Chapter 3 Part 2

Question 1

Principal or Agency Transactions (State and Federal)

Answer 1

May not knowingly buy or sell to a client from own personal account without disclosure and consent

Agency: Bringing two of your clients together in a trade

Agency transaction the biggest temptation would be the bump in compensation

May obtain consent after transaction but before execution (consent cannot be provided on a blanket base)

Not acting as a broker if in an agency trade he does not take compensation (other than advisory fee)

Rule does not apply to BD if client does not advise on transaction

Question 2

Advertising under the USA and SEC

Answer 2

USA- Unlawful to publish, circulate or distribute any AD not complying with investment advisers act of 1940

SEC definition- Any notice, circular, website, letter addressed to 1+ person that offers:

• analysis regarding securities
• Any device used to make a decision regarding securities
• Any other investment advisory service

Question 3

Unlawful advertisements

Answer 3

• Testimonials (even a like on facebook)
• Being called approved by SEC or administrator
• May not use abbreviations like IAR or RIA, only full word
• Only presenting positive advice without negatives, must show 12 year period of recommendations
• Must stress difficulty of using strategies to pick stocks
• Must disclose ownership in recommended positions

Question 4

Investment Advisory Contacts (State and Federal)

Answer 4

3 Main differences between state and fed:

1. Must be in writing for State (could be oral for SEC)
2. Must be competitive for state, only reasonable for SEC based on services
3. State law is more stringent on performance based comp

Contract must disclose:

• Services to be provided, including custody
• Term of contract
• Amount of advisory fee or formula to compute
• Amount of prepaid fee that could be returned upon termination
• Whether discretionary power will be granted
• No assignment of contract without consent of client
• Minority ownership changes must be told to client
• No performance fee unless meeting qualified client exception or administrator allows it (fee based off assets is not performance fee) or waiving of fees allowed in event of losses unless it is a qualified client which is a:
  1. Natural person or company with 1MM under management
  2. Assets before entering contract of 2.1MM
  3. Officer, director or IAR employed for 12 months

Question 5

Investment advisory contract strictly State

Answer 5

If adviser participate in profits on the funds

Must disclose the following to the client:
1. May be more advantageous to take a riskier approach

2. Where relevant, the advisor may receive increased comp on unrealized and realized gains
3. Periods used to evaluate performance and how it effects fee
4. Index to be used to compare returns

Question 6

Fulcrum Fee

Answer 6

Outperform index by 5% over a set period, adviser would receive a fee increase

Underperform you could lose the same amount

Question 7

Assignment

Answer 7

Sale of advisory contract with a client to another investment adviser

If it is a partnership, no assignment occurs in case of death or withdrawal of a minority partner

Pledging securities in a corporation is considered assignment

Allowed to add additional equal partners without customer consent but must notify them

Question 8

Agency Cross Transactions

Answer 8

Acts as agent on both sides of trade

Must get written consent in advance before first trade and disclose:

• Adviser will receive commission for both
• Potential conflict of interest
• Annually disclose amount of times trades took place and compensation for it
• May be terminated at anytime
• May not recommend to both buyer and seller, but may recommend to one of the two

Client must receive written trade confirmation stating:

• Nature of transaction
• date, and time if requested
• Amount of compensation

Question 9

Cash Referral Fees (SEC)27g

Answer 9

Must meet 4 criteria under SEC
1. Must be registered under the investment advisers act

2. Cannot be subject to a statutory disqualification
3. Must have a written agreement in place
4. Must meet one of the three circumstances:
   - Payment for impersonal advisory services
   - Employee is affiliated with the IA
   - Third party using sales pitch developed by IA that discloses they are not affiliated and the amount they are receiving

SEC requires a solicitors written disclosure doc and that form adv part 2A be delivered to solicited client

Question 10

Cash Referral Fees (State)

Answer 10

Solicitor must be registered as an IAR

Does not have to be strictly for the IA that you are under (weird)

Question 11

Cash Referral Fee (both)

Answer 11

May pay for referrals from lawyers, accountants or insurance agents

Size of payment cannot be based on assets brought in though

Question 12

Fraudulent or Prohibited Practices When Providing Investment Advice

Answer 12

• Must have consent to share client information (if it is a joint account only need one)
• Must disclose authorship if using another company’s materials (except stats)
• Must disclose limitations and difficulties of using a stock picking system
• Allocating to a broker in exchange for other products without disclosure
• May not lend to clients unless they are an affiliate or institution is in the business of loaning
• Unfairly criticizing a clients professional advisers
• Sharing in profits or losses unless you are only an agen (performance based comp is not considered sharing in profits)

Question 13

Investment Advisers Act of 1940 makes it unlawful to provide advice to clients unless you

Answer 13

• Adopt written policies an procedures to prevent fraud
• Review policies no less than annually
• Designate a supervised individual to administer

Question 14

Section 28 (e) of SEC Act of 1934

Answer 14

Soft dollars- Allocating commission dollars towards purchasing of research

Directed Transactions- Sending client trades to a broker-dealer for services

Not deemed a breach of fiduciary duty if the extra commission paid in the soft dollar arrangement is worthy of the brokerage and research services provided

Must disclose soft dollar relationships to clients even if client is not paying extra money

Question 15

Item 12 of Part 2A of form ADV

Answer 15

IA must describe in ADV:

• products, reach and services
• Whether clients pay higher commissions than obtainable in exchange for rearing, products and services
• Whether research is used for all accounts or only those paying for it
• Any procedure used to direct client transactions to brokers

SEC also requires IA must explain that:
-The IA benefits due to not paying for research

Question 16

28 (e) Safe Harbor vs out

Answer 16

In Harbor:

• Research reports on companies or stock
• Trade Journals
• Quant analytical software
• Seminars with appropriate content
• effecting and clearing securities

Out:
Telephone lines
Office furniture
Travel expenses to attend seminars
Rent
Software not relating
Training for exams
Internet service

Question 17

Client Referrals

Answer 17

If an IA receives a referral from a BD in exchange for business, must be disclosed

Question 18

Directed Brokerage

Answer 18

An IA recommending a BD must reveal conflicts of interest

If a client selects brokerage to use, IA must disclose if the BD is unable to perform or if there are cheaper options available to the IA

Question 19

Trade Aggregation and Allocation

Answer 19

Making one large trade to save on cost

If trade cannot be done at one price, must average

Question 20

Voting Client Securities

Answer 20

Must be infor on advisers policy in Part 2a

Must describe:

• Whether or how the client can direct the IA’s vote
• How IA addresses conflicts of interest between himself and the client
• How clients can learn what the IA voted
• How client may obtain proxy voting procedures

Question 21

Compliance Programs

Answer 21

All IAs registered with SEC must implement a plan designed to prevent breaking of federal law, update annually and designate a chief compliance office

Chief compliance officer ID must be disclosed in the ADV

Should identify conflicts and compliance factors and address them in policy

Question 22

SEC minimum compliance guidelines

Answer 22

Portfolio management process

Trading practices, including best execution obligation, soft dollar arrangements and aggregated trades

Trading of advisers and personal trading of supervised persons

Disclosures to clients

Safeguarding of client assets

Creation of required records and maintenance

Marketing advisory services

Safeguard of client info

Business continuity plans

Question 23

Political Contributions by IAs (Pay to play)

Answer 23

Prohibits advisors from receiving comp for advisory services to a gov entity until 2 years after a donation is made to a public official or candidate in charge of public retirement funds

Covered employees may make $350 donation to campaign in which they can vote

$150 for others without violation

Covered Employee includes:

• Gps or managing members
• Any employee soliciting a gov entity and their supervisor
• Any political action committee controlled by IA

Exception- New Hires who made contribution 6 months prior unless job is soliciting clients (2 year look back for them)

Returned contributions not exceeding $350, discovered in 4 months after contribution and returned within 60 days from discovery

Question 24

Limit on Exceptions

Answer 24

IA with over 50 employees, permitted 3 exceptions within calendar year

50 or fewer, permitted 2

Question 25

Enforcement of Invetment Advisors Act of 1940

Answer 25

SEC

FINRA, NYSE and other SRO’s have no jurisdiction over IAs

SEC may take following actiobs:
Subpoena witnesses
Acquire evidence
Subpoena books and records
Administer oaths
Request an injunction
Go to court

May censure, place limits or suspend for up to 12 months, or revoke registration

Criminal penalties max fine of 10k and/or prison for 5 years max

Question 26

USA enforcement

Answer 26

Up to administrator

May take same actions

No max term on the suspension

Appeals are made through state court

Appeal for both is within 60 days

Max fine of 5k and 3 years prison
Prison only an option if offense is committed knowingly

Question 27

Covered Accounts

Answer 27

Accounts with BDs that:

• Permits multiple payments or transactions (not a business account)
• Any other account that exposes customer to more risk such as a margin account

Should have policy in place to identify customers

Question 28

Different types of authentication

Answer 28

Sing factor-(ID/password)
Dual factor- Key FOBS, secured IDs
Adaptive-factor- Challenge questions
Biometric Authentication- Fingerprint scan

Question 29

Regulation S-P

Answer 29

Requires safeguarding of identity information

Allows disclosure of non public info unless customer does not agree to disclosure

Gives customer 30 days to opt out

Relates to a customer (someone with ongoing business with firm)

Must provide reasonable opt out methods (writing a letter is not reasonable)

Only individuals are covered

Question 30

State vs FINRA Principal registrations

Answer 30

After passing the 66, technically you could go to the administrators office and become an IA

Could be opening your own firm or working as an IAR for all they know

Question 31

Business Continuity

Answer 31

Every IA shall establish, implement and maintain written procedures relating to a business continuity plan

Should include size of firm, types of service provided, number of location

Also includes:

• Protection of records
• Alternate means of communication with customers, employees, key personnel, service providers and regulators to relay important message
• Office relocation in event of need
• Assignment of duties in event of death
• Minimization of business disruptions

ALL SHOULD HAVE SUCCESSION PLAN

Question 32

Unit Test 1 First attempt

Review exempt transactions

66/80 or 82.5%

Answer 32

A -1
D
A
C
B
C
D
B
D -1 due to it being an accusation
B current assets only
D -1
A
A
D
B
C
A
B
D
D
A
D
C
C
C
B
D
B
D Think that Notice Filings are not ordered, therefore not right answer
C -1 (institutional clients are exempt transactions)
C -1 
B 1 year from effective date
D-1 
D -1
C
C
D
A
B
C
D
C
A
B
C
B
B -1 Still have jurisdiction even though the rep does not have to be registered to sell in the state cause client is visiting
A
C
C
C Notice on the day following and financial report day after that. Discretion is 10, custody is 35
B
B -1 Must notify if there is a partner change
C
D
B (amount of assets of private funds before needing to register is 150MM)
C
B
D
C
B
D -1(Definition of investment council) Investment council if rendering investment advice, and substantial part of business involves supervisory services
C
D -1 Advertising "for free" must be no strings attached, may ask but not obligate
B
A
C
B
D
C
A
C
D
C -1 Any change in advisory firm partnership must be notified
A
C
D
D
B
A