CFC Ethics and Professional Standards 2 — Questions and Answers
Question 1: Under the Investment Advisers Act of 1940, investment advisers registered with the SEC must provide clients with:
- A prospectus for every recommended security
- Form ADV Part 2 (the adviser brochure) disclosing fees, services, and conflicts (Correct answer)
- Annual audited financial statements
- A guarantee of performance benchmark outperformance
Correct answer: Form ADV Part 2 (the adviser brochure) disclosing fees, services, and conflicts
SEC-registered investment advisers must deliver Form ADV Part 2 to clients, disclosing material information about the adviser's business, fees, conflicts of interest, and disciplinary history.
Question 2: The 'suitability' standard historically applied to broker-dealers differs from the 'fiduciary' standard in that suitability:
- Requires acting in the client's best interest at all times
- Requires only that recommendations be appropriate for the client at the time, not necessarily the best option (Correct answer)
- Prohibits all commissions
- Applies only to insurance products
Correct answer: Requires only that recommendations be appropriate for the client at the time, not necessarily the best option
Under the traditional suitability standard, a broker needs only to show a recommendation was appropriate given client circumstances, while fiduciary duty demands the best available option for the client.
Question 3: When a financial planner learns that a client is engaged in financial elder abuse against a family member, the planner's primary ethical obligation is to:
- Ignore it as outside the scope of financial planning
- Report it to appropriate authorities and consider withdrawing from the engagement (Correct answer)
- Continue the engagement without comment to avoid losing the client
- Advise the client on how to minimize legal exposure
Correct answer: Report it to appropriate authorities and consider withdrawing from the engagement
Facilitating or concealing elder financial abuse violates ethical and potentially legal obligations; planners should report suspected abuse to adult protective services or law enforcement.
Question 4: Regulation Best Interest (Reg BI) requires broker-dealers, when making a recommendation, to act in the:
- Firm's financial interest
- Best interest of the retail customer, placing their interest ahead of the firm's (Correct answer)
- Interest of the highest-paying client
- Suitability interest based on account type only
Correct answer: Best interest of the retail customer, placing their interest ahead of the firm's
SEC Reg BI requires broker-dealers to act in the retail customer's best interest at the time of a recommendation and not place their own financial interests ahead of the client's.
Question 5: A financial professional who uses client funds for personal investments without authorization is guilty of:
- Negligence
- Churning
- Misappropriation (embezzlement) (Correct answer)
- Front-running
Correct answer: Misappropriation (embezzlement)
Misappropriation of client funds for personal use constitutes embezzlement — a serious ethical violation and criminal offense that permanently damages professional standing.
Question 6: Front-running by a financial adviser refers to:
- Recommending securities before doing adequate research
- Trading in a security for personal accounts ahead of executing a large client order in the same security (Correct answer)
- Selling securities before reading the prospectus
- Advising clients before the market opens
Correct answer: Trading in a security for personal accounts ahead of executing a large client order in the same security
Front-running involves trading for one's own account based on advance knowledge of pending client orders, exploiting non-public order-flow information for personal gain.
CFC Ethics and Professional Standards 2
Under the Investment Advisers Act of 1940, investment advisers registered with the SEC must provide clients with: