Unit 1 - Chapter 3 - Fed & State Regulation of IA & IARs

Question 1

What is the Investment Advisers Acts of 1940?

Answer 1

Defines the term investment adviser and requires persons that fall within the definition to register with the SEC of with the states in which they do business. IA registered under this act do not have to register with the state securities Administrator.

Question 2

What are the two primary purposes of the Investment Advisers Act of 1940?

Answer 2

1. ) Regulation of persons, both natural and legal, in the business of giving investment advice
2. ) establishment of standards of ethical business conduct for the industry

Question 3

Fidiciary

Answer 3

A person legally appointed and authorized to hold assets in trust for another person. Manages the assets for the benefit of the other person rather than for his or her own profits and must exercise a standard of care imposed by law.

Question 4

Person Associated with an IA

Answer 4

Any partner, officer, or director of the investment adviser (or anyone performing similar functions) or any person directly or indirectly controlling or controlled by the IA, including any employees or the investment adviser, except that was far as registration requirements are concerned, persons associated with the IA whose functions are clerical or administrative are not included in the meaning of the term

Question 5

Supervised Person

Answer 5

Any partner, officer, or director of the investment adviser (or anyone performing similar functions) or any employee of the investment adviser or other person who provides investment advice on behalf of the investment adviser and is subject to the supervisions and control of the IA.

Question 6

Define Investment Adviser

Answer 6

Any person who, for compensation, engages in the business of advising others as to the value of securities or the advisability of investing in securities or, as part of a regular business, issues analyses or reports concerning securities

Question 7

How does SEC Release IA-1092 identify an investment adviser?

Answer 7

1. ) anyone that provides investment advice, reports, or analyses with respect to securities
2. ) is in the business of providing advice or analyses
3. ) receives compensation, directly or indirectly, for these services
   - if someone engages in these three activities, that person is an investment adviser subject to the Investment Act of 1940, therefore they much register with the SEC or state

Question 8

A person in the business of providing advice

Answer 8

1. ) Gives advice on a regular basis such that it constitutes a business activity conducted with some regularity (frequency of the activity is a factor but not the only determinant)
2. ) advertises investment advisory services and presents himself to the public as an investment adviser or as one who provides investment advice

Question 9

Explain what compensation can be in the context of IAs.

Answer 9

A person who receives economic benefit as a result of providing investment advice. Compensation includes advisory fees, commissions, or other types of fees relating to the services rendered

Question 10

What are the exclusions from the definition of Investment Adviser under Federal law?

Answer 10

1. ) Any bank defined in the Bank Holding Company Act of 1956
2. ) Any lawyer, accountant, teacher, or engineer whose advice is solely incidental to the practice of his profession (unless they have a separate advisory business)
3. ) Any b/d whose performance of such services is solely incidental to conduct his business as a broker or dealer and who receives no special compensation (sp. comp is anything in excess of the b/d service being provided)
4. ) A publisher of any bona fide newspaper, new magazine or business or financial publication of general and regular circulation
   a. ) advice must be general and impersonal, not specific to any portfolio of clients
   b. ) contains disinterested commentary and analysis as opposed to promotional material
   c. ) general and regular circulation, in that it is not timed to specific market activity
5. ) Any person whose advice, analyses, or reports are related only to securities that are direct obligations of, or obligations guaranteed by the US or by certain US governments sponsored organizations
6. ) Nationally recognized statistical rating organizations (i.e. S&P or Moodys)

Question 11

What are the exclusions from the definition of an Investment Adviser under State Law?

Answer 11

1. ) Banks, savings institutions and trust companies
2. ) Any lawyer, accountant, teacher, or engineer whose advice is solely incidental to the practice of his profession (unless they have a separate advisory business)
3. ) Any b/d whose performance of such services is solely incidental to conduct his business as a broker or dealer and who receives no special compensation (sp. comp is anything in excess of the b/d service being provided)
4. ) The definition of an IA encompasses publishers as well as authors. However, it does exclude a publisher of any bona fide newspaper, new magazine or business or financial publication of general and regular circulation
5. ) IARs
6. ) A person who is a federal covered adviser
7. ) Any person excluded by the Investment Advisers Act of 1940
8. ) Any other person the Administrator specifies is excluded

Question 12

Who are federal covered investment advisers?

Answer 12

1. ) those required to be registered or registered as an IA with the SEC b/c they meet the minimum threshold of AUM (currently $110M)
2. ) those under contract to manage an investment company registered under the Inv Co. Act of 1940, regardless of the amount of AUM
3. ) those not registered with the SEC b/ they are excluded from the definition of an investment adviser by the Inv Co. Act of 140

Question 13

Large Investment Advisers Under Dodd-Frank

Answer 13

Advisers with at least $100MM or more of AUM are elibile for SEC registration, once AUM reaches $110MM, registration with the SEC is mandatory, unless covered by one of the exemptions. All large IAs must register with the SEC. State registration is not required

Question 14

Small Investment Advisers under Dodd-Frank

Answer 14

Advisers with less than $25MM of AUM. Unless the IA is an adviser to an investment company registered under the Act of 1940, registration with the SEC is prohibited and registration with the state is required. If the IA is required to be registered in 15 states or more, registration with the SEC is permitted

Question 15

Mid-size Advisers under Dodd-Frank

Answer 15

Includes those with AUM of $25-$100MM. Mid-Size advisers are allowed to register with the SEC if:

1. ) the adviser is not required to be registered as an IA with the securities Administrator of the state in which it maintains its principal office and place of business
2. ) if registered, the adviser would be subject to examination as an investment adviser by that securities Administrator
3. ) if the adviser is required to register in 15 or more states
4. ) adviser elects to take advantage of the buffer

Question 16

What are the registration exemptions under Dodd-Frank?

Answer 16

1. ) pension consultants but only those with at least $200MM AUM
2. ) mid-size advisers with at least $100MM in AUM, but less than $110M in aUM who elect to register with the sEC rather than the state
3. ) IA affiliated with an adviser already registered with the SEC
4. ) IA expecting to be eligible for SEC registration within 120 days of filing a form ADV
5. ) multistate investment advisers (15 states or more)
6. ) internet adviser

Question 17

Time of Measuring AUM for SEC registration

Answer 17

AUM reported on the IA’s annual updating amendment. The effect of this is that a federal covered adviser’s AUM could drop below $90MM during the year w/o triggering the need to change to state registration, as long as the annual update showed at least the minimum $90MM required. If AUM drops below $90MM the IA must withdraw SEC registration and register with the appropriate state(s) within 180 days

Question 18

What persons are IA’s but are exempt from registration under the USA and state Administrator?

Answer 18

1. ) b/ds registered under the act
2. ) other IAs
3. ) institutional investors, including employee benefit plans with assets of not less than $1MM
4. ) existing clients who are not residents but are temporarily in the state
5. ) limited to five or fewer clients, other than those limited above, resident in that state during the preceding 12 months (de minimis exemption)
6. ) any other the Administrator exempts by rule or order

Question 19

What is the definition of a client an IA?

Answer 19

The following are deemed a single client:

1. ) natural person
2. ) minor child of the natural person
3. ) any relative, spouse, or relative of the spouse of the natural who has the same principal residence
4. ) all accounts of which the natural person and/or the persons referred to in this paragraph (a)(1) are the only primary beneficies
5. ) All trusts of which the natural and/or the persons referred to in this paragraph (a)(1) are the only primary beneficiaries

Question 20

When is an IA considered to have an office in a state?

Answer 20

1.) when they advertise to the public and are available to meet with prospective clients in that particular state and the firm/IA had transaction with six or more individual residents (b/d or institutional investments do not count, only individuals) of the state during a 12 mo period

Question 21

When will notice filing not be required by an IA?

