CFM Regulatory Compliance & Ethical Standards 2 — Questions and Answers
Question 1: Under the Investment Advisers Act of 1940, which activity requires SEC registration as an investment adviser?
- Providing incidental investment advice as part of another profession without compensation
- Selling mutual fund shares on a commission basis only
- Managing a private hedge fund with 15 or more clients and $110M+ AUM (Correct answer)
- Publishing a financial newsletter with general market commentary
Correct answer: Managing a private hedge fund with 15 or more clients and $110M+ AUM
Advisers managing over $110 million AUM with 15+ clients generally must register with the SEC under the Investment Advisers Act of 1940.
Question 2: The CFM Code of Ethics requires fund managers to disclose conflicts of interest:
- Only when the conflict results in financial harm to the client
- Promptly and fully before the conflict can affect investment decisions (Correct answer)
- Annually in the fund's audited financial statements
- Only to the fund's board of directors, not to individual investors
Correct answer: Promptly and fully before the conflict can affect investment decisions
Ethical standards require prompt and full disclosure of conflicts before they can influence investment decisions affecting clients.
Question 3: A fund manager receives a large gift from a broker-dealer whose services the fund uses. What is the most appropriate ethical response?
- Accept the gift since it rewards a positive business relationship
- Decline or return the gift and report it to the compliance officer (Correct answer)
- Accept the gift but disclose it only if it exceeds $500 in value
- Ask the broker-dealer to direct the gift to a fund charity instead
Correct answer: Decline or return the gift and report it to the compliance officer
Accepting gifts from service providers creates a conflict of interest; the appropriate action is to decline or return it and notify compliance.
Question 4: Which SEC rule requires fund managers to adopt written compliance policies and procedures?
- Rule 10b-5
- Rule 206(4)-7 (Correct answer)
- Rule 12b-1
- Rule 15c3-1
Correct answer: Rule 206(4)-7
SEC Rule 206(4)-7 requires registered investment advisers to adopt and implement written compliance policies and procedures reasonably designed to prevent violations.
Question 5: Front-running in fund management occurs when a manager:
- Executes trades for the fund before processing client redemptions
- Trades in personal accounts ahead of executing known fund orders to profit from price movement (Correct answer)
- Allocates IPO shares to the fund before other client accounts
- Submits fund orders to multiple brokers simultaneously to achieve best execution
Correct answer: Trades in personal accounts ahead of executing known fund orders to profit from price movement
Front-running is the illegal practice of trading personal accounts based on advance knowledge of pending fund orders that will move the market.
Question 6: The Investment Company Act of 1940 requires that a majority of a mutual fund's board of directors must be:
- Certified public accountants with audit experience
- Independent directors not affiliated with the fund's investment adviser (Correct answer)
- Appointed by the SEC after a background investigation
- Representatives elected annually by fund shareholders
Correct answer: Independent directors not affiliated with the fund's investment adviser
The Investment Company Act requires a majority of fund board members to be independent directors unaffiliated with the fund's investment adviser.
Question 7: Under ERISA's fiduciary standards, a fund manager overseeing pension assets must primarily act in the interest of:
- The plan sponsor (employer) who selected the manager
- The fund manager's firm and its shareholders
- Plan participants and beneficiaries (Correct answer)
- The Department of Labor as the regulatory overseer
Correct answer: Plan participants and beneficiaries
ERISA's fiduciary duty requires fund managers handling pension assets to act solely in the interest of plan participants and beneficiaries.
CFM Regulatory Compliance & Ethical Standards 2
Under the Investment Advisers Act of 1940, which activity requires SEC registration as an investment adviser?