CIC Ethical Business Practices 5 — Questions and Answers
Question 1: A CIC manages a pension fund and also has a 15% ownership stake in a real estate firm they are considering recommending to the fund. This situation requires:
- No special action since pension funds are exempt from conflict-of-interest rules
- Full disclosure of the ownership stake to the pension fund's trustees before making any recommendation (Correct answer)
- Disclosure only if the investment generates a profit
- Recusal from all real estate investment decisions permanently
Correct answer: Full disclosure of the ownership stake to the pension fund's trustees before making any recommendation
The counselor must fully disclose the ownership interest to the trustees to allow them to make an informed decision about the recommendation.
Question 2: Which of the following best defines 'churning' in the context of investment ethics?
- Rotating between asset classes based on macroeconomic forecasts
- Excessive trading in a client's account primarily to generate commissions (Correct answer)
- Rebalancing a portfolio quarterly to maintain target allocations
- Replacing underperforming mutual funds with better-performing alternatives
Correct answer: Excessive trading in a client's account primarily to generate commissions
Churning refers to excessively trading in a client's account to generate commissions rather than to serve the client's investment objectives.
Question 3: A prospective client asks a CIC to guarantee that their portfolio will not lose more than 10% in any given year. The counselor should:
- Provide the guarantee in writing to win the client
- Decline to make the guarantee as investment returns cannot be promised (Correct answer)
- Offer a conditional guarantee tied to market performance
- Accept the mandate only if the portfolio is 100% in U.S. Treasuries
Correct answer: Decline to make the guarantee as investment returns cannot be promised
Investment counselors are prohibited from guaranteeing investment outcomes because all investments carry risk beyond the counselor's control.
Question 4: Under FINRA rules, a registered representative who is also a CIC wishes to participate in a private securities transaction outside the scope of their employment. They must first:
- Disclose the transaction to the SEC within 30 days of completion
- Provide written notice to their employer and receive approval before participating (Correct answer)
- Limit their participation to a passive investor role without pre-approval
- File a Form U4 amendment prior to the transaction
Correct answer: Provide written notice to their employer and receive approval before participating
FINRA rules require written notice to and approval from the employing firm before a registered representative participates in any private securities transaction.
Question 5: A CIC's research report contains an error that was not discovered before publication. Upon discovering the error, the ethical obligation is to:
- Quietly correct future reports and hope clients did not act on the flawed information
- Issue a prompt correction and notify clients who may have relied on the erroneous report (Correct answer)
- Correct the error only if a client explicitly complains
- Retract all research reports for the past year as a precaution
Correct answer: Issue a prompt correction and notify clients who may have relied on the erroneous report
Prompt correction and client notification are required when an error in published research could have influenced client investment decisions.
Question 6: The 'know your customer' (KYC) requirement in investment counseling is primarily intended to:
- Satisfy regulatory paperwork requirements for new account opening
- Ensure recommendations are suitable by understanding the client's financial situation, goals, and risk tolerance (Correct answer)
- Prevent fraud by verifying the client's identity through government-issued ID
- Comply with anti-money-laundering record-keeping rules
Correct answer: Ensure recommendations are suitable by understanding the client's financial situation, goals, and risk tolerance
KYC primarily ensures that the counselor understands each client well enough to make suitable investment recommendations aligned with their goals and risk tolerance.
Question 7: A CIC who manages accounts for members of the same family discovers a conflict between the investment goals of a parent (income-focused) and an adult child (growth-focused). The counselor should:
- Manage both accounts identically to avoid favoritism
- Treat each account independently based on the individual client's stated objectives (Correct answer)
- Defer entirely to the parent's preferences since they are the senior family member
- Merge the accounts to simplify portfolio management
Correct answer: Treat each account independently based on the individual client's stated objectives
Each client's account must be managed according to that individual's own objectives, risk tolerance, and investment policy, regardless of family relationships.
CIC Ethical Business Practices 5
A CIC manages a pension fund and also has a 15% ownership stake in a real estate firm they are considering recommending to the fund.
This situation requires: