Administrator of such security, or that the Administrator or SEC approves of the agent or broker dealer;
  7. misrepresenting the status of customer accounts;
  8. promising a client services without the intent or ability to perform them.
44
Q

Can brokerage commissions or markups ever be higher than normal?

A

Yes, provided it is disclosed to the client.

45
Q

What are a broker’s disclosure obligations with respect to his commissions?

A

Unless a commission is higher than normal, a broker dealer is not required to disclose the amount of the commission on an offer to sell before the transaction. The amount of the commission is always required to be disclosed on the trade confirmation.

46
Q

An agent or adviser tells a client that he has inside information when he does not. Is this fraud?

A

Yes. An agent that states or implies that he has inside information when he does not has acted fraudulently.

47
Q

What is the difference between telling a client that a security is registered with a state Administrator and telling a client that a security is approved by a state Administrator?

A

Saying that a security is “registered” is permissible; saying that a security is “approved” constitutes fraud.

48
Q

What is SIPC?

A

SIPC (Securities Investor Protection Corporation) protects clients of broker dealers in the event of a broker dealer bankruptcy by appointing a trustee to return client assets.

49
Q

What information must be included in an order ticket?

A

The account ID, a description of the security (including the number of shares or par value), the terms and conditions of the order, the time of order entry and execution, the execution price and the identity of the agent. The client’s name and address need not be included on the order ticket.

50
Q

What is the definition of material inside information?

A

Any information about a company that has not been released to the public and that would likely affect the value of a security.

51
Q

Are there any exemptions from the anti-fraud provisions of the Uniform Securities act?

A

No. There are no exemptions from the Uniform Securities Act’s anti-fraud provisions.

52
Q

What should an agent or investment adviser representative do if he comes into possession of material inside information?

A

Immediately report the possession of the information to a supervisor or compliance officer. The agent or investment adviser representative may not make recommendations based on the inside information, even if acquired accidentally.

53
Q

Can an agent or investment adviser representative use information from a broker dealer or investment adviser’s research report if the report has not been made public?

A

Yes, this is not considered inside information.

54
Q

When does an insider information violation occur?

A

Only when the information is used for trading. Simply giving someone the information, if it is not used, is not in itself a violation.

55
Q

What are the repercussions for engaging in practices that are considered dishonest and unethical business practices under the Uniform Securities Act?

A

Engaging in such prohibited actions can result in denial, suspension or revocation of registration, a fine, or in the case of fraudulent practices, imprisonment.

56
Q

What is churning?

A

Inducing trading in a customer’s account which is excessive in size or frequency in view of the financial resources, objectives and character of the account. It is prohibited under the Uniform Securities Act.

57
Q

What constitutes unethical delivery delays by a broker dealer?

A

A pattern of unreasonable and unjustifiable delays in the delivery of securities and/or in the payment upon request of free credit balances to its customers.

58
Q

What kinds of recommendations by an agent or broker dealer are considered unethical?

A

Recommendations about a security transaction without reasonable grounds to believe that such recommendation is suitable for the customer, based on reasonable inquiry concerning the customer’s investment objectives, financial situation and needs, and any other relevant information known by the broker dealer or agent.

59
Q

What kinds of recommendations may an agent or broker dealer make to a client who refuses to discuss investment objectives?

A

The agent may not make any recommendations, but may accept unsolicited orders from the client.

60
Q

Who can imply that securities are approved by a state securities administrator?

A

No one can ever imply that securities are approved by the Administration, to do so is fraud. The Administrator does not approve or disapprove of securities. State securities administrators clear securities for public distribution.

61
Q

What are blanket recommendations? Are they ever ethical?

A

An agent makes a blanket recommendation when he recommends the same security or transaction to a majority of his clients. It is unethical behavior because it does not take into account each client’s financial needs.

62
Q

When is it permissible for agent to accept instructions from a party other than his client?

A

The agent must have a written third-party trading authorization on file.

63
Q

When may an agent exercise discretion in effecting a transaction for his customer’s account?

A

An agent must have written authority to use his own discretion in making investment decisions for the client regarding selection of securities, whether to buy or sell and the number of shares. Decisions relating solely to time and price are not considered discretion. Discretionary trades must be suitable for the customer. The agent must obtain the written authorization prior to the first discretionary trade.

64
Q

When must an agent obtain a written margin agreement from a client?

A

The agent must obtain a properly executed written margin agreement from his client promptly after the initial transaction in the margin account.

65
Q

What are the rules regarding commingling of customer and firm assets?

A

Securities held in a client’s name must not be commingled - held in the same account - with securities of the firm.

66
Q

What are matched purchases?

A

Matched purchases are a prohibited form of market manipulation. They occur when investors collude to buy and sell securities among themselves, creating a false impression of activity in the security, thus driving up prices and allowing them to sell at a profit.

67
Q

What is a wash sale?

A

Wash sales are a prohibited form of market manipulation. They occur when an investor simultaneously buys and sells in different brokerage accounts, creating a false impression of activity in the security and driving up prices.

68
Q

Who is exempt from the anti-fraud provisions of the Uniform Securities Act?

A

No one is ever exempt from the anti-fraud provisions of the Uniform Securities Act.

69
Q

What is arbitrage?

A

Arbitrage is the simultaneous buying and selling of the same security in different markets. Arbitrage is not considered market manipulation, and it is not prohibited under the Uniform Securities Act.

70
Q

What are the Uniform Securities Act rules regarding guaranteed securities?

A

Securities professionals may not guarantee the performance of securities, nor may they guarantee against loss by providing funds to a client account. However, it is allowable to refer to a guaranteed security when an entity other than the issuer is making the guarantee.

71
Q

When can an individual imply that securities have been approved by the Administrator or the SEC?

A

Never. Individuals may never imply that securities have been approved by a state securities administration or the SEC. This is fraudulent.

72
Q

What kinds of broker dealer or agent advertising are prohibited under the Uniform Securities Act as deceptive advertising practice?

A

Any advertising or sales presentation that is deceptive or misleading is prohibited, including using nonfactual data (like charts of graphs) based on conjecture or unrealistic claims to detract from or defeat the purpose of information given in a prospectus or disclosure, leaving out information about risk factors or deal killers, or highlighting positive information while minimizing negatives.

73
Q

What are the Uniform Securities Act rules regarding broker dealer and agent disclosures of conflicts of interest?

A

An agent or broker dealer must disclose that the broker dealer is controlled by, controlling, affiliated with or under common control with the issuer of any security before entering into a contract with or for a customer for the purchase or sale of such security. An agent must also disclose any other conflicts of interest, such as the fact that his spouse is a control person at such issuer. The disclosure must be made in writing, or if made orally must be supplemented with a written disclosure no later than the completion of the transaction.

74
Q

What does the Uniform Securities Act require an agent to do upon receipt of a written customer complaint?

A

The agent must immediately report the complaint to his supervisor.

75
Q

What does the Uniform Securities Act require an agent or broker dealer to do upon receipt of an oral customer complaint?

A

Nothing; the Uniform Securities Act only requires that action be taken in response to a written customer complaint.

76
Q

What does the Uniform Securities Act require a broker dealer to do upon receipt of a written customer complaint?

A

The firm must notify the complainant that the complaint was received and make an appropriate entry in the firm’s complaint file. If an agent were the subject of the complaint, the agent must be notified but does not receive a copy of the complaint.

77
Q

What does the Uniform Securities Act require a broker dealer to do if a complaining client withdraws its complaint?

A

The firm must return the original written complaint to the customer and keep a copy in its complaint file.

78
Q

What is front running?

A

Front running occurs when a broker dealer or agent places its own person order ahead of a previously received customer order. It is fraudulent under the Uniform Securities Act.

79
Q

What are the Uniform Securities Act rules regarding the backdating of securities transaction records?

A

Backdating records and documents is never permitted, despite potential tax benefits to clients.

80
Q

Are clients permitted to waive their rights under the Uniform Securities Act?

A

No. Any such waiver is null and void.

81
Q

In connection with the solicitation of investment company shares, what must an agent or broker dealer disclose to clients regarding sales charges?

A
  1. If there is a front-end load, a contingent deferred sales load, or a Rule 12b-1 fee or service fee in excess of 0.25% of average net fund assets per year;
  2. whether there are sales charge discounts on the purchase of shares in dollar amounts at or above a breakpoint; and
  3. whether there is a letter of intent feature that will reduce sales charges.
82
Q

Are broker dealers or investment advisers permitted to lend money to clients?

A

No, unless the broker dealer or investment adviser is a financial institution engaged in the business of loaning funds, or the client is an affiliate.

83
Q

Are agents and investment advisers permitted to borrow money from clients?

A

No, unless the client is a broker dealer, an affiliate or a financial institution in the business of loaning money.

84
Q

What is “selling away”? Is it ethical?

A

Selling away, or trading off the books, occurs when an agent effects securities transactions not recorded on the books or records of the broker dealer. It is prohibited under the Uniform Securities Act unless the broker dealer has previously authorized the transaction in writing.

85
Q

Are agents permitted to share in their clients’ accounts?

A

Agents are permitted to share in the profits and losses of client accounts with the written authorization of the client and the broker dealer.

86
Q

Are investment adviser representatives permitted to share in their clients’ accounts?

A

Investment adviser representatives (and broker dealers and investment advisers) are never permitted to share in client accounts.

87
Q

When can a state Administrator take disciplinary action without a hearing?

A

If the Administrator suspects fraudulent activity it can issue a cease and desist order. This immediately requires a person to refrain from doing a certain activity. This order can be issued before the fraud actually occurs.

88
Q

Are investment advisers permitted to provide investment advice to clients who do not share their financial information or investment objectives?

A

No. An investment adviser cannot provide such advice because it will be unable to make suitable recommendations to the client.

89
Q

When may an investment adviser representative exercise discretion in effecting a transaction for his customer’s account?

A

An investment adviser representative must have written authority to use his own discretion in making investment decisions for the client regarding selection of securities, whether to buy or sell, and the number of shares. Decisions relating solely to time and price are not considered discretion. Oral discretionary authority is permissible for the initial transaction in a customer’s account within the first 10 business days after the date of the first transaction.

90
Q

Is an investment adviser permitted to provide his client with third party reports and recommendations?

A

Yes, provided the adviser discloses that the report or recommendation was prepared by a third party. No disclosure is required when the adviser uses various research materials to make client recommendations.

91
Q

What is an unreasonable advisory fee?

A

An unreasonable advisory fee is one that is unreasonable in relation to fees charged by other advisers for similar services.

92
Q

Are testimonials on advertising literature, sales brochures or websites permissible for agents, broker dealers, investment advisers and investment adviser representatives?

A

Testimonials are permitted for broker dealers and agents, but not for investment advisers and investment adviser representatives.

93
Q

When may an investment adviser disclose information about a client’s identity or investments?

A

Only to other parties of a joint account, if required by law, or if otherwise consented to by the client.

94
Q

What are the Uniform Securities Act rules regarding investment advisers engaging in principal or agency transactions?

A

Written client consent is required either prior to execution of the principal or agency transaction, or (together with sufficient information to inform the client of the adviser’s conflicts of interest) after execution but prior to settlement.

95
Q

What are the Uniform Securities Act rules regarding agents and broker dealers engaging in principal or agency transactions?

A

No client consent is required, but the broker dealer must indicate its capacity as principal or agent on the trade confirmation.

96
Q

What is an agency cross transaction?

A

An agency cross transaction occurs when an investment adviser executes a trade between two of its clients.

97
Q

What is required of an investment adviser executing an agency cross transaction?

A

An investment adviser must obtain the written consent of both customers prior to executing an agency cross transaction. Note: an investment adviser is prohibited from soliciting both sides of the trade. One of the clients must enter the order on an unsolicited basis.

98
Q

When must an investment adviser disclose whether it is acting as a broker or a dealer when executing a trade for a customer?

A

An investment adviser must disclose whether it is acting as a broker or a dealer before entering the trade. This is different than the requirement for broker dealers, which can disclose their capacity after entering the trade on the trade confirmation.

99
Q

When must an broker dealer disclose whether it is acting as a broker or a dealer when executing a trade for a customer?

A

A broker dealer must disclose its capacity - whether it is acting as a broker or a dealer - after entering the trade on the trade confirmation. This is different than the requirement for an investment adviser, which must disclose its capacity before entering the trade.

100
Q

When can a securities professional act outside its clients best interest?

A

Never. Securities professionals - including broker dealers, agents, investment advisers, and investment adviser representatives - have a fiduciary duty to their clients and must always act in their client’s best interest.

101
Q

What are the registration implications for a broker dealer that charges its clients a wrap fee?

A

A broker dealer that charges a wrap fee must register as an investment adviser if it provides its clients any investment advice.

102
Q

When must a Currency Transaction Report be filed?

A

The Bank Secrecy Act requires every financial institution to file a Currency Transaction Report for all cash transactions exceeding $10,000.

103
Q

How is a cash transaction defined for purposes of determining if a Currency Transaction Report must be filed.

A

For purposes of a CTR, cash includes money, cashier’s checks or traveler’s checks deposit by a client totaling $10,000 or more in one day.

104
Q

Under what circumstances can an Investment Adviser or Broker Dealer advertise statistical devices or analyses for portfolio recommendations

A

Only if it also discloses the limitations for the particular models or systems being advertised.

Series 65 (6 decks)

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