3 - Federal and State Regulation of Investment Advisers and Their Representatives Flashcards Preview

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Flashcards in 3 - Federal and State Regulation of Investment Advisers and Their Representatives Deck (26):

Investment Advisor

defined under both the Investment Advisers Act of 1940 and the USA as "any person who, for compensation, engages in the business of advising others as to the value of securities of the advisability of investing in securities or as part of a regular business, issues analyses or reports concerning securities."

Under the Uniform Securities Act, an investment adviser is a person, corporation, partnership, or sole proprietorship who, in the regular course of business, advises others as to the advisability of selling securities. Harrison holds himself out as a financial planner and normally includes a section on investments in his plans. Furthermore, Harrison is compensated for his services-yet another standard of the definition, investment adviser. Under the USA, certain recognized professional designations are exempt from having to qualify by passing the licensing exam but not from registration.


A federal covered investment adviser employs the services of a third-party solicitor. The Investment Advisers Act of 1940 would require the solicitor to deliver:
a copy of the IA's brochure.
a copy of the solicitor's brochure.
a copy of the solicitor's script.
a copy of the IA's Form ADV Part 1.

I and II

Third-party solicitors must provide a copy of the investment adviser's brochure (Form ADV Part 2A), as well as a copy of the solicitor's brochure. The solicitor's script must be approved by the IA, and only the SEC receives a copy of the Form ADV Part 1.


The Model Rule

specifically refers to the authority of the Administrator to determine whether an adviser's fee schedule is competitive. Logic would dictate that fees that consistently exceed the return earned on the portfolio should not be acceptable. Investment advisers, upon making proper disclosure, are permitted to charge both fees and commissions, and there is no requirement to discount one's hourly fee, regardless of the size of the client's portfolio.


Which of the following would have to register as an investment adviser under the Uniform Securities Act?
A) A retired aeronautical engineer who charges a nominal fee for holding seminars on opportunities in aerospace stocks.
B) An accountant who advises clients about investments as an incidental part of services.
C) A trust company.
D) An economics professor who occasionally gives a lecture to business groups about the stock market.


Excluded from the definition are banks, publishers of general paid circulation publications (newspapers or magazines), investment adviser representatives, and certain professionals (lawyers, accountants, engineers, teachers) if the advice is incidental to their profession and no additional compensation is charged. In the case of the engineer, the advice is not incidental and is being given for compensation.

Agents who are compensated only on the basis of recommended trades are not receiving special compensation and are, therefore, not considered to be in the business of giving advice.


A federal covered investment adviser may enter into a contract with a client that provides for performance-based compensation under all of the following conditions

B) compensation is based on gains, less losses, for a period of no less than 1 year.
C) the client must meet certain minimum financial standards.
D) the formula used to calculate compensation includes realized capital losses and unrealized depreciation.

Since these types of compensation agreements may only be entered into with clients meeting minimum financial standards, the SEC assumes that clients understand the increased risks they are being exposed to. The minimum net worth requirement is $2 million, or a client is qualified if he has at least $1 million under management with the adviser. Any performance fee must take into consideration gains and losses, both realized and unrealized, and the performance period must be no less than one year.

Please note - state covered investment advisers must make this "incentive" disclosure so if the question asked about them, there would be no exception.

The rule requires that the performance be measured against a recognized benchmark but does not specify one.


Thresholds for SEC vs State Registration

Anything over $110Mil or more - considered Large - SEC Registration

$100 but not $110Mil - SEC or State Registration

$25 - $100Mil - Mid size - State Registration

Below $25Mil - State Registration


Written advisory contracts must contain

he services to be provided; the term of the contract; the amount of the advisory fee or the formula used to compute it; provisions for refunds, if any, if the advisory fee is prepaid and the contract is terminated; provisions as to whether discretionary authority is given and to what extent; and provisions requiring the consent of the client to assign the contract.


SEC Rule 206(4)

advertisements may not contain (1) untrue statements of material fact; (2) testimonials; (3) references only to specific past recommendations; (4) references to charts, tables, formulas, or other devices used to forecast securities prices without setting forth the difficulties or limitations in their use; (5) offerings of free service without the intent or ability to perform; or (6) guarantees of future performance.


An investment adviser wishes to engage the services of a third party to solicit new clients for the firm. To be in compliance with the Investment Advisers Act of 1940:
- the solicitor must be registered as an IAR.
- compensation may not be sales related.
- the solicitor must not be subject to statutory disqualification.
- disclosure of the solicitation arrangement must be made to clients upon request.

II and III

Third-party solicitors are not required to be registered as IARs and therefore may not receive sales-related compensation. However, they must not be subject to statutory disqualification that would prevent them from becoming registered. Disclosure is necessary whether or not it is requested.


Form ADV-E

The Form ADV-E is used as the cover page for the annual surprise audit performed by the independent accountant on all IAs who maintain custody of customer assets.


agency cross transaction

An investment adviser representative for ABC Money Managers, a wholly owned IA subsidiary of ABC Securities, Inc., sold 1,000 shares of registered securities traded on the NYSE to one of her advisory clients. ABC Securities charged commissions for both the buyer and seller of these securities.

When an investment advisory firm handles both sides of a transaction for a client of an investment adviser representative, the firm has performed an agency cross transaction-a legal practice provided all of the required disclosures are made and permissions obtained.

An agency cross transaction occurs when an investment adviser acts as both adviser and broker-dealer and requires prior written approval from the client and special reporting requirements. The adviser cannot recommend the transaction to both parties, only one side or the other.


An adviser acts as pension consultant to employee benefit plans with assets of $200 million or more, is he / she required to register as investment adviser in a particular state

The pension consultant in this question would not be required to register with the state because those who act as pension consultants and have at least $200 million in assets under management have the option to register with the SEC.


Which of the following types of compensation is an investment adviser prohibited from accepting?
A) Commissions on trades effected for clients.
B) Quarterly fee based on account performance.
C) Annual fee as a fixed dollar amount.
D) Annual fee based on a percentage of assets under management.

Fixed annual fees, wrap fees, fees based on a percentage of assets under management, and commissions from trades effected for clients are acceptable forms of compensation. Unless the client has at least $1 million under management or a personal net worth of at least $2 million, performance-based fees are not permitted.


Under the Investment Advisers Act of 1940, an adviser is required to be registered with the SEC if:
A) the adviser is the publisher of a news magazine of general and regular circulation.
B) the adviser's clientele is exclusively federal credit unions and the adviser has less than $100 million in assets under management.
C) the adviser's advice relates solely to securities issued or guaranteed by the U.S. government.
D) the adviser's clients are investment companies registered under the Investment Company Act of 1940.


Advisers to registered investment companies are required to be SEC registered. Under the Advisers Act, as modified by the Dodd-Frank Act, advisers are exempt from SEC registration if they manage less than $100 million in assets and have no investment company clients. Persons are excluded from the Advisers Act definition of investment adviser if they are publishers of news or business/financial publications of general and regular circulation or if their advice relates solely to U.S. government securities.


Included in the Investment Advisers Act of 1940 are a number of different recordkeeping requirements. If the firm were to dissolve, partnership agreements must be kept for

Is there recordkeeping requirements for agents or IARs.

Both ​​the Investment Company Act of 1940 ​(applicable here because this is a covered adviser) and the NASAA Model Rule on Recordkeeping ​require that investment advisers maintain certain records, such as partnership agreements and corporate articles of incorporation, for a period of no less than three years after dissolution.

Recordkeeping requirements for broker-dealers are three years and partnership articles and any amendments, articles of incorporation, charters, minute books, and stock certificate books of an investment adviser and of any predecessor, shall be maintained in the principal office of the investment adviser and preserved until at least three years after termination of the enterprise.

There are no recordkeeping requirements for agents or IARs.


Automated Performance Advisers (APA), a registered investment adviser in 3 states, has spent several years and in excess of $1 million developing the software for a computerized program that APA believes will allow the model portfolios it designs for its clients to consistently outperform the market. In the first year of beta testing the program, returns have ranged from 40% to 60% above the relevant benchmarks. Because of this success, and in an effort to recoup some of the development costs, APA is now charging, in addition to their standard 25 basis points per quarter, a performance-based fee of 10% of the increase of value in a client’s portfolio. In so doing, APA would be

In violation of the Uniform Securities Act

First of all, this is a state-registered investment adviser, so the Investment Advisers Act of 1940 and the SEC have no jurisdiction. Then, we look at this quote from the USA: “Except as may be permitted by rule or order of the Administrator, it is unlawful for any investment adviser to enter into, extend, or renew any investment advisory contract unless it provides in writing that the investment adviser shall not be compensated 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.” Even though we know that there are conditions under which performance-based compensation is permitted, unless the question specifically refers to that exception, the answer is that it is not permitted.


As a result of an SEC hearing, an investment adviser's penalty is $5,000 and a 50-day suspension. If the IA wishes to appeal this verdict, a request for review must be filed with the:

U.S. Court of Appeals within 60 days of the order

Under both federal and state laws, appeals must be filed within 60 days of the order. In the case of an SEC hearing, the appeal is filed with the U.S. Court of Appeals for the district in which the original hearing was held.


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 be named as agent or trustee for a client's account or else use a qualified custodian.
D) 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.


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 three months, not every six months.


De minimis rule for a registered investment adviser

who has no place of business in the state is fewer than six clients. Doing business with six clients within the last 12 months exceeds this de minimis amount and, therefore, the exemption from registration does not exist. All others listed as possible answers are institutional or professional type of investment clients. If a registered investment adviser works only with this type of client, an exemption from registration in that state exists as long as the registered investment adviser has no place of business in that state.

If an adviser has no more than five clients who are residents of the state during the year, the adviser does not have to register with the state. This is the de minimis exemption; advisers with no place of business in this state must register if they have more than five noninstitutional clients in the state.


Investment Councel

1) the IA's principal business must be giving investment advice
2) Provide investment supervisory services

example: firms whose exclusive business is placing their clients assets into model portfolios


Time Period for Maintianance of Records

the Investment Advisors Act of 1940 as well as the USA requires that an investment adviser's books and records be maintained in a readily accessible place for five years.

During the first two years the rule requires that the records be maintained in the principal office of the adviser


A client of an investment adviser needs a bridge loan and approaches the IA to see if the firm is interested. Because the IA is not in the business of lending money, a special agreement is drawn up specifying the terms of the loan. Under NASAA's Model Rule dealing with Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers

permits borrowing from clients only

the loan could only be made after the advisory contract was terminated

Loans may never be made to clients unless the firm is in the business of lending money. Since this IA states that it is not their business model, the only way this loan could be made is if there was no adviser/client relationship.

The NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federal Covered Advisers permits borrowing from clients only when they are in the lending business or are affiliates of the firm.


What is considered to be in the business of investment advising?

If a person advertises as one who provides investment advice or engages in providing investment advice or analyses on a regular basis (even if not the person's principal business activity), the person is considered in the business of giving investment advice. If the person receives any compensation that represents a clearly definable charge, commission, or fee for such advice (whether paid separately or not), she is considered in the business. If the person engages in other financial activities in connection with the advice, it cannot be used to avoid the business standard.

The insurance agent who discusses the merits of life insurance does not sell investment advice or securities, only insurance policies. The insurance agent does not hold herself out as an adviser nor does she provide advice on securities.


Under the Investment Advisers Act of 1940, unless delayed by the SEC, registration of an investment adviser becomes effective how many days after filing?

This is one of the differences between the Uniform Securities Act and the Investment Advisers Act of 1940. Registrations become effective at noon on the 30th day after filing under the Uniform Securities Act. They become effective 45 days after filing, unless delayed by the SEC, under the Investment Advisers Act of 1940.


An investment advisory contract is considered assigned if an adviser formed as a:
A) partnership with five partners and adds two partners.
B) partnership with two partners and adds five partners.
C) corporation with two officers and adds five officers.
D) corporation with five officers and adds two officers.


If an advisory firm is formed as a partnership and there is a change in the majority of partners, this is considered to be an involuntary assignment to the new partnership. In this case, client approval is required.


nonissuer transaction

A tranasction not directly or indirectly executed for the benefit of the issuer. Nonissuer transactions refer to any disposition of a security that does not confer a benefit to the issuer (company).

none of the proceeds go to the issuer, and the most common nonissuer transaction occurs between investors in the secondary market. An issuer transaction provides capital to issuers.