Chapter 3

Question 1

Unless the customer has given the agent discretionary authority, each transaction in a customer’s account must be approved by the client. This activity could occur when an agent is attempting to churn the customer’s account in order to generate commissions. However, unauthorized trading violations can also occur when an agent is attempting to do what is in the best interest of the client.

Answer 1

Unauthorized Trading

Question 2

All trades in a client’s account must be authorized by the customer unless the agent has been granted discretionary authority in writing. Even with discretionary authority, agents cannot simply enter any order that they wish for the account. Orders entered on a discretionary basis must still be suitable for the account.

Answer 2

Discretionary Authority

Question 3

If the client specifies whether the order is a buy or a sell, the security to be bought or sold, and the amount of the security to be bought or sold, the client may verbally authorize the agent to choose the price at which the order is executed and/or the time of execution. This order is only good for that business day the customer made the verbal request.

Answer 3

Price/Time Exception

Question 4

Intentionally not disclosing a potential discount when the client is close to reaching the required dollar threshold.

Answer 4

Breakpoint Sales

Question 5

Encouraging a client to purchase mutual fund shares just prior to the payment of a dividend, implying that the investor will receive an immediate return on his capital. The investor is, in effect, receiving their own money back as taxable income and paying an inflated sales charge.

Answer 5

Selling Dividends

Question 6

when a broker-dealer acts in a dealer or principal capacity

Answer 6

it is buying or selling stock for its own account. While it must treat its clients fairly in such trades as well, it is not representing the client’s interest in the same way it does when simply acting as a broker.

Question 7

A wash sale (trade)

Answer 7

involves the simultaneous purchase and sale of the same security with the intent to give the appearance of active trading without an actual change in beneficial ownership. This is not the same as arbitrage, which is the simultaneous buying and selling of a security at 2 different prices in 2 different markets resulting in profits without risk. Arbitrage is a lawful trading activity.

Question 8

Matched Sales

Answer 8

When two or more parties are involved in a pattern of buying and selling a security merely to give the appearance of active trading, this is known as engaging in matched sales. Whereas there is usually only one manipulator in a wash sale, matched sales involve two or more conspirators.

Question 9

Painting the Tape

Answer 9

When manipulative trading involves a series of purchases, or a series of sales, rather than paired buys and sells, the activity is known as painting the tape (ghosting). This is also illegal, since the intent is to give the false appearance of a trend in a stock’s price and lure other investors into the same trading activity.

Question 10

Form ADV Annual Update

Answer 10

For state registered investment advisers, the USA requires the firm file an updated Form ADV with the state within 90 days of the investment adviser firm’s fiscal year end. Federal covered investment advisers must file an updated Form ADV with the SEC within 90 days of the investment adviser firm’s fiscal year end.

Question 11

Wrap Account Brochure

Answer 11

When a client pays the investment adviser a flat fee for “advisory and order execution” transactions, it is called a wrap account. The wrap fee is generally calculated based upon the size of the investment portfolio (assets under management or AUM), and may factor in the number of transactions anticipated if the investor is actively trading in the client’s account.

Any material changes to the wrap fee brochure must be filed immediately, and an amendment or sticker that specifies the changes must be provided to investors. Any non-material change must be filed within 90 days of the end of the adviser’s fiscal year-end with the Administrator.

Advisers who charge wrap fees send customers “Part 2A – Appendix 1” instead of the “normal” Part 2A. Appendix 1 discloses the features and expenses specific to wrap fee arrangements.

