Unit 1 - Chapter 3B - Fed & State Regulation Of IA & RIAs

Question 1

What does Rule 204A-1, Investment Adviser Code of Ethics require?

Answer 1

1. ) a copy of the IA’s code of ethics adopted and implemented pursuant to the Investment Advisers Act of 1940?
2. ) a record of any violation of code of ethics and the action taken
3. ) record of written acknowledgments, as require by the code of ethics rule for each person who is currently, or within the past five years was, a supervised person of the IA
4. ) each adviser’s code of ethics to require an adviser’s access persons to periodically report their personal securities transactions and holdings to the adviser’s chief compliance officer or other designated persons

Question 2

What should advisory firms include when crafting their procedures for employees’ personal securities transactions?

Answer 2

1. ) prior written approval before access persons can pace a personal securities transaction
2. ) maintenance of lists of issues of securities that the firm is analyzing or recommending for client transactions and prohibitions on personal trading in securities of those issuers
3. ) maintenance of lists of issuers about which the advisory firm has inside information, and prohibitions of any trading in securities of those issuers
4. ) Reminders that investment opportunities must be offered first to clients before the adviser or its employees may act on them

Question 3

Define access peron

Answer 3

Any of the adviser’s supervised persons who

1. ) has access to non public info regarding any clients’ purchase or sale of securities, or non public info reward the portfolio holdings of any reportable fund
2. ) involved in making securities recommendations to clients or who has access to such recommendations that are non public

Question 4

What are the records required under Rule 204A-1?

Answer 4

1. ) record of each report made by an access person
2. ) record of the names of persons who are currently, or within the past five years were, access person of the IA
3. ) record of any decision, and the reason supporting the decision, to approve the acquisition of securities by access persons, for at least 5 years after the end of the fiscal years in which the approval was granted

Question 5

What does Part 2 of the ADV consists of?

Answer 5

1. ) 2A - Firm Brochure
2. ) 2A - Appendix 1 of Form ADV: Wrap Fee Program Brochure
3. ) Part 2B - Brochure Supplement

Question 6

When is not required to file the brochure of supplements?

Answer 6

When the IA is registered or is registered with the SEC

Question 7

What are the 6 required disclosure categories of Form Part 2B?

Answer 7

1. ) Cover Page
2. ) Educational background and business experience
3. ) Disciplinary information
4. ) Other business activities
5. ) Additional compensation
6. ) Supervision

Question 8

When does a IA have to prepare a Brochure Supplement for Supervised Persons?

Answer 8

1. ) when any supervised person who formulates investment advice for a client has direct client contact
2. ) when any supervised person has discretionary authority over a client’s assets, even with no direct contact

Question 9

Wrap Fee Program

Answer 9

A program under which a client is charged a specific fee or fees not based directly on transactions in a client’s account, for investment advisory services (which may include portfolio management or advice concerning the selection of other investment advisers) and for execution of client transactions.

Question 10

What must the IA provide to the client when supplying wrap fee programs?

Answer 10

ADV Part 2A - Appendix 1

Question 11

What are the brochure delivery requirements for SEC registered advisers?

Answer 11

A firm brochure must be delivered to each client, and must be provided at the time an advisory agreement is entered into with that client, within 120 days of the IA’s fiscal year a free brochure must be provided. If there are no material changes, no brochure is required to be sent.

Question 12

What is the brochure delivery requirement for state registered advisors?

Answer 12

The same as federal with the exception that advisers are required to deliver the brochure to the client at least 48 hrs before entering into an advisory contract or at the time of entering into an advisory contract, if the advisory client has the right to terminate the contract without penalty within five business days after entering in the the contract. Any client charged a fee is entitled to a refund of the if they do not receive the brochure within 48 hrs

Question 13

What are the three categories of clients the IA is not required to deliver brochure supplements?

Answer 13

1. ) clients to whom the IA is not required to deliver a firm brochure or a wrap fee program brochure
2. ) clients who receive only impersonal investment advice, even if they receive a firm brochure. (I.e. those paying $500 or more per yr for a subscription)
3. ) individual clients who are any executive officers, directors, trustees, GPS or ppl serving in a similar capacity of that firm or any employees of that firm who in connection with their regular functions or duties participate in the investment activities of that firm and have been performing such functions or duties for at least 12 months

Question 14

What are the two exemptions under state and federal law from the delivery requirements of a brochure?

Answer 14

1. ) contracts with a registered investment company are exempted
2. ) advisers entering into a contract providing solely for impersonal advisory services for less than $500 annually

Question 15

When must the brochure be updated?

Answer 15

1. ) annually

2. ) whenever any information in the brochure becomes materially inaccurate

Question 16

What conditions must be met for registered federal and state advisors to custody client assets?

Answer 16

1. ) have a qualified custodian
2. ) give notice to your clients when accounts are opened with the custodian
3. ) account statements must be delivered to clients at least quarterly by the custodian or the adviser (if by advisor, an ind public accountant must verify all of the funds and securities by actual examination at least once during the each calendar yr at time chosen by the accountant w/o prior notice

Question 17

What are exceptions to the custody requirements?

Answer 17

1. ) share of mutual funds (open-end) you may use the mutual fund’s transfer agent in lieu of a qualified custodian since the mutual fund transfer agent maintains the securities for the client on the mutual fund’s books
2. ) Reg Investment Companies since they must comply with strict requirements of the Investment Company Act of 1940

Question 18

What does custody mean?

Answer 18

Holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them, which also includes:

1. ) possession of client funds or securities (but not of checks drawn by clients and made payable to third parties) unless you receive them inadvertently and you return them to the sender promptly but in any case within three business days (72 hrs) of receiving them (the SEC never considers the receipt of a third-party check to constitute custody while the Administrator will if the check is not sent on within three business days
2. ) any arrangement under which you are authorized or permitted to withdraw client funds or securities maintained with a custodian upon your instruction to the custodian
3. ) any capacity that grief you or your supervised person legal ownership of or access to client funds or securities

Question 19

Qualified Custodian

Answer 19

A bank or savings association that has deposits insured by the FDIC under the Federal Deposit Insurance Act, a registered b/d holding the client assets in customer account

Question 20

What are the two major benefits to an IA using a qualified custodian?

Answer 20

1. ) since the custodian is sending quarterly reports to the client, that admin burden is lifted from the IA
2. ) there is no requirement for a surprise annual audit by an ind accountant

Question 21

What must an IA provide when deducting fees directly from client accounts?

Answer 21

1.) written authorization
2.) notice of fee deduction
3.) notice of safeguards
Note: If these are met, IA will receive a waiver form the financial requirements for the net worth and bonding requirements

Question 22

What is the exception that a IAR does not need provide a client when acting in a fiduciary capacity?

Answer 22

Personal transactions that are consistent with those recommended to clients

Question 23

What is included in the required disclosure from the IA to the client?

Answer 23

1. ) State or regulatory proceedings in which the adviser or a mang. person was found to have violated rules or statutes that led to the denial, suspension, or revocation of the firm’s or indiv. mangagment person registration
2. ) Court proceedings, injunctions, or felony
3. ) SRO proceedings in which the business or person was barred, suspended, expelled or fined in excess of $2,500, or any limitation put in place

Question 24

What are examples of materials that are not disclosure to clients?

Answer 24

1. ) all fees paid by client in connection of the contract , including how fees are negotiated
2. ) affiliation with BDs
3. ) When have discretionary authority and not disclosing prepaid advisory fees
4. ) failure to properly allocated funded in bunched trades and not providing its allocation policy
5. ) any material legal action against the adviser (if any action has occurred within the last 10 yrs, it must be provided within 48 hrs to the client “48-hr rule”

Question 25

Hedge Clauses

Answer 25

For the exam, remember that “waivers are never permitted” in the context of clients waiving any of their right under the Act. Hedge Clauses may not be used in any disclaimer as it may be misleading.

Question 26

Principal Transaction

Answer 26

It is unlawful for a IA directly or indirectly when acting as principal for his own account to knowingly sell any security to or purchase any security from a client or acting as broker for a person other than such client knowingly effect any sale or purchase of any security for the account of such client w/o disclosing in writing beforehand and receiving client consent.

Consent can occur after the transaction but prior to settlement. The IA is not acting as a broker within the meaning of the acts if they IA receives no compensation (other than its normal advisory fee) for effecting an agency transaction between advisory clients.

If the adviser is a BD this does not apply.

Question 27

Settlement

Answer 27

The ending point of a transaction is when the actual exchange of securities and payment occurs

Question 28

Blanket Approvals

Answer 28

Not permitted when referring to trades, approval must be given to the client on each transactions in a post-trade pre-settlement scenario.

Question 29

What is the SEC definition of Advertisement?

Answer 29

Any notice, circular, website, letter, or written communication addressed to more than one person, or any notice of other announcement in any publication or by radio or TV that offers:

1. ) analysis, report, publication concerning securites
2. ) graph, chart, formula, or other device to be used in making any determination concerning securities
3. ) other investment advisory service with regard to securities

Question 30

What are considered unlawful advertisements by an IA?

Answer 30

1. ) use of testimonials, including any statement of a client’s experience with the adviser or a client’s endorsement
2. ) represents or implies that the adviser has been sponsored, recommended, or approved or that its abilities or qualifications have in any respect been passed upon by the SEC or the Administrator
3. ) makes reference to past, specific, profitable recommendations made by the IA
4. ) represents that any graph, chart, formula or other device can in and of itself be used to determine which securities to buy or sell
5. ) represents that a report, analysis, or other service such as tax prep was provided w/o charge when the report analysis or other service was provided with some obligation
6. ) fails to disclose any ownership position in securities being recommended by the IA

Question 31

What must be included in a IA contract

Answer 31

1. ) services to be provided
2. ) term of the contract (renewals must be in writing)
3. ) amount the advisory fee or the formula for computing the fee
4. ) amount or manner calculation of the amount any prepaid fee to be returned in the event of contract termination
5. ) whether the contract grants discretionary power to he adviser or rep
6. ) that no assignment of the contract can be made w/o the consent of the other party to the contract
7. ) if the advisory firm is structure as a partnership, can change to minority ownership will be communicated to the clients

Question 32

What are the exceptions to the performance fee arrangements?

Answer 32

1. ) a natural person or company that has at least $1MM in AUM with the IA
2. ) a natural person or company that IA has reason to believe that immediatly prior to entering into the contract has a net worth excluding of the primary residence in excess of $2MM
3. ) a natural person who is an officer or director of the invest adviser or one of their IARs who has been employed in the industry at least 12 months

Question 33

What are the contracts disclosure differences of state IA v a federal covered adviser when entering in contracts?

Answer 33

1. ) fee arrangements may create an incentive for the IA to make investments that are riskier or more speculative than would be the case in the absence of a performance fee
2. ) The IA may receive increased compenstation w/ regard to unrealized appreciation as well as realized gains in the client’s account
3. ) periods that will be used to measure investment performance throughout the contract and their significance in the computation of the fee
4. ) nature of any index that will be used in a comparative measure of investment and performance, the significance of the index, and the reason the IA believes that index is appropriate

Note: Performance based compensation must use the net performance, considering both gains and losses

Question 34

Agency cross transactions

Answer 34

the IA acts as agent for both its advisory client and the party on the other side of the trade. In this transaction, the IA cannot recommend the transaction to both parties of the trade and must be obtained in writing before the first transaction

Question 35

Cash Referral Fees

Answer 35

Payment of cash referrals by IAs to persons who solicit business for them is NOT prohibited by the SEC providing 4 conditions are met

1. ) The IA must registered under the USA
2. ) IA has to be qualified and not disqualified from the USA
3. ) A written agreement must be in place
4. ) They must be made in the following circumstances: i.) payments are for the provision of impersonal advisory services ii.) IA pays a fee to a person affiliated with the IA (e.g. partner, officer, director, etc. of the IA) iii.) third party solicitors who are not affiliated with the IA

Under the USA, anyone who solicits on behalf of an IA must be registered as an IAR. Under the USA, the IAR does not have to be registered of the IA

Question 36

What documents must an adviser keep for the SEC when paying referral fees?

Answer 36

1. ) Written disclosure agreement to be furnished by the solicitor to the client
2. ) copies of the investment adviser’s disclosures documents (e.g. Form ADV Part 2A) delivered to the solicited client by the solicitor

Question 37

What must charts and formulas disclose when used in an advertisement piece?

