CFM Regulatory Compliance & Ethical Standards 4 — Questions and Answers
Question 1: A fund manager discovers that a trade error resulted in a gain that was allocated to the fund instead of the manager's error account. Ethical standards require the manager to:
- Retain the gain in the fund since the error benefited clients
- Transfer the gain to the error account and credit the fund only if errors cause losses
- Report the error to compliance and correct the allocation appropriately (Correct answer)
- Average the gain across all client accounts to ensure equitable treatment
Correct answer: Report the error to compliance and correct the allocation appropriately
Trade errors must be reported to compliance and corrected so that funds are neither advantaged nor disadvantaged by manager mistakes.
Question 2: The SEC's Regulation Best Interest (Reg BI) primarily applies to which type of financial professional?
- Registered investment advisers managing discretionary accounts
- Broker-dealers making recommendations to retail customers (Correct answer)
- Commodity trading advisers managing futures accounts
- Transfer agents processing mutual fund share transactions
Correct answer: Broker-dealers making recommendations to retail customers
Reg BI requires broker-dealers to act in the best interest of retail customers when making investment recommendations, imposing a standard higher than suitability.
Question 3: When allocating IPO shares across multiple client accounts, a fund manager must ensure the allocation is:
- Prioritized toward larger accounts that generate more management fees
- Made on a first-come, first-served basis based on client order entry time
- Fair and consistent with the manager's pre-established allocation policy (Correct answer)
- Directed entirely to the fund's most profitable client relationship
Correct answer: Fair and consistent with the manager's pre-established allocation policy
Fair allocation of IPO shares requires adherence to a pre-established, documented allocation policy that treats all eligible accounts equitably.
Question 4: Under the Dodd-Frank Act, advisers to private funds with over $150 million in private fund AUM must:
- Register with state securities regulators in each state where clients reside
- Register with the SEC as investment advisers (Correct answer)
- File quarterly reports with the CFTC on fund positions
- Obtain annual approval from the fund's limited partners for continued management
Correct answer: Register with the SEC as investment advisers
The Dodd-Frank Act eliminated the private adviser exemption for most private fund advisers with over $150M in private fund AUM, requiring SEC registration.
Question 5: Which practice violates the prohibition on market manipulation under SEC Rule 10b-5?
- Executing a large block trade that temporarily moves the market price
- Publishing a research report that results in increased investor demand for a security
- Coordinating with others to artificially inflate a stock's price through matched trades (Correct answer)
- Using algorithmic trading strategies that result in rapid order execution
Correct answer: Coordinating with others to artificially inflate a stock's price through matched trades
Matched trades coordinated to artificially inflate prices constitute market manipulation, which is expressly prohibited under SEC Rule 10b-5.
Question 6: A fund manager's personal trading in securities held by the fund could violate which ethical principle?
- The prohibition on excessive fee arrangements under the Advisers Act
- The duty of loyalty by placing personal interests ahead of client interests (Correct answer)
- The requirement to maintain adequate capital reserves under banking regulations
- The obligation to file Form ADV updates with the SEC within 30 days
Correct answer: The duty of loyalty by placing personal interests ahead of client interests
Personal trading in fund securities may violate the duty of loyalty if it allows the manager to profit at the expense of clients or creates conflicts of interest.
Question 7: The Form ADV Part 2 document, required by SEC rules, must be provided to advisory clients and contains:
- The fund's audited annual financial statements and NAV calculations
- A narrative description of the adviser's business, fees, conflicts, and disciplinary history (Correct answer)
- The fund's portfolio holdings as of each quarter-end reporting date
- The adviser's net capital computation and financial condition disclosure
Correct answer: A narrative description of the adviser's business, fees, conflicts, and disciplinary history
Form ADV Part 2 (the 'brochure') requires advisers to provide clients a narrative disclosure of business practices, fees, conflicts of interest, and disciplinary history.
CFM Regulatory Compliance & Ethical Standards 4
A fund manager discovers that a trade error resulted in a gain that was allocated to the fund instead of the manager's error account.
Ethical standards require the manager to: