Part 1 Laws, Regs, Guidelines (Units 1-7)

Question 1

Which of the following powers are under the jurisdiction of the Administrator?
A) Issuing a final order suspending the registration of a person as long as, upon written request, a hearing will be granted in no more than 15 days
B) Performing an annual audit of broker-dealers registered in the state
C) Issuing a cease and desist order to an agent without any prior notice
D) Performing an annual audit of investment advisers registered in the state

Answer 1

Whenever it appears to the Administrator that any person has engaged, or is about to engage, in any act or practice constituting a violation of any provision of the USA or any rule or order hereunder, he may in his discretion issue a cease and desist order, with or without a prior hearing against the person or persons engaged in the prohibited activities, directing them to cease and desist from further illegal activity. Any person aggrieved by a final order of the Administrator (that means after the hearing has taken place) may obtain a review of the order in the appropriate court by filing a written petition in court, within 60 days, not 15, after the entry of the order. Broker-dealers and some IAs have to file annual audited financials with the Administrator, but the audit is conducted by an independent accountant, not the Administrator.

Question 2

The USA defines an IA representative as:

Answer 2

The Uniform Securities Act defines an investment adviser representative as anyone who is a partner, officer, director, or other employee or person associated with an investment adviser other than clerical or ministerial personnel who (1) make recommendations or provide advice regarding securities; (2) manage accounts or portfolios of clients; (3) determine which recommendations or advice should be given; (4) solicits, offers, or negotiates for the sale of, or sells, advisory services; or (5) supervises any such persons. An individual or a firm may be registered as an investment adviser, but only an individual can be an investment adviser representative.

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Question 3

Is a solicitor for an IA required to be an IAR - For Federal covered and state?

Answer 3

Under federal regulations, if an investment adviser intends to pay a third party (nonemployee) solicitor to solicit clients for investment advisory services, the adviser must be properly registered, there must be a written agreement between the adviser and the solicitor, and there can be no outstanding or pending orders or disciplinary actions against the solicitor involving finance or dishonesty. The solicitor does not have to be registered as a registered investment adviser representative because he is not representing the registered investment adviser in the giving of investment advice, in the management of accounts, or in the supervision of anyone else working for the registered investment adviser in these areas. The solicitor is being paid a fee for the solicitation of business for the registered investment adviser with a requirement of full disclosure to the client of the relationship with the adviser.
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FOR STATE - in States - yes solicitors register as IARs

Question 4

What is custody (u7lo2)

Answer 4

As an IA, you may have custody of client funds or securities only if: you have a qualified custodian, you give notice to your clients promptly when account is opened, acct stmts are delivered to clients, you notify Administrator promptly in writing on Form ADV that the IA has custody. (BD are not constrained by this rule, they must only provide receipts anytime they accept customer assets.
CUSTODY means holding client funds or securities or having any authority to obtain possession of them

Question 5

Which of the following statements is TRUE regarding the civil liability provisions of the Uniform Securities Act?

A) If the registration statement contains misrepresentations that were made deliberately, criminal penalties, in addition to civil ones, may be levied.
B) Only those who actually signed the registration statement are exposed to potential liability.
C) Purchasers may waive their rights to suit under the civil liability provisions if done so by the purchase contract.
D) The statute of limitations for civil suits is 3 years from the date of discovery.

Answer 5

A
Under state law, civil suits must be filed within 2 years of the date of discovery of the improper action or 3 years after the sale, whichever comes sooner. Purchasers may not waive their rights under the act for any provision. Although those who signed are liable, there is a list of others who also might be, including members of the board of directors, legal counsel, accountants, et cetera.

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Question 6

What is the effective date for registration of IA’s for state and fed?

Answer 6

Registration with the SEC takes effect on the 45th day after filing a complete application. And in the case of state registration, as will all securities professionals, at noon on the 30th day.

Question 7

What are economic lagging indicators?

Answer 7

Average duration of unemployment, Ratio of consumer installment credit to personal inc, ratio of mfg and trade inventories to sales, avg prime rate, change in CPI for services; total amt of commercial and industrial loans, change in index of labor cost per unit of output

Question 8

When can IA fees be based on performance?

Answer 8

indiv/compay with at least $1M under management;or a net worth (excluding residence for indiv) in excess of $2.1M; or a director of IA or IAR employeed at least 12 months. And the performance base must go either way - gain or loss (net performance).

Per Kaplan: An investment adviser may enter into, extend, or renew an investment advisory contract that provides for compensation to the investment adviser on the basis of a share of capital gains upon or capital appreciation of the funds, or any portion of the funds, of the client if the client entering into the contract is:

a natural person or a company who, immediately after entering into the contract, has at least $1 million under the management of the investment adviser; or
a person who the investment adviser and its investment adviser representatives reasonably believe, immediately before entering into the contract, is a natural person or a company whose net worth, at the time the contract is entered into, exceeds $2,100,000.
Do not be confused by thinking this is an institutional client (a registered investment company)—they need at least 100 investors and registration with the SEC.
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Question 9

What are USA exempt transactions?

Exempt Transaction is a verb (action) vs. exempt security is a noun

Answer 9

1. unsolicited brokerage transaction
2. Isolated nonissuer transactions (very few per year, # varies by state), do not involve securities professionals (like for sale by owner in real estate)
3. Underwriter transactions (between issuer and BD performing in capacity of an underwriter)
4. bankruptsy, guardian, or conservator transaction (but not UGMA or UTMA)
5. Institutional investor transactions (banks, insurance co, investmt co)
6. Limited offering transactions - private placement directed at not more than 10 persons (offerees) in previous 12 months, provided all the nonistitutional buyers purchase for investment purposes only, no commissions or remuneration is pa id for soliciting, no general solicitation or advertising is used.
7. Preorganization certificates (exempt if no commission for solicitation, the number of subscribers does not exceed 10, no pymt made by any subscriber) (this tool just postpones registration)
8. Transactions with existing security holders of the issuer as long as no commission paid (holders of convertible securities, rights, or warrants)
9. Nonissuer transactions by pledgees.

Question 10

What are the termination procedures for an IAR?

Answer 10

If an IAR terminates employment with an IA, notification requirements depend on how the IA is registered.
If the IA is state registered, then the firm notifies Administrator. If the IA is Fed registered then the IAR notifies the Administrator. In either case, notification must be promptly.
hint: visualize the I in IAR as #1. Only 1 notifies the administrator.

Question 11

Define Investment Advisor and describe what it means to be excluded or exempt?

Answer 11

Person (individual, corporation, partnership, association, trust, organization, government) (3 NON-PERSONS = minor, deceased, mentally incompetent) who engages in
–business of advising others on investments,
–for compensation,
–part of regular business
(3 prong)

The definition includes

• -financial planners,
• -pension consultants who advise employee benefit plans, sports and entertainment representatives who provide financially related services.

EXCLUSIONS (for persons who meet 3 prong test but by law are excluded from definition. If excluded, that person is not subject to provisions of Inv. Advisors Act or USA. EXEMPTIONS means not being subject to the registration provisions of the acts even though that person meets the definition.

Question 12

Under the NASAA Model Rule on Custody Requirements for Investment Advisers, an adviser who has custody of client securities or funds must
submit to a surprise audit of client accounts by an independent accountant each year
provide an audited balance sheet to the Administrator each year and include a balance sheet with his disclosure statement (brochure) to all prospective clients
send monthly statements to clients on the status of their accounts
A) II and III
B) I, II, and III
C) I and II
D) I and III

Answer 12

C
An adviser who has custody must submit to an annual surprise audit by an independent accountant and include an audited balance sheet with Part 2A of Form ADV, which must be filed with the Administrator and also forms the basis of the information that must be contained in the disclosure brochure. Other requirements include segregation of client securities, deposit of client funds into separate bank accounts, written notification to clients of the location of their property, and quarterly (not monthly) reports to clients on their accounts.

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Question 13

What are coincident or current economic indicators?

Answer 13

Non-ag employement, Personal income (minus SS, veteran benefits, welfare), industrial production, manufacturing.

Question 14

What are State (USA) requirements for registering securities

Answer 14

Per USA, must register securities unless:

1. Exempt security
2. Exempt transaction
3. Federal covered security

Question 15

Do BDs need to disclose their capacity? If so, how and when?

Answer 15

A BD can act in principal or agency capacities. U6lo1. In principal capacity the BD is the contra-party to the transaction = other side of the trade with the client. Agency - just matching up buyer and seller.
BDs must always indicate their capacity on the trade confirmation, sent no later than the settlement date (completion of the trade). They will indicate if they acted as broker and disclose amount of commission or as principal and may have to under some circumstances disclose amount of markup.

Question 16

What are requirements with regard to disclosure of capacity by IAs?

Answer 16

They are in business of giving advice not executing securities transactions - that is the business of BDs. But on rare occassions they might buy from or sell to an advisory client (acting as principal) or put together a buyer and seller (acting in capacity as agent). This is not prohibited but there are additional disclosure and consent requirements:
Client receives full disclosure in the capacity for which the IA proposes to act and client gives consent.
Consent can be oral or written and can be before or after execution of the trade, but must be done prior to completion of the transaction. Completion is considered the day the trade settles which currently is second business day after the trade is made.
NOTE: this is only applicable if the IA is receiving compensation for acting as broker/agent (other than IA fees). It is the compensation that creates the conflict of interest. If IA is also BD and transaction was not a result of advisory advice then they were acting as BD not IA.
WHEN IA ACTS AS AGENT FOR BOTH SIDES OF THE TRADE = CROSS AGENCY TRANSACTION:
Written consent must be received prospectively (in advance) and disclosure that IA receives commissions from both sides, potential conflict of interest, NO TRANSACTION WHERE IA or control persons RECOMMEND TRADE TO BOTH SIDES, arrangement can be terminated, annual statements,

Question 17

What does it mean to be excluded or exempt from definition of IA and What are the exclusions and exemptions?
EXCLUSIONS: 7 Exclusions under USA and under 5 exclusions under Investment Advisors Act 1940.
EXEMPTIONS: Federal (Inv Advisors Act 1940) versus State Law (USA)

Answer 17

EXCLUSIONS (for persons who meet 3 prong test but by law are excluded from definition. If excluded, that person is not subject to provisions of Inv. Advisors Act or USA. EXEMPTIONS means not being subject to the registration provisions of the acts even though that person meets the definition.

EXCLUSIONS under USA (7):

• -bank, bank holding company, savings institution, trust company (not credit unions, not Svgs and Loan Associations, and not IA subsidiaries of holding companies)
• -LATE lawyer, accountant, teacher, engineer whose advice is solely incidental to their practice.
• -BD and agents whose advice is solely incidental to conduct of its business as a broker-dealer, with no special compensation like a wrap fee program)
• -Publishers may qualify: general and impersonal nature, not promotional material.
• -IARs
• -federal covered adviser
• -anyone Administrator specifies.

EXCLUTIONS UNDER Inv Advisers Act 1940:

• -the same first 4
• -any person who advice relates only to securities that are direct obligations of or guaranteed by the US.

EXEMPTIONS Fed Law (Inv Advisors Act 1940) exempts the following who are defined as IAs but exempt from registration requirements of the act:

• –Intrastate Advisers (only w/in one state). only works with residents of the state an no advice dealing with securities listed on any national exchange.
• –Advisers to Insurance Companies
• –Private Fund Advisers (Dodd Frank Act 2010)
  
  • -advisers solely to private funds with less than $150M AUM.
  • -non-US advisers with no place of business in US and minimal AUM (less than $25M) attributable to US clients
  • -advisers solely to venture capital funds.

EXEMPTIONS State Law (USA) exempts the following who are defined as IAs but exempt from registration requirements of the act:

• –those who have NO place of business in the state but are registered in another state provided their only clients are:
  
  • -BDs
  • -other IAs
  • -Institutional Investors (=banks, trust companies, Svgs and Loan Assoc., insurance co. investment co (mutual funds), employee benefit plans with assets not less than $1M, and government agencies.)
  • -existing clients temporarily in the state
  • -limited to 5 or fewer clients resident in state during 12 preceding months - de minimus exemption
  • -any others the Administrator exempts by rule or order

Question 18

The SEC has enumerated specific items that must be included in Investment Adviser written compliance manuals EXCEPT

A)
the advisory firm must review policies and procedures at least on an annual basis
B)
the advisory firm should implement procedures for allocating investment opportunities such as best executions among clients
C)
the advisory firm should indicate the educational requirements necessary for employment
D)
the advisory firm must monitor the consistency of portfolios with guidelines established by clients, disclosures, and regulatory requirements

Answer 18

C
Guidelines under SEC rules require (at minimum) that the chief compliance officer of each federal covered investment adviser conduct an annual review of its compliance procedures. Among the duties of the compliance officer is to monitor the consistency of portfolios with guidelines established by clients, disclosures, and regulatory requirements. The firm should implement procedures for allocating investment opportunities such as best executions among clients. If the firm does have internal educational requirements, that would be found in its HR manual, not in its compliance manual.

Question 19

What is Regulation S-P

Answer 19

Collecting and protecting client information from identity theft. Think S-ecurity and P-rotection to remember

Question 20

Which of the following transactions would NOT be exempt under the Uniform Securities Act?
A) A registered dealer sells Canadian government securities to a retail client.
B) The executor of an estate sells securities to liquidate the property.
C) Securities are sold that were collateral for a defaulted loan.
D) A customer calls his broker-dealer and submits an order to purchase a specific security.

Answer 20

A
Unsolicited, nonissuer transactions (customer calls the broker-dealer to order or sell a security) are exempt transactions, as are fiduciary transactions to liquidate estates or receiverships by guardians, executors, administrators, trustees in bankruptcy, or conservators. Sales of securities that had been pledged as collateral for a defaulted loan are also exempt transactions. The sale of Canadian government securities by a registered dealer represents a security that is exempt under the Uniform Securities Act, but the transaction itself is not.

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Question 21

Fed exemptions from BD registration

Answer 21

Only if BD conducts all business in one state and no trading on a national securities exchange. Just intrastate and they register in the state in which they are located.

Question 22

3 Methods of State Registration of Securities

Answer 22

notice filing (for Federal covered securities, mostly investment companies. Just for state to collect fee), coordination (most common for those securities that are not Federal covered, like OTC. Coordinating Federal registration with State registration), and qualification (Securities not eligible for registration any other way).

Question 23

What are the exemptions from registration as an IAR?

Answer 23

3 different exemptions: 2 for those who represent state registered IAs and 1 for fed covered IAs.
For those representing state registered IAs:
1. De Minimus: If IAR does not have place of business in the state AND during preceeding 12 months has no more than 5 retail clients in that state.
2. Snowbird exemption
For those representing Fed covered IAs:
203a of 1940 Act. Only register when IAR has a place of business.

Question 24

What is a guaranteed Security?

Answer 24

Where a party other than issuer guarantees pymt of principal and interest or dividend. THERE IS NO GUARANTEE ON PERFORMANCE OF INVESTMT (gains cannot be part of guarantee).
Performance guarantees are prohibited.
(there are some very limited exceptions)

Question 25

define agent

Answer 25

Only a natural person. An individual who represents a BD or issuer in effecting purchases or sales of securities on behalf of others.

Question 26

A pension consultant who advises corporate retirement plans with assets of $135 million must register with which of the following?

A) Both the state and the SEC
B) The state
C) Either the state or the SEC
D) SEC

Answer 26

B
Under the Dodd-Frank Bill, until a pension fund manager has at least $200 million in AUM, registration with the states is required. Once the $200 million level is reached, SEC registration becomes an option.

Question 27

What are procedures for any material changes in Form U4?

Answer 27

If there are any material changes to U4 like change of permanent address, the U4 amendment must be filed within 30 days.
U5 is for terminations.

Question 28

Defalcator Investment Planning (DIP) has $175 million in AUM and has offices in States A, K, and R. DIP would be required to provide a balance sheet as part of its brochure if it charged fees of

A)
$600 for the next 6 months of advisory service.
B)
$1,500 for the next year’s advisory service.
C)
$1,500 for the next 3 months of advisory service.
D)
$1,200 for the next 6 months of advisory service.

Answer 28

Federal covered investment advisers, who charge substantial prepayment of advisory fees, must include a balance sheet with their brochure. The definition of a substantial prepayment is: more than $1,200, 6 or more months in advance. The correct choice is the only one meeting both requirements. Remember, it isn’t $1,200 or more, it is more than $1,200 and it must be for at least 6 months of service to count. Please notice that with $175 million in AUM, DIP must be SEC registered; the location of its offices is irrelevant to the question.

Question 29

Under the Investment Advisers Act of 1940, which of the following is considered an investment adviser?
A) A person who publishes a regular newsletter of advice on U.S. Treasury bonds and other U.S. government securities
B) A syndicated columnist who gives weekly reports and recommendations on investments
C) The trust officer of a commercial bank who manages investment accounts for clients
D) A lawyer who specializes in consulting on investing in securities

Answer 29

D
Publishers and writers of general, regular, paid circulation publications (newspapers and magazines) are excluded from the definition of investment adviser. Under the federal law, anyone giving advice dealing only with U.S. government securities is excluded from the definition, as are those who work for banks and trust companies. The lawyer is not excluded because the advice provided is not incidental to the profession; it is the lawyer’s specialty.

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Question 30

IA’s organized as partnerships with changes in partners

Answer 30

An adviser that is a partnership must notify its clients of changes in a minority of the partners within a reasonable period of time. If it is a majority or material change in partners, it is treated as an assignment and would require consent of the clients.
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Question 31

BD Registration

Answer 31

SEC and
Under the Uniform Securities Act, broker-dealers must register in any state where they engage in securities transactions with individual investors. If they have a place of business in the state regardless of the nature of their clients or if they have even one retail client in the state. see p50.

No state registration needed: Broker-dealers with no offices in the state who engage in transactions in the state with certain institutional investors, such as insurance companies or investment companies, need not register in that state. Transactions between the issuer and a broker-dealer are exempt transactions.
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Question 32

What is UPIA and what does it stipulate?

Answer 32

The Uniform Prudent Investors Act
The UPIA specifically uses the terms, skill and caution, when describing the actions of the fiduciary. Other components of the UPIA state that, rather than viewing individual securities, the overall effect on the entire portfolio is considered. This means that high-risk securities can have a place, as long as the overall portfolio meets the objectives. That is the benefit of diversification, something that is considered essential to prudent investment of money belonging to others.

Question 33

Where do IAs, RIAs, BDs, Agents register - Fed or State?

Answer 33

IAs: Federal (SEC) or state but never both
IARs: State only
BDs: Fed (through FINRA) and State
Agents: Fed (through FINRA) and State

Question 34

Under the NASAA Statement of Policy on Unethical or Dishonest Business Practices of Broker-Dealers and Agents, in which of the following situations has an agent acted properly in placing an order for a client’s account?

1.The client agrees with an agent’s recommendation of a particular security and the amount that should be purchased. The client then tells the agent to proceed with the purchase when the timing seems best. Because the market as a whole is dropping, the agent waits two weeks until the economy looks brighter before making the purchase. The agent does not have written discretionary authority.
2. The agent obtains written discretionary authority to manage the client’s account. The agent then proceeds to restructure the entire account without further consultation with the client.
3. The agent obtains an existing client’s oral agreement that shares of XYZ fund are a good buy right now. The client gives the agent oral authority to determine how much of his account should be allocated to XYZ shares. Without written discretionary authority, the agent places an order.
4. A client supplies the agent with written trading authorization. The client proceeds to request the agent to purchase $7,000 of any ADR that would be appropriate for the account. The agent goes ahead and purchases $7,000 of a Taiwanese computer chip company’s ADRs.
A) II and IV
B) II and III
C) I and IV
D) I and III

Answer 34

Written authority is necessary to restructure an account without client consultation. This is one of the benefits of a discretionary account; the flexibility it gives to the agent. Once the client has supplied the written authorization, the agent has the ability to select any or all of the asset, the action, or the amount. When the client says, “Buy $7,000 worth of an appropriate stock,” the amount and the action have already been determined; all the agent has to do is select the asset. Authority to use discretion may be given orally if the discretion relates only to the price or the time at which an order regarding a specified amount of a particular security will be executed, but time and price discretion is only good for that day. Oral authority is not sufficient when the agent is using discretion to determine the amount of a security to be purchased.

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Question 35

Current Yield Formula

Answer 35

annual dividends per share DIVIDED BY market price of stock per share

Question 36

If an investment adviser files an initial registration with a state on June 30, which of the following statements regarding the filing fee to be paid is TRUE?
A) The full year’s fee must be paid.
B) The fee will be prorated from the effective date.
C) The fee will be prorated from the filing date.
D) No filing fee is required until December 31.

Answer 36

A
While some states make exceptions for filings late in the year, under the USA there is no pro rating of filing fees. The full year’s fee must be paid with the initial registration request.

Question 37

Under NASAA’s Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers, which of the following must be included in an advisory contract?

1, Whether the contract grants discretionary power to the adviser

2. The term of the contract
3. A clause preventing assignment without consent
4. The formula used for computing the fee

A) I, II, and IV
B) I, II, III, and IV
C) II only
D) I and II

Answer 37

B
Written advisory contracts must disclose services provided; the term of the contract; the amount of the fee or the formula used to compute it; the amount of fee to be refunded, if any, if the advisory fee is prepaid and the contract is terminated; provisions as to whether the adviser has discretionary authority and to what extent; and provisions requiring consent of the client to assign the contract.

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Question 38

Are Investment Advisers and reps as well as BD and reps fiduciaries

Answer 38

Unlike BDs and their reps, IAs and their IARs have a fiduciary responsibility. (that’s why IAs/IARs need client consent when they act as principals or agents in trades)

Question 39

What does jurisdiction mean and Under what circumstances does the Administrator have legal jurisdiction?

Answer 39

• -Jurisdiction under the USA means that the Administrator has legal authority to regulate securities activities that take place in their state.
• -any offer to buy/sell a security as well as accept an offer, if the offer:
  
  • -originated in the Administrator’s state
  • -directed to the Administrator’s state
  • -accepted in the Administrator’s state

Question 40

What is a security

Answer 40

These 6 items are NOT: any life insurance products that are not variable; interest in a retirement plan (IRA or 401k, etc); collectibles; commodities such as precious metals grains, incl futures and forwards; condo for persona residence; currency

Question 41

What is a CEF Closed End Fund

Answer 41

A mutual fund that raises capital by issuing common stock. More like a corporation. Can issue bonds too. The capitalization is fixed unlike open end fund.

Question 42

Time period for maintaining records

Answer 42

IA: Readily accessible for 5 years. 1st 2 years at principle office per Inv. Adv. Act 1940 and NASAA Model Rule. Fed and states are almost identical but Fed registered follow SEC rules; state registered follow state rules

Question 43

Who is excluded from definition of agent

Answer 43

1. clerical and admin - as long as they do not take on any securities-related functions.
2. When representing issuers in effecting transactions:
   a. in certain exempt securities (securities issued/guaranteed by USA, state, or political subdivision or Canada, province or political subdivision; foreign govt securities with which USA has diplomatic relations; securities issued by a US bank, savings, trust co.; commercial paper rated in top 3 categories with denominations of 50K or more with maturities of 9 mo or less; investment contracts for employee stock purchase, svgs, pensions, or profit sharing)
   b. exempt from registration (unsolicited brokerage transaction; transactions between issuer and underwriters; transactions with financial institutions; private placements)
   c. with existing employees/partners/directors of issuer IF NO sales related commission is paid for soliciting.

Question 44

Requirements for IAs with regard to changes in ownership

Answer 44

1. Partnerships: Notify clients if a change involving minority of partners.
2. Corps: Do not need to notify for changes in shareholders
3. IAs may only assign contracts with client permission: partnerships where there is a change in majority ownership and corps where they pledge a majority of stock as collateral for a loan.

Question 45

The Uniform Securities Act requires that a consent to service of process be filed for the registration of

trustees
issuers
investment advisers
broker-dealers
A)
III and IV
B)
I and II
C)
II and IV
D)
I, II, III, and IV

Answer 45

A
The state securities Administrator has jurisdiction over investment advisers, broker-dealers, and any who are associated with those entities. Issuers don’t register; it is their securities that do. The Administrator may have jurisdiction over securities offered for sale by a company in the Administrator’s state and generally requires a consent to service of process for a securities registration.