Question 12

A qualified client

Answer 12

is defined as a customer with a net worth of at least $2 million (not including the customer’s primary residence) or $1 million under the adviser’s management

Question 13

IA

qualified custodian

Answer 13

◾An FDIC insured financial institution
◾A registered broker-dealer who holds client assets
◾A registered futures commission merchant who holds client assets
◾Foreign financial institution holding assets for clients

Question 14

Prudent Man Rule

Answer 14

is the guideline that fiduciaries must observe in managing client assets, and it applies to investment advisers

Question 15

The Prudent Man Rule requires a fiduciary to:

I. Make only investment decisions a prudent person without specialized knowledge would make

II. Always and only choose the most conservative investments

III. Consider the needs of the beneficiary

IV. Obtain the beneficiary’s prior permission to effect any transaction

A
II & IV
B
I & II
C
I & III
D
II & III

Answer 15



C

I & III

Question 16

Agency Cross Transactions

Answer 16

facilitates the sale of the securities from one of their clients to another of the investment advisor

Question 17

Which of the following are required in order for an investment adviser to accept a blanket authorization to execute agency cross trades for a customer?

I. The consent must be renewed annually

II. The client must grant permission prior to each trade

III. The client must have the right to revoke the consent at any time

IV. The adviser must not recommend a transaction to both parties to the agency cross

A
III & IV 
B
II & III 
C
I & IV 
D
I & III

Answer 17

A

III & IV

Question 18

Principal Transactions

Answer 18

It may sometimes be appropriate for an investment adviser to sell securities to a customer from its own account or buy securities from a customer for its own account. These are principal transactions since the IA is on one side of the trade with the customer on the other side of the trade.

Like agency cross transactions, principal transactions involve a conflict of interest. The conflict is more serious in a principal transaction than in an agency cross, so blanket authorizations to do such trades are not permitted. The IA must obtain authorization for each trade prior to the transaction.

Question 19

Affinity fraud

Answer 19

is a tool used by criminals to gain the trust of victims by claiming to be members of the same identifiable group, such as a religious affiliation, race, national origin, or profession, or to have similar interests. While affinity fraud has always been common, social media gives con artists a rapid and largely anonymous way to identify, and identify with, target groups.

Question 20

Under the Uniform Securities Act, “publicly distributed written materials” are materials which are sent to at least 35 persons, and:

A Contain a testimonial
B Provide graphs, charts, or formulas being offered to determine which securities to buy or sell
C May refer indirectly to past recommendations that were profitable to any person
D Are paid for by the recipients

Answer 20

D

Are paid for by the recipients

Question 21

A security where the holder may have to pay something of value later in order to maintain ownership, would be a definition of:
A
Non-assessable stock
B
Futures contract
C
Cumulative preferred stock
D
Assessable stock

Answer 21

D

Assessable stock

Question 22

The term offer or offer to sell includes which of the following?
A
When some of a corporation’s issued securities are exchanged for securities of a merged corporation or when a corporation sells a portion of its assets in exchange for receiving securities of the other corporation.
B
Gift of non-assessable stock
C
When, as a result of a court-approved reorganization, a security is issued in exchange for outstanding securities.
D
Every attempt to buy, obtain an interest in, attempt to dispose of, or offer a security for value

Answer 22

D

Every attempt to buy, obtain an interest in, attempt to dispose of, or offer a security for value

Nice try! The correct answer was D.

The term offer or offer to sell includes every attempt to buy, obtain an interest in, attempt to dispose of, or offer a security for value. A stock transfer as a result or mergers or reorganization is not a sale, or offer, or offer to sell. Neither is a gift of non-assessable stock.

Question 23

Criminal penalties for fraudulent securities transactions that took place within a State require which one of the following to initiate criminal prosecution of the alleged offender?
A
NASAA
B
State Attorney General 
C
FINRA
D
State Securities Administrator

Answer 23

B

State Attorney General

Question 24

Which of the following statements is (are) true regarding the Uniform Securities Act?
I The maximum criminal fine for violations of the Act is $25,000
II The maximum prison sentence for a violation of the Act is three years
III In order for a violator of the Act to be imprisoned, the transgression must be willful
IV A violator of the Act can be fined and imprisoned
A
I and IV
B
I, II, III and IV
C
II
D
II, III and IV

Answer 24

D

II, III and IV