CIM Ethics & Regulatory Standards 2 — Questions and Answers
Question 1: Under the Investment Advisers Act of 1940, which duty requires an adviser to place client interests ahead of its own at all times?
- Suitability obligation
- Fiduciary duty of loyalty (Correct answer)
- Know-your-customer rule
- Best-efforts underwriting duty
Correct answer: Fiduciary duty of loyalty
The SEC interprets the Advisers Act as imposing a fiduciary duty of care and loyalty, requiring advisers to put client interests first.
Question 2: A portfolio manager receives material nonpublic information about a pending merger from a friend at the target firm. What should the manager do?
- Trade only in personal accounts, not client accounts
- Trade after confirming the information with a second source
- Refrain from trading and communicate the issue to compliance (Correct answer)
- Trade only if the position is less than 1% of the portfolio
Correct answer: Refrain from trading and communicate the issue to compliance
Acting on material nonpublic information violates insider trading laws, so the manager must not trade and should escalate to compliance.
Question 3: Section 28(e) of the Securities Exchange Act provides a safe harbor for which practice?
- Paying higher commissions for eligible research and brokerage services (Correct answer)
- Allocating IPO shares to favored clients
- Cross-trading between client accounts without disclosure
- Charging performance fees to retail clients
Correct answer: Paying higher commissions for eligible research and brokerage services
Section 28(e) protects managers who pay more than the lowest commission in good faith for eligible research and brokerage services.
Question 4: Which SEC form must a registered investment adviser deliver to clients describing its services, fees, and conflicts of interest?
- Form 10-K
- Form ADV Part 2A brochure (Correct answer)
- Form U4
- Form 13F
Correct answer: Form ADV Part 2A brochure
Form ADV Part 2A is the plain-English brochure disclosing an adviser's business practices, fees, and conflicts.
Question 5: When a hot IPO is oversubscribed, how should a manager allocate shares among eligible client accounts to satisfy fair dealing?
- Give all shares to the largest account
- Allocate to accounts with the best past performance
- Allocate pro rata according to a predetermined policy (Correct answer)
- Allocate first to the manager's family accounts
Correct answer: Allocate pro rata according to a predetermined policy
Fair dealing requires a consistent, documented allocation method such as pro rata distribution among eligible accounts.
Question 6: Regulation Best Interest (Reg BI) primarily applies to which type of firm?
- Registered investment advisers giving ongoing advice
- Broker-dealers making recommendations to retail customers (Correct answer)
- Banks offering deposit accounts
- Public companies issuing securities
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 recommendations.
Question 7: Under the SEC Custody Rule (Rule 206(4)-2), an adviser with custody of client assets generally must:
- Hold all client securities in its own name
- Use a qualified custodian and undergo a surprise examination (Correct answer)
- Obtain FINRA approval for every withdrawal
- Report holdings to the IRS monthly
Correct answer: Use a qualified custodian and undergo a surprise examination
The Custody Rule requires client assets to be held by a qualified custodian, typically with an annual surprise exam by an independent accountant.
CIM Ethics & Regulatory Standards 2
Under the Investment Advisers Act of 1940, which duty requires an adviser to place client interests ahead of its own at all times?