IAR Laws, Regulations & Guidelines 4 — Questions and Answers
Question 1: Under state securities law, which of the following is an example of a 'fraudulent, deceptive, or manipulative' practice by an IAR?
- Recommending a diversified portfolio to a risk-averse client
- Charging a reduced fee for a long-standing client relationship
- Borrowing money from a client without prior written consent from the firm (Correct answer)
- Declining to accept a client whose investment objectives do not match the adviser's specialty
Correct answer: Borrowing money from a client without prior written consent from the firm
Borrowing money from clients without proper firm consent is explicitly prohibited as a fraudulent practice under NASAA Model Rules.
Question 2: The Investment Advisers Act of 1940 requires investment advisers to make which of the following disclosures when acting as a principal in a transaction with an advisory client?
- Written disclosure and client consent before completion of the transaction (Correct answer)
- Oral disclosure before the order is placed
- Disclosure in the next quarterly statement
- Annual disclosure in the Form ADV brochure
Correct answer: Written disclosure and client consent before completion of the transaction
Section 206(3) requires written disclosure of the adviser's capacity as principal and written client consent before the transaction is completed.
Question 3: Which of the following investment advisers is eligible for SEC registration under an exemption despite having less than $100M in AUM?
- An adviser that serves only state pension funds
- An adviser that provides advice only on government securities
- An adviser to a registered investment company (Correct answer)
- An adviser that has offices in fewer than 5 states
Correct answer: An adviser to a registered investment company
Advisers to registered investment companies (mutual funds) are eligible for SEC registration regardless of AUM because they are required to register with the SEC.
Question 4: An IAR sends a mass email to clients containing a testimonial that praises the IAR's past stock picks. Under current SEC rules, this is:
- Prohibited under any circumstances as per the original 1961 testimonial ban
- Permitted if accompanied by required disclosures about the nature of the testimonial (Correct answer)
- Permitted only if the client was compensated for the testimonial
- Prohibited because email is not a permissible advertising medium
Correct answer: Permitted if accompanied by required disclosures about the nature of the testimonial
The SEC's 2021 Marketing Rule permits testimonials in advertising if accompanied by clear and prominent disclosures about any compensation and the limitations of the testimonial.
Question 5: Under the Uniform Securities Act, which of the following would qualify as an 'investment adviser' subject to registration?
- A bank providing incidental investment advice as part of banking services
- A certified financial planner who charges fees for comprehensive financial plans including securities recommendations (Correct answer)
- An attorney providing incidental investment advice in the course of legal representation
- A broker-dealer whose advisory services are solely incidental to its brokerage business
Correct answer: A certified financial planner who charges fees for comprehensive financial plans including securities recommendations
A CFP charging fees for financial plans that include securities advice meets the three-pronged test: providing advice on securities, as a business, for compensation.
Question 6: NASAA's Model Rule on unethical business practices prohibits an IAR from doing which of the following?
- Recommending a speculative security to an aggressive-growth investor
- Entering into a performance fee arrangement with a qualified client
- Guaranteeing a client against investment losses (Correct answer)
- Charging different fee rates for accounts of different sizes
Correct answer: Guaranteeing a client against investment losses
Guaranteeing clients against investment losses is an expressly prohibited unethical practice under NASAA Model Rules, as it creates false expectations.
Question 7: An investment adviser discovers that its chief compliance officer (CCO) has been filing inaccurate Form ADV amendments. Under SEC rules, the adviser's primary obligation is to:
- Terminate the CCO immediately and notify clients
- Correct and refile accurate amendments promptly and implement supervisory controls (Correct answer)
- Wait until the next annual amendment to correct the inaccuracies
- Self-report only if the inaccuracies involved performance data
Correct answer: Correct and refile accurate amendments promptly and implement supervisory controls
An adviser must promptly file corrected Form ADV amendments to ensure clients and regulators have accurate information, and must strengthen supervisory procedures to prevent recurrence.
IAR Laws, Regulations & Guidelines 4
Under state securities law, which of the following is an example of a 'fraudulent, deceptive, or manipulative' practice by an IAR?