AIP Client Advisory & Ethical Practices 3 — Questions and Answers
Question 1: Under Regulation Best Interest (Reg BI), broker-dealers are required to act in the best interest of retail customers at the time of a recommendation. Which factor MOST distinguishes Reg BI from a full fiduciary standard?
- Reg BI applies to all investment recommendations, while fiduciary applies only to retirement accounts
- Reg BI requires best interest at point of sale but does not impose an ongoing monitoring obligation (Correct answer)
- Reg BI is stricter than fiduciary because it requires written documentation of every recommendation
- Reg BI eliminates all conflicts of interest, while fiduciary only requires disclosure of conflicts
Correct answer: Reg BI requires best interest at point of sale but does not impose an ongoing monitoring obligation
Reg BI establishes a best-interest standard at the time of recommendation without creating a continuous duty to monitor, unlike a comprehensive fiduciary obligation.
Question 2: A client is 68 years old with a fixed income and low risk tolerance. An advisor recommends a variable annuity with a 7-year surrender period. Which ethical principle is MOST likely being violated?
- Confidentiality
- Suitability (Correct answer)
- Independence
- Competence
Correct answer: Suitability
Recommending a long surrender-period product to an elderly, low-risk-tolerance client with fixed income likely violates suitability requirements.
Question 3: An advisor learns material non-public information about a company from a client who is a corporate executive. The advisor's ethical obligation is to:
- Use the information to benefit the client's portfolio since it came from the client themselves
- Refrain from trading on the information and consult compliance immediately (Correct answer)
- Trade the information only for the client who disclosed it, not for other clients
- Document the information and wait 30 days before acting on it
Correct answer: Refrain from trading on the information and consult compliance immediately
Trading on material non-public information is illegal under insider trading laws regardless of the source, and must be reported to compliance.
Question 4: When performing a needs analysis for a client, which element is LEAST relevant to determining appropriate investment recommendations?
- Time horizon
- Risk tolerance
- The advisor's quarterly revenue targets (Correct answer)
- Liquidity requirements
Correct answer: The advisor's quarterly revenue targets
Investment recommendations must be driven entirely by client needs, not by the advisor's revenue or compensation targets.
Question 5: A client verbally authorizes a trade over the phone but declines to sign a written confirmation. Under best practices for documentation, the advisor should:
- Proceed with the trade and send a written record of the verbal authorization to the client (Correct answer)
- Refuse to execute the trade until written authorization is obtained
- Proceed with the trade and document only internally without notifying the client
- Cancel the trade and close the account due to the client's non-compliance
Correct answer: Proceed with the trade and send a written record of the verbal authorization to the client
Verbal authorizations should be executed per the client's instruction with contemporaneous written documentation sent to the client for their records.
Question 6: Which of the following is a hallmark characteristic of a fiduciary relationship in investment advisory practice?
- The advisor recommends only products from a pre-approved proprietary list
- The advisor is obligated to put the client's interests ahead of their own (Correct answer)
- The advisor charges commission-based fees tied to product sales
- The advisor is exempt from disclosure requirements for affiliated products
Correct answer: The advisor is obligated to put the client's interests ahead of their own
The defining characteristic of a fiduciary is the legal and ethical obligation to prioritize the client's interests above all others.
Question 7: An advisor recommends a mutual fund that is virtually identical to a lower-cost alternative but pays the advisor a higher 12b-1 fee. This situation BEST illustrates:
- Appropriate use of proprietary products
- A conflict of interest that must be disclosed and managed (Correct answer)
- Standard industry practice for fund selection
- An example of portfolio diversification strategy
Correct answer: A conflict of interest that must be disclosed and managed
Recommending higher-cost products that generate greater advisor compensation when lower-cost equivalents exist represents a conflict of interest requiring disclosure.
AIP Client Advisory & Ethical Practices 3
Under Regulation Best Interest (Reg BI), broker-dealers are required to act in the best interest of retail customers at the time of a recommendation.
Which factor MOST distinguishes Reg BI from a full fiduciary standard?