Part 1 Flashcards

Question

Recordkeeping requirements under state/federal laws 1. Maintain required books and records easily accessible for \_\_years (including __ communications) a. Kept at the principal office for \_\_years b. May be kept in normally accepted manner (microfiche, digital, etc.) provided records can be read and copied c. Material changes—prompt notice to Administrator—amend \_\_ d. Partnership agreements, articles of incorporation, charters,and minute books of the investment adviser and any predecessor must be preserved until at least __ years after termination of the enterprise. e. __ person’s U4 – tenure of the individual

Answer 1

Recordkeeping requirements under state/federal laws 1. Maintain required books and records easily accessible for five years (including electronic communications) a. Kept at the principal office for two years b. May be kept in normally accepted manner (microfiche, digital, etc.) provided records can be read and copied c. Material changes—prompt notice to Administrator—amend ADV d. Partnership agreements, articles of incorporation, charters,and minute books of the investment adviser and any predecessor must be preserved until at least three years after termination of the enterprise. e. Supervised person’s U4 – tenure of the individual

Answer 2

Investment adviser representatives (IARs): individuals supervised by investment advisers 1. Partners, officers, or directors (with active role) 2. Employees and associates making recommendations,managing accounts, and soliciting advisory services 3. Individuals supervising the above (no separate principal registration—FINRA)

Answer 3

IAR Exclusions Excluded are: 1. Clerical and Admin personnel; 2. individuals providing only impersonal investment advice; and 3. research analysts—if no advisory clients.

Answer 4

IAR Exemptions Exemptions under state law include: 1. de minimis: no place of business in the state and fewer than six retail (individual) clients in preceding 12 months; and 2. snowbird exemption. Exemptions under federal law include: 1. if with a covered adviser, only registers in states where IAR maintains a place of business.

Answer 5

File Form U4 1. Disclose if ever been convicted or even just arrested,(charged), with no time limit, for any felony or securities related misdemeanors 2. Automatic registration of officers, directors, partners who are IARs. If already registered in State A, then auto registered in State B.

Answer 6

IAR Registration Registration effective date * 1. Not solely on passing exam * 2. Not until granted registration by state – notification to the firm * 3. Can perform clerical duties Termination procedures * 1. IAR—with state IA, IA notifies Administrator (If an IAR goes from one IA to another IA, both IA's have to notify) * 2. IAR—with federal covered IA, IAR notifies Administrator. IA is not even registered with state Administrator. * 3. Effective 30 days after receipt of application to withdraw, but Administrator retains jurisdiction for one year (can still hold the IAR responsible).

Answer 7

IAR Registration D. Renewal date next December 31 E. No net worth or bonding requirements F. No recordkeeping except material change (e.g.,disciplinary, change of address) reported on Form U4 within 30 days

Answer 8

Broker-dealer 1. Securities Exchange Act of 1934—federal act regulating broker-dealers and associated persons 2. Both federal and state law (USA) define as: * a. a person engaged in business of effecting securities transactions for accounts of others (broker) or for own account (dealer) 3. Unlike IAs, BDs generally register with both SEC and state(s) in which they do business. 4. Functions include the following: * a. Transactions with clients (retail or institutional) * b. Underwriting new issues * c. Market-making

Answer 9

Broker-Dealer Exclusions 1. Agents (state term for registered representative) 2. Issuers of securities 3. Bank, savings institution, or trust company 4. Internet broker-dealers—may only make available general information, not specific advice or recommendations 5. Broker-dealer with no office in state who limits clients to issuers of the security, other broker-dealers, or institutional investors 6. Person with no office in state who directs offers to existing clients who are not residents of the state. Snowbird.

Answer 10

No De Minimis exclusion for B/Ds, unlike for IA and IAR

Answer 11

Broker-Dealer Exemptions 1. USA: Canadian broker-dealers; limited registration * a. Solely with existing Canadian clients temporarily resident in this state * b. Canadian resident in this state in her RRSP 2. Securities Exchange Act of 1934 * a. Intrastate broker-dealers

Answer 12

Agent (registered representative) 1. Individuals representing a broker-dealer in effecting or attempting to effect purchases or sales of securities 2. Individuals representing an issuer in effecting or attempting to effect purchases or sales of securities

Answer 13

Agent Exclusions A. Exclusions (representing broker-dealers) 1. Clerical and administrative personnel 2. Board member or capital contribution only (silent partner). Partners (officers, directors) who play an active role in the securities business of a broker-dealer must register as agents; those who don't are exempt from registration. * a. Exchange Act definition of associated person includes outside directors and capital contribution only partners

Answer 14

Agent Exclusions Issuer Agent Exclusions 1. Exempt transactions. 2. These 5 exempt securities * US and Canadian government and municipal securities * Foreign government securities, not foreign local gov (candian local ok) * Banks, savings institution, trust companies securities, **also Credit Unions(unlike IA exception)** * Employee benefit plan issued securities * Commercial paper/certain money market instruments 3. Issuer employee who sell to other employees of the issuer and no compensation is received. (Sell to public must be an agent even if no compensation)

Answer 15

Any individual represening a broker/dealer( as opposed to an issurer) in sales must be registered as an agent, even if selling exempt securities.

