CFM Regulatory Compliance & Ethical Standards 5 — Questions and Answers
Question 1: Under the Global Investment Performance Standards (GIPS), composite performance must include:
- Only accounts that outperformed the benchmark in a given period
- All fee-paying discretionary accounts managed to a similar strategy (Correct answer)
- Accounts selected by the manager to best represent strategy performance
- Only accounts with at least a three-year performance history
Correct answer: All fee-paying discretionary accounts managed to a similar strategy
GIPS requires that all fee-paying discretionary accounts managed according to a similar strategy be included in composites to prevent cherry-picking of results.
Question 2: A 'whistleblower' under the SEC's Dodd-Frank whistleblower program is entitled to:
- Guaranteed employment protection but no financial award for information provided
- An award of 10-30% of sanctions collected when the tip leads to a successful SEC enforcement action exceeding $1 million (Correct answer)
- Immunity from all civil liability related to securities law violations they report
- Reimbursement of legal fees only if the reported violation results in a conviction
Correct answer: An award of 10-30% of sanctions collected when the tip leads to a successful SEC enforcement action exceeding $1 million
The SEC whistleblower program awards 10-30% of monetary sanctions collected in successful enforcement actions exceeding $1 million based on original information provided.
Question 3: An investment fund that relies on the '3(c)(7)' exemption from Investment Company Act registration must limit its investors to:
- Accredited investors with at least $1 million in net worth
- Qualified purchasers owning at least $5 million in investments (Correct answer)
- No more than 100 beneficial owners regardless of investor sophistication
- Institutional investors with at least $100 million in discretionary AUM
Correct answer: Qualified purchasers owning at least $5 million in investments
The 3(c)(7) exemption is available to funds that sell exclusively to 'qualified purchasers,' which includes individuals owning at least $5 million in investments.
Question 4: The ethical principle of 'independence and objectivity' in fund management is most threatened when a manager:
- Invests in sectors outside the fund's stated strategy with board approval
- Accepts excessive compensation or gifts that could influence investment recommendations (Correct answer)
- Charges performance fees tied to benchmark-relative returns
- Votes fund shares on all proxy proposals submitted by portfolio companies
Correct answer: Accepts excessive compensation or gifts that could influence investment recommendations
Accepting excessive compensation or gifts from interested parties compromises independence and objectivity by creating personal financial incentives that may bias recommendations.
Question 5: Which regulatory requirement applies when a hedge fund manager 'crosses' trades between two client accounts it manages?
- Cross trades are unconditionally prohibited between any affiliated accounts
- Cross trades must be executed at a fair price and disclosed to both client accounts (Correct answer)
- Cross trades require prior SEC approval and public notice filing
- Cross trades are permitted only if both accounts are qualified institutional buyers
Correct answer: Cross trades must be executed at a fair price and disclosed to both client accounts
Cross trades between client accounts are permissible only if conducted at a fair market price and properly disclosed to both parties involved in the transaction.
Question 6: A fund manager seeking to terminate a client relationship ethically must:
- Immediately liquidate all client positions and return proceeds within 24 hours
- Provide reasonable notice and assist in transitioning the account to minimize client disruption (Correct answer)
- Obtain SEC approval before withdrawing from an advisory relationship
- Refund all management fees collected during the prior 12 months before terminating
Correct answer: Provide reasonable notice and assist in transitioning the account to minimize client disruption
Ethical termination of a client relationship requires providing reasonable notice and cooperating in an orderly transition to avoid harming the client.
Question 7: Under FINRA Rule 3110, broker-dealers managing fund distribution must maintain a supervisory system that:
- Eliminates the need for written compliance policies when fewer than 10 registered representatives are employed
- Is reasonably designed to achieve compliance with applicable securities laws and FINRA rules (Correct answer)
- Requires all supervisory procedures to be approved by the SEC annually
- Limits supervision responsibilities to branch managers only, not home office personnel
Correct answer: Is reasonably designed to achieve compliance with applicable securities laws and FINRA rules
FINRA Rule 3110 requires broker-dealers to establish and maintain a supervisory system, including written procedures, reasonably designed to achieve compliance with applicable laws and rules.
CFM Regulatory Compliance & Ethical Standards 5
Under the Global Investment Performance Standards (GIPS), composite performance must include: