Compensation

Question 1

Sharing Fees, or Commissions

Answer 1

In order for such sharing to be permissible, each agent must be registered with the state Administrator. In addition, each of the agents involved in the transaction must either be representatives for the same broker-dealer or be representatives for broker-dealers that are all controlled and/or owned by the same entity.

Question 2

Prohibited Sharing of Commissions

Answer 2

Agents may not share their commissions or any other form of compensation associated with the sale or purchase of a security with a customer or any other non-agent.

Question 3

Soft Dollar Compensation Agreements

Answer 3

The term “soft-dollar compensation” refers to the practice of broker-dealers providing services for which they would normally charge (such as research reports) for free to advisors in exchange for directing their business to that broker-dealer. These are referred to as directed transactions.

Under Section 28(e), it is legal for the advisor to accept soft-dollar compensation, but the fact must be disclosed to the client, the client must consent, and it must be listed on the advisor’s form ADV.

Question 3

Material Fact of Transaction Fees

Answer 3

The amount of any fees or commissions that an agent or broker-dealer charges in connection with a security transaction is a material fact. If the transaction will result in a charge of any type, the nature of that charge must be disclosed.

Question 4

Allowable Forms of Compensation

Answer 4

Investment advisers are generally prohibited from tying their compensation to the performance of their clients’ securities.

Under normal circumstances, investment advisers may be compensated in one of two ways: a flat fee for providing advice or a flat percentage of the assets in client’s investment portfolio to be paid at specific intervals (for example, annually or quarterly).

However, if the investment adviser serves institutional clients (for example, investment companies) or clients that either have a net worth of at least one and a half million dollars or that have at least seven hundred and fifty thousand dollars in an investment account with the firm, the investment adviser’s compensation for these clients may be based on performance.

Question 5

Charging Performance Based Fees

Answer 5

The person (legal or natural) must have at least $1 million dollars under management.

Have a net worth of $2 million dollars (joint holdings with spouses may be considered to meet this requirement).

Be a director or officer at the investment advisory firm that charges the fee, and have been employed in the securities industry for at least one year.

Question 6

Maintaining Custody of Client’s Assets

Answer 6

• Statements must go out to client’s at a minimum of quarterly

Question 7

Co-mingling of Client Securities

Answer 7

Prohibited

The Uniform Securities Act requires that all of the securities owned by a client (in the client’s name) be maintained in the client’s individual account.

The client’s securities cannot be kept in the firm’s own account even if records are kept that reflect the portion of the account that belongs to the client.

Question 8

Lending Money to Clients

Answer 8

First, investment advisers are permitted to loan money to a client if the investment adviser is a financial institution, such as a bank, that loans money as a standard part of its business.

Second, investment advisers are permitted to loan money to clients that are affiliated with the investment adviser.

Question 9

Borrowing Money from Clients

Answer 9

Investment advisers are permitted to borrow money from a client if the client is a financial institution that loans money as a standard part of its business (such as a bank). Investment advisers are also permitted to borrow money from a client that is a broker-dealer. Finally, investment advisers are allowed to borrow money from clients that are affiliated with the investment adviser.

Question 10

Matching Purchases

Answer 10

Matching purchases is a form of market manipulation and is prohibited by the Uniform Securities Act. Parties engaging in matching purchases are attempting to artificially increase the market value of a security.

In this case, the market manipulation occurs when parties agree to repeatedly buy and sell the same security or securities to create the illusion of substantial trading activity for the security or securitie

Question 11

Front Running

Answer 11

Front running is a form of market manipulation and is prohibited by the Uniform Securities Act. Front running occurs when a securities professional times investments for the securities firm in a manner that benefits the firm at the detriment of the firm’s clients.

For example, a large purchase or sale of shares in a particular security is likely to have an impact on the security’s market price. If a firm has a client that has requested that the firm sell a large number of the client’s shares in a stock, the firm cannot sell its own shares in the stock prior to selling its client’s shares.

Question 12

Backdating

Answer 12

Backdating any of the records associated with a transaction is strictly prohibited, as such tactics could be use to falsify the purchase or sale price of a security.

Question 13

Arbitrage

Answer 13

arbitrage occurs when a single party takes advantage of differing prices for the same security in different markets by buying the security in a market where it has a low price and then selling the same security in a second market where it has a higher price.

Question 14

Requirements for Discretionary Power

Answer 14

If the client’s authorization of discretionary authority is provided verbally, the investment adviser is required to secure written authorization from the client within ten business days once the investment adviser has exercised its discretionary power.

Question 15

Fiduciary Responsibilities

Answer 15

Although both broker-dealers and investment advisers are required to act ethically at all times, the fiduciary responsibilities of an investment adviser means that investment advisers cannot promote their own interests above the interests of their clients.

Question 16

Third Party

Answer 16

Investment advisers may accept orders from third parties, but the investment adviser must have written authorization from the client in order to do so.

Question 17

Private Information

Answer 17

In order to ensure that investment advisers keep all such nonpublic information private, investment advisers must have written policies and procedures in place that outline the methods the investment adviser will use to ensure that it does not disclose nonpublic information.

Investment Advisers may not disclose this information without written consent from the client or legally ordered to do so.

Question 18

Investment Advisory Contract Standards

Answer 18

Investment advisers must ensure that each investment advisory contract complies with minimum standards. Investment advisory contracts must outline each of the services that the investment adviser will provide to the client.

• How fees will be calculated
• How fees will be refunded
• The term of duration
• Any discretionary authority
• Prohibited from assigning the contract to another party without the client’s approval

Each of these requirements applies to each new, extended, or renewed investment advisory contract.

Question 19

Investments not Considered Securities

Answer 19

Investment options offered by banks, such as certificates of deposit (CDs) insured by the FDIC, are not securities.

Insurance companies also offer a number of investment options that are not considered securities, including fixed annuity offerings and various forms of life insurance (including term life insurance, whole life insurance, endowment life insurance and universal life insurance).

Commodities such as gold or wheat that trade on a futures market are also excluded from the definition of securities.

Question 20

Custody of a Client’s Funds

Answer 20

Adviser must have a qualified custodian to maintain and hold the securities and funds. They must be in a separate account and not included with other client funds.

Must receive quarterly statement from custodian, or adviser. Statement can be sent to third party if requested.

Question 21

Insider Trading and Securities Fraud Enforcement Act of 1998

Answer 21

The Insider Trading and Securities Fraud Enforcement Act of 1988 (also known as ITSFEA) is federal legislation that established more severe penalties for persons engaging in securities transactions based on material inside information.

This act expanded the definition of the term inside information to include scenarios that were not contemplated under the Securities Exchange Act of 1934.

Question 22

Possible Money Laundering Activity

Answer 22

If the broker-dealer knows that money involved in the transaction is the result of criminal activity or that the transaction is intended to disguise illegal activity, the transaction must be reported.

If the broker-dealer would be required to engage in criminal activity in order to complete a requested transaction, it must be reported.

If the broker-dealer is aware that the purpose of the transaction is to circumvent the provisions of the Bank Secrecy Act, the transaction must be reported.

The last red flag requires the broker-dealer to consider the purpose that will be served by the transaction. If the broker-dealer cannot identify a legitimate purpose for a particular transaction based on available facts, the transaction should be reported as suspicious.

Question 23

Fraud by Ommission

Answer 23

Omitting a material fact is a fraudulent act. Fraud by omission occurs when a person knowingly fails to share information with a client when the information in question is likely to have an impact on the client’s investment decision.

Question 24

Sharing Profits and Losses with Clients

Answer 24

Asa general rule can’t share in the profits and losses with clients.

Exceptions:

If an agent obtains prior approval from a client in writing and shares ownership of an account with a client, the agent may share profits and losses associated with the joint account with the client

In this situation, profits and losses for the joint account are shared based on the percentage of account owned by each party.

Although agents are permitted to have joint accounts with their clients under the circumstances described above, broker-dealers are not.

Broker-dealers are prohibited from establishing joint accounts with their clients.

Question 25

Rumors

Answer 25

Agents making investment recommendations to clients must base their recommendations on verifiable facts. The Uniform Securities Act prohibits agents from making investment recommendations that are based on rumors.

Question 26

Resolution to Problems

Answer 26

If a client provides a written complaint to an agent, the agent is obligated to provide the written complaint to their employing broker-dealer. Failure to do so is a violation of the Uniform Securities Act.

The Uniform Securities Act also prohibits professionals in the securities industry from trying to get a client to sign a waiver that would prevent the client from entering into litigation in the event the securities professional engages in an illegal activity.

Question 27

Acting as a Principal in a Transaction

Answer 27

Investment advisers are required to notify their clients any time the investment adviser (or investment adviser representative) is a principal for any recommended security transaction

In other words, the investment adviser must inform their client if the investment adviser actually owns the security it recommends to the client or will buy the security it recommends the client sell.

Investment advisers are permitted to act as a principal in this manner; however, the client must be informed prior to the transaction and must acknowledge and approve of the investment adviser’s capacity in the transaction in writing prior to the completion of the transaction.

Question 28

Agency Cross Transactions

Answer 28

In some instances, an investment adviser may act as an adviser and a broker for the same transaction. This activity is referred to as an agency cross transaction.

When an investment adviser engages in an agency cross transaction, the investment adviser is compensated for two activities: providing investment advice and acting as a broker for the actual transaction.

Must notify client of this conflict of interest in writing for approval.

Investment Adviser is prohibited from representing both the buyer and the seller.

