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

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Flashcards in Unit 1 - Chapter 3B - Fed & State Regulation Of IA & RIAs Deck (53):

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

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


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

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


Define access peron

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


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

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


What does Part 2 of the ADV consists of?

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


When is not required to file the brochure of supplements?

When the IA is registered or is registered with the SEC


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

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


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

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


Wrap Fee Program

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


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

ADV Part 2A - Appendix 1


What are the brochure delivery requirements for SEC registered advisers?

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


What is the brochure delivery requirement for state registered advisors?

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


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

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


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

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


When must the brochure be updated?

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


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

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


What are exceptions to the custody requirements?

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


What does custody mean?

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


Qualified Custodian

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


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

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


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

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


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

Personal transactions that are consistent with those recommended to clients


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

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


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

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


Hedge Clauses

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


Principal Transaction

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

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

If the adviser is a BD this does not apply.



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


Blanket Approvals

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


What is the SEC definition of Advertisement?

Any notice, circular, website, letter, or written communication addressed to more than one person, or any notice of other announcement in any publication or by radio or TV that offers:
1.) analysis, report, publication concerning securites
2.) graph, chart, formula, or other device to be used in making any determination concerning securities
3.) other investment advisory service with regard to securities


What are considered unlawful advertisements by an IA?

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


What must be included in a IA contract

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


What are the exceptions to the performance fee arrangements?

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


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

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

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


Agency cross transactions

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


Cash Referral Fees

Payment of cash referrals by IAs to persons who solicit business for them is NOT prohibited by the SEC providing 4 conditions are met
1.) The IA must registered under the USA
2.) IA has to be qualified and not disqualified from the USA
3.) A written agreement must be in place
4.) They must be made in the following circumstances: i.) payments are for the provision of impersonal advisory services ii.) IA pays a fee to a person affiliated with the IA (e.g. partner, officer, director, etc. of the IA) iii.) third party solicitors who are not affiliated with the IA

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


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

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


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

The limitations and difficulties of using the system


When can IAs lend money to clients?

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


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

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


Directed Transactions

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


Soft Dollars

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


What must an IA explain when receiving soft dollar benefits?

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


What should an IA's Policy and Procedures address?

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


What are the enforcement powers of the SEC?

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

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


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

60 days


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

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


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

$10,000 fine and 5 year prison sentence


What is a covered account?

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


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

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


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

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


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

30 days


Model Rule

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


What should a business continuity plan include?

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