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Question 46

what is structuring?

Answer 46

Currency Transaction Reports (CTRs) are filed on FinCEN Form 112 for each cash transaction that exceeds $10K. If one designs deposits to fall under the $10k radar this is structuring, a prohibited practice.

Question 47

In addition to the normal required filings, an investment adviser who maintains custody of client funds and/or securities will be required to complete
A) Form ADV-W
B) Form ADV Part 1
C) Form ADV Appendix 1
D) Form ADV-E

Answer 47

D
The Form ADV-E (E for Examination) is completed by every investment adviser who maintains custody of client assets. Then, the form is used by the independent accountant who performs the surprise annual examination of the adviser’s records. The accountant is the one who submits the ADV-E to the SEC (or the state, if appropriate).

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Question 48

CLM read answer …
A federally chartered credit union is domiciled in Texas. The credit union is making an offering of securities in Nebraska. To comply with the Uniform Securities Act’s exclusion from the definition of agent, any individual offering the security in Nebraska
A) could not sell without being an agent
B) would have to be an employee of a broker-dealer registered in Texas
C) would have to be an employee of a broker-dealer registered in Nebraska
D) would have to receive only nominal commissions

Answer 48

A
It is unusual to have an answer set up this way, but it does happen sometimes on the exam—”to comply with”—and then there is no way to comply. First of all, the USA’s exclusions from the definition of agent only apply to individuals working for the issuer, never broker-dealers. Then, the exclusion only applies when selling the following exempt securities in nonexempt transactions:

-U.S. government and municipal securities;
-Securities of governments with which the United States has diplomatic relationships;
-Securities of U.S. commercial banks and savings institutions or trust companies (when not engaged in securities-related broker-dealer activities);
-Commercial paper rated in the top three categories by the major rating agencies with denominations of $50,000 or more with maturities of nine months or less; and
-Investment contracts issued in connection with employee’s stock purchase, savings, pensions, or profit-sharing plans.
Selling other exempt securities, such as those issued by a federally chartered credit union, on behalf of the issuer, requires one to become registered as an agent of the issuer. Don’t confuse this with the exemption offered in the case of exempt transactions. In that case, regardless of whether the security is exempt or not, if an individual’s only sales activity while representing an issuer is in exempt transactions, then the exclusion from the definition of an agent applies. It is obviously a much broader exemption than when selling exempt securities.

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Question 49

How is Form ADV Organized: Part 1

Answer 49

Part 1A: asks for info about direct owners and executive officers (control persons) and Disclosure Reporting Pages (or DRPs) = disciplinary events for advisor or affiliates.
Part 1B : additional questions required for state registered only. Not needed for SEC reg. advisers.
Part 2A: A-Adviser = about adviser firm
Part 2B: B=bodies = the people who work there

Question 50

Which of the following statements regarding the SEC’s power to revoke the registration of an investment adviser is TRUE?

A) An investment adviser receiving substantial prepayment of fees from 50% of its clients that fails to include a copy of its balance sheet in its brochure delivered to all clients would give the SEC cause for beginning revocation proceedings.
B) If it is determined that an investment adviser is insolvent, the SEC may revoke the registration.
C) Failure to adequately supervise a person associated with the adviser could be cause for the SEC to revoke the firm’s registration.
D) Revocation would occur, with appropriate notice, when a firm’s annual updating amendment was received by the SEC 120 days after the end of the registrant’s fiscal year.

Answer 50

C
Failure to supervise, if proven, is one of the most common causes for disciplinary action against a broker-dealer or investment adviser. Insolvency is not a cause for revocation under the Investment Advisers Act of 1940, but it is for a state-registered investment adviser (it’s tough to keep these straight; please see Appendix A). A late ADV annual updating amendment might be cause for some action but almost certainly not a revocation; it is not that serious an offense. The balance sheet would only have to be part of the disclosure statement (brochure) given to those from whom substantial prepayment of fees is received.

Question 51

An agent has a new client who is prone to tergiversation. As such, it would probably make sense to:
A) open a discretionary account
B) accept unsolicited orders only
C) make recommendations on a frequent basis
D) obtain permission from both the client and the broker-dealer before sharing in the profits and losses in the account.

Answer 51

Those who tergiversate repeatedly change their attitude or opinions. As a consequence, the client who likes an agent’s recommendation one day may quickly change his mind the next. Therefore, the agent could be placed in an untenable position, being unable to satisfy the client. To avoid this possibility, it would be most sensible to leave all the decisions to the client and only accept unsolicited orders.

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Question 52

Exclusions from BD under USA.

Answer 52

Agents; issuers; banks, savings institutions, and trust companies (but not any BD subsidiaries); BD with NO place of business in the state and deal exclusively with issuers, other BDs, other financial institutions, investment companies or employee benefit plans with assets of not less than $1M. There is snow bird exception/temp in a state. However, unlike RIAs and IARs, there is no de minimis exemption.

Question 53

What are federal and state exemptions from registrations provision for IAs?

Answer 53

EXEMPTIONS means not being subject to the registration provisions of the acts even though that person meets the definition.

EXEMPTIONS Fed Law (Inv Advisors Act 1940) exempts the following who are defined as IAs but exempt from registration requirements of the act:

• –Intrastate Advisers (only w/in one state). only works with residents of the state an no advice dealing with securities listed on any national exchange.
• –Advisers to Insurance Companies
• –Private Fund Advisers (Dodd Frank Act 2010)
  
  • -advisers solely to private funds with less than $150M AUM.
  • -non-US advisers with no place of business in US and minimal AUM (less than $25M) attributable to US clients
  • -advisers solely to venture capital funds.