The investment adviser must track all agency cross transactions and provide an itemized statement of these transactions on an annual basis.

Question 29

Client Confidentiality

Answer 29

No information on the client’s identity, or their investments.

Two exceptions:

1. Client authorizes the information to be released to third party.
2. If the investment adviser is legally ordered to release the information. This exception normally occurs as the result of a subpoena for information.

Question 30

Excessive Mark Up of Security

Answer 30

not always considered an act of fraud

The excessive markup of a security is considered a fraudulent act only in instances in which the person performing the markup intentionally and attempted to mislead clients regarding the markup.

Question 31

False or Misleading Statements

Answer 31

Fraud only occurs when a person intentionally attempts to mislead

Question 32

Segregation of Client’s Accounts

Answer 32

A broker-dealer must segregate client accounts appropriately. Broker-dealers may not place securities that are owned by a client in the firm’s own account.

Instead, client-owned securities must be placed in a separate client account.

Must also segregate Free Securities. Free securities are any securities in a margin account that are not collateral for the margin loan.

Question 33

Make Available Securities That Are Allotted for Distribution

Answer 33

If a broker-dealer is allotted a specific quantity of a security for distribution, the broker-dealer must make the entire allotment available under a bona fide public offering.

This requirement applies whether the broker-dealer is itself an underwriter or a member of the selling group, or if the broker-dealer has merely acquired the security from another party that is an underwriter or member of the selling group for distribution.

Broker-Dealer may not hold on to these securities, but needs to make them available.

Question 34

Disclosure of Relationships Between Broker-Dealer and Issuer of a Security

Answer 34

Broker-dealers must ensure that clients are informed of certain relationships between the broker-dealer and the issuer of a security.

If a broker-dealer controls the issuer of a security, is controlled by the issuer of a security, is affiliated with the issuer of a security, or is controlled by an entity that also controls the issuer of a security, the broker-dealer must disclose this information to its clients prior to initiating any sale or purchase of the security on behalf of the client.

The initial disclosure may be made verbally. However, if the initial disclosure is made verbally, a written disclosure must follow and must be provided to the client by the time the security transaction is complete.

Question 35

Borrowing and Lending Practices

Answer 35

In short, an agent should not perform the functions of borrowing, lending, and protecting a client’s funds or securities.

Question 36

Suggestions of Excessive Trading

Answer 36

Investment advisers must not attempt to persuade their clients to engage in trading practices that are unnecessarily large or frequent.

This prohibition applies whether an investment adviser is making trade recommendation to its client or is actually using the discretionary power granted by the client to make trades.

Question 37

Disclosure of Potential Conflict-of-Interest Situations

Answer 37

Investment advisers must provide written notification to their clients of any material conflict of interest that the investment adviser or any of its employees have that could hinder the investment adviser’s ability to provide objective and unbiased investment advice.

Investment advisers must provide the written notification of the conflict of interest to their client or clients before providing any investment advice related to the conflict of interest.

Question 38

Prohibited and Fraudulent Business Practices

Answer 38

Under the provisions of the Uniform Securities Act, all fraudulent business practices are prohibited; however, not all prohibited business practices are considered fraudulent. A fraudulent business practice occurs in instances where a person intentionally acts in a deceptive or misleading manner.

The Uniform Securities Act prohibits persons engaged in securities transactions from conducting themselves unethically, even if the unethical behavior does not involve any attempt to deceive.

Question 39

Insider Trading

Answer 39

The term “insider trading” refers to an individual with “inside” knowledge of a publicly traded company capitalizing on the knowledge to make money. The only instance in which this is legal is when the knowledge that the insider has is publicly available.

Additionally, inside traders can be compelled to pay up to three times the amount of money made or three times the amount of loss avoided associated with their inside trading transaction.

Question 40

Selling Away

Answer 40

Selling away refers to registered individuals making securities transactions somewhere other than the broker-dealer with which they have agency. It is sometimes referred to as “selling off the books.”

In short, securities transactions by agents must be recorded in their broker-dealer’s records. Selling away is generally a prohibited practice, as it may breach their contract with their current broker-dealer and assist with a registered individual’s attempt to transact fraudulently.

The term “selling away” covers all securities transactions, and exceptions are not made for private offerings and personal transactions.

For registered individuals to execute a legal sold-away transaction, they must obtain express permission in writing from the broker-dealer that they currently represent.

Question 41

Client’s Rights of Recovery

Answer 41

If the Administrator agrees with the client, he or she may order that the client be refunded the cost of the advice, any losses associated with the advice, a fair interest rate (to be set by the Administrator) on the initial investment , and any legal or court costs associated with the claim (within reason).

It is important to note that only when improper securities are sold may the purchaser recover the purchase price.

If improper advice is given, the purchaser may only recover the cost of the advice plus any losses incurred due to the advice, but not the original principal.

Question 42

Cyber Security