Client Communication and Disclosure Flashcards

According to the Investment Advisers Act of 1940 (Rule 204-3, the "Brochure Rule"), an investment adviser must deliver the Form ADV Part 2A brochure to a prospective client:

Answer: Prior to or at the time of entering into an investment advisory agreement.

SEC Rule 204-3 generally requires an investment adviser to deliver its brochure (Form ADV Part 2A) to a client before or at the time the advisory agreement is executed. An alternative allows for delivery at the time of the agreement if the client can terminate without penalty within five business days, but the primary and most encompassing answer is delivery at or before the agreement is made.

Under the SEC's Marketing Rule (Rule 206(4)-1), which of the following is permissible in an adviser's advertisement, provided all necessary disclosures are made?

Answer: A testimonial from a current client praising the adviser's performance.

The SEC's modernized Marketing Rule permits the use of testimonials and endorsements in advertisements, so long as the adviser makes certain clear and prominent disclosures. These disclosures include whether the person giving the testimonial is a client and whether they were compensated. The other options, such as guaranteeing results or cherry-picking performance, are explicitly prohibited or would be considered misleading.

A CIC's firm is preparing to share certain nonpublic personal client information with a nonaffiliated third-party marketing firm. To comply with Regulation S-P, what is the firm's primary obligation to its clients?

Answer: Provide clients with a clear privacy notice and a reasonable opportunity to opt out of the sharing.

Regulation S-P requires financial institutions to provide customers with a notice of their privacy policies and practices. Critically, it mandates that firms must not disclose nonpublic personal information to a nonaffiliated third party unless the firm has provided the consumer with a notice and the consumer has not elected to opt out of the disclosure.

A Certified Investment Counselor's standard advisory agreement includes a clause stating, "The client agrees the adviser shall not be liable for any losses resulting from ordinary negligence." How is this type of provision, often called a hedge clause, viewed by the SEC?

Answer: As a misleading statement that violates the anti-fraud provisions of the Advisers Act.

The SEC has consistently stated that hedge clauses in advisory agreements with retail clients that attempt to limit an adviser's liability for conduct that would constitute a breach of fiduciary duty (such as negligence) are misleading and inconsistent with the anti-fraud provisions of the Investment Advisers Act. Such clauses could lead a client to believe they have waived a non-waivable cause of action against the adviser.

When a CIC's firm receives "soft dollar" benefits from a broker-dealer, which disclosure is required in its Form ADV Part 2A?

Answer: A description of the services received and the conflicts of interest, such as the incentive to select brokers based on research rather than solely on best execution.

Item 12 of Form ADV Part 2A requires advisers to describe their brokerage practices, including any soft dollar arrangements. The firm must disclose the products and services received and explain the conflicts of interest this creates, including the potential for the adviser to be motivated to choose broker-dealers based on the benefits they receive rather than on achieving the best execution for clients.

Under the Investment Advisers Act Rule 204-2 (the "Books and Records Rule"), for what minimum period must an advisory firm generally retain client communications, such as emails related to investment advice?

Answer: Five years, with the first two years in an easily accessible place.

Rule 204-2 requires that records, including originals or copies of all communications received and sent relating to investment advice or recommendations, must be maintained for a period of not less than five years from the end of the fiscal year during which the last entry was made on such record. For the first two years, these records must be kept in an appropriate office of the investment adviser, meaning they must be easily accessible.