Answer 21

If a IA is federal covered adviser and only deals with institutions, other IAs, or other B/Ds

Question 22

How many days does a IA have to register with the SEC once its AUM reach $110MM?

Answer 22

90 days

Question 23

How many days does a IA have to register with the state Administrator once its assets fall below $90MM and is no longer qualified for SEC registration?

Answer 23

180 days

Question 24

What are the two testable differences between the federal and state private fund adviser exemption?

Answer 24

1. ) If qualifying for exemption 3(c)(1) issuer (no more than 100 investors), NASAA’s Model Rule require that all investor’s be qualified clients
2. ) Neither the private fund adviser nor any of its advisory affiliates are subject to an event that would disqualify an issuer under Rule 262 of SEC Regulation A (“bad actor” provisions)

Question 25

Exempt Reporting Advisers (ERAs)

Answer 25

As long as the adviser continues to qualify for the exemption on either federal or state level, registration is not required. However, certain reports will have to be filed with the SEC or the state(s) as appropriate

Question 26

What do IA’s use Form ADV for?

Answer 26

1.) register with the SEC
2.) register with one or more state securities authorities
3.) amend those registrations’
Note: Filing is usually accomplished through the IARD

Question 27

What is the Investment Adviser Registration Depository (IARD)?

Answer 27

An electronic filing system that facilitates investment adviser registration, regulatory review, and the public disclosure information of investment adviser firms. FINRA is the owner and operator.

Question 28

What does control mean?

Answer 28

the power directly or indirectly to direct management or policies of an investment adviser, whether through ownership or securities by contract or otherwise. The firm’s officer’s, partners, or directors exercising executive responsibility is presumed to control the firm

Question 29

When must the ADV be updated?

Answer 29

Annually, 90 days after the end of the adviser’s fiscal year. This is an opportunity for the IA to update all items on the ADV, most critically the AUM.

Question 30

What are the effective registration dates for registration applications?

Answer 30

Federal: SEC registration takes effect on the 45th day after filing.
State: at noon on the 30th day

Question 31

What form must be filed to withdraw registration?

Answer 31

ADV-W - becomes effective 60 days after filing with the SEC and 30 days for state registered IAs

Question 32

When does the SEC have the power to cancel the registration of an IA?

Answer 32

Upon finding the IA is no longer in existence, is not engaged in business as an IA, or does not meet the necessary dollar standards to remain SEC registered

Question 33

What is the criteria that must be met in order for an IA to use the term investment counsel?

Answer 33

1. ) IA’s principal business must be giving investment advice (this basically excludes financial planners and other for who investment advice is only a part of what they do)
2. ) provide investment supervisory services to an account if:
   a. ) have discretionary authority over and provide ongoing supervisory or management service with respects to the account
   b. ) you do not have have discretionary authority over the account, but you have ongoing responsibilities to select recommendations, based upon the needs of the client, as to specific securities or other investment
   c. ) you are compensated based on the average value of the client’s assets you managed over a specified period of time, that suggests that you provide continuous and regular supervisory or management service for the account. Compensation can mean pay based on: time spent with a client visit, retainer, provide market timing recs, provide impersonal investment advice, make an initial asset allocation, provide advice on an intermittent or periodic basis

Question 34

In what circumstances can a financial planner not use the term investment counsel?

Answer 34

When its principal service is not giving investment advice. FPs typically provide other financial advice such insurance planning, estate planning, tax planning, etc.

Question 35

What is the amount of fees collected to be considered “substantial prepayment of fees” by the SEC and the USA?

Answer 35

SEC: $1200 six months or more in advance
USA: $500 six months or more in advance

Question 36

When must a federal covered adviser provide a balance sheet?

Answer 36

When a federal covered adviser requires or solicits clients for substantial prepayment of fees

Question 37

When must a state registered adviser provide a balance sheet?

