IACCP Practice Exam

Question 1

Q1: Under which circumstance must an SEC registered Adviser obtain a surprise examination by an independent public accountant to verify the assets for which it is deemed to have custody?

a) SEC-registered Adviser has authority to deduct fees from its client accounts.
b) SEC-registered Adviser holds general power of attorney for two of its client accounts.
c) SEC-registered Adviser requires prepayment of its total annual financial planning retainer in the amount of $1,000.
d) SEC-registered Adviser is general partner and manager for a hedge fund that relies on the audit provision under the custody rule.

Answer 1

Answer: B

Under Rule 206(4)-2 of the Advisers Act, the client funds and securities of which investment advisers have custody must be verified by a surprise examination at least once during each calendar year by an independent public accountant. This rule allows for two exceptions:

(1) an adviser with limited custody solely because of its authority to deduct advisory fees from client accounts; and
(2) an adviser to a pooled investment vehicle(s) that is subject to an annual financial statement audit by an independent public accountant registered with, and subject to regular inspection by, the PCAOB, and that distributes the audited financial statements prepared in accordance with GAAP to the pool’s investors within the time period prescribed by the rule.

SEC-registered advisers that require prepaid fees of less that $1200 more than six months in advance are not required to obtain an annual surprise examination.
See Advisers Act Custody Rule 206(4)-5

Question 2

Q2: Which three entities are excluded from the Advisers Act definition of “investment adviser”? (Choose three.)

a) A bank or bank holding company.
b) Any broker or dealer whose provision of investment advice is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefore.
c) The publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation.
d) An investment institution that provides investment advice solely to a registered investment company.

Answer 2

Answer: A, B & C

Investment advisers to registered investment companies are not excluded from the definition of “investment adviser” and, moreover, must register with the SEC regardless of the amount of assets under the adviser’s management.
See Advisers Act 202(a)(11) for the definition of an “investment adviser” (and exclusions thereof)

Question 3

Q3: DCH, an SEC-registered adviser, is notice filed in Massachusetts, Connecticut, Rhode Island, Vermont and Maine. The Adviser’s office and all of its employees are located in Massachusetts. The Adviser’s representatives all meet the Advisers Act definition of “Investment Adviser Representative.”
Where must the representatives of DCH (i.e., individuals who provide investment advice on behalf of DCH) be licensed as investment adviser representatives?

a) Massachusetts, Connecticut, Rhode Island, Vermont, and Maine
b) Any state in which the investment adviser representative provides advice to more than 5 clients who reside in that state
c) Massachusetts
d) Washington DC, where the SEC is headquartered

Answer 3

Answer: C

Section 203A and Rule 203A-3 of the Advisers Act prohibit any state from requiring licensing, qualification or registration of any supervised person of an SEC-registered investment adviser that does not have a place of business within that state. Thus, regardless of whether DCH is notice filed in other states, IA Reps of DCH need only comply with any qualification and/or licensing requirements of the state in which they have a place of business (i.e., Massachusetts).
See Advisers Act Rule 203A-3
(Definition of Investment Adviser Representative)

Question 4

Q4: DCH, an SEC registered investment adviser, has three supervised persons who provide investment advice to clients (Adam, Bob and Chris).

Adam provides advice to: six individual clients who have $500,000 (3 clients) and $700,000 (3 clients) in assets under DCH’s management respectively. Two of the above clients have a net worth of $1,000,000. Sixty-five (65) small companies each with a net worth of $5,000,000.

Bob provides advice to: eight individual clients, who have $500,000 (4 clients) and $1,000,000 (4 clients) in assets under DCH’s management respectively. All eight of the above clients have a net worth of $1,200,000. Twenty-five (25) small companies each worth over $5,000,000.

Chris provides advice to: eight individual clients, who have $500,000 (5 clients), $700,000 (2 clients), and $800,000 (1 client) in assets under DCH’s management respectively. All eight of the above clients have a net worth of $1,000,000. Forty (40) small companies each worth over $10,000,000.

Who should be licensed as an investment adviser representative?

a) Adam and Bob
b) Adam and Chris
c) Chris only
d) Adam only

Answer 4

Answer: C
This question requires a thorough understanding of Advisers Act Rule 203A-3 and the federal definition of “Investment Adviser Representative.” In general, an IA Rep is any supervised person of an SEC-registered investment adviser who:
(i) has more than 5 “natural person” clients, and
(ii) more than ten percent of whose clients are “natural persons.”
Nevertheless, it is important to note that for purposes of this definition, a “qualified client” (i.e., a person who has either$1,000,000 in assets under the adviser’s management or a net worth of $2 million or more) does not count as a natural person.
– 10% or less of Adam’s clients are “natural persons,” and therefore Adam does not need to license
as an IA Rep.
– Bob does not have more than 5 clients who are “natural persons,” but rather has 4 natural person
clients remembering that those with $1,000,000 or more in assets under DCH’s management do
not count as “natural persons”).
– Chris has 8 natural person clients, which comprise just over 15% of his client base. Chris,
therefore, must license as an IA Rep.
See Advisers Act 203A-3
(Definition of Investment Adviser Representative)

Question 5

Q5: DCH provides investment advice to:

1) John Doe;
2) A revocable living trust set up by John Doe’s grandfather for the benefit of John Doe and two of his minor children (assume grandfather is living);
3) John Doe’s cousin who lives with John Doe;
4) John Doe’s 20-year-old sister who lives down the street;
5) John Doe’s 19-year-old son who lives across the country from John.