EXEMPTIONS State Law (USA) exempts the following who are defined as IAs but exempt from registration requirements of the act:

• –those who have NO place of business in the state but are registered in another state provided their only clients are:
  
  • -BDs
  • -other IAs
  • -Institutional Investors (=banks, trust companies, Svgs and Loan Assoc., insurance co. investment co (mutual funds), employee benefit plans with assets not less than $1M, and government agencies.)
  • -existing clients temporarily in the state
  • -limited to 5 or fewer clients resident in state during 12 preceding months - de minimus exemption
  • -any others the Administrator exempts by rule or order

Question 54

What are USA exempt securities?(Exempt Transaction is a verb (action) vs. exempt security is a noun)

Answer 54

1. US and Canadian govt. and muni securities (fed, state, province, and political subdivisions)
2. Foreign Govt. Securities with which US maintains diplomatic relations (no political subdivisions unless guaranteed by sovereign govt.)
3. Depository institutions securities
4. Insurance company securities
5. Public utility and common carrier securities (railroad)
6. Federal covered securities
7. Securities issued by nonprofits
8. Securities of employee benefit plans.
9. Certain mm instruments - commercial paper is most common example (less than 9 mo. maturity, 3 highest ratings, at least $50k)

Question 55

Disclosure of IA capacity: What is required when an IA acts as principal or agent or in cross agency transactions?

Answer 55

1. Client receives full disclosure in writing of capacity.
2. Client gives consent for IA to act in that capacity. Can be written or oral and can be after transaction is executed but must be done before completion of transaction (2nd business day after the trade is made).
   NOTE: BDs only need to include capacity in trade confirmation - no consent is required
3. In a cross agency transaction the IA may not make the recommendation to both parties of the trade. Also in cross agency transactions, permission to engage in them must be obtained in writing BEFORE/prospectively the first transaction. The client is in essence giving blanket permission to engage in this activity. Unlike when the IA is acting as principal or agent, no blanket authorization is permitted; consent must be obtained prior to settlement of transaction.

Question 56

Under SEC Release 1A-1092, which of the following has (have) met the test of providing advice or analysis concerning securities?
A stockbroker calls a client and recommends the purchase of a certain stock.
A lawyer recommends against purchasing shares of a mutual fund in favor of another investment.
A publisher of an investment newsletter provides general information and recommendations concerning specific securities.
A) I only
B) I, II, and III
C) I and II
D) I and III

Answer 56

B
Any person who gives advice (positive or negative, specific or general) or issues reports or analyses concerning specific securities meets the criterion of providing advice. This does not mean that these examples qualify for the definition of investment adviser. They only qualify for the first criterion. For example, a lawyer may be exempt from the definition if she provides advice incidental to the profession and does not receive compensation, but may still meet the first criterion. Likewise, if the stockbroker’s only compensation is commissions from securities transactions, the exclusion is in effect.

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Question 57

What are state and federal exclusions from the definition of IA?

Answer 57

EXCLUSIONS (for persons who meet 3 prong test but by law are excluded from definition. If excluded, that person is not subject to provisions of Inv. Advisors Act or USA.

EXCLUSIONS under USA (7):

• -bank, bank holding company, savings institution, trust company (not credit unions, not Svgs and Loan Associations, and not IA subsidiaries of holding companies)
• -LATE lawyer, accountant, teacher, engineer whose advice is solely incidental to their practice.
• -BD and agents whose advice is solely incidental to conduct of its business as a broker-dealer, with no special compensation like a wrap fee program)
• -Publishers may qualify: general and impersonal nature, not promotional material.
• -IARs
• -federal covered adviser
• -anyone Administrator specifies.

EXCLUTIONS UNDER Inv Advisers Act 1940:

• -the same first 4
• -any person who advice relates only to securities that are direct obligations of or guaranteed by the US.

Question 58

Washington, Adams, and Jefferson, Inc. (WAJI) is an investment adviser whose principal and only office is in Alexandria, VA. WAJI’s sole business is advising institutional investors. Rutherford Buchanan is employed by the firm in the main office and has the responsibility of servicing the firm’s bank and insurance company clients. Which of the following statements is correct regarding Rutherford’s licensing requirements?
A) Rutherford must register as an IAR of WAJI with the state of Virginia.
B) Rutherford is exempt from registration because his only clients are institutions.
C) Rutherford is exempt from registration because he has fewer than 6 retail clients.
D) Rutherford cannot register as an IAR of WAJI because providing advice exclusively to institutions exempts the firm from registration.

Answer 58

A
Regardless of whom the clients are, Rutherford has a place of business in Virginia and that requires registration with the Administrator as an IAR. If WAJI does business in other states where it does not have a place of business, it is exempt from registration because the only clients are institutions. If WAJI is not registered in the state, Rutherford can’t register as their IAR. The de minimis exemption for fewer than 6 retail clients only applies when there is no place of business in the state.

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Question 59

What is entanglement and adoption?

Answer 59

Entanglement is the term used to describe material posted to a securities professional’s social media site by a third party where the securities professional has taken part in the preparation of the material. This differs from adoption where the firm has endorsed or approved of the post, but played no part in its preparation.

As a general matter, the regulators do not treat posts by customers or other third parties as the firm’s communication with the public. Under certain circumstances, however, third-party posts may become attributable to the firm. Whether third-party content is attributable to a firm depends on whether the firm has (1) involved itself in the preparation of the content or (2) explicitly or implicitly endorsed or approved the content.

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Question 60

Under USA, you are a BD if:

Answer 60

1. you have a place of business in the state; OR

2. you have even one retail client the state

Question 61

When is it acceptable to trade based on a 3rd party order?

Answer 61

Placing an order for a client on the instructions of a third party is called third-party trading authority. In order to place an order for the client’s account on the instruction of a third party, prior written authority must be obtained by the adviser from the client. Placing a third-party order without written authorization would not only be unethical conduct, the adviser would also incur civil liability to the client for any losses incurred. An investment adviser may not even accept orders from a client’s spouse without written authorization. Only Phil’s procedure was correct because he did provide written authorization for his lawyer to execute trades on his behalf.

Question 62

CLM read answer … How long must IAs and BDs keep records?
Certain documents belonging to a federal covered investment adviser must be kept for a period of time after the enterprise closes. Those documents are
A) sent to the Administrator for safekeeping
B) required to be shredded
C) the responsibility of the investment adviser
D) sent to the SEC for safekeeping

Answer 62

C
Broker-dealers and investment advisers must keep certain records for a period of 3 years after the termination of the business. How and where those records are maintained is the responsibility of the firm, not the regulators. This is a separate requirement from the one that has active broker-dealers keeping records for 3 years and investment advisers for 5.

Question 63

When an IA registers in a new state, who is automatically registered as IARs?

Answer 63

Officers, directors, and partners of the firm who are functioning as IARs.

Question 64

what are alternative investments

Answer 64

ETNs, Leverage ETFs, Inverse Funds, structured products

Question 65

Notice Filing is for what?

Answer 65

State registration of federal covered securities, generally investment companies registered with SEC under Invest Co. Act 1940.

Question 66

USA says you don’t have register (though they may require Notice filings) Federal Covered SECURITIES. What are they?

Answer 66

1. Open end or closed end investmt co., UIT, or face amt certificate co (FACC) registered under investmt company act of 1940.
2. Securities listed on NYSE, NYSE American LLC, NASDAQ,
3. Rule 506b or 506c of Regluation D (private placement exemption)
4. Most securities exempt from registration under Securities Act of 1933 - no state can overstep what Fed says does not need to register. Except if the municipal issuer is located in the state in which securities are being offered, that security is not considered a federal covered security.

Question 67

IA brochure delivery requirements

Answer 67

For SEC registered advisors: Must be delivered even if the advisory contract is oral (fed law - contracts may be oral; state law contracts must be in writing). And must be delivered before or at the time the advisory contract is entered into. And summary of material changes within 120 days of fiscal year end.
For State registered advisors: same except brochures are required to be delivered 48 hours prior to entering into advisory contract and if not the client may terminate contract and get refund of set up fees.
Exemptions from Brochure Rule:
1. Contracts with Investment companies covered under the Inv. Co Act 1940 b/c those contracts are covered by that act.
2. Advisers entering into a contract for impersonal advisory services only like publishers as long as annual charge is under $500.

Question 68

What are the parts of the ADV and briefly describe each?

Answer 68

Part 1:
1A:
—About IA, business practices, control people, people who provide advice for firm, location of principal office, location of records, form of business.
—ALL advisers - Fed or state registered - must complete.
1B:
—Only filed by State registered advisers.

Part 2:
—For state registered, must be filed with Administrator. For Fed registered, must be available for inspection.
PART 2A:
—Info about the ADVISERS “A” and Advisory firm. (compensation arrangements, types of clients, types of investments, types of strategies, educational and business background of advisers, etc)
—Requires advisers to create a narrative brochure containing info about the advisory firm.
—Fed and State required.
—Must be delivered to clients of ALL IAs withing 120 days of the end of the fiscal year.
PART 2A Appendix 1 is wrap fee brochure

PART 2B:

• –requires advisers to create brochure supplements containing information about certain supervised persons.
• –Fed and state required.

ADV-E The Form ADV-E (E for Examination) is completed by every investment adviser who maintains custody of client assets. Then, the form is used by the independent accountant who performs the surprise annual examination of the adviser’s records. The accountant is the one who submits the ADV-E to the SEC (or the state, if appropriate)

ADV-W is filed to withdraw registration voluntarily.

ADV UPDATE must be updated and filed within 90 days of the end of the fiscal year.

Question 69

What is pegging, front running, and matched orders?

Answer 69

Pegging involves entering buy orders for the purpose of supporting a stock price (i.e., to keep it from falling). This is a form of market manipulation and is illegal. Front running involves a representative or firm entering orders ahead of client orders. Straddles are an option position that combines a put and a call on the same stock; there is nothing improper with that strategy. Matched orders involve buying and selling a stock from one hand to the other to create the false appearance of trading volume and is another form of market manipulation.

Question 70

CLM read answer
Under the USA, every investment adviser organized as a partnership, must include in its contracts an agreement to notify clients within a reasonable period of time of
A) the decision to charge fees in advance rather than arrears
B) a change in the location of securities held in custody
C) a change in the method of computing fees
D) the addition or removal of any of the partners

Answer 70

D
Investment advisers organized as partnerships must include in their advisory contracts a statement that they will notify all clients of a change to the composition of the partnership within a reasonable period of time. All of the other choices mentioned here would require prompt notification, which although not quantified in the USA, is much sooner than a reasonable period of time.

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Question 71

What are leading economic indicators

Answer 71

Money supply, building permits, Avg wkly initial claims for unemployment, manufacturers’ new orders for consumer goods and nondefense capital goods, Int rate spread btwn 10yr t-bond and Fed Funds Rate; stock prices, index of supplier deliveries, Index of xonsumer expectations.

Question 72

Which of the following would be considered an unethical business practice?
A) Broker-dealers charging larger than ordinary commissions on certain transactions
B) Agents correcting execution orders in their customer’s accounts
C) Broker-dealers sending retail clients an email 30 days in advance of a change to fees
D) Agents exercising discretion in discretionary accounts

Answer 72

B
When a good-faith error is made, only the firm can make the correction; the regulators are concerned that giving that power to an agent could lead to covering up unethical activity. When the security involved in the trade is thinly traded (inactive), it is customary to charge a higher commission to cover the added expense. Broker-dealers are required to deliver a copy of their fee schedule no later than account opening. When changes are made, notice must be given at least 30 days in advance and may be done electronically (by email or posting on the firm’s website).

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Question 73

What is NSMIA?
Under the NSMIA, state securities Administrators retain authority to
A)
impose state registration requirements on all investment advisers
B)
regulate the securities registration and offering process for registered investment companies
C)
forward all filing fees received from issuers, broker-dealers, and agents to the SEC
D)
enforce antifraud provisions

Answer 73

NSMIA dictates IA state registration versus SEC
D
Under the NSMIA, state Administrators are not prohibited from enforcing the antifraud provisions of state and federal securities laws. Investment companies and SEC-registered advisers are exempt from state registration, but they may be required to pay state filing fees.
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Question 74

The SEC has determined that advertising regarding past recommendations made by investment advisers is misleading if

• -results do not reflect the deduction of fees
• -actual market conditions during the referenced period are not disclosed
• -the advertisement did not reflect performance for a minimum period of 3 years
• -the advertisement did not disclose that it applied to only a specific group of clients

A) I, II, III, and IV
B) II and IV
C) I and II
D) I, II, and IV

Answer 74

All investment adviser advertising must reflect fees, state actual market conditions during the referenced period, and disclose the specific group of clients to which it applies. However, advertising that reflects past performance must show a minimum period of 1 year, not 3 years.

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Question 75

What is a red herring?

Answer 75

A preliminary prospectus for a new security issue. Used to acquaint investors with the essential facts concerning a new issue. Also used to solicit indications of buyer interest.

Question 76

what is the process for registering securities with SEC?

Answer 76

• Registration statement filed with SEC
• 20 day cooling period before registration becomes effective. This is a minimum and usually takes the SEC longer to clear the registration. No one can solicit during this time but can get indications of buy interest.
• Then the final - effective - prospectus.
• On the effective date of the registration statement, securities may be sold.

Question 77

Under the Investment Advisers Act of 1940, which of the following statements is NOT true regarding custody of a client’s funds or securities?

A) Client securities must be segregated and kept safe.
B) The adviser must report the location of funds or securities at 6-month intervals.
C) The adviser must arrange for an audit of the client’s accounts at least once annually and arrange for the results to be forwarded to the SEC.
D) The adviser must be named as agent or trustee for a client’s account or else use a qualified custodian.

Answer 77

B
Advisers who have custody must segregate client securities and funds and keep them in a safe place. Client funds must be deposited in bank accounts containing only the client’s funds, and unless using a qualified custodian, the adviser must be named as agent or trustee. The adviser is required to report quarterly with a written, itemized statement indicating the funds and/or securities in the adviser’s possession and all transactions in the account. Annually, the adviser must arrange for an independent audit of the client’s account and the results must be forwarded to the SEC. Thus, the adviser reports every 3 months, not every 6 months.

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Question 78

In general, a broker-dealer will disclose any changes to its fee schedule

A) within 30 days following the change
B) when requested by the client
C) by notifying clients of the change in advance
D) to the Administrator and then to the clients

Answer 78

C
Most broker-dealers disclose fee changes at least 30 days in advance, and there is no requirement whatsoever to notify the Administrator.

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Question 79

If you are registered as an agent for a broker-dealer in State Y and you conduct business as an agent of theirs in State Z, a state in which you are not registered as their agent, you

expose yourself and your employer to disciplinary action by State Z
expose yourself to a possible fine
may obligate your broker-dealer to offer your client the right to rescind the sale
may have your registration in State Y revoked

A) II and III
B) II, III, and IV
C) I, II, and III
D) I, II, III, and IV

Answer 79

D
Agents must be registered in each state where selling or offering to sell securities unless an exemption is available. Failure to do so exposes the agent and the broker-dealer to fines and possible disciplinary action. In addition, the individual could have his registration revoked where he is registered, and the broker-dealer could be required to offer customers the right to rescind any securities transactions.

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Question 80

What are Federal Covered Securities?

Answer 80

Securities covered by federal securities laws, which therefore cannot be regulated by state securities administrators (except for anti-fraud violations). They include:

• -Investment company securities: closed or open end funds, unit investment trust, or FACC face amount certificate company.
• -Securities listed on the NYSE and NYSE American LLC (Formerly known as American Stock Exchange), NASDAQ
• -Securities offered pursuant to provisions of rule 506b and 506c of Reg D (private placement transaction)
• -most securities that are exempt from registration under the Securities Act of 1933.

Question 81

Explain Regulation D parts 506b and 506c

Answer 81

A company raising capital through private placement rule 506b can sell offering to unlimited amount of accredited investors and 35 max non-accredited investors. BUT NO ADVERTISING may be done on the offering.
506c permits advertising, but all purchasers must be accredited, and the issuer takes reasonable steps to verify that purchasers are accredited investors (reviewing w-2s, bank statements, brokerage statement, credit reports, etc.)

Question 82

Whats an accredited investor?

Answer 82

• -Institutions (banks, insurance co., invest. co.)
• -Employee benefit plan (if managed or if it has total assets >$5M)
• -directors, officers, general partners of the issuer
• -charitable org, corp, or partnership with >$5M
• -natural person who has net worth (or joint with spouce) of >$1M not including personal residence.
• -natural person with income >$200k or >$300K with spouse in each of last 2 years and expects same this year.
• -entities made up of accredited investors

Question 83

Included among the powers of the Administrator is the ability to

A)
request the court to appoint a receiver to freeze the bank accounts of a broker-dealer who is the subject of an injunction
B)
sentence an investment adviser representative who has been convicted of fraud to a prison sentence, not to exceed 3 years
C)
arrest an agent who violates the USA
D)
deny the registration of a securities professional, if doing so is in the public interest

Answer 83

A
If a temporary or permanent injunction is issued against any securities professional, upon request of the Administrator, a receiver or conservator may be appointed over the defendant’s assets. The Administrator cannot arrest but can seek a warrant. In order to deny a registration, not only must it be in the public interest, but there must be some other issue, such as insolvency, incomplete application, et cetera. Although the maximum prison sentence under the USA is 3 years, it is the courts that do the sentencing, not the Administrator.

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Question 84

Under the Investment Advisers Act of 1940, what is the maximum fine that may be imposed for violating the act?
(And how does this compare to USA rules?)

A)
$1,000
B)
$10,000
C)
$20,000
D)
$5,000

Answer 84

B
Any person who violates the act or SEC rules is subject to a fine of up to $10,000 and/or a prison term of up to 5 years. Note that this is different than the Uniform Securities Act, which provides for penalties of 3 years and $5,000.

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Question 85

Which of the following is not included in the definition of broker-dealer as found in the Uniform Securities Act?

A)
Banks
B)
Attorneys
C)
Credit unions
D)
Investment advisers

Answer 85

A
In the Uniform Securities Act, it specifically states: “Broker-dealer” means any person engaged in the business of effecting transactions in securities for the account of others or for his own account. “Broker-dealer” does not include (1) an agent, (2) an issuer, (3) a bank, savings institution, or trust company. Attorneys are excluded from the definition of investment adviser, as long as their advice is incidental to their legal practice, but that exclusion does not apply to the term “broker-dealer”. Even though credit unions engage in banking activity, they are not included in the exclusion. Being an investment adviser does not exclude a person from the need to register as a broker-dealer if that person is performing the functions of a BD.

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