Answer 16

Agent Exemptions 1. BD is exempt from registration—agent doesn’t register. 2. Snowbird 3. Client moves—agent cannot be registered in new state if the broker-dealer is not. 4. No de minimis

Answer 17

Broker-Dealer and Agent Registration A. Broker-dealers (Form BD) (Form U4 agents) 1. Form of organization 2. Method of business 3. Background and history 4. Convictions (10 years; felonies and securities-related misdemeanors—statutory disqualification), arrests—no time limit 5. Financial condition (BD) 6. Consent to service of process = power of attorney * a. Permanent document 7. Registration of broker-dealer automatically registers individual (agent) who is partner, officer, or director with those functions

Answer 18

Broker-Dealer and Agent Registration Registration effective date 1. Not solely on passing exam * a. Not until granted registration by state—noon of 30th day 1) Expires December 31 unless renewed Termination procedures 1. Agent—notification to Administrator by both agent and brokerdealer 2. Effective 30 days after receipt of application to withdraw, but Administrator retains jurisdiction for one year

Answer 19

Broker-Dealer and Agent Registration D. Broker-dealer recordkeeping requirements under state/federal laws 1. Maintain required books and records easily accessible for three years (including electronic communications) a. Kept at the principal office for first two years b. May be kept in normally accepted manner (microfiche, digital, etc.) provided records can be read and copied c. Material changes (e.g., move to new location)—prompt noticeto Administrator—amend BD As opposed to 5 yrs and 2 yrs for IA. No requirement to keep clients tax returns.

Answer 20

Financial requirements of BDs 1. Minimum net capital 2. State requirement cannot be higher than SEC requires

Answer 21

Agent registration 1. Citizenship, yes 2. USA does not require fingerprints 3. Registration in suspense when BD inactive 4. Surety bond required if maintaining discretion (some states, unlike IAR) * In lieu of surety bond, Administrator will accept deposits or cash or securities. 5. Multiple registrations—affiliated or okay by Administrator

Answer 22

1. with the expectation of **profits**; 2. **Investment** of money; 3. in a **Common** enterprise; 4. to be derived primarily from the efforts of **3rd party** management PIC3

Answer 23

(3) **Collectibles**; (4) **Commodities** or futures contracts for commodities; (5) **Condominiums** used for personal residences; and (6) **Currency** (1) **Insurance**, endowments or annuities with fixed payouts; (2) Interests in a **retirement** plan;

Answer 24

An exempt security is exempt from registration based on the nature of the issuer or the type of security. An exempt transaction is exempt from registration based on the manner in which the sale is made or the nature of the purchaser.

Answer 25

(1) Coordination (issuer supplies state securities administrators with the federal registration statement filed under the Securities Act of 1933. This is the most frequently used method of registration); and (2) Qualification (issuer supplies all information directly to the state securities administrator).

Answer 26

Registration is effective at the same time the federal registration becomes effective, provided: (1) there are no issued stop orders or pending proceedings against the issuer; (2) the registration has been on file for the minimum number of days specified by the Administrator (10-20, depending on the state); and (3) a statement of the minimum and maximum proposed offering prices and maximum underwriting discounts and commissions have been on file for two business days.

Answer 27

Annuities with fixed payouts are not securities, but annuities with variable payouts are securities, because the amount of the payouts depends on the performance of securities within the annuity.

Answer 28

An issuer transaction is one in which the proceeds of the sale go to the issuer. All newly issued securities transactions are issuer transactions.

Answer 29

A primary offering is an issuer transactions involving new securities. An initial public offering is the first time an issuer distributes securities to the public.

Answer 30

A non-issuer transaction (also called a secondary transaction, or a transaction between investors) is one in which the proceeds of the sale do not go to the issuer. Non-issuer transactions are exempt transactions.

Answer 31

Federally Covered Securities * **municipal** securities (federally covered everywhere except the state they're located- Columbus OH muni is exempt in OH, but it is federally covered everywhere except in the state of OH.) * Regulation D- **private** placement * **Investment** companies * **Exchange**-listed/**Nasdaq** MPIE (1) Securities listed on the New York Stock Exchange, the American Stock Exchange, the Chicago Stock Exchange and the Nasdaq Stock Market, and any security equal in seniority or senior to these securities; (2) investment company securities registered under the Investment Company Act of 1940; and (3) offers and sale of certain exempt securities, such as those offered by a municipal/governmental issuer (except in the state the municipal securities are being offered) and (4) private placements under Regulation D of the Securities Act of 1933.

Answer 32

Investment companies are required to file a notice with Administrators in states in which their securities will be sold, and to pay specified filing fees.

Answer 33

(1) Documents filed with registration statements filed with the SEC, and documents filed as amendments thereto; (2) A report on the value of the securities being offered in the state; and (3) consent to service of process.

Answer 34

A security may be registered by coordination if a registration statement has been filed with the SEC under the Securities Act of 1933 in connection with the same offering.

Answer 35

1. US and Canadian government and **municipal securities** 2. Foreign government securities, **not foreign local gov (candian local ok)** 3. Banks, savings institution, trust companies securities **(Not Credit Unions)** 4. Insurance company securities 5. Public utility and common carrier securities 6. Federal covered securities 7. Non profit securities 8. Employee benefit plan issued securities 9. Commercial paper/certain money market instruments bolded ones are also federal exemptions * **Government** * **Bank** * Insures * **Nonprofit** * **Utility** * EE's * with **Commercial paper**

Answer 36

Exempt transactions (USA) * Isolated nonissuer transaction (for sale by owner) * Unsolicited brokerage transactions (initiated by client) * Underwriter transactions * Bankruptcy transactions * Institutional investor transactions * Limited offering transactions(private placement) 10 person offers in 12 months * Preorganization certificates * Existing security holder trans w/ no commission * Lender transactions(security as collateral) bolded ones are also federal exemptions * Unsolicited * **Private** * Placement * Excites * Institutional * Lenders because it * Ups * **Nonissuer** * Bankruptcy

Answer 37

(1) Consent to service of process; (2) if the Administrator requires, copies of the latest prospectus filed with the SEC under the Securities Act of 1933; (3) copies of its articles of incorporation and by-laws, a copy of the underwriting agreement or a specimen copy of the security; (4) if the Administrator requires, copies of any other information filed under the Securities Act of 1933; and (5) each amendment to the federal prospectus promptly after it is filed with the SEC.

Answer 38

Any security may be registered by qualification, and any security not eligible for registration by another method must be registered by qualification. Securities that will be sold only in one state must be registered by qualification. Generally, any security that will also be registered with the SEC will be registered by coordination.

Answer 39

nformation used by a prospective purchaser to make an informed investment decision.

Answer 40

Yes. Warrants and rights are securities.

Answer 41

Yes. Options are always securities, even if the underlying asset is not an security. Thus, an option on foreign currency is a security, but the foreign currency itself is not a security.

Answer 42

No. Variable annuities are securities. Fixed annuities are not securities.

Answer 43

Yes. Municipal bonds are securities.

Answer 44

Federal covered securities are securities with a federally imposed exemption from state registration. Examples include nationally traded securities, U.S. Government and municipal securities, investment companies and Regulation D private placement securities.

Answer 45

A futures contract is a security when the underlying asset is a security. Example: futures on commodities are not securities. But, futures on stock indexes, such as a future on the S&P 500, are securities.

Answer 46

Coordination is available to any issuer also registering its securities at the federal level.

Answer 47

An issuer must submit three copies of all federal registration documentation and amendments to the state securities administrator.

Answer 48

Registration by notification is available to any issuer that is already registered at the federal level.

Answer 49

Registration by qualification is available to any issuer. This is typically used in an intra-state registration.

Answer 50

With the trade confirmation. If a prospectus is not received prior to or with the trade confirmation the sale is illegal.

Answer 51

(1) U.S. government securities, (2) Municipal securities, (3) Securities issued by national or state banks, (4) Securities issued by credit unions, (5) securities issued by nonprofit organizations, (6) Commercial paper meeting specific criteria, and (7) Bankers acceptances.

Answer 52

A transaction where the proceeds of the sale go to someone other than the issuer. These transactions are exempt from state registration. This covers every secondary market transaction.

Answer 53

An unsolicited order is one where a customer contacts an agent and requests to buy or sell securities. Unsolicited orders are exempt transactions.

Answer 54

A rights sale permits an investor to maintain a proportional share in a company when the company issues new shares. Rights sales are exempt transactions.

Answer 55

The **issuer** must demonstrate that a particular transaction is exempt.

Answer 56

Administrator’s Jurisdiction A. Offer * 1. Attempt to solicit purchase * 2. Attempt to dispose of security or interest in security for value * 3. Sale of rights, warrants, or convertible security is an offer of the underlying stock B. Sale * 1. Transfer for value * a. Bonus of warrants or stock * 2. Purported gift of assessable stock is offer and sale * Assessable - creditor can ask for more money

Answer 57

Administrator’s Jurisdiction C. Sale does not include: 1. gifts of non-assessable stock; 2. stock dividend or stock split (if no payment); 3. bona fide pledge or loan (use stock as collateral); or 4. act resulting from approved merger or business reorganization. 5. Reclassification of the issuer’s securities

Answer 58

Administrator’s Jurisdiction D. Jurisdiction 1. The Administrator has power over any offer to buy or sell that: * a. originated in the Administrator’s state; * b. was directed to(received in) the Administrator’s state; or * c. was accepted in the Administrator’s state. 2. However, the Administrator does not have jurisdiction merely because a check was mailed or certificates were sent from the Administrator’s state. The Administrator has jurisdiction from the state in which the offer was made (ND), received (WY), and accepted (ID). Mailing of the certificate is of no consequence.

Answer 59

Actions of the Administrator A. Enforcement of all antifraud provisions as well as violations of the USA 1. Issue cease and desist order for suspected improper activity a. With or without a prior hearing b. If cease and desist order is ignored, can apply to courts for an injunction * An injunction can only be issued by a court. Stop/Final Order must have a hearing first.

Answer 60

Actions of the Administrator 2. Summary orders to postpone or suspend until final determination is reached * a. Must notify applicant and employer once order is entered. * b. Must hold hearing within 15 days of written request 3. May investigate and subpoena in any state where registered, whether or not firm has an office in the state

Answer 61

Actions of the Administrator B. Deny suspend or revoke a license of professional (IAR or Agent) 1. It must be in the **public** interest and one of the following must have occurred: a. Filing false or misleading application b. Any felony or securities-related misdemeanor conviction within the last **10** years c. Willful violation of the USA’s ethical trade practices d. Court injunction/administrative order if **ingored** e. Disciplinary action by other securities authorities within the last 10 years f. Dishonest, unethical practice g. Firm’s failure to **supervise** employees h. Failure to pay fees i. Insolvency j. The applicant is not qualified on the basis of such factors as training, experience, and knowledge of the securities business. (all 3 must **exist**) k. The Administrator may not deny solely on the basis of lack of experience if the applicant is qualified by training, knowledge, or both

Answer 62

Actions of the Administrator An Administrator can compel the testimony of witnesses when conducting an investigation. C. Deny, suspend, or revoke a security’s registration 1. It must be in the public interest and: a. the registration statement is inaccurate, misleading, or incomplete; b. an officer of the issuer has been convicted of a securities-related crime (10 years); c. the security is subject to court injunction; d. the offering is deemed fraudulent; e. the offering expenses or promoter’s fees are excessive or unreasonable; or f. the registration has been revoked by the Administrator of another state. 2. All cases—final order of the Administrator a. Appropriate prior notice b. Opportunity given for a hearing c. Written findings of fact and conclusions of law

Answer 63

Actions of the Administrator Cancellation of registration (non-punitive) * 1. Registrant has ceased to do business * 2. Registrant is deceased * 3. Registrant is declared mentally incompetent Administrator retains jurisdiction for one year

Answer 64

Civil Rights of Recovery for a security’s sale or for investment advice purchased in violation of the Uniform Securities Act A. Sale 1. Rights of buyer - Made Whole * a. Recover money plus reasonable interest (or state’s legal rate) minus income received during period * b. Court costs and attorney fees, but not damages B. Advice 1. Advisory client * a. Recover advisory fees, losses on recommendations, court plus legal fees, interest minus income received C. Right of rescission —30 days’ notice: If buyer receives offer of rescission and fails to accept or reject within 30 days, may not sue D. Statute of limitations 1. Must be within two years(1 year for federal) of discovery or three years of violation, whichever occurs first * The death of the adviser or the client does not remove a cause of action for civil liability.