How many clients does DCH have?

a) One
b) Two
c) Three
d) Four

Answer 5

Answer: C

The Advisers Act defines a “client” as a natural person, and

(i) any minor child of the natural person;
(ii) any relative (by blood or marriage) of the natural person who has the same principal residence;
(iii) all accounts of which the natural person and/or the persons referred to above are the only primary beneficiaries; and
(iv) all trusts of which the natural person and/or the persons referred to above are the only primary beneficiaries.

A legal organization (e.g., corporation, partnership, trust, etc.) also counts as a client where the investment advice relates to the entity and not the owner, while two or more legal organizations that have identical clients are considered one client.

Thus, John, the trust, and John’s cousin would all be considered one client.

Question 6

Q6: An investment adviser that votes proxies on behalf of advisory clients must fulfill which two requirements? (Choose two.)

a) Abstain from voting any proxies on behalf of an ERISA plan client.
b) Offer its proxy voting policies and procedures to all clients for which it votes proxies.
c) Maintain copies of each proxy statement it receives and each vote it casts.
d) Send clients an annual statement concerning how their proxies were voted.

Answer 6

Answer: B & C

Advisers Act Rule 206(4)-6 requires an investment adviser that votes proxies for advisory clients to offer its proxy voting policies and procedures to all clients for which it votes proxies and maintain copies of each proxy statement it receives and each vote it casts.
See SEC Proxy Voting Release
(SEC Release No. IA-2106, January 31, 2003)
Available at: http://www.sec.gov/rules/final/ia-2106.htm

Question 7

Q7: An SEC-registered adviser will be deemed to have custody in which three situations? (Choose three.)

a) Adviser holds client securities in a fire-proof safe in its offices.
b) Adviser’s Portfolio Manager serves as a trustee for a new corporate account.
c) Adviser has the authority to directly debit advisory fees from client accounts.
d) A client writes a check payable to the client’s custodian, which Adviser forwards on to the custodian.

Answer 7

Answer: A, B & C

Generally, an investment adviser that has any direct or indirect access to client funds or securities is deemed to have “custody” of client assets. A and C depict situations where the adviser (if only momentarily) has possession of or access to a client’s funds or securities, while B indicates a relationship in which the PM has the ability to disburse funds on behalf of the account. Where a check is made payable to a third party, the adviser has no access to the underlying funds and therefore does not have custody of the funds.

Please note that where an adviser only has custody due to the direct debiting of fees, the adviser may continue to answer “no” to custody questions on Form ADV.

See SEC Final Custody Rule (SEC Release No. IA-2968, December 30, 2009)
Available at: http://www.sec.gov/rules/final/2009/ia-2968.pdf
See SEC Staff Responses to Questions About the Custody Rule (September 9,2010)
Available at: http://www.sec.gov/divisions/investment/custody_faq_030510.htm

Question 8

Q8: Which three scenarios would trigger a violation of the SEC Pay-to-Play Rule? (Choose three.)

a) A subadviser of a pooled investment vehicle, whereby a government entity (Pension X) is an investor and pays advisory fees, makes a political contribution to the official in charge of selecting investment advisers for Pension X.
b) An adviser of a pooled investment vehicle whereby a government entity (Pension X) is an investor and pays advisory fees, makes a political contribution to the official in charge of selecting investment advisers for Pension X.
c) An adviser of a pooled investment vehicle directs its outside counsel to make a political contribution to an official in charge of selecting investment advisers for Pension X which is an investor in the adviser’s pooled investment vehicle and pays advisory fees to the investment adviser.
d) A Covered Associate of a registered investment adviser makes a political contribution of $150 to a politician in his/her voting district, and that politician is part of a committee that advises on municipal fund investments.

Answer 8

Answer: A, B & C

Rule 206(4)-5 prohibits an investment adviser from providing or agreeing to provide, directly or indirectly, payment to third-parties (e.g., finders, solicitors, placement agents and pension consultants) or thirdparty solicitation firms for a solicitation of advisory business from any government entity on behalf of such adviser, unless such third parties are “regulated persons,” which include certain broker-dealers, registered investment advisers and municipal advisers that are themselves subject to pay to play restrictions.

Option (d) does not violate Pay to Play because a covered Associate is allowed to make political contributions to a candidate they are eligible to vote for up to $350.00 total during one election.

See Advisers Act Pay-to Play Rule 206(4)-5

Question 9

Q9: An independent solicitor for an SEC registered adviser must provide the solicited client with which two documents?
(Choose two.)

a) A copy of the solicitor’s agreement entered into between the solicitor and the adviser.
b) A solicitor’s disclosure brochure at the time of the solicitation.
c) A copy of the adviser’s Form ADV Part 2.
d) A copy of the adviser’s Code of Ethics.

Answer 9

Answer: B & C

The SEC Cash Solicitation rule requires an unaffiliated solicitor to provide solicited clients with a solicitor’s disclosure brochure and the adviser’s Form ADV Part 2 at the time of the solicitation. While a contract must be in place between the adviser and the solicitor, there is no requirement that a copy of the agreement itself be given to clients, nor must a Code of Ethics be provided by the solicitor (although the adviser is required to provide clients with a copy of its Code of Ethics upon request).
See Advisers Act Rule 206(4)-3 (Cash Solicitation Rule)

Question 10

Q10: Which three groups of books and records are considered required books and records according to the Advisers Act?
(Choose three.)

a) Check books, bank statements, cancelled checks and cash reconciliations of the investment adviser.
b) All paid or unpaid bills or statements (or copies thereof), paid or unpaid, relating to advisory business.
c) Marketing brochures (or other advertising materials) sent to fewer than 10 advisory clients.
d) General and auxiliary ledgers (or other comparable records) reflecting asset, liability, reserve, capital, income and expense accounts.

Answer 10

Answer: A, B & D

The Advisers Act books and records rule explicitly encompasses all of the records described in this question except for marketing brochures (or other advertising materials) sent to fewer than 10 advisory clients, which the rule explicitly exempts from record retention requirements.
See Advisers Act Rule 204-2 (Books and Records)

Question 11

Q11: An SEC-registered investment adviser’s access persons are required to submit personal securities holdings and/or transaction reports at which three intervals? (Choose three.)

a) Initially upon becoming an access person
b) Monthly
c) Quarterly
d) Annually

Answer 11

Answer: A, C & D

Advisers Act Rule 204A-1 requires all access persons to submit an initial holdings report of reportable securities (updated annually) and quarterly transaction reports.
See Advisers Act Code of Ethics Rule 204A-1

Question 12

Q12: Personnel at DCH Advisers buy and sell the same securities that they also recommend to advisory clients. Moreover, certain DCH personnel may receive confidential, nonpublic information about public companies on which they sit on the Board of Directors.
Which three procedures may be implemented and utilized to help detect and prevent front-running, insider trading or other violations of the securities laws? (Choose three.)

a) Blackout Periods
b) Pre-clearance Procedures
c) Restricted Lists
d) Form ADV Disclosure

Answer 12

Answer: A, B & C
The procedures listed in A, B and C (or a combination thereof) may all be utilized to help detect and prevent violations of the federal securities laws, including insider trading (which is of primary concern here). While thorough and accurate Form ADV disclosure may, in certain situations, help protect advisers against claims of a breach of fiduciary duty and/or conflict of interest, it cannot (in and of itself) protect against other violations of the federal securities laws such as insider trading violations.
See SEC Release No. IA-2256, IC-26492
[Code of Ethics (2004)]

Question 13

Q13: Which Form ADV disclosure is explicitly required for an SEC-registered investment adviser?

a) Pre-clearance procedures
b) A short description of the adviser’s Code of Ethics
c) A short description of the adviser’s Policies and Procedures Manual
d) Blackout period procedures

Answer 13

Answer: B

Item 11 of Form ADV Part 2 explicitly asks for a description of the adviser’s Code of Ethics.
See SEC Release No. IA-2256, IC-26492
[Code of Ethics (2004)]

Question 14

Q14: Which two situations are aspects of an investment adviser’s fiduciary duty to its clients?
(Choose two.)

a) If an investment adviser representative is also a registered representative of a broker-dealer that effects trades for advisory clients, the adviser must offset any commissions received by the representative, against the advisory fee charged to clients.
b) An investment adviser must ensure that any investment recommendation given to a client is suitable to the client’s financial circumstances and risk tolerance.
c) An adviser has a duty to seek best execution on behalf of the clients.
d) An adviser must refrain from entering into business transactions with the advisory client’s other service providers.

Answer 14

Answer: B & C

Best execution and suitability of recommendations are cornerstones of an investment adviser’s fiduciary duty owed to advisory clients. While advisers are not prohibited from engaging in the activities described in A and D, the adviser should ensure that these activities and any potential conflict of interest arising from these activities are fully disclosed in Form ADV. Moreover, these activities may be prohibited under other state and/or federal statutes or regulations in certain circumstances (e.g., ERISA).
See SEC v. Capital Gains Bureau (U.S. Supreme Ct., 1963)

Question 15

Q15: Which two securities are exempt pursuant to SEC Codes of Ethics reporting requirements? (Choose two.)

a) U.S. Government Bonds
b) Exchange-Traded Funds
c) Unaffiliated open-end registered mutual funds
d) Municipal Bonds

Answer 15

Answer: A & C

U.S. government bonds and open-end mutual funds are not “reportable securities” for Code of Ethics purposes.
It is important to note that a SEC No-Action Letter (National Compliance Services, November 30, 2005) clarified that while unit investment trust exchange-traded funds (“ETFs”) (i.e., ETFs that trade in the secondary market) are reportable, open-end ETFs (akin to open-end mutual funds) are not reportable.
See Advisers Act Code of Ethics Rule 204A-1

Question 16

Q16: The SEC Codes of Ethics Rule does not require:

a) Personal securities transaction reports for access persons.
b) Acknowledgements from all supervised persons that they received a copy of the firm’s Code of Ethics.
c) Pre-clearance procedures for access persons to buy or sell a reportable security for their own account(s).
d) Reporting of any violations of the firm’s code of ethics by supervised persons promptly to the CCO and/or other designated persons.

Answer 16

Answer: C

While Advisers Act Rule 204A-1 requires access persons to obtain the adviser’s approval before investing in an initial public offering (“IPO”) or private placement, there is no such requirement that an adviser pre-clear an access person’s investment in any other type of security. Nevertheless, mandatory preclearance for other types of securities is a best practice utilized by many advisers.
See Advisers Act Codes of Ethics Rule 204A-1

Question 17

Q17: An adviser should compare which two sets of trading documents in order to detect trade errors?

a) Pre-trade order tickets and post-trade order tickets
b) Pre-trade order tickets and post-trade confirmations
c) Post-trade order tickets and post-trade confirmations
d) Post-trade confirmations and Investment Committee minutes

Answer 17

Answer: B

Consistent with an investment adviser’s fiduciary duty to its clients, losses caused by the adviser’s own trade error are the responsibility of the adviser and should not be borne by clients. The most effective way to detect trade errors is by comparing a pre-trade order ticket to the post-trade confirmation to ensure that the two documents are consistent. Reviewing a post-trade order ticket to the confirmation is of little help in determining whether the order was erroneously executed during the initial order.
Best Practices/Fiduciary Duty

Question 18

Q18: Pursuant to Section 28(e) of the Securities Exchange Act of 1934, which two products/service are characteristic of eligible soft dollar products/service under the safe harbor?
(Choose two.)

a) A research product obtained via commissions paid from client accounts over which the investment adviser has investment discretion.
b) A research product received via commodities trades placed by the investment adviser.
c) A research product received from a broker which the client has directed the investment adviser to use.
d) A brokerage service that assists the investment adviser in executing client transactions.

Answer 18

Answer: A & D
Commissions generated from transactions involving commodities or financial futures are not afforded the protection of Section 28(e).
Likewise, Section 28(e) is not available for directed brokerage arrangements since the safe harbor is only available where a person with investment discretion is causing a client to “pay up.” In directed brokerage arrangements, the client selects the brokerdealer to be used and therefore the adviser is not causing the client to pay up.
See SEC Soft Dollar Guidelines,
(SEC Release No. 34-54165, July 24, 2006)
Available at: http://www.sec.gov/rules/interp/2006/34-54165fr.pdf

Question 19

Q19: Pursuant to the SMC Capital No-Action letter, what methods of trade allocation may an adviser follow when aggregating client trades?

a) Pro-rata allocation only
b) Rotational allocation but full and fair disclosure must be made to clients
c) Pro-rata or random allocation in the sole discretion of the adviser so long as no client is favored over others
d) Pro-rata, rotational or random allocation as long as sufficient disclosure is made and no clients are favored nor disadvantaged

Answer 19

Answer: D
In the SMC Capital, Inc. no-action letter, the SEC indicated that aggregation of client orders would not violate the anti-fraud provisions of Section 206 of the Advisers Act if the practice of allocating orders is fully disclosed in the adviser’s Form ADV and separately disclosed to existing clients and no advisory account is favored over any other account. All clients participating in the aggregated order shall receive an average share price with all other transaction costs shared on a pro-rata basis.
See SMC Capital No-Action Letter
[SMC Capital, Inc. (September 5, 1995)]

Question 20

Q20: Which scenario best describes an agency cross transaction?

a) The investment adviser places a discretionary trade between an advisory client and a non-advisory brokerage client of an affiliated broker-dealer and receives a commission.
b) The investment adviser purchases a security from or sells a security to an advisory client.
c) The investment adviser/broker-dealer purchases 10 shares of stock A from a market-maker, then immediately sells the 10 shares to an advisory client at the same price.
d) An investment adviser moves Client A’s stock to Client B’s account, and Client B’s stock to Client A’s account (the stock never hits the market and no commission is
charged) .

Answer 20

Answer: A

For purposes of the Advisers Act and SEC Rules, an agency cross transaction for an advisory client is defined as “a transaction in which a person acts as an investment adviser in relation to a transaction in which such investment adviser, or any person controlling, controlled by or under common control with such investment adviser, acts as broker for both such advisory client and for another person on the other side of the transaction” (SEC Rule 206(3)-2(5)(b)).
See Advisers Act Rule 206(3)-2

Question 21

Q21: An adviser is most likely to use “fair market” valuation for which type of securities?

a) Interests in Hedge Funds
b) Fixed Income Securities
c) Exchange-traded Funds
d) Exchange-listed Securities

Answer 21

Answer: A
Fair Market valuation is typically utilized for hedge funds. A hedge fund manager generally should value investments according to applicable Generally Accepted Accounting Principles (GAAP). For companies such as hedge funds, GAAP typically requires the use of “fair value” – the amount at which an item could be exchanged in a current transaction between willing parties other than in a forced or liquidation sale.
Best Practices/Fiduciary Duty

Question 22

Q22: If a client directs the investment adviser to utilize a particular broker-dealer, which three disclosures must be made in Form ADV Part 2?
(Choose three.)
a) Directed brokerage may cost the client more money.
b) Not all advisers require clients to direct brokerage.
c) Adviser does not have the ability to refuse the directed brokerage request.
d) Most favorable execution may not be achieved.

Answer 22

Answer: A, B & D
Form ADV Part 2A Item 12 A 3 requires that if a client directs the investment adviser to utilize a particular broker-dealer, the following disclosures (among others) must be made:
• Not all advisers require their clients to direct brokerage.
• Adviser may be unable to achieve most favorable execution of client transactions.
• Directing brokerage may cost clients more money. For example, in a directed brokerage account, the client may pay higher brokerage commissions because the adviser may not be able to aggregate orders to reduce transaction costs, or the client may receive less favorable prices.

Question 23

Q23: ABC Advisers provides discretionary management services to clients. ABC Advisers is given brokerage discretion to determine the broker-dealer to use for client transactions and the commission costs that will be charged to its clients. ABC directs all trades through its affiliated broker-dealer, XYZ Brokers, whom it believes provides the best quality brokerage services to its clients.
Which statement properly characterizes this situation?

a) ABC is violating its fiduciary duty of best execution.
b) ABC is not necessarily violating its best execution obligations, but will be under heightened scrutiny and should ensure it fully discloses all potential conflicts of interest.
c) ABC should disclose in Form ADV that it will not be able to achieve best execution.
d) Since this is a directed brokerage arrangement, ABC has no fiduciary duty of best execution in the above scenario.

Answer 23

Answer: B
Investment advisers who manage or supervise client portfolios on a discretionary basis have a fiduciary obligation of best execution. As a fiduciary, a money manager has an obligation to obtain ‘best execution’ of clients’ transactions under the circumstances of the particular transaction. The money manager must execute securities transactions for clients in such a manner that the clients’ total cost or proceeds in each transaction is the most favorable under the circumstances.
Full and fair disclosure is always important and this covers best execution practices, which can be described in Form ADV Part 2, an advisory agreement, etc. Remember that disclosures must match the firm’s actual practices.
Best Practices/Fiduciary Duty

Question 24

Q24: ABC Advisers offers non-management investment consulting services. ABC employs Bob, who is also a registered representative of a broker-dealer. Clients may elect to engage Bob to implement advisory recommendations, for which Bob will receive commissions.
Which statement is most accurate?
a) Bob may not execute securities transactions for advisory clients of ABC.
b) Bob may execute securities transactions as long as there is adequate Form ADV 2A disclosure that Bob will receive additional compensation.
c) Bob may execute securities transactions, but must offset commission charges against the investment adviser consulting fees charged to the client.
d) Bob may execute securities transactions without offsetting commission charges or drafting Form ADV disclosure because ABC does not manage advisory accounts and therefore no conflict of interest is present.

Answer 24

Answer: B
Form ADV: Part 2A, Items 5 and 11: 5: Fees and Compensation requires Advisers to disclose if the Adviser or a supervised person accepts compensation for the sale of securities or other investment products.
11: Code of Ethics, Participation or Interest in Client Transactions and Personal Trading requires Advisers to disclose all Participation and Interest in Client Transactions in which Applicant or a related person Acts as Broker or Agent and effects securities transactions for compensation for any clients.

Question 25

Q25: An investment adviser is not required to promptly update Form ADV (i.e., within 30 days) in which situation? a) A change in assets under management in Part 1 b) A material inaccuracy in information in Part 2A c) A change in ownership in Schedule A d) A change in disciplinary disclosure in Part 1 and Part 2A: Item 9

Answer 25

Answer: A In addition to the Form ADV annual updating amendment requirement, advisers must amend Form ADV by filing additional amendments (other-than-annual amendments) promptly if: • information you provided in response to Items 1, 3, 9 (except 9.A(2), 9.B.(2), and 9.E), or 11 of Part 1A or Items 1, 2.A. through 2.F., or 2.I. of Part 1B become inaccurate in any way; • information you provided in response to Items 4, 8, or 10 of Part 1A or Item 2.G. of Part 1B become materially inaccurate; or • information you provided in your brochure becomes materially inaccurate. See General Instructions to Form ADV Available at: www.sec.gov/about/forms/formadv-instructions.pdf

Question 26

Q26: The Clover Capital No-Action letter includes which two required actions for advisers? (Choose two.) a) Disclose the effect of material market or economic conditions on the results portrayed. b) Reflect the deduction of custodial fees. c) Disclose whether and to what extent the results portrayed include the reinvestment of dividends and other earnings. d) Disclose that performance records are kept for the required 5-year period pursuant to the Advisers Act.

Answer 26

Answer: A & C In SEC no-action letter, Clover Capital Management, Inc., the staff of the SEC’s Division of Investment Management listed eleven practices which it holds to be inappropriate under the Advertising Rule of the Advisers Act. See Clover Capital Mgmt., Inc. SEC No-Action Letter (October 28, 1986)

Question 27

Q27: When a portfolio manager changes advisory firms, the manager’s performance at the previous adviser may be included in the new firm’s performance if which three conditions are met? (Choose three.) a) Both investment adviser firms have substantially similar investment objectives, policies and strategies. b) There must be an agreement between the previous firm and the current advisory firm. c) The current firm obtains back-up documentation of performance from the predecessor firm. d) No other person played a significant part in achieving the performance from the predecessor firm included in the current firm’s advertisement.

Answer 27

Answer: A, C & D “While the use of prior performance results by a subsequent investment adviser may raise an issue under Rule 206(4)-1, we do not believe that the Adviser’s use of [the portfolio manager’s] performance results would in and of itself be misleading provided: (1) that no individual or entity, other than [the portfolio manager] played a significant part in the performance of the accounts of [the portfolio manager] and (2) the results of [the portfolio manager’s] accounts whose performance you seek to advertise were not materially different from the performance of [the portfolio manager’s] accounts which did not become accounts of the Adviser.” See Horizon Asset Management, LLC, SEC No-Action Letter (September 13, 1996)

Question 28

Q28: A “wrap-fee” program can be best described as a service whereby an investment adviser: a) Offers multiple investment advisory services (e.g., portfolio management and financial planning) for a single “wrapped” fee. b) Charges a fee or fees not directly based on transaction costs which covers both advisory services and trade executions. c) Offsets all client commission costs against the advisory fee charged. d) Executes a predetermined number of client transactions under a single “wrapped” fee.

Answer 28

Answer: B Wrap Fee Program: Any advisory program under which a specified fee or fees not based directly upon transactions in a client’s account is charged for investment advisory services (which may include portfolio management or advice concerning the selection of other investment advisers) and the execution of client transactions. [Used in: Part 1, Item 5; Schedule D] See General Instructions to Form ADV (Glossary of Terms) Available at: www.sec.gov/about/forms/formadv-instructions.pdf

Question 29

Q29: Which two “testimonials” would be allowed under the Advisers Act? (Choose two.) a) Unbiased third party reports where favorable responses are not emphasized over unfavorable responses. b) Television advertisements where a favorable oral statement is made concerning the adviser. c) A favorable statement by a former or present client concerning the adviser’s services coupled with unfavorable statements by former or present clients concerning the adviser’s services. d) A partial client list selected by objective, non-performance based criteria with appropriate disclaimers.

Answer 29

Answer: A & D (A) In a series of no-action letters, the SEC staff has permitted the distribution of articles concerning an investment adviser where the articles are prepared by an unbiased third party and do not include a statement of a client’s experience or a client endorsement. (D) SEC staff said that it would not object if the investment adviser distributed the partial client list if the following three conditions were satisfied: • The investment adviser could not use performance-based criteria (but would use some other objective criteria, e.g., account size, geographic location and client classification) in choosing which clients to include in the list; • Each client list would have to bear a disclaimer stating that “it is not known whether the listed clients approve of [investment adviser] or the advisory services provided”; and • Each client list would include a statement describing the objective criteria used to determine which clients to include in the list. See Denver Investment Advisers, Inc., SEC No-Action Letter (June 30, 1993). See Stalker Advisory Services (available January 18, 1994).

Question 30

Q30: An investment adviser may use past specific recommendations in an advertisement in which two situations? (Choose two.) a) If adviser includes a list of all portfolio recommendations for the prior one year period from the date of the recommendation used. b) If adviser uses recommendations selected on objective, non-performance based criteria consistently applied with appropriate disclosure included (e.g., largest positions held). c) If adviser uses a list of the 15 holdings that contributed most positively to a representative account’s performance directly next to an equally conspicuous disclosure of the two holdings that contributed most negatively, but only if performance calculation methodology is disclosed. d) If adviser uses past recommendations with the following disclaimer: “Past performance is no guarantee of future results.”

Answer 30

Answer: A & B The Rule excludes from the past specific recommendations prohibition any advertisement that complies with three conditions. 1) The advertisement must “set[s] out or offer[s] to furnish a list of all recommendations made by such investment adviser within the immediately preceding period of not less than one year.” 2) The advertisement or list must state (i) the name of each security recommended; (ii) the date and nature of each recommendation (e.g., buy, sell or hold); (iii) the market price of the security at the time of the recommendation; (iv) the price at which the recommendation was to be acted on; and (v) the market price of each security as of the most recent practicable date. 3) The advertisement or list must include the following legend on the first page (in print or type as large as the largest print or type used in the text of the advertisement or list): “It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities in this list.” See Advisers Act Rule 206(4)-1(a)(2). See also, e.g., In re Stellar Mgmt., Inc. [Investment Advisers Act Release No. 1416 (June 6, 1994).]

Question 31

Q31: Which two circumstances are true in a firm’s requirement to prepare and deliver a Wrap Fee Program Brochure (ADV Part 2A, Appendix 1)? (Choose two.) a) The firm may rely on another sponsor to create and deliver to the firm’s wrap fee program clients in a wrap fee program which has multiple sponsors. b) The firm can combine the required disclosures into the Form ADV Part 2A Brochure and wrap fee program brochure if the firm provides other advisory services outside of the wrap fee program, offering a single disclosure brochure for all clients. c) The firm must prepare a wrap fee program brochure if they offer multiple investment advisory services (e.g., portfolio management and financial planning) for a single “wrapped” fee. d) The firm does not need to prepare a wrap fee program brochure if the firm only acts as a portfolio manager to a wrap fee program.

Answer 31

Answer: A & D If you sponsor a wrap fee program, you must give a wrap fee program brochure to each client of the wrap fee program. However, if a wrap fee program that you sponsor has multiple sponsors and another sponsor creates and delivers to your wrap fee program clients a wrap fee program brochure that includes all the information required in your wrap fee, you do not have to create or deliver a separate wrap fee program brochure. A wrap fee program brochure takes the place of your advisory firm brochure required by Part 2A of Form ADV, but only for clients of wrap fee programs that you sponsor. The wrap fee program brochure must be used to meet the disclosure brochure requirements for sponsors of wrap fee programs. Disclosing a wrap fee program in a Part 2A brochure will not satisfy a sponsor’s disclosure brochure requirements, even if the sponsor must use Part 2A to disclose other advisory services. Similarly, a wrap fee brochure cannot be used to meet the disclosure brochure requirements for other advisory services.

Question 32

Q32: Which two specific requirements regarding the delivery of the ADV Part 2A Brochure to clients are true? (Choose two.) a) The brochure is delivered only to clients with a written advisory agreement (clients with oral agreements are excluded). b) Within 120 days of fiscal year end, a summary of material changes with the updated brochure or with an offer to provide a copy of the updated brochure is delivered to clients. c) Clients who must receive a brochure include: clients who receive only impersonal investment advice, pay less than $500 per year, or are SEC-registered investment companies for business development companies. d) Documentation must be kept to evidence delivery.

Answer 32

Answer: B & D • Under SEC Rule 204-3(b), firms must deliver the brochure to all clients, even if the advisory agreement with the client is oral. • Each year you must (i) deliver, within 120 days of the end of your fiscal year, to each client a free updated brochure that either includes a summary of material changes or is accompanied by a summary of material changes, or (ii) deliver to each client a summary of material changes that includes an offer to provide a copy of the updated brochure and information on how a client may obtain the brochure. • Firms do not have to deliver an interim amendment to clients unless the amendment includes information in response to Item 9 of Part 2A (disciplinary information). • Firms are not required to deliver the brochure to either clients who receive only impersonal investment advice from you and who will pay you less than $500 per year or clients that are SEC-registered investment companies or business development companies (the client must be registered under the Investment Company Act of 1940 or be a business development company as defined in that Act, and the advisory contract must meet the requirements of section 15(c) of that Act). See SEC Rule 204-3(c)

Question 33

Q33: Regulation S-P requires that a registered investment adviser: a) Provide to customers an initial privacy notice not later than when the customer relationship is established, and an annual privacy notice after that. b) Provide to pension plan clients an initial privacy notice not later than when the customer relationship is established, and an annual privacy notice after that. c) Provide to institutional clients an initial privacy notice not later than when the client relationship is established, and an annual privacy notice after that. d) Provide to customers an initial privacy notice not later than when the customer relationship is established, and annual privacy notices only if the firm discloses client information to non-exempt third parties.

Answer 33

Answer: D ``` All investment advisers and broker-dealers, among others, must deliver initial privacy notices that describe in general terms the firm’s information sharing and collecting practices. Reg S-P was amended in 2015 to not require annual delivery of the privacy statement if: • The financial institution does not disclose nonpublic personal information of consumers to third parties, other than disclosure permitted by Exempt Category; and • The financial institution has not changed its policies and practices with regard to disclosing nonpublic personal information from the policies and practices that were disclosed in the most recent disclosure sent to consumers. The privacy rule protects individuals who are defined as “consumers.” However, a subcategory of “consumers” are “customers” who must receive certain privacy notices, such as an annual privacy notice, that do not have to be delivered to consumers. The privacy rule does not apply to institutional or business clients. • See: Regulation S-P: Privacy of Consumer Financial Information and Safeguarding Personal Information (https://www.law.cornell.edu/cfr/text/17/part-248/subpart-A) ```

Question 34

Q34: Which transaction is an investment adviser required to report to the Financial Crimes Enforcement Network (FinCEN)? a) All related cash transactions totaling more than $10,000 within a five-day period. b) One cash transaction totaling more than $15,000. c) One cash transaction totaling more than $10,000 or two or more related cash transactions totaling more than $15,000. d) One cash transaction or two or more related cash transactions totaling more than $10,000.

Answer 34

Answer: D All advisory firms have a responsibility to report to FinCEN on FinCEN/IRS Form 8300 (Form 8300) the receipt of cash in excess of $10,000 (coin and paper money) and cash equivalents such as cashier’s checks, money orders, bank drafts, or traveler’s checks, or having a face amount of not more than $10,000 received in any transaction in which the recipient knows that the instrument is being used in an attempt to avoid the reporting requirements. See FinCEN/IRS Form 8300 and Instructions http://www.fincen.gov/forms/files/fin8300_cashover10k.pdf

Question 35

Q35: A Chief Compliance Officer who has supervisory responsibilities and relies on the defense provided for in section 203(e)(6) (Censure, denial, or suspension of registration) of the Advisers Act must ensure which two actions? (Choose two.) a) The adviser has adopted procedures reasonably designed to prevent and detect violations of the federal securities laws. b) The adviser has an appointed Chief Executive Officer. c) The adviser has provided an advisory contract to all clients. d) The adviser has a system in place for applying procedures.

Answer 35

Answer: A & D Footnote 73 in Compliance Programs Rule Release: Section 203(e)(6) provides that a person shall not be deemed to have failed to reasonably supervise another person if: (i) the adviser had adopted procedures reasonably designed to prevent and detect violations of the federal securities laws; (ii) the adviser had a system in place for applying the procedures; and (iii) the supervising person had reasonably discharged his supervisory responsibilities in accordance with the procedures and had no reason to believe the supervised person was not complying with the procedures. See Compliance Programs of Investment Companies and Investment Advisers Adopting Release (SEC Release No. IA-2204). Available at http://www.sec.gov/rules/final/ia-2204.htm See also Section 203(e)(6).

Question 36

Q36: Which three guiding principles did the SEC provide in the Final Release adopting the Compliance Programs Rules? (Choose three.) a) The title of Chief Compliance Officer does not in and of itself carry supervisory responsibility. b) The Compliance Programs Rules do not require advisers to hire an additional executive to serve as chief compliance officer. c) Rule 206(4)-7 requires all advisers to appoint a board of directors to oversee compliance activities. d) Rule 206(4)-7 does not require advisers to consolidate all compliance policies and procedures into a single document.

Answer 36

Answer: A, B & D Having the title of Chief Compliance Officer does not, in and of itself, carry supervisory responsibilities. Thus, a Chief Compliance Officer appointed in accordance with rule 206(4)-7 (or rule 38a-1) would not necessarily be subject to a sanction by us for failure to supervise other advisory personnel. A compliance officer who does have supervisory responsibilities can continue to rely on the defense provided for in section 203(e)(6) of the Advisers Act. Rule 206(4)-7 does not require advisers to consolidate all compliance policies and procedures into a single document. See Compliance Programs of Investment Companies and Investment Advisers Adopting Release (SEC Release No. IA-2204). Available at http://www.sec.gov/rules/final/ia-2204.htm

Question 37

Q37: A Chief Compliance Officer to a registered investment company is required to meet which three mandates? (Choose three.) a) Review, no less frequently than annually, the adequacy of the policies and procedures of the fund and of each investment adviser, principal underwriter, administrator, and transfer agent and the effectiveness of their implementation. b) Annually provide a written report to each investment adviser, principal underwriter, administrator and transfer agent. c) Adopt and implement written policies and procedures reasonably designed to prevent violation of the Federal Securities Laws by the fund, including policies and procedures that provide for the oversight of compliance by each investment adviser, principal underwriter, administrator, and transfer agent of the fund. d) Obtain the approval from the fund's board of directors, including a majority of directors who are not interested persons of the fund, of the fund’s policies and procedures and those of each investment adviser, principal underwriter, administrator, and transfer agent of the fund.

