Chapter 3 Part 2 Flashcards
Principal or Agency Transactions (State and Federal)
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
Advertising under the USA and SEC
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
Unlawful advertisements
- 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
Investment Advisory Contacts (State and Federal)
3 Main differences between state and fed:
- Must be in writing for State (could be oral for SEC)
- Must be competitive for state, only reasonable for SEC based on services
- 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
Investment advisory contract strictly State
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
- Where relevant, the advisor may receive increased comp on unrealized and realized gains
- Periods used to evaluate performance and how it effects fee
- Index to be used to compare returns
Fulcrum Fee
Outperform index by 5% over a set period, adviser would receive a fee increase
Underperform you could lose the same amount
Assignment
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
Agency Cross Transactions
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
Cash Referral Fees (SEC)27g
Must meet 4 criteria under SEC
1. Must be registered under the investment advisers act
- Cannot be subject to a statutory disqualification
- Must have a written agreement in place
- 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
Cash Referral Fees (State)
Solicitor must be registered as an IAR
Does not have to be strictly for the IA that you are under (weird)
Cash Referral Fee (both)
May pay for referrals from lawyers, accountants or insurance agents
Size of payment cannot be based on assets brought in though
Fraudulent or Prohibited Practices When Providing Investment Advice
- 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)
Investment Advisers Act of 1940 makes it unlawful to provide advice to clients unless you
- Adopt written policies an procedures to prevent fraud
- Review policies no less than annually
- Designate a supervised individual to administer
Section 28 (e) of SEC Act of 1934
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
Item 12 of Part 2A of form ADV
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
28 (e) Safe Harbor vs out
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
Client Referrals
If an IA receives a referral from a BD in exchange for business, must be disclosed
Directed Brokerage
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
Trade Aggregation and Allocation
Making one large trade to save on cost
If trade cannot be done at one price, must average
Voting Client Securities
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
Compliance Programs
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
SEC minimum compliance guidelines
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
Political Contributions by IAs (Pay to play)
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
Limit on Exceptions
IA with over 50 employees, permitted 3 exceptions within calendar year
50 or fewer, permitted 2
Enforcement of Invetment Advisors Act of 1940
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
USA enforcement
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
Covered Accounts
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
Different types of authentication
Sing factor-(ID/password)
Dual factor- Key FOBS, secured IDs
Adaptive-factor- Challenge questions
Biometric Authentication- Fingerprint scan
Regulation S-P
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
State vs FINRA Principal registrations
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
Business Continuity
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
Unit Test 1 First attempt
Review exempt transactions
66/80 or 82.5%
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