Answer 65

Criminal penalties for violation of the Uniform Securities Act * 1. Willful violation of the USA. Remember, unless it's a willful violation, most likely it would be a civil viloation. * 2. Fines to $5,000, jail up to three years, or both (State law) * Fed law is $10k, up to 5 years jail * 3. Statute of limitations is five years for fraudulent activity * 4. 60 days to appeal final order * a. Appeal does not act as a stay unless ruled otherwise by the court. * 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.

Answer 66

Required Disclosures A. Disclosure of capacity 1. Broker-dealer acting as agent or as principal 2. Investment adviser acting as principal or agent in purchase or sale of recommended securities * a. Written disclosure to client before completion of the transaction * b. Client’s consent before completion of the transaction, can be oral. 3. Agency cross transaction: Representing both sides of a trade involving an advisory client * a. Client executes a written consent prospectively authorizing these transactions * b. Written disclosure to client before completion of the transaction * c. Cannot recommend the trade to both parties, must be initiated by one side first.

Answer 67

Required Disclosures B. Broker-dealer conflicts of interest 1. Proprietary products 2. Incentives from program sponsors (trips, etc.) 3. Financial interest in recommended security (sister is CEO) 4. Favorable research report after bringing company public

Answer 68

Required Disclosures C. Investment adviser conflicts of interest 1. Disclose ownership in recommended securities 2. Disclose gifts or incentives associated with recommended product 3. Advisers must notify clients if they are a representative of a broker-dealer and will recommend purchase of products through that broker-dealer to receive a commission 4. Disclose if recommending products of only the brokerdealer or insurance company with whom they are associated 5. Disclose that client may execute through other broker-dealers 6. Disclose amount of compensation when: * a. the transaction is through a broker-dealer with whom the adviser is associated; * b. compensation is received from an issuer; or * c. compensation is received for the sale of non-securities products. 7. Disclose personal trades if: * a. inconsistent with advice given to client; or * b. investment adviser benefits from client acting on recommendation

Answer 69

Broker-dealer disclosure of fees 1. Typically disclosed when a customer account is opened * a. Must be up-to-date 2. Fee changes * a. Typically at least 30 days in advance * 1) Methods used include email, postal mail, or website 3. Disclosure method used * a. Chart * b. List * c. Table * d. Narrative 4. NASAA Model Fee Disclosure Schedule * a. Template to be used 5. Typical fees include: * a. issuance of a stock certificate; * b. account transfer; * c. wiring funds; * d. margin account interest; * e. postage and handling; * f. annual account fee; or * g. safekeeping of certificates. 6. Not included are: * a. commissions; * b. markups and markdowns; and * c. advisory fees (these three are disclosed in other documents).

Answer 70

Indicate the unlawful representations concerning registrations A. Securities professionals * 1. Cannot infer or imply approval of qualifications by any regulatory body B. Securities registrations * 1. Cannot infer or imply approval of issue by any regulatory body * 2. Disclaimer on prospectus

Answer 71

Performance Guarantees A. Guaranteeing results is unethical—minimize losses or assure profit * 1. Agent agrees to buy back at original price (or with a bonus) * 2. Guaranteed security (is allowed)—Payment of principal and interest or dividends (not capital gain, cannot be guaranteed), promised by a third party (e.g., parent company for a subsidiary’s debt)

Answer 72

IA Contracts and Brochures A. Investment adviser contracts 1. Federal covered and state-registered IAs * a. Services to be provided * b. Duration of the contract * c. Advisory fee * d. Formula for computing advisory fee * e. Amount of prepaid fee returned if contract is terminated * f. Whether discretion is granted * g. No waiver of fees for underperformance * h. Assignment only with consent * i. Notification to clients of changes in advisory partnerships * 1) Only when the change is to a minority interest * 2) If a majority interest changes, it is assignment (consent needed)

Answer 73

IA Contracts and Brochures 2. Written requirement— initial and renewal * a. Required under USA * b. Not required under Investment Advisers Act of 1940 * c. Required under Investment Company Act of 1940

Answer 74

IA Contracts and Brochures A. Brochure rule 1. Brochure is Form ADV Part 2A (describes the firm) and Supplement, Form ADV Part 2B (personnel). * a. Updated annually at time of updating amendment 2. Deliver to a client or prospective client the current brochure and supplement before or at the time of entry into an investment advisory contract with that client. * a. If not delivered 48 hours in advance, client has five business days’ right to rescind without penalty (USA) 3. If there are material changes in the brochure since last annual updating amendment, deliver the following to each client annually within 120 days after the end of the fiscal year: * a. A free current brochure, or * b. A summary of material changes to the brochure including an offer to provide a copy of the updated brochure and information on how a client may obtain the brochure * c. May be delivered electronically * d. If no material changes, no brochure or summary 4. Must include balance sheet if investment adviser requires prepayment of fees of more than $1,200 ($500 USA), 6 months or more in advance, or have custody (USA) 5. Disclosure of material legal or disciplinary action within past 10 years, including fines of $2,500 or more * a. Prompt amendment required for material changes 6. Exemptions—investment adviser does not have to deliver brochure if the advisory clients are limited to the following: * a. Investment companies * b. Impersonal advice (subscriptions)—cost under $500

Answer 75

IA Contracts and Brochures B. Wrap fee brochure 1. Charge a fixed fee for portfolio management, advice, and execution 2. Wrap fee brochure based on Appendix 1 of Form ADV Part 2A 3. must be provided in lieu of standard brochure and must disclose that wrap fee may cost more than purchasing services separately * duplicates need not be provided to clients who have already received the required disclosure on that program from another adviser. 4. Must identify whether any of its related persons is a portfolio manager in the wrap fee program and, if so, describe the associated conflicts

Answer 76

IA Contracts and Brochures C. Contents of the solicitor’s brochure 1. The name of the solicitor 2. The name of the investment adviser 3. The nature of the relationship between the solicitor and the IA 4. The fact that solicitor will receive compensation, the terms of the compensation arrangement, and indicate whether client will pay a specific charge or a higher advisory fee because the solicitor recommended the IA to the client While the sales script used may be written by the solicitor, its content is the responsibility of the adviser.

Answer 77

Public Communications A. Social media including emails and text messages * 1. Regulatory concerns * a. Content, not method of delivery * b. Compliance same as in written communications * c. Agent’s or IAR’s use of personal tools for business use * d. Supervision of recordkeeping and training

Answer 78

Public Communications B. Broker-dealer advertising 1. Can’t be deceptive or misleading 2. Cannot do Highlighting or excerpting a prospectus 3. Broker-dealer’s website is advertising * a. Distinguish between what is and is not a recommendation * 1) Libraries of research reports, news and quotes, screening tools, etc. are not recommendations. * 2) Targeted email or pop-up, list of specific securities to reach client’s goals, buy recommendations from a specific sector, etc. are recommendations.

Answer 79

Public Communications C. Investment adviser advertising 1. Advertisements include any notice, circular, letter, website, or other written communication addressed to more than one person, or any report, chart, or formula used in making investment decisions. 2. Identification * a. Name of firm * b. Name of preparer if material is prepared outside the firm * c. Date of first use * d. Identification of information not current 3. Past performance * a. Can be used if the following disclaimer and disclosure are included: * 1) No assurance of future results * 2) Includes all gains and losses * Advertising that reflects past performance must show a minimum period of 1 year. All investment advisers' advertising must reflect deduction of fees; disclose the specific group of clients to which it applies, if applicable; and state actual market conditions during the referenced period. 4. Testimonials prohibited (testimonial for BD is fine) * a. “Like” on Facebook or endorse on LinkedIn 5. Offers of free service permissible (no obligations) 6. Other advertising prohibitions * a. Implying extensive research facilities when not a fact * b. Misleading or inconsistent clauses and caveats (hedge clauses) * c. Implying approval by regulators * d. Use of abbreviation RIA or IAR * e. Use of titles not earned (MBA, JD, CPA, CFP®) * f. Lack of disclosure of outside data sources * g. Charts and formulas— must explain limitations/difficulties

Answer 80

Public Communications D. Social media for agents and IARs 1. Personal devices 2. Obtaining proper approvals * a. Tweets (after first) probably not—LinkedIn, probably yes 3. Linking to third-party sites * a. Entanglement - firm has participated in the development of content of 3rd party site * b. Adoption - firm endorses the content of 3rd party site

Answer 81

Fiduciary responsibility 1. Have reasonable and independent basis for investment advice 2. Act in clients’ best interest * a. Suitability (usually unsuitable—blanket recommendations) * b. Clients’ interests come first 3. Best execution: Does not always require lowest commissions; must consider all services being rendered 4. Recognize limitations of own capabilities

Answer 82

Fiduciary Responsibility B. Compensation—any economic benefit receivedfrom any source: fees, commissions, retainer,soft dollars 1. Compensation restrictions * a. Generally no performance-based compensation * b. Performance-based compensation is allowed if: * 1) it is for a qualified client. * Performance fees may be charged, regardless of the client's age, to anyone with a net worth in excess of $2.1 million or with at least $1 million under management with the firm. * b) Executive officers or IARs of the adviser * Compensation is based on gains and losses combined over at least 1 year. 2. NASAA requires disclosure of (state registered IAs): * a. incentive for greater risk taking; * b. compensation may be on unrealized gains; and * c. why the index used was chosen. 3. No rebating commissions on mutual funds

Answer 83

Fiduciary Responsibility C. Cash referral fees to solicitors under the Investment Advisers Act of 1940 3 conditions: 1. Written agreement 2. IA who must be registered if they are required to be registered 3. Solicitor cannot be subject to statutory disqualification 1. Must have written agreement (disclose conflicts of interest) * a. Description of activities and compensation * b. Agreement to provide adviser’s brochure and solicitor’s disclosure document to customer (disclose if higher cost will result) * c. The IA receives acknowledgment from client that both documents have been received * d. Third-party solicitors for covered advisers are not required to be registered as an IAR (employees of the IA who solicit are) 2. Solicitors for state-registered advisers who are Third-party or employees of the IA must be registered (IAR).

Answer 84

Fiduciary Responsibility D. Directed transactions 1. Adviser directs client to broker-dealer with reasonable charges for services performed 2. Client directs investment adviser to use specific broker-dealer 3. Disclosure required 4. Soft dollars likely

Answer 85

Fiduciary Responsibility E. Allowable soft-dollar payments under safe harbor provision of Section 28(e) of Securities Exchange Act of 1934 1. Research reports 2. Software 3. Services for benefit of clients 4. Seminar registration fees F. Soft-dollar payments not protected by Section 28(e) 1. Reimbursement for travel expenses to seminars 2. Furniture, equipment, or non-customer-related services 3. Rent

Answer 86

Custody and Discretion A. Custody of customer funds and securities 1. Definition * a. Holds customer cash or securities * b. Authority to disburse funds from bank account without client’s consent * c. Automatic fee payments considered custody 1) If custody only because of this, IA is not required to meet the USA’s net worth or bonding requirements for advisers with custody

Answer 87

Custody and Discretion B. Rules 1. USA requires notification to the Administrator, unless state law prohibits custody. Promptly by updating ADV. 2. Must be segregated and marked to identify ownership 3. Written notice to client of location and prompt notification of changes 4. Complete and accurate records of deposits and account activity 5. Quarterly itemized statement to customer 6. Qualified custodian—bank or non-affiliated brokerdealer (still means has custody) 7. If no qualified custodian * a. Annual surprise independent audit * b. Form ADV-E 8. IA not keeping custody, NASAA requires certificates and funds inadvertently sent returned within three business days * Third-party checks forwarded to third party within three business days. If not forwarded(even if returned to customer), then it's considered IA took custody.

Answer 88

Discretion C. Definition of investment discretion 1. Select the asset and/or the action and/or the amount (3 As) * a. Written authorization prior to first trade 2. Time or price is not discretion * a. Day order 3. Unlike BDs, IAs can use oral authorization for discretion for 10 business days after initial discretionary trade. After that, written only.

Answer 89

Custody and Discretion 1. Third-party trading authorization 2. Commingling of firm and client assets 3. Improper hypothecation - pledge customer's securities as collateral 4. AML – CTR on FinCEN Form 112 \> $10,000

Answer 90

Prudent Investor Rule Uniform Prudent Investors Act (UPIA) A. Fiduciaries are required to use skill and caution when making investment decisions with other people’s money 1. Applied to any investment as part of the total portfolio, rather than to individual investments. 2. Trade-off in all investments between risk and return identified as the fiduciary’s primary consideration. 3. Fiduciary can invest in anything that plays appropriate role in achieving the risk/return objectives of the trust and meets requirements of prudent investing. 4. Diversification of investments is integrated into the definition of prudent investing. 5. Delegation of investment functions is permitted, subject to safeguards.

Answer 91

Unethical Practices A. Examples of unethical business practices 1. Unsuitable recommendations 2. Splitting commissions, unless with appropriately registered personnel of same or affiliated firms—the Administrator can make an exception. It's ok as long as cost doesn't increase. * a. Notification to clients not required * In order to share commissions, agents must be registered as an agent for the same broker-dealer or for an affiliated broker-dealer. Additionally, in order to receive a commission, an agent must be registered in the state where the transaction is made. 3. Misleading or untrue statements 4. Repeating rumors 5. Promising certain services with no intent to deliver 6. Sharing customer profits or losses * a. Written consent of client and employing BD * b. Permissible sharing only applies to agents, never to brokerdealers,IAs, or IARs 7. Borrowing from customers or lending money to customers (unless in lending business or an affiliate) * a. Banks are okay, bank officers are not * b. Mortgage banks are okay, mortgage brokers are not * c. Not even from your mother 8. Written complaints—contact supervisor (Must be kept by BD for 3 years and IA for 5 years) 9. Larger than ordinary commissions without disclosure 10. No front running- Securities professional place a personal order ahead of customer order. 11. Use of third-party reports without disclosure 12. Deliberately failing to follow customer instructions 13. Misrepresenting the status of customer accounts 14. Withholding shares of an oversubscribed IPO 15. Failing to refer to qualified professional (e.g., CPA)

Answer 92

Criminal Activities A. Soliciting sales or purchases in unregistered, nonexempt securities unless in an exempt transaction B. No unauthorized disclosure of confidential client information is allowed unless: 1. the client has consented; 2. the information is required by a court order (divorce, IRS); or 3. the account is joint with spouse.

Answer 93

Criminal Activities C. Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA) 1. Using information not available to the public to profit or avoid a loss 2. Insider (control person)—officer, director, more than 10%shareholder, and immediate family 3. Liabilities and penalties * a. Up to greater of almost $2 million (indexed) or 300% profit made/loss avoided (treble damages - civil penalty) * b. 20-year jail term (criminal penalty) * c. Both tipper and tippee may be held liable * 1) Registered representative and broker/dealer may be liable * d. Bounty to informant (whistleblower) 4. Use of material inside information * a. Received after stop or limit order placed, don't have to cancel order.

Answer 94

Criminal Activities D. Effecting transactions off the books of the agent’s employing broker-dealer without prior written permission * 1. This practice is sometimes called selling away E. Churning: excessive activity based on * 1. financial resources, objectives, and character of the account F. Market manipulation * 1. Matched orders * a. One account sells shares to another account at the same time and for the same price * 2. Wash trades * simultaneous selling and repurchase of the same security for the purpose of generating the appearance of trading activity and increasing the price. * 3. Both create the false impression of activity * Pegging involves entering buy orders for the purpose of supporting a stock price (i.e., to keep it from falling). Arbitration is not market manipulation.

Answer 95

IA Reporting A. Form 13F - Must file * 1. Discretion over $100 million or more of 13F securities * 2. 45 days after end of each quarter B. Political contributions (“Pay to Play” Rules) * 1. Can’t receive compensation for advisory services to a government entity—two years after contribution * 2. De minimis: $350(if can vote for them)/$150(if cannot vote for them) per election * 3. New hire exception: * soliciting role — no exception, still 2 year lookback. * no soliciation role -contribution made more than six months ago do not trigger ban. * 4. Can avoid this by returned contributions: within four months of contribution, $350 maximum, returned within 60 days

Answer 96

Cybersecurity A. NASAA 2014 Pilot Survey 1. Cyber preparedness * a. Threats and vulnerabilities 2. Cybersecurity compliance program * a. Written policies, procedures, or training programs * 1) Safeguarding client information * 2) Red flags for identity theft 3. Cybersecurity and social media * a. Written policies, procedures, or training programs * b. Social media for business purposes 4. Cyber incidents * a. If there have been any, has the firm “plugged the gap” 5. Cyber disposal * a. Procedures for disposing storage devices 6. Cybersecurity safeguards * a. Encryption * b. Anti-virus and anti-malware * c. Email security * 1) Authentication

Answer 97

Cybersecurity B. Methods for protecting the firm and its customers 1. Strong methods of authentication 2. Antivirus software installed on electronic devices used to access client information * a. How often are updates downloaded to antivirus software? 3. Where is data backed-up and is it encrypted? 4. Does your firm allow remote access to servers or workstations via a virtual private network (VPN) or similar technology? 5. Does your firm use free Cloud services such as iCloud, Dropbox, or Google Drive, to store personal and confidential client information? 6. Does your firm utilize your firm’s website to use or access client information data? 7. Does your firm’s website include a client portal? 8. Protecting against ransomware * a. Malware for data kidnapping * 1) Attacker encrypts the victim's data * 2) Demands payment for the decryption key * b. Use a layered approach * 1) Anti-virus * 2) Web filtering * 3) Firewalls * c. Back-up data * 1) Often * 2) Keep old uninfected files available * 3) Offline

Answer 98

Privacy Controls A. Regulation S-P—Firms must adopt policies and procedures to address the protection of nonpublic personal information. 1. Initial and annual notice to customers * a. Customers have an ongoing relationship 2. Initial notice only to consumers * a. Consumers obtain a product or service and have no further contact with the firm 3. Opt-out methods must be easy * a. Writing a letter is not, an email is

Answer 99

A. The Investment Advisers Act of 1940 is federal law and that comes under the jurisdiction of the SEC.

Answer 100

A If an adviser provides its clients with reports or recommendations prepared by a third party without disclosure of the source, the adviser has acted unethically. There is, however, an exception to this rule, which happens to apply here. If the adviser uses third-party reports as a basis for its own recommendation or as a support to its own recommendation to its client, it does not have to disclose this information.

Answer 101

A Any written communication that offers a security for sale—including newspaper and media communications, such as radio and television offers—is considered a prospectus. This definition excludes individual offers made orally and discussions between an agent and a customer. A publicity release that describes a security, a newsletter from a brokerage firm announcing the availability of a security, and an advertisement in a newspaper describing the benefits of a certain mutual fund may be considered prospectuses. A telephone call from an agent to a client advising the purchase of a security is not considered a prospectus because it involves an individual telephone solicitation between an agent and a client.

Answer 102

C Both executors and administrators are fiduciaries. An agent is a fiduciary if the agent has discretionary authority over the assets in the account, but time and price authority is not considered discretion. A sale made by the custodian for a minor in an UGMA or UTMA account does not qualify as an exemption transaction under the USA, even though, as a matter of law, the custodian is functioning in a fiduciary capacity.

Answer 103

C It is a prohibited practice to automatically recommend securities without having a reasonable basis for the recommendation; other agents recommending the security is not a reasonable basis for recommendation. Purchasing securities with high transaction costs is not prohibited, provided that disclosure is made to the client. An agent is not required to describe all facts surrounding an investment, but he must present all those that are material. Regarding estimates of a company's interest rate risks, the representative did not misrepresent a material fact that would have otherwise precluded the client from purchasing the security.

Answer 104

B Ratings are not a requirement for a security to be registered.

Answer 105

A Although the normal time for withdrawal of a registration is the 30th day after filing the Form U5, the Administrator has the jurisdiction to shorten that period if circumstances warrant it.

Answer 106

A Agents must always determine suitability before soliciting purchases or sales. An investment cannot be suitable for all your clients; therefore, the practice of blanket recommendation is unethical.

Answer 107

A Anyone who solicits or receives an order while representing a broker-dealer is an agent. Silent partners, administrative personnel, and executives of broker-dealers with no sales responsibilities are not agents under the terms of the USA because they do not solicit or receive orders.

Answer 108

D There is a limit as to how far an investment adviser or IAR can go to prevent clients from giving testimonials. After all, as in so many businesses, referrals are a key to growth. As long as this note was posted without any knowledge of the IA (or IAR), there is no problem. However, once the IA (or IAR) finds out about it, a request must be made to remove it. The prohibition on testimonials is not limited to social media.

Answer 109

For a private placement to remain an exempt transaction under the Uniform Securities Act, * the offer may be directed to no more than 10 individuals during any 12-month period. * no commissions may be paid to agents of the offering broker on sales to noninstitutional buyers, * there must be reasonable belief that the purpose in buying the securities by noninstitutional clients is for investment rather than resale purposes.

Answer 110

D An unincorporated investment club, an individual who buys and sells securities for his own account, associations, and partnerships (whether or not they issue certificates), and the U.S. government are specifically listed as persons in the act. On the exam, minor children, deceased individuals, and mentally incompetent individuals are the only choices that are not persons under the act.

Answer 111

w hen registering securities with the SEC, the principal executives of the company involved with money and a majority of the board of directors are required to sign the registration statement attesting to the facts presented as being true to the best of their knowledge and belief. This includes the chief executive officer, chief financial officer, and a majority of the board, but not the chief operating officer.

Answer 112

C The effective date of registration by qualification is set by the Administrator. The effective date under registration by coordination is set by the SEC, and notice filing(by investment companies) is merely the filing of certain documents in order for the registrant to be able to offer securities in that state.

Answer 113

B In the case of a U.S. government security, the security is exempt, but the transaction is not. All the other choices are exempt transactions because they are either to an institutional investor, existing owners for no consideration, or by certain fiduciaries, such as an executor.

Answer 114

A It is the investment adviser representative's responsibility to notify the Administrator. The advisory firm is not registered with the state; only the representative is registered.

Answer 115

A Passing the exams does not automatically give one an effective investment adviser representative's license. Notice is received by the investment adviser from the appropriate state and/or federal authorities and then, in accordance with that firm's procedures, advisory activity may start. The Administrator does not have direct contact with the individual.

Answer 116

A When an investment adviser ceases to exist, either through going out of business or being succeeded by another firm (as is the case here), it is their responsibility to ensure that articles of incorporation, charters, minute books, and stock certificate books of the investment adviser and of any predecessor be preserved until at least three years after termination of the enterprise. Although it is true the contracts have been assigned to the successor firm (Gold and Sylver), the consent for that had to be obtained by LTFSI. A change of this nature requires prompt amendment to the Form ADV Part 1.

Answer 117

D Unless an exception is granted by the Administrator, it is prohibited for an agent to share commissions with any person not also registered as an agent for the same or affiliated broker-dealer.

Answer 118

A Industry rules require that investment advisers make disclosure when acting as principals (from inventory) or agents in a transaction with an advisory client. This disclosure must be made in writing—furthermore, client consent to acting in this capacity must be obtained prior to the completion of the transaction.

Answer 119

broker-dealers can operate either in a principal or agency capacity when executing transactions for their clients. When acting in a principal capacity, the BD is the contra party to the trade. That is, they are on the other side of the trade of the client. When the client is buying a security, the broker-dealer is selling it out of inventory. In this case, the firm's profit comes from a markup. If the client is selling a security and the broker-dealer purchases it for its inventory, once again, the firm is acting as a principal (every trade has two principals-the buyer and the seller) and, in this case, the profit comes from a markdown. When acting in an agency capacity, the firm is acting like any other broker or agent (real estate broker, insurance agent, or employment agent) in that they are simply putting the buyer and seller together. And, like all agents or brokers, they earn a commission. For the exam, it is important to know that broker-dealers must always indicate their capacity on the trade confirmation, sent no later than completion of the trade (settlement date) . Theywill indicate if they acted as a broker (and always disclose the amount of commission) or if they acted as a principal (and, depending on the circumstances-not tested-may have to indicate the markup or markdown).

Answer 120

Capacity by Investment Advisers However, on rare occasions, an investment adviser might buy from or sell to an advisory client in the capacity of a principal. Or, the adviser might put together a buyer and seller acting in the capacity of an agent. The regulators have recognized that both principal and agency transactions create the potential for advisers to engage in self-dealing. Principal transactions, in particular, may lead to abuses such as price manipulation or the placing of unwanted securities into client accounts. When an adviser engages in an agency transaction on behalf of a client, it is primarily the incentive to earn additional compensation that creates the adviser's conflict of interest. Although recognizing the potential for these abuses, the regulators did not prohibit advisers entirely from engaging in all principal and agency transactions with clients. Rather, they chose to address these particular conflicts of interest by imposing the following **disclosure** and client **consent** requirements. ■ The client receives full written disclosure as to the capacity in which the adviser proposes to act. ■ Client consent is obtained. Consent, which can be oral or written, may be obtained before or after the execution of the trade, but both of these must be done prior to completion of the transaction. This is unlike a broker-dealer who, when acting as a principal in a trade with a customer or as the customer's agent, need only indicate that capacity on the trade confirmation; **consent** is not required.

Answer 121

When acting as the principle * BD must: disclose capacity * IA must: disclose capacity and get consent (written or oral)

Answer 122

C Form D is the form that must be filed electronically with the SEC no later than 15 days after the first sale of securities in the offering.

Answer 123

Exempt transaction—private placements under Rule 506(b) and 506(c) of Regulation D a. Rule 501—accredited investor 1) Institutional investors 2) Employee benefit plans over $5 million 3) Insider of the issuer 4) Individual with own or joint (with spouse) net worth greater than $1 million (excluding the net equity of residence) or earnings over $200,000 for past two years/joint $300,000 and expected this year b. File a Form D within 15 days of sale

Answer 124

New Updated Accredited Investors **Natural Persons** **Professional certifications** and designations and other credentials. Good standing necessary. * Licensed Investment Adviser Representative (Series 65); * Licensed General Securities Representative (Series 7); * Licensed Private Securities Offerings Representative (Series 82). **Knowledgeable employees** * Directors and certain executive officers of the private fund, or of an affiliated person of the private fund that manages the investment activities of the private fund * accredited investor only for offerings by the private fund **Family clients of family offices** * Be a family client of a family office that itself qualifies as an accredited investor. * Have her investment be directed by a person that is capable of evaluating investments. **Entities** * Investment Advisers - registered with state, SEC, or exempt * rural business investment companies, * Entities with more than $5 million in asset * limited liability companies with more than $5 million in assets, * certain family offices and family clients with more than $5 million in assets, * entities owning investments in excess of $5 million.

Answer 125

The consent to service of process provides the Administrator with power of attorney to accept legal papers on behalf of registrants. This power of attorney does not grant the Administrator the authority to terminate the registration at will nor does it empower the Administrator to verify information or expedite the registration process.

Answer 126

Investment adviser representatives are not allowed to share in the capital appreciation or depreciation of their customers' accounts in the same manner as agents.

Answer 127

The Uniform Securities Act permits filing an amendment to an existing registration, increasing the number of shares to be offered and sold, if the public offering price and underwriter's discounts and commissions remain unchanged.

Answer 128

Under the NASAA Model Custody Rule, it is unlawful for any investment adviser to take or have custody of any securities or funds of any client if 1. the Administrator, by rule, prohibits custody; or 2. in the absence of rule, the investment adviser fails to notify the Administrator that he has or may have custody. It is true that there is a minimum net worth or bond required, but that is not part of NASAA's Custody Rule—those requirements are found in Model Rule 202(d)-1, NASAA's Minimum Financial Requirements for Investment Advisers.

Answer 129

Investment Counsel - IA whose principal business consists of rendering investment advice and a substantial portion of his advisory business involves investment supervisory services. A person is deemed to be in control of an IA with an ownership level of at least 25% If a state-covered IA meets the bonding, net worth, or recordkeeping requirements of the IA's home state, it suffices for any other state in which the IA is registered. Federal-covered IAs meet SEC requirements only.

Answer 130

The SEC does not approve securities registered with it, does not pass on the investment merit of any security, and never guarantees the accuracy of statements in the registration statement and prospectus. In its review process, the SEC merely attempts to make certain that all pertinent information is fully disclosed in the registration statement and prospectus by requiring that: ■ the issuer file a registration statement with the SEC before securities are offered or sold in interstate commerce; ■ a prospectus that meets the requirements of the act be provided to prospective buyers; and ■ penalties (civil, criminal, or administrative) be imposed for violations of the act.

Answer 131

When a good-faith error execution orders in their customer’s accounts, only the broker-dealer can make the correction, not the agent. Differences between static and interactive content on social media include: Static content requires preapproval. Interactive content can be reused by others and can be commented on by others. Both static and interactive content can be changed by its originator, but static can only be changed by its originator and interactive by the originator or others.

Part 1 Flashcards

(156 cards)