Financial Advisor Financial Advisor Ethics and Compliance 5 — Questions and Answers
Question 1: Which document must an SEC-registered investment adviser provide to new clients at or before entering into an advisory contract?
- Form ADV Part 1
- Form ADV Part 2 (the brochure) (Correct answer)
- Form U4
- Schedule 13D
Correct answer: Form ADV Part 2 (the brochure)
Form ADV Part 2 (the brochure) must be delivered to clients at or before entering into an advisory agreement, disclosing fees, conflicts, and business practices.
Question 2: A financial advisor discovers that a client's account statement contains an error that overstates the account value by $5,000. The advisor's ethical obligation is to:
- Wait to see if the client notices before taking action
- Correct the error and notify the client promptly (Correct answer)
- Only correct the error at the next annual review
- Report the error to regulators before informing the client
Correct answer: Correct the error and notify the client promptly
Advisors have an ethical obligation to promptly correct errors and disclose them to clients to maintain trust and accuracy.
Question 3: What is the primary purpose of a financial adviser's 'Know Your Customer' (KYC) obligations?
- To comply with tax reporting requirements
- To understand the client's financial situation, risk tolerance, and objectives for suitable recommendations (Correct answer)
- To verify the client's identity for anti-money laundering purposes only
- To assess the adviser's potential liability exposure
Correct answer: To understand the client's financial situation, risk tolerance, and objectives for suitable recommendations
KYC requirements exist to ensure advisers understand their clients well enough to make suitable recommendations aligned with their financial goals and risk tolerance.
Question 4: An advisor recommends a variable annuity to a client in their early 30s with long-term growth goals. The annuity has high surrender charges. This recommendation may raise concerns about:
- Insider trading
- Suitability and adequacy of disclosure regarding fees and restrictions (Correct answer)
- Anti-money laundering compliance
- Unauthorized trading
Correct answer: Suitability and adequacy of disclosure regarding fees and restrictions
High-cost products with significant surrender charges must be recommended only when they align with the client's needs, with full disclosure of all fees and restrictions.
Question 5: Which of the following is an example of a prohibited practice under FINRA rules regarding communications with the public?
- Providing balanced descriptions of investment risks and returns
- Using hypothetical performance projections as if they were actual past results (Correct answer)
- Disclosing all fees and charges associated with a product
- Including a statement that past performance does not guarantee future results
Correct answer: Using hypothetical performance projections as if they were actual past results
Presenting hypothetical performance as actual historical results is misleading and prohibited under FINRA rules governing communications.
Question 6: A client instructs their advisor to invest only in socially responsible investments. The advisor believes a non-ESG stock will significantly outperform. The advisor should:
- Override the client's instructions and buy the higher-performing stock
- Follow the client's instructions and only invest in socially responsible investments (Correct answer)
- Split the allocation between ESG and non-ESG without telling the client
- Refuse to manage the account if they disagree with the client's preferences
Correct answer: Follow the client's instructions and only invest in socially responsible investments
Advisors must respect client-specified investment restrictions and constraints, as client autonomy is a fundamental principle of the advisory relationship.
Question 7: Under anti-money laundering (AML) rules, a financial adviser who suspects a client is structuring transactions to avoid currency reporting requirements should:
- Inform the client that their transactions may be flagged
- File a Suspicious Activity Report (SAR) with FinCEN without tipping off the client (Correct answer)
- Refuse to process any future transactions for that client
- Contact the client's attorney for guidance before taking any action
Correct answer: File a Suspicious Activity Report (SAR) with FinCEN without tipping off the client
Under the Bank Secrecy Act, advisers must file a SAR with FinCEN when suspicious activity is detected, and are legally prohibited from alerting the client ('tipping off').
Financial Advisor Financial Advisor Ethics and Compliance 5
Which document must an SEC-registered investment adviser provide to new clients at or before entering into an advisory contract?