Chapter 3 - Fraudulent and other prohibited practices

Question 1

________ is intentional misrepresentation, concealment, or omission of the truth for the purpose of deception.

Answer 1

Fraud

Question 2

True or False: No one dealing in securities is exempt from the anti-fraud provisions of the USA act. These provisions apply to all securities transactions.

Answer 2

True

Question 3

True or False: Violations of anti-fraud provisions cannot take place without a sale occurring.

Answer 3

False. Violations of anti-fraud provisions can indeed occur without a sale taking place. These provisions apply to any fraudulent activities involving securities, regardless of whether a sale has been completed.

Question 4

True or False: It is unlawful for any person to directly or indirectly transact business in a state as a BD or agent unless he is registered under the USA Act.

Answer 4

True. It is also unlawful to employ any device or scheme to defraud another person or make any untrue statement of material fact, or omit material facts

Question 5

True or False: It is lawful for any person to directly or indirectly transact business in a state as a broker-dealer (BD) or agent without being registered under the Act. It is lawful to act as a principal for their own account (to knowingly sell to or purchase any security from a client) without proper disclosure to the client.

Answer 5

False, it is unlawful to act as a principal for their own account

Question 6

The client must give consent, but this consent is not required to be in _________.

Answer 6

Writing

Question 7

Proper disclosure is constituted by delivery of written disclosure to the client ________ to the completion of the transaction.

Answer 7

Prior

Question 8

True or False: The principal disclosure requirement does not apply to any transaction with a customer of a Broker-Dealer if the Broker-Dealer is not acting as an Investment Adviser in relation to the transaction.

Answer 8

True. The principal disclosure requirement under Section 206(3) of the Investment Advisers Act of 1940 applies specifically to transactions where an investment adviser (IA) is acting as a principal or broker-dealer (BD) in relation to the transaction. If a BD is not acting as an IA in the transaction, the principal disclosure requirement does not apply.

Question 9

True or False: It is unlawful for any IA to enter into, extend, or renew any investment advisory contract unless it states in writing that the adviser will be compensated on the basis of a share of capital gains or capital appreciation of funds (performance fees).

Answer 9

False. The adviser will not be compensated unless compensation is based on the total value of a fund averaged over a defined period (e.g., 1% of assets under management each year).

Question 10

In general, the ______ Act does not allow performance-based fees. However, the Administrator does have the ability to allow such arrangements by rule or order.

Answer 10

Uniform Securities

Question 11

What ACT allows performance-based fees for qualified clients only? This rule permits IAs to charge a performaqnce-based compensation if the client meets certain criteria, such as having a minimum net worth or a specified amount of assets under management.

Answer 11

The Investment Advisers Act of 1940 allows performance based fees for qualified clients. A qualified client is an investor with a net worth of $2.2 million or $1.1 million in AUM.

Question 12

______________ means the transfer of rights and duties of a contract to another party.

Answer 12

Assignment

Question 13

If an IA is a partnership and a __________ member dies or withdraws, it is an assignment and client consent would be required.

Answer 13

Majority

Question 14

Changing from a sole proprietorship to a partnership is an _________________.

Answer 14

Assignment. This change involves transferring the rights and duties of the business from a single owner to multiple partners, which can impact the structure and management of the business.

Question 15

If an IA is a partnership, no assignment of an investment advisory contract is considered to result from the death, withdrawal, or admission to the IA of members having only a ___________ interest in the business.

Answer 15

Minority

Question 16

True or False: Advisory contracts do not need to contain the names, titles, addresses, and other personal information of all principals of an advisory firm.

Answer 16

True. Advisory contracts do not need to include the names, titles, addresses, and other personal information of all principals of an advisory firm.

Question 17

List some examples of fraudulent practices:

Answer 17

Inside Information, failing to determine suitability, commingling customer funds with the agent’s own funds and deliberately failing to follow a customer’s instructions.

Question 18

Agents with ______________ authority must execute unsolicited orders for customers but may add shares to such orders.

Answer 18

Discretionary

Question 19

__________ in a client’s discretionary account refers to the unethical and illegal practice where a broker excessively trades assets in the account to generate commissions for themselves.

Answer 19

Churning

Question 20

___________ under the Uniform Securities Act refers to the practice of buying securities and then selling them before the purchase has fully settled.

Answer 20

Free-riding

Question 21

Allowing customers to cancel trades which have already been executed is permissible.

Answer 21

False, it is prohibited

Question 22

True or False: Personally arranging credit for customers, either extended by the agent or a 3rd party, for customers who cannot afford a transaction that has been executed is prohibited.

Answer 22

True. This would not include normal transactions in a margin account. There are exceptions to the rule prohibiting personally arranging credit for customers. According to FINRA Rule 3240, borrowing from or lending to customers is generally prohibited, but there are specific exceptions where such arrangements are allowed. They are:

1. Immediate Family: If the customer is a member of the registered person’s immediate family.
2. Financial Institutions: If the customer is a financial institution regularly engaged in the business of providing credit, financing, or loans.
3. Registered Persons: If both the customer and the registered person are registered persons of the same member firm.
4. Personal Relationship: If the lending arrangement is based on a personal relationship outside of the broker-customer relationship.
5. Business Relationship: If the lending arrangement is based on a business relationship outside of the broker-customer relationship.

These exceptions are subject to the member firm’s written procedures and, in many cases, require prior notification and approval from the firm

Question 23

True or False: Stating that registrations mean approval by the regulators is permissible.

Answer 23

False. Implying approval or endorsement by a state or federal regulator is generally prohibited. The SEC and state regulators do not pass, approve, or endorse registrants.

Question 24

True or False: Is it permissible to represent that the state administrator approves of a broker-dealers or agent’s abilities?

Answer 24

False: It is not permissible to represent that the state administrator approves of a broker-dealers or agent’s abilities. The state administrator’s role is to register and regulate broker-dealers and agents, ensuring they meet the necessary qualifications and comply with securities laws. However, this registration does not imply an endorsement or approval of their abilities or the quality of their services.

Question 25

True or False: Implying approval or endorsement by a state or federal regulator is generally prohibited. The SEC and state regulators do not pass, approve of, or endorse registrants.

Answer 25

True