Answer 37

An audited balance sheet must be included in the brochure for any state registered investment adviser who requires or solicits clients for substantial prepayment of fees. In addition, those who maintain custody of client funds and/or securities must include an audited balance sheet with the ADV Part 2A. State registered IAs who have discretionary authority must file a balance sheet 90 days of the end of the adviser’s fiscal year, but it does not have to be audited

Question 38

When must an IA disclosure financial impairment to clients?

Answer 38

When they have discretionary authority or custody of the client fund or require or solicit substantial prepayment of fees. The IA must disclose any financial condition that is reasonably likely to impair their ability to meet contractual commitments to their clients

Question 39

What are the financial requirements for state registered advisers?

Answer 39

The Administrator may require a net worth or surety bond for IAs that has custody over securities or funds or has discretion over a client’s account. Typically $10,000 for discretionary authority and $35,000 for custody. If the IA accepts prepayment of fees of $500 or more, the IA must maintain a positive net worth at all times

Question 40

What happens when a IA fails to maintain the minimum net worth?

Answer 40

By the close of business of the next business day, the IA must notify the Administrator, then by the COB of the next business day must file a financial report wit the Administrator and must obtain a bond in an amount of the net worth deficiency rounded up to the nearest $5,000.

Question 41

How is Net Worth calculated?

Answer 41

Assets over liabilities as determined by GAAP, but shall not include Goodwill, Patents, Copyrights, all other assets of intangible nature, home, home furnishings, automobiles and other personal items not readily marketable in the case of an individaul

Question 42

What actions must a IAR take to be defined as a IAR?

Answer 42

1. ) makes recs or otherwise renders advice regarding securities
2. ) manages accounts or portfolios of clients
3. ) determines which recs or advice regarding securities should be given
4. ) solicits, offers or negotiates for the sale of or sells investments advisory services
5. ) supervises employees who perform any of the foregoing

Question 43

When is state registration required for federally covered IARs?

Answer 43

When the IAR where that individual has a place of business in the state?

Question 44

What does place of business mean for an IAR?

Answer 44

1. ) office at which the investment adviser rep regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients
2. ) any other location that is held out to the general public as a location at which the IAR provides investment advisory services, solicits, meets with, or otherwise communicates with clients

Question 45

When do IAR register with the SEC?

Answer 45

Never. IAR registration is done on a state basis, even when they are representing a federal covered advisor

Question 46

What are the financial requirements of IARs?

Answer 46

No financial requirements. Like other securities professionals, insolvency is a cause of denial or revocation of registrations

Question 47

Define Impersonal investment advice

Answer 47

Investment advisory services provided by means of written material or oral statements that do no purpose to meet the objectives of needs of specific individual accounts

Question 48

What are the exclusions from being an IAR?

Answer 48

When the activities are confined to clerical duties of those activities that are incidental to the investment advisory services offered

Question 49

What is the de minimis exemption for IARs?

Answer 49

If an IRA does not maintain a place of business in that state and, during the preceding 12-month period, has not had no more than 5 retail clients, registration is not required

Question 50

What are the termination procedures for IARs?

Answer 50

It depends how the IA is registered.

1. ) if the IA is state-registered, the firm must notify the Administrator
2. ) if the IA is federally covered, the IAR must notify the Administrator
3. ) the only area in which termination of agents and IARs is the same is that in both cases, termination is accomplished by filing Form U-5

Question 51

What is scalping?

Answer 51

The practice whereby an IA, before the dissemination of a securities recommendation, trades on the anticipated short-run market activity that may result from the recommendation

Question 52

When must a state-registered IA provide an audit to investors?

Answer 52

When it has custody and advises a pooled investment vehicle it must provide dates of the audit, copy of the audited financial statements and evidence of the mailing of the audited financial statements to all LPs, members, or other beneficial owners within 120 days of the end of its fiscal yr

Question 53

How long must a IA keep their books and records?

Answer 53

Must be in a accessible place for 5 years. During the first 2 years, the records must be maintained at the principal office of the IA

Question 54

What is the difference between record retention time periods between IAs and B/Ds?

Answer 54

For IAs it is 5 years

For B/Ds it is 3 years