Answer 37

The limitations and difficulties of using the system

Question 38

When can IAs lend money to clients?

Answer 38

An IA can not lend money to clients unless the IA is a financial institution engaged in the business of loaning money or the client is an affiliate

Question 39

From an ethical standpoint what are the requirements to provide investment advice to clients to be considered “lawful”

Answer 39

1. ) adopt and implement written policies and procedures reasonably designed to prevent violation
2. ) review at least annually the adequacy of the policies and procedures and their effectiveness
3. ) designated an individual responsible for administering the policies and procedures

Question 40

Directed Transactions

Answer 40

Arrangements under which products or services other than execution of securities transactions are obtained by an adviser from or through a B/D in exchange for the direction by the adviser of client brokerage transactions to the B/D

Question 41

Soft Dollars

Answer 41

The theory that commission dollars pay for a bundle of services, this is the practice of allocating certain dollars to pay the research component

Question 42

What must an IA explain when receiving soft dollar benefits?

Answer 42

1. ) the adviser benefits b/c it does not have to produce or pay for the research or other products or services with soft dollars
2. ) the adviser therefore has an incentive to select or recommend brokers based no the adviser’s interest in receiving these benefits, rather than on the client’s interest in getting the most favorable execution

Question 43

What should an IA’s Policy and Procedures address?

Answer 43

1. ) portfolio management process - allocation of investment opportunities and consistency with clients
2. ) trading practices, including procedures by which the adviser satisfies its best execution obligation, uses client brokerage to obtain research and other services and allocation of trades
3. ) Proprietary trading of the adviser and supervised advisers
4. ) Disclosures made to investors, clients and regulators such as acct statements and advertisements
5. ) Safeguarding of client assets from conversations and inappropriate personnel
6. ) Accuracy of record keeping
7. ) Marketing Advisory services, including the use of solicitors
8. ) Processes to value client holdings and asses fee based on those valuations
9. ) business continuity plans

Question 44

What are the enforcement powers of the SEC?

Answer 44

Censure, place limitations on the activities, functions, or operations of, suspend for a period not exceeding 12 months, revoke the registration of IA, if appropriate and if necessary go to federal court

State Administrators are responsible for their respective enforcement and may take similar actions, and court hearings must go through the state court system

Question 45

In a state enforcement case, how long does an IA have to file an appeal?

Answer 45

60 days

Question 46

What is the maximum fine for a state criminal infraction under the USA?

Answer 46

$5,000 and a prison sentence not to exceed 3 years

Question 47

What is the maximum fine for federal infraction under the SEC?

Answer 47

$10,000 fine and 5 year prison sentence

Question 48

What is a covered account?

Answer 48

an account that a financial institution offers or maintains, meant to handle multiple payments of transactions i.e. a margin account

Question 49

What policies and procedures have in place in regards to covered account protection?

Answer 49

1. ) identify relevant red flags for the institution
2. ) detect red flags that have been incorporated into the program of the financial institution
3. ) respond appropriately
4. ) ensure he program is updated periodically to reflect changes in risks to customers

Question 50

Under Regulation S-P, what is the difference between a consumer and customer?

Answer 50

Consumer is an individual who obtains a financial product or service from a firm and has no further contact with the firm. A customer is an individual who has an ongoing relationship with a firm. Consumers receive an initial notice, where is the customer receive an initial and annual notice

Question 51

Under Regulation S-P, how many days notice does a customer have to opt-out of nonpublic personal information disclosures?

Answer 51

30 days

Question 52

Model Rule

Answer 52

Rule requires that every IA shall establish, implement, and maintain written procedures relating to a Business Continuity and Succession Plan

Question 53

What should a business continuity plan include?

Answer 53

1. ) protection, backup, and recovery of books and records
2. ) Alternate means of communications with customers, key personnel, employees, vendors, service providers, regulators
3. ) Office relocation in the event of tremporary or permanent loss of a principal place of business
4. ) Assignment of duties to qualified responsible persons in the event of the death or unavailability of key personnel
5. ) Otherwise minimizing service disruptions and client harm that would result from sudden sig business interruption