Answer 37

Answer: A, C & D The Chief Compliance Officer will report directly to the board of directors. She must annually furnish the board with a written report on the operation of the fund's policies and procedures and those of its service providers. Rule 38a-1 requires fund boards to adopt written policies and procedures reasonably designed to prevent the fund from violating the federal securities laws. See Investment Company Act Rule 38a-1 Available at http://www.sec.gov/rules/final/ia-2204.htm

Question 38

Q38: An investment adviser is required to complete which mandate according to the Advisers Act Compliance Programs Rule 206(4)-7? a) Approve a chief compliance officer appointed by the investment company board of directors. b) Adopt comprehensive anti-money laundering policies and procedures. c) Review, no less frequently than annually, the adequacy of the policies and procedures and the effectiveness of their implementation. d) Review, no less frequently than quarterly, the accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements.

Answer 38

Answer: C Rule 206(4)-7 requires each registered adviser to review its policies and procedures annually to determine their adequacy and the effectiveness of their implementation. The review should consider any compliance matters that arose during the previous year, any changes in the business activities of the adviser or its affiliates, and any changes in the Advisers Act or applicable regulations that might suggest a need to revise the policies or procedures. See Advisers Act Rule 206(4)-7 Available at http://www.sec.gov/rules/final/ia-2204.htm

Question 39

Q39: An individual charged with insider trading would most likely be charged under which statute? a) Rule 17e-1(Brokerage transactions on a securities exchange) of the Investment Company Act of 1940 b) Title I of The Employee Retirement Income Securities Act (ERISA) c) Rule 10b-5 (Employment of manipulative and deceptive devices) of the Securities Exchange Act of 1934 d) Section 215 (Validity of contracts) of the Investment Advisers Act of 1940

Answer 39

Answer: C Rule 10b-5-1 of the Securities Exchange Act of 1934 provides that a person trades on the basis of material nonpublic information if a trader is “aware” of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. See Rule 10b-5 of the Securities Exchange Act (Employment of Manipulative and Deceptive Devices)

Question 40

Q40: Which two persons qualify as “accredited investors”? (Choose two.) a) Adam, who currently has $750,000 in assets under management with a registered investment adviser. b) Bob, whose individual net worth exceeds $1,000,000. c) Charlie, who along with his wife Christine, had annual income in excess of $300,000 in each of the two most recent fiscal years and who is expecting $500,000 in income for the current year. d) David, who is trustee for a trust with assets in excess of $1,000,000.

Answer 40

Answer: B & C Rule 501 of Regulation D (Securities Act of 1933) includes the following persons/entities under the definition of “accredited investor”: 1) A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such natural person; 2) A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or 3) A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes. See Securities Act of 1933 Rule 501(a)(“Accredited Investor”)

Question 41

Q41: Which two types of supervised persons are also considered access persons? (Choose two.) a) Persons having access to nonpublic information regarding client purchases or sales. b) Persons serving as directors of an affiliate of the adviser. c) Persons recommending securities transactions to clients. d) Third-party service providers engaged in implementing recommended transactions.

Answer 41

Answer: A & C Rule 204A-1(e)(1)(i) of the Advisers Act defines “access persons” as: Any of your supervised persons: (A) Who has access to nonpublic information regarding any clients’ purchase or sale of securities, or nonpublic information regarding the portfolio holdings of any reportable fund, or (B) Who is involved in making securities recommendations to clients, or who has access to such recommendations that are nonpublic. NOTE: If providing investment advice is your primary business, all of your directors, officers and partners are presumed to be access persons.

Question 42

Q42: Which fact about the adviser's business does not have to be identified in Item 4 (Advisory Business) of Form ADV Part 2? a) Adviser provides advice on financial planning and insurance. b) The dollar amount of the adviser’s discretionary and/or nondiscretionary assets under management. c) The identification of the firm’s principals who own 25% or more of the firm. d) The identification of the firm’s principals who own 15% or more of the firm.

Answer 42

Answer: D For purposes of this item, your principal owners include the persons you list as owning 25% or more of your firm on Schedule A of Part 1A of Form ADV (Ownership Codes C, D or E).

Question 43

Q43: Which disclosure is not required to be included on the cover page of a firm’s Form ADV, Part 2A? a) Additional information about adviser is available on the SEC’s website at www.adviserinfo.sec.gov. b) Adviser’s website address (if adviser has one) c) “RIA” designation d) The information in this brochure has not been approved or verified by the U.S. Securities and Exchange Commission or by any state securities authority.

Answer 43

Answer: C If Advisers refer to themselves as a “registered investment adviser” or describe themselves as being “registered,” they must include a statement that registration does not imply a certain level of skill or training. (Form ADV instructions for Part 2A)

Question 44

Q44: Which three items must be included on an adviser’s order memoranda? (Choose three) a) The account for which the order was entered. b) Any modification or cancellation of the order or instruction. c) The identity of the person reconciling the order. d) The identity of the bank, broker or dealer by or through whom the order was executed.

Answer 44

Answer: A, B & D The Advisers Act books and records rule requires advisory firms to maintain a memoranda of each order given by the adviser to buy or sell any security or of any instructions received by the adviser regarding the purchase, sale, receipt or delivery of any security showing: a) Any modification or cancellation of the order or instruction; b) The terms and conditions of the order, instruction, modification or cancellation; c) The identity of the person who recommended the transaction to the client and of the person who placed the order; d) The account for which the order was entered and the date of entry; e) The identity of the bank, broker or dealer by or through whom the order was executed (where appropriate); and f) Any designation of orders entered pursuant to use of a discretionary power. See Advisers Act Rule 204-2 (Books & Records)