Chapter 7 - Communications with Clients and Prospects

Question 1

Disclosure essentially means

Answer 1

That you need to present your client with all material facts relating to the investment and need to make sure not to misrepresent or omit any material facts. (NOTE - it is ok to omit immaterial facts, just not material ones)

Question 2

Situations that require proper disclosures

Answer 2

• clients of an IA or IAR provided with reports prepared by someone else need to know that fact
• BDs that are under common ownership with an issuer must disclose that fact
• when a new security is on offer, BDs or Agents must provide prelim prospectus and/or final prospectus before purchase confirmation
• BDs must provide information clients are entitled to upon request and must respond to written requests and complaints
• compensation structures must be disclosed
• material conflicts of interest must be disclosed

Question 3

Material facts include

Answer 3

• the people and firms making transactions or providing advice
• securities or advice involved
• person’s role in a given transaction
• how the person is compensated

Question 4

Requirements for a client contract

Answer 4

• must be in writing
• outline all services to be provided
• must have a term limit
• must contain an advisory fee
• must include formula for calculating that fee
• specify amount of the fee to be returned if terminated early
• whether or not it grants discretionary authority over client portfolio
• can’t transfer contract to another person without client consent
• IA will not be compensated on losses/gains
• if IA is a partnership, must notify client if changes in partnership
• no language that waives client’s rights under Investment Advisers Act of 1940

Question 5

The following activities are explicitly declared fraudulent:

Answer 5

• Using advertising that doesn’t comply with Adviser Act of 1940
• Taking custody of funds without meeting safekeeping requirements
• paying cash for client solicitations (exceptions on another card)
• failing to disclose to a client all materials facts (detail on another card)

Question 6

Cannot pay cash for client solicitations, unless:

Answer 6

• solicitor is not subject to an order from the SEC and has not been convicted of a felony or relevant misdemeanor in last 10 years
• payment is based on a written arrangement
• compensation arrangement was disclosed to the client

Question 7

Fraud has been committed if you fail to disclose all material facts concerning:

Answer 7

• a financial condition that is likely to impair the adviser’s ability to meet obligations to clients
• a legal or disciplinary event that is material to the adviser’s ability to meet obligations to client

Question 8

Common categories of investment advisory fraud:

Answer 8

• direct theft
• self dealing
• ponzi scheme
• overstating assets

Question 9

Firms must adopt a standardized code of ethics. T/F

Answer 9

False, must come up with their own

Question 10

A firm must disclose its code of ethics in form _____

Answer 10

Form ADV Part 2A

Question 11

Access persons must report their securities holding to compliance within _____ days of becoming an access person and _______ thereafter

Answer 11

10 days, annually

Question 12

Access persons must report all securities holding EXCEPT

Answer 12

• gov’t securities
• money market instruments
• money market funds
• unaffiliated mutual fund shares
• unit investment trust securities which are invested exclusively in unaffiliated mutual fund shares

Question 13

Access persons must report an security transactions to compliance within _____ days of doing so

Answer 13

30 days

Question 14

Records of transactions by access persons must be held for ________ years

Answer 14

5 years

Question 15

Do NOT have to report access person transactions if they are associated with

Answer 15

• an automatic investment plan

- in an account they don’t control

Question 16

Specifically prohibited items for advertisements:

Answer 16

• testimonials about service
• references to past recommendations, unless they provide full list of recommendations for last 12 months
• any statement that implies that a formula, graph or chart can tell you when to buy a security
• any promises of free services, unless those actually are free
• any indication that the advertisement is approved of by the state admin or regulators
• false or misleading statements

Question 17

An IA’s website cannot contain customer testimonials, but a _____ website could

Answer 17

BDs

Question 18

For BDs that operate within a bank, the following rules apply

Answer 18

• BD should offer services in an area separate from the location of retail banking
• BDs name needs to be clearly stated where BD activity is taking place
• BD needs to distinguish their services from the bank’s
• BD must disclose orally and in writing that securities sold/purchased are not insured by FDIC, not guaranteed by the bank, and are subject to losses (should try to get a written consent to this from client)
• If a Rep of a BD makes reference to SIPC coverage, must clearly explain that to client
• Can use the following short hand versions (Not FDIC insured, no bank guarantee, may lose value)

Question 19

Any BDs or agents selling shares in an investment company (defined as unit investment trusts, open/close end mutial funds, and face amount certificates) must adhere to the following rules re: communication

Answer 19

• all sales charges must be disclosed to clients
• cannot call a fund “no load” or “no sales charge” if there is a charge up front, deferred fee, or marketing/service fee that exceeds .25% of the avg assets of the fund per year
• all discounts due to breakpoints need to be disclosed
• recommendation must be suitable to investor
• cannot recommend multiple investment companies with same objectives for purchase
• cannot recommend sale of current mutual fund for another if it is currently suitable
• cannot state mutual fund’s yield/income without also stating annual returns for 1, 5, 10 years
• cannot say that investing in an investment company is same as investing in a CD
• cannot make guarantees on credit quality or insurance
• can’t “sell dividends”
• cannot make unfounded future projections
• delivery of a prospectus is not “full and fair disclosure”
• can’t mark up or highlight a prospectus