NASAA Series 63 — All Questions

A small issuer registers a stock offering by qualification. The Administrator is concerned that the business plan cannot be carried out unless a substantial portion of the offering is sold. The Administrator may:

• a.Guarantee the offering from state funds so that investors are repaid in full if the issuer never reaches the minimum
• b.Prohibit the offering outright without a hearing, because the plan cannot succeed unless most of the offering is sold
• c.Require the underwriter to purchase any unsold shares at the offering price, converting the deal into a firm-commitment underwriting
• d.Require as a condition of registration that the proceeds be impounded in escrow until a specified amount is received✓

The act lets the Administrator condition an effective registration on impounding the proceeds until the issuer receives a specified minimum amount, protecting investors in an undersubscribed deal. Escrow of proceeds is a condition, not an outright prohibition, and a denial would require notice and an opportunity for hearing. No state guarantees offerings, and the Administrator cannot force an underwriter into a firm commitment.Uniform Securities Act

After a securities registration statement becomes effective in a state, the Administrator may require the person who filed it to:

• a.Repurchase shares from any dissatisfied investor within thirty days, as a standing condition of every effective registration
• b.Guarantee a minimum rate of return to purchasers
• c.Register the securities again in every other state where they are offered, as a condition of keeping the registration effective here
• d.File reports, no more often than quarterly, showing the progress of the offering and the sale of the registered securities✓

The act authorizes the Administrator to require periodic reports, but not more frequently than quarterly, to keep the record of the offering current. Repurchase obligations arise only as a remedy for a violation, not as a routine condition. No securities registration ever carries a guaranteed return, and each state's registration requirement stands on its own.Uniform Securities Act

A corporation issues short-term notes to raise working capital. For the notes to fall within the commercial paper exemption, they must generally:

• a.Mature within nine months, be rated in one of the top categories by a nationally recognized rating agency, and be issued in large denominations✓
• b.Be guaranteed by a commercial bank
• c.Be sold only to individual investors
• d.Be convertible into common stock

The commercial paper exemption is limited to high-quality, short-term paper: a maturity of nine months or less, a top-tier rating, and denominations large enough that the instruments are bought by institutions rather than small retail investors. Convertibility would give the note an equity feature and take it outside the exemption. Neither a bank guarantee nor a retail-only distribution is part of the test.Uniform Securities Act

An investor is offered shares of a bank holding company that owns a single commercial bank. Regarding state registration, these shares are:

• a.Federal covered securities in every case, because banks and their holding companies are all supervised by federal banking regulators
• b.Exempt transactions in every case, because a sale of bank-related shares is treated as an isolated non-issuer transaction under the act
• c.Not automatically exempt, because the exemption covers securities issued by a bank itself, not by a separate holding company✓
• d.Exempt securities, because the act extends the bank exemption to a holding company whose only business is owning and controlling a single commercial bank

The exemption is drafted around securities issued or guaranteed by a bank, savings institution, or trust company; a holding company is a separate corporate issuer and does not inherit its subsidiary's status. Such shares may still qualify as federal covered securities if they are listed on a national exchange, but that depends on listing, not on the banking business. Nothing about the sale makes it an exempt transaction by default.Uniform Securities Act

Organizers of a proposed corporation solicit subscriptions from a handful of prospective shareholders before the company exists. For this preorganization certificate exemption to apply:

• a.A registration statement must be filed by qualification
• b.At least twenty-five subscribers are required
• c.The subscribers must each invest at least $10,000
• d.The number of subscribers must be limited, no commission may be paid for soliciting them, and no payment may be made by any subscriber✓

The preorganization certificate or subscription exemption is conditioned on a small, capped number of subscribers, the absence of any commission for soliciting them, and the fact that no subscriber actually pays money at that stage. A minimum investment is not part of the test, and requiring a large number of subscribers would contradict the exemption's private character. Because it is an exemption, no registration statement is filed.Uniform Securities Act

An agent handles a conservative retiree's account and generates 60 round-trip trades in six months, producing commissions that consume a large share of the account's value. This practice is best described as:

• a.Churning, which is excessive trading in light of the customer's resources, objectives, and account character✓
• b.A permissible active-management style, because the retiree received confirmations of every trade and never objected
• c.Selling away, because the agent handled the retiree's account outside the supervision and approval of the employing firm
• d.Front-running, because the agent traded for his own account ahead of the retiree's orders to profit from the expected price move

Churning is trading that is excessive in size or frequency given the customer's financial resources, investment objectives, and the nature of the account, and it is judged by the pattern rather than by any single trade. The customer's silence is not consent and does not cure the violation. Front-running involves trading ahead of a known block order, and selling away involves transactions outside the employing firm, neither of which is described here.NASAA Model Rule

A customer tells his agent, 'Buy 500 shares of a good technology company sometime this week.' The agent selects the issuer and buys the shares two days later. The agent has:

• a.Committed no violation because the customer approved afterward
• b.Exercised discretion without prior written authorization, because choosing the security and the day requires a signed discretionary agreement✓
• c.Acted properly, because the customer authorized a technology purchase
• d.Acted properly under time and price discretion

Discretion over the security, the number of shares, or whether to buy or sell requires prior written authorization from the customer and acceptance by the firm. Time and price discretion is narrower: the customer must specify the security, the action, and the amount, and that limited authority is generally good only for the day it is given. After-the-fact approval does not retroactively authorize a discretionary trade.NASAA Model Rule

An agent learns that his firm is about to execute a very large buy order for a thinly traded stock and immediately buys shares for his own account before entering the customer's order. This is:

• a.Permissible, provided the agent discloses the personal purchase to the customer after the trade has been executed
• b.Permissible, because the agent's own order was small compared with the customer's order and could not move the price
• c.Front-running, a prohibited practice that misuses knowledge of a pending customer order✓
• d.Merely a suitability issue, because the question is whether the stock fit the customer's objectives and not the order of the trades

Front-running is the use of advance knowledge of a pending block order to trade ahead of it for the agent's own benefit, and it is prohibited regardless of the size of the personal order. Later disclosure does not cure a violation that was complete when the order was entered. The problem is misuse of customer order information and market integrity, not the suitability of the security.NASAA Model Rule

An investment adviser deposits a client's advance advisory fee into the firm's general operating account and uses it to pay office rent. This conduct is:

• a.Acceptable if the client is later refunded
• b.Permitted for any adviser with a surety bond, provided the customer is furnished the required written confirmation and the details are recorded on the books the firm must maintain
• c.Acceptable because the fee had already been earned on paper, a conclusion the NASAA model rules are commonly understood to support for a person already registered and in good standing elsewhere
• d.Commingling of client funds with firm assets, a prohibited business practice✓

Client funds and securities must be kept separate from firm assets, and mixing them exposes clients to the firm's creditors and obscures the audit trail. Prepaid fees that have not yet been earned belong to the client and must be handled under the applicable custody and prepayment rules. Neither a later refund nor a surety bond makes commingling permissible.NASAA Model Rule

A hesitant client says she will invest only if she cannot lose money. Her agent replies, 'Don't worry, if the stock drops below your purchase price I'll personally cover the difference.' The agent has:

• a.Merely made a puffing statement, because the promise was an expression of confidence and not a contract
• b.Acted properly, because the promise came from the agent personally and not from the firm, so it is not a firm guarantee
• c.Violated the prohibition on guaranteeing a customer against loss✓
• d.Acted properly if the firm's compliance department approves the arrangement in writing beforehand

Guaranteeing a customer against loss, whether by the firm or personally by the agent, is an unethical practice under the NASAA model rules because it misrepresents the risk of the investment. No firm approval can authorize the guarantee. A statement that removes the client's perception of risk is a misrepresentation of a material fact rather than harmless puffery.NASAA Model Rule

An agent proposes to share in the profits and losses of a customer's account. Under NASAA rules, this arrangement:

• a.Is permitted for an agent only with the written authorization of both the customer and the employing broker-dealer, and generally only in proportion to the agent's own capital contribution✓
• b.Is prohibited under all circumstances for every registered person
• c.Requires only the branch manager's verbal approval
• d.Is permitted whenever the customer requests it orally

Sharing in a customer account is permitted for an agent only where both the customer and the employing broker-dealer give written authorization and the sharing is proportionate to the agent's financial contribution to the account. Oral requests and verbal approvals do not satisfy the rule. Investment adviser representatives face a stricter standard, but the flat 'never for anyone' answer overstates the rule for agents.NASAA Model Rule

An agent is short of cash and asks a wealthy retail client for a $20,000 personal loan, promising repayment with interest. Under NASAA rules this is:

• a.Permitted if the agent discloses the loan at year end
• b.Permitted because the client is wealthy and the loan is documented
• c.Permitted because the loan is unrelated to securities
• d.Prohibited, because borrowing money or securities from a customer is an unethical practice unless the customer is a financial institution in the business of lending or a permitted family relationship and firm policy allows it✓

Borrowing money or securities from a customer, or lending to one, is an unethical business practice because it creates a conflict of interest and a risk of exploitation. Narrow exceptions exist where the customer is in the business of lending, such as a bank, or is an immediate family member, and only where the firm's written procedures permit the arrangement. The client's wealth, the loan's unrelated purpose, and later disclosure do not cure the violation.NASAA Model Rule

An agent arranges private investments in a real estate partnership for several clients, collects a finder's fee directly from the sponsor, and never mentions the activity to his broker-dealer. This is:

• a.Selling away, a prohibited private securities transaction effected without the knowledge and consent of the employing broker-dealer✓
• b.Permitted, because an interest in a real estate partnership is real property and not a security, so the Act does not reach the activity
• c.A suitability violation only
• d.Permitted, because the fee was paid by the sponsor rather than the clients, so the arrangement creates no conflict the firm must supervise

Effecting securities transactions away from the employing firm without providing prior written notice and obtaining the firm's approval is the prohibited practice known as selling away, and it deprives the firm of its supervisory responsibility. A limited partnership interest is a security, so the real estate label does not help. The source of the compensation is irrelevant, and the violation exists even if every investment turned out to be suitable.NASAA Model Rule

An agent tells a prospect, 'My state registration means the Administrator has reviewed my qualifications and approved the investments I recommend.' This statement is:

• a.Accurate, because registration requires an examination
• b.Prohibited, because it is unlawful to represent that registration means the Administrator has approved the registrant's qualifications or the merits of any security✓
• c.Accurate for exempt securities only
• d.Accurate if the firm is also registered

The act expressly makes it unlawful to represent that registration, or the effectiveness of a securities registration, means the Administrator has passed on the merits of a security or the qualifications of the person. Registration is a disclosure and compliance filing, not an endorsement. That is true whether or not an examination was required and regardless of the firm's status or the type of security.Uniform Securities Act

Two traders repeatedly buy and sell the same thinly traded security between themselves at rising prices to attract outside buyers. This conduct is:

• a.Permitted because both traders consented and neither of them was deceived by the other trader
• b.Permitted, provided every trade is reported to the tape, because accurate reporting removes any misleading effect on the market
• c.Legitimate market making, because the traders are providing liquidity in a thinly traded security
• d.Market manipulation through matched orders creating misleading activity, which is prohibited✓

Wash sales and matched orders create the false appearance of trading volume and price movement and are prohibited manipulative practices. Consent between the participants is irrelevant because the deception targets the investing public. Reporting the trades does not legitimize them, and genuine market making involves bona fide two-sided quotations rather than prearranged trades with no change in beneficial ownership.NASAA Broker-Dealer and Agent Dishonest or Unethical Business Practices Model Rule, §1.p(1)-(3)

Before recommending a security to a new customer, an agent must:

• a.Obtain the Administrator's prior approval of the recommendation before presenting it to the customer for consideration
• b.Guarantee that the recommendation will meet the customer's stated return objective over the holding period
• c.Make reasonable inquiry into the customer's financial situation, investment objectives, tax status, and needs, and have a reasonable basis for believing the recommendation is suitable✓
• d.Confirm only that the customer has enough cash or margin capacity to pay for the trade on the settlement date

Recommending securities without reasonable grounds to believe they suit the customer, based on information the agent has actually gathered about the customer's situation and objectives, is an unethical practice. A customer who refuses to provide information limits what the agent may reasonably recommend. Administrators do not pre-approve recommendations, and settlement ability alone says nothing about suitability.NASAA Model Rule

Which statement best distinguishes the duties of an investment adviser from those of a broker-dealer effecting transactions for a customer?

• a.Neither owes any duty beyond executing orders accurately and charging the commissions disclosed on the confirmation
• b.An adviser owes duties only to institutional clients, while a broker-dealer owes duties only to retail customers
• c.A broker-dealer is always a fiduciary to every customer, while an adviser owes only a duty of suitability
• d.An investment adviser is a fiduciary owing duties of loyalty and care, including full disclosure of material conflicts, while a broker-dealer's recommendations must at a minimum be suitable for the customer✓

The advisory relationship rests on a fiduciary standard: the adviser must place the client's interests first, disclose material conflicts such as compensation arrangements and proprietary products, and seek best execution. A broker-dealer making recommendations must have reasonable grounds to believe they are suitable and must disclose material facts about the transaction. Series 63 tests this suitability standard at the uniform-law level; separately, the federal SEC Regulation Best Interest now requires broker-dealers to act in a retail customer's best interest, a heightened federal overlay that does not displace the state suitability framework tested here. Both roles carry duties well beyond accurate order entry, fiduciary status does not depend on the client being institutional, and the roles are not reversed: an adviser is held to more than suitability, while a broker-dealer is not a fiduciary across the board.NASAA Broker-Dealer and Agent Dishonest or Unethical Business Practices Model Rule, §1.c and §1.d

A broker-dealer sells a customer bonds out of the firm's own inventory. Which disclosure obligation applies?

• a.The firm must state on the confirmation that it acted as principal for its own account, not as the customer's agent✓
• b.None, because a principal trade is simply a sale by the firm and the confirmation already shows the price the customer paid
• c.The firm must disclose only the current market price of the bonds and the amount of any accrued interest
• d.The firm must disclose that it acted as an agent for the customer, because a dealer selling from its own inventory is always paid a separate commission

A customer is entitled to know the capacity in which the firm acted, and the confirmation must say whether the firm acted as agent or as principal for its own account. Selling bonds from the firm's own inventory is a principal trade, so describing it as an agency trade, or leaving capacity out because the price is shown, is an unethical practice. Disclosing only market price and accrued interest does not meet the requirement, and no Administrator approval is required to act as principal in an ordinary customer trade.SEC Rule 10b-10(a)(2), 17 CFR 240.10b-10

A broker-dealer decides to raise its account maintenance and transfer fees substantially. Under NASAA rules, the firm:

• a.May charge any amount as long as it appears on the confirmation
• b.Must obtain each customer's written consent to every fee
• c.Must give customers notice of the change and may not charge unreasonable or undisclosed fees✓
• d.May implement the change without notice because fees are a business decision, a conclusion the NASAA model rules are commonly understood to support for a person already registered and in good standing elsewhere

Charging unreasonable and inequitable fees for services, or failing to disclose a change in the firm's fee schedule, is an unethical business practice. Customers must receive notice so they can decide whether to keep the account. Written consent for every fee is not required, and simply printing an excessive charge on a confirmation does not make it reasonable.NASAA Model Rule

A broker-dealer publishes a market letter recommending a stock in which it holds a substantial proprietary position and for which it makes a market. The letter must:

• a.Disclose the firm's position and its role as a market maker, and present projections as opinions rather than as fact✓
• b.Disclose the proprietary position but omit the market-maker role, because market making is treated as a routine function rather than a conflict of interest
• c.Present the price target as a firm projection, since the firm's own position in the stock gives it superior knowledge of the eventual outcome
• d.Be cleared by the Administrator before it is sent to customers in the state, because all written market commentary is treated as sales literature requiring pre-approval

A market letter on a stock in which the firm holds a position and makes a market must disclose both facts, because they are material conflicts of interest, and must present forecasts as opinion rather than fact. Disclosing the position but leaving out the market-making role still hides a conflict, since a market maker profits from the trading the letter may stimulate. Holding a position gives the firm no special knowledge of a price target, and presenting that target as a firm projection is a misrepresentation. Market letters are not pre-cleared by the Administrator or filed with the SEC for approval.NASAA Model Rule

Regarding advertising and sales literature used to offer securities in a state, the Administrator:

• a.May by rule require the filing of advertising and sales literature, except for federal covered securities and exempt securities and transactions✓
• b.May prohibit only advertising that mentions past performance
• c.Has no authority over advertising of any kind
• d.May require prior approval of advertising for federal covered securities

The act allows the Administrator to require that prospectuses, pamphlets, circulars, letters, and other sales literature used in the state be filed, and material that is false or misleading may be halted. That filing authority does not extend to federal covered securities, where federal law preempts, or to exempt securities and exempt transactions. Antifraud authority over misleading advertising remains in all cases.Uniform Securities Act

A customer receives a margin call and cannot meet it. The agent offers to lend the customer the money personally so the position need not be sold. This is:

• a.Permitted as long as the agent charges no interest, since an interest-free loan is a personal favor rather than a securities-related transaction with the customer
• b.Permitted if the agent lends the customer shares from his own account rather than cash, because the prohibition covers only loans of money to customers
• c.Permitted if the loan is secured by the customer's own securities held in the account, since the position then carries no risk for the agent
• d.Prohibited, because lending money to a customer creates a conflict of interest and is an unethical practice outside narrow exceptions✓

Lending money or securities to a customer, or borrowing from one, is a prohibited practice for an agent. Narrow exceptions exist, such as loans from an immediate family member or arrangements the firm's written procedures permit, but covering a margin call to avoid a forced sale is not one of them. Waiving interest does not turn the loan into a personal favor outside the securities business, the rule covers loans of securities as well as cash, and securing the loan with the customer's own holdings does not remove the conflict of interest.NASAA Model Rule, Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended April 7, 2025), Section 2.a

A customer instructs her agent to sell her entire position in a stock. The agent, believing the stock will rebound, sells only half. The agent has:

• a.Acted properly if the stock later recovers
• b.Acted within the agent's authority, because discretion over the quantity of shares to sell is covered by the time-and-price exception to written discretionary authority
• c.Committed a prohibited practice by failing to follow the customer's instructions and effectively exercising unauthorized discretion✓
• d.Committed no violation, because a customer's instruction to sell is a preference that the agent may modify when he reasonably believes it harms her

Failing to execute a customer's order as instructed is an unethical practice, and substituting the agent's own judgment for the customer's amounts to unauthorized discretion. The exception to written discretionary authority is limited to the time and price at which an order is executed, not to the quantity or whether to trade. An agent may voice a contrary opinion but cannot treat the instruction as a mere preference. A favorable market outcome does not retroactively excuse the deviation.NASAA Model Rule, Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended April 7, 2025), Sections 1.f and 1.g

An agent realizes a new account form is missing a signature, so he signs the customer's name himself, reasoning that the customer had already agreed by telephone. This conduct is:

• a.Acceptable, because the customer had already given oral consent by telephone and the agent made a note of that call in the firm's file copy
• b.Acceptable if the customer later ratifies the signature in writing, because ratification cures the missing signature on the account form
• c.Acceptable if the agent initials the signature as entered on the customer's behalf and no customer suffers any financial harm from the account opening
• d.Prohibited, because falsifying or forging records and signatures is an unethical practice regardless of intent✓

Signing a customer's name, backdating documents, or otherwise falsifying firm records is prohibited because it destroys the integrity of the books and records regulators rely on. Telephone consent does not authorize an agent to sign for the customer. Later ratification, or a note or initials beside the signature, does not undo the falsified document, and the absence of financial harm is not a defense; the violation is complete when the record is made.NASAA Model Rule, Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended April 7, 2025), closing paragraph (conduct not inclusive: forgery, nondisclosure, misstatement of material facts)

An agent urges a client to buy a mutual fund now because 'the fund pays a big distribution next week and you'll pick up extra income.' This sales tactic is:

• a.Acceptable if the fund is otherwise suitable, because the distribution adds to the client's total return
• b.Selling dividends, a prohibited practice, because the share price drops by the distribution amount and the investor gains nothing while incurring a tax liability✓
• c.Sound advice, because the client collects the distribution as income and still keeps the full value of the shares
• d.Acceptable because the distribution is publicly announced and the agent is only repeating accurate published information

Selling dividends means urging a purchase because of an imminent distribution. The share price (net asset value) drops by the amount of the distribution on the ex-date, so the investor receives back part of the money just invested, gains nothing, and owes tax on the payment. The pitch is therefore misleading. The distribution does not add to the client's total return, receiving cash sooner is not a benefit when the share value falls by the same amount, and public announcement of the distribution does not cure the misleading emphasis.NASAA Model Rule

A client intends to invest $48,000 in a mutual fund whose sales charge drops at a $50,000 breakpoint. The agent processes the order at $48,000 without mentioning the breakpoint. This is:

• a.Acceptable, because a breakpoint discount is available only when the client commits to a letter of intent or accumulates holdings across several purchases
• b.A breakpoint sale, a prohibited practice, because the agent failed to disclose that a slightly larger investment would reduce the sales charge✓
• c.Acceptable so long as the agent charged the sales charge disclosed in the prospectus, since the prospectus schedule satisfies the duty to explain discounts
• d.Acceptable because the client chose the amount

Failing to disclose an available breakpoint, or deliberately keeping an order just below one to preserve a higher sales charge, is an unethical practice. The agent must alert the client to quantity discounts, letters of intent, and rights of accumulation. Breakpoints apply to a single purchase as well as to accumulated holdings, so they are not limited to letters of intent or accumulation. Charging the rate in the prospectus schedule does not discharge the duty to point out a cheaper tier, and the fact that the client named the dollar figure does not relieve the agent of the disclosure duty.NASAA Model Rule

An agent regularly advises clients to redeem shares of one mutual fund family and buy a similar fund in another family, generating a new front-end sales charge each time. Absent a documented benefit to the client, this is:

• a.Acceptable, because every replacement fund is individually suitable for the client and the agent's compensation is disclosed in each prospectus
• b.Proper diversification across fund sponsors, because holding one family's funds concentrates the client's exposure to a single management company
• c.Acceptable because the client signs each order ticket and is shown the new sales charge on the confirmation, so every switch is client-directed
• d.Improper mutual fund switching, because inducing exchanges between fund families without reasonable grounds imposes needless sales charges✓

Recommending that a client move between fund families without reasonable grounds is an unethical practice, since the new sales charge is a real cost with no corresponding benefit when comparable objectives are available within the existing family. Suitability of each individual fund does not justify the repeated charges. Spreading money across sponsors is not a reason when the switch only generates charges, and a signed order ticket or a confirmation showing the charge documents the trade without supplying the required reasonable basis.NASAA Model Rule, Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended April 7, 2025), Sections 1.b and 1.c

A customer emails an agent complaining that a trade was never authorized. The agent should:

• a.Delete the email since the matter is disputed
• b.Promptly forward the written complaint to the firm so it can be reviewed, acted on, and preserved in the firm's records✓
• c.Wait to see whether the customer follows up, because an email is not a formal complaint and need not be sent to the firm until it is repeated
• d.Resolve it with the customer directly if the amount is small, and tell the firm only if the customer demands compensation or threatens arbitration

Written customer complaints must be routed promptly to the firm and retained, because the firm has supervisory and recordkeeping obligations and regulators may inspect complaint files. An email alleging an unauthorized trade is a written complaint whether or not it is repeated, so waiting is not permitted. Settling a complaint privately, even a small one, without the firm's knowledge is itself an unethical practice, and destroying the record compounds the original problem.NASAA Model Rule, Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended April 7, 2025), Section 1.v

A state-registered investment adviser takes custody of client securities. Under the NASAA custody rule, the adviser generally must:

• a.Notify the Administrator, hold client assets in an account in the firm's own name alongside its own funds, and send clients a statement once a year
• b.Notify the Administrator that it has custody, segregate client assets with a qualified custodian, send account statements to clients, and arrange for an independent verification of the assets✓
• c.Keep client assets with a qualified custodian, rely on annual account statements from that custodian, and obtain an independent examination every third year
• d.Skip any notice to the Administrator because custody is disclosed only to clients, and have its own compliance officer verify the assets

The NASAA custody rule requires an adviser with custody to notify the Administrator, maintain client funds and securities with a qualified custodian in segregated accounts, have a reasonable basis for believing the custodian sends account statements at least quarterly, and obtain an independent surprise examination every calendar year. Holding assets in the firm's own name defeats segregation, annual statements and an examination only every third year fall short of the quarterly and annual requirements, and an adviser with custody must notify the Administrator rather than disclose it to clients alone. Having custody does not relax the adviser's recordkeeping duties.NASAA Model Rule 102(e)(1)-1 (Custody Requirements for Investment Advisers)

An investment adviser wants to charge a fee based on a share of the capital gains in a client's account. Under NASAA rules, such a performance-based fee is:

• a.Permitted only for clients who meet defined net worth or assets-under-management standards, with the arrangement and its risks disclosed in writing✓
• b.Permitted for any client whose account exceeds the adviser's minimum, as long as the fee is capped at twenty percent of the capital gains the adviser earns for the account
• c.Permitted for any client who signs a written waiver acknowledging that the fee may encourage the adviser to take greater investment risks with the account
• d.Prohibited for every client without exception, because an adviser who shares in capital gains has an unavoidable conflict of interest with the client

Performance-based compensation is limited to clients who satisfy financial thresholds designed to identify investors able to bear the incentive risk, and the arrangement must be disclosed along with the conflicts it creates. An account-size minimum or a percentage cap does not substitute for those eligibility standards, and a client waiver cannot either, because provisions purporting to waive compliance with the act are void. The fee is not banned outright, since eligible clients may agree to it. Guaranteeing against loss is itself prohibited, so it could never be a condition of a permitted fee.NASAA Model Rule

An investment adviser directs client brokerage to a firm that provides research reports and also pays the adviser's office rent. Regarding these soft dollar arrangements, the adviser:

• a.May accept research without telling clients, because the Section 28(e) safe harbor removes any conflict of interest in choosing the broker
• b.May accept research and brokerage services that benefit clients within the recognized safe harbor and must disclose the arrangement, but paying general overhead such as rent falls outside it✓
• c.May use client commissions to pay for research and office rent alike, provided both arrangements are disclosed in its brochure
• d.May accept any product or service the broker offers, provided the commission rate is competitive with other brokers

Section 28(e) of the Exchange Act protects an adviser that pays more than the lowest commission for brokerage and research services that give it lawful and appropriate assistance in making investment decisions, and the arrangement must be disclosed because it creates a conflict in choosing the executing broker. General overhead such as rent, salaries or travel is not brokerage or research and falls outside the safe harbor, even if the rent payment is disclosed. The safe harbor does not extend to anything of value merely because commissions are competitive, and it does not remove the conflict that requires disclosure.Exchange Act §28(e) (15 U.S.C. 78bb(e))

An investment adviser proposes to act as broker for a client on one side of a trade while representing the counterparty on the other. This agency cross transaction:

• a.Is allowed once the adviser tells each client orally about its dual role, and no written consent, confirmation or annual statement is needed so long as the commissions are reasonable
• b.Requires only that the commissions the adviser collects from both clients be reasonable and shown on the trade confirmation
• c.Requires disclosure of the adviser's role and the conflicts involved, and the client's consent, with the adviser never having recommended the trade to both parties✓
• d.Is allowed only when the adviser has recommended the trade to both clients, because each side then relies on the same advice

Advisers Act Rule 206(3)-2 allows an agency cross transaction only if the client has given written consent after written disclosure of the adviser's role and conflicts, the client receives a confirmation and periodic statements, and the adviser has not recommended the transaction to both the buyer and the seller. Oral disclosure does not meet the rule and neither does a showing that commissions were reasonable. A trade that the adviser recommended to both sides is exactly what the rule rules out. The Administrator does not approve individual trades, and the practice is not banned outright.Advisers Act Rule 206(3)-2 (17 CFR 275.206(3)-2)

An investment adviser pays an accountant a fee for every client the accountant refers. Under NASAA rules, this arrangement requires that:

• a.Nothing be disclosed, because the client pays no additional fee, assuming the applicant has satisfied the net worth, surety bonding, and qualification-examination conditions the Administrator may impose
• b.The arrangement be in writing and disclosed to the client in writing, so the client knows the referral was compensated✓
• c.The solicitor register as an investment adviser in every state, a conclusion the NASAA model rules are commonly understood to support for a person already registered and in good standing elsewhere
• d.The referral fee be capped at five percent of the first year's advisory fee, on the view that the relevant exemption stays available to the party unless and until the Administrator revokes it by a formal order

Compensated solicitation arrangements must be documented in a written agreement and disclosed to the prospective client in writing so the client can weigh the referral's independence. Whether the client pays more is beside the point; the conflict itself is the material fact. The rules impose disclosure and documentation requirements rather than a universal percentage cap, and a solicitor is not automatically an investment adviser in every state.NASAA Model Rule

An agent's friend asks about the holdings and balance in a mutual acquaintance's brokerage account. The agent should:

• a.Decline, because customer account information is confidential and may be released only with the customer's consent or under proper legal authority✓
• b.Share the types of securities held but not the dollar amounts, because only account values are protected
• c.Share the information if the friend is also a customer of the firm and gives a written promise to keep it private
• d.Share it once the friend explains that both of them know the customer, since a common acquaintance counts as implied consent and no further authority is needed

Customer account information is confidential, and under the Gramm-Leach-Bliley Act a financial institution may disclose it to a nonaffiliated third party only with the customer's consent or under a recognized exception such as legal process. A friend asking about a mutual acquaintance's holdings fits no exception. Describing the types of securities held discloses protected information even without dollar amounts, being a client of the same firm gives no right to another customer's data, and a shared acquaintance is not customer consent.15 U.S.C. 6802 (Gramm-Leach-Bliley Act privacy provisions)

A client loses money on a trade the agent recommended. To keep the client from complaining, the agent quietly writes a personal check covering the loss and tells no one at the firm. The agent has:

• a.Acted properly because no securities were involved in the payment
• b.Acted properly because the client suffered no net loss
• c.Committed a prohibited practice by settling a complaint without the firm's knowledge and effectively guaranteeing the customer against loss✓
• d.Resolved the matter appropriately at his own expense

Reimbursing a customer for losses out of personal funds both conceals a potential complaint from the firm's supervisory system and operates as a guarantee against loss, each of which is an unethical practice. The firm must be able to review the underlying recommendation and record the complaint. Making the client whole financially does not cure the concealment.NASAA Model Rule

In investigating a suspected violation, the Administrator may:

• a.Conduct investigations inside or outside the state, administer oaths, subpoena witnesses and records, and require written statements under oath✓
• b.Require testimony and written statements, but never compel the production of books, papers, or correspondence without first obtaining a court order
• c.Compel testimony only after a criminal indictment has been returned or an information has been filed against the person who is under investigation
• d.Act only within the borders of his or her own state, relying on the administrators of other states for any evidence located outside the state's boundaries

The act grants broad investigative authority: the Administrator may investigate in or outside the state, publish information about violations, administer oaths, compel attendance of witnesses, and require the production of books, papers, and other records on his or her own subpoena. A court is involved only if a person refuses to comply, when the Administrator asks the court to compel obedience through its contempt power. The powers do not depend on a criminal charge and are not confined to the state's borders.Uniform Securities Act (1956) Section 407

Which statement about a cease and desist order is correct?

• a.It may be issued only after a full hearing on the merits, provided the firm files the required consent to service of process and the Administrator does not enter an order to the contrary
• b.The Administrator may issue it with or without a prior hearing, but must go to court to obtain an injunction enforcing it✓
• c.It may be issued only against registered persons
• d.It automatically revokes the recipient's registration, since the Administrator generally treats this as a routine matter resolved through the state's ordinary coordination procedures

The Administrator may issue a cease and desist order with or without a prior hearing to stop conduct that violates the act, subject to the recipient's right to request a hearing. The Administrator cannot enforce the order directly; obtaining an injunction or other coercive relief requires applying to a court. Revocation is a separate proceeding, and the antifraud reach of the act extends to unregistered persons as well.Uniform Securities Act

Before denying, suspending, or revoking a registration, the Administrator must generally find that:

• a.The registrant has been convicted of a felony
• b.The registrant has caused a customer to lose money
• c.A majority of the registrant's customers have complained
• d.The order is in the public interest and a statutory ground exists, after appropriate notice, an opportunity for hearing, and written findings of fact and conclusions of law✓

Disciplinary orders require both a public interest finding and one of the enumerated statutory grounds, such as a material misstatement in an application, a securities-related conviction, an injunction, or a violation of the act. Procedural protections include prior notice, an opportunity for a hearing, and written findings. Customer losses and complaint counts may be evidence but are not themselves the legal standard.Uniform Securities Act

The Administrator believes immediate action is needed against a registrant while a proceeding is pending. The Administrator may:

• a.Do nothing until a final order is entered
• b.Have the registrant arrested pending the outcome
• c.Summarily postpone or suspend the registration pending final determination, provided prompt written notice is given and a hearing is promptly scheduled if requested✓
• d.Order the registrant to pay restitution without any hearing

The act permits a summary postponement or suspension of a registration while a proceeding is pending, balanced by the requirement of prompt written notice of the order and the reasons for it, plus a hearing within a short period if the affected person requests one. Waiting helplessly for a final order would defeat the purpose of the emergency power. Arrests and criminal sanctions are for courts, not the Administrator.Uniform Securities Act

Under the Uniform Securities Act as commonly adopted, a person convicted of a willful violation of the act faces criminal penalties of:

• a.Imprisonment only, with no fine, because the act leaves monetary penalties to the civil courts and to private plaintiffs who were injured
• b.A fine imposed directly by the Administrator through an administrative order, with no prosecution in court and no right to a jury trial
• c.A fine, imprisonment, or both, with prosecution generally required to begin within five years of the alleged violation✓
• d.Civil liability only, because willful violations are punished by rescission and damages in private suits rather than by criminal penalties

Willful violations are criminal offenses punishable by a fine, imprisonment, or both, and the model act sets a five-year limit from the alleged violation for beginning a prosecution (an optional bracketed provision). Criminal cases are brought in court by the appropriate prosecuting authority, not decided by the Administrator through an administrative fine. The act does not confine remedies to civil liability, and it does not make imprisonment the only sanction. Proof of willfulness means proof that the person intended the act, though not that the person knew it was unlawful.Uniform Securities Act (1956) Section 409(a)

An investor buys a security in a sale that violated the registration provisions of the act. In a civil suit, the investor may generally recover:

• a.The consideration paid plus interest, less any income received on the security, together with costs and reasonable attorney's fees, upon tender of the security✓
• b.Only the difference between the purchase price and the current market price
• c.Triple the amount invested as punitive damages
• d.Nothing, because civil remedies are unavailable under the act

The civil liability provision makes the buyer whole by returning the purchase price plus interest, reduced by income already received, along with court costs and reasonable attorney's fees, in exchange for tendering the security back. If the investor no longer owns it, damages are calculated in a comparable way. The act's remedy is restitutionary rather than a punitive multiple of the investment.Uniform Securities Act

A broker-dealer discovers it sold securities in violation of the act and sends the purchaser a written offer of rescission. Which statement is correct?

• a.The offer must be accompanied by a cash payment before the buyer responds
• b.The purchaser may accept at any time within three years
• c.The purchaser generally loses the right to sue if the written offer, containing the required disclosures and the offer of the price paid plus interest, is not accepted within the period specified by the act✓
• d.The Administrator must approve the offer in advance

A proper rescission offer must be in writing, disclose the violation, and offer to repay the consideration plus interest less income received; a purchaser who does not accept within the statutory response period loses the right to bring the civil action. This gives a firm that self-corrects a way to cut off liability. The offer itself does not require prepayment or prior approval by the Administrator, and it is not open indefinitely.Uniform Securities Act

A registrant disagrees with a final order entered by the Administrator. The registrant may:

• a.Demand a jury trial before the Administrator
• b.Obtain judicial review by filing a petition in the appropriate court within sixty days of the order, though filing generally does not stay the order✓
• c.Appeal directly to the SEC
• d.Ignore the order until the Administrator brings an enforcement action

Final orders are subject to judicial review on a written petition filed within sixty days, and the reviewing court examines the administrative record. Filing the petition does not by itself suspend the order unless the court so directs, so the registrant must comply in the meantime. State administrative orders are not appealed to the SEC, and administrative hearings are conducted without juries.Uniform Securities Act

An Administrator has jurisdiction over an offer or sale when:

• a.The offer originated in the state, or was directed into and received in the state, or the acceptance of the offer took place in the state✓
• b.Only when the security is traded on an exchange located in the state
• c.Only when both the buyer and the seller reside in the state at the time of the transaction and the sale is completed there by delivery of the security to the buyer
• d.Only when the security is registered in the state, because the Administrator has no authority over offers of securities that are not registered there

Jurisdiction attaches where an offer originates, where it is directed and received, and where an offer to buy or sell is accepted, which is why a single transaction can fall under two states' laws. Residency of both parties is not required and the place of exchange trading is irrelevant. The antifraud provisions reach offers even where no sale occurs, and the Administrator's authority does not depend on the security being registered in the state.Uniform Securities Act (1956) Section 414

Regarding records of registered broker-dealers and investment advisers, the Administrator:

• a.May inspect records only after obtaining a search warrant
• b.May by rule require registrants to make and keep specified records and may examine those records within or outside the state, at any reasonable time and as often as necessary✓
• c.May inspect records only during an annual audit announced in advance
• d.May require records but may never inspect them outside the state

The act authorizes the Administrator to prescribe recordkeeping requirements and to conduct reasonably frequent examinations of registrants' records, whether the records are located in the state or elsewhere. Examinations may be announced or unannounced and do not require a warrant, because registration carries consent to inspection. Registrants must also ensure records are preserved for the periods set by rule.Uniform Securities Act

Which statement about the Administrator's rulemaking authority is correct?

• a.Rules take effect only after the SEC approves them and the state legislature ratifies each one, since state rulemaking cannot operate on its own independent legal authority
• b.The Administrator may adopt rules but may not prescribe forms, because the content of every registration form is fixed by the act itself
• c.Rules may be adopted without public notice and enforced at once, because the act requires publication only of the Administrator's orders and not of rules or forms
• d.The Administrator may make, amend, and rescind rules, forms, and orders necessary to carry out the act, and rules must be published before they can be enforced✓

The act gives the Administrator broad authority to adopt, amend, and rescind rules and forms and to issue orders as necessary to administer the statute, and it requires that all rules and forms be published so that regulated persons have notice. Publication is required for rules and forms, not just orders. Forms are within the Administrator's rulemaking power, and state rules are not submitted to the SEC or the legislature for approval, though they cannot conflict with preemptive federal law.Uniform Securities Act (1956) Section 412

Which of the following may the Administrator NOT do?

• a.Issue an injunction or sentence a violator to prison✓
• b.Subpoena records located in another state
• c.Deny an application for registration after notice and an opportunity for hearing
• d.Issue a cease and desist order

Injunctions and criminal sentences are judicial remedies: the Administrator must ask a court for an injunction and must refer evidence to a prosecutor for criminal charges. Administrative powers include denying, suspending, and revoking registrations after notice and an opportunity for hearing, issuing cease and desist orders, and compelling the production of records wherever they are kept. Keeping the administrative and judicial roles straight is a heavily tested distinction.Uniform Securities Act

A non-resident broker-dealer is sued under a state's securities act. Because the firm filed a consent to service of process, legal papers may be:

• a.Served on the Administrator with the same effect as personal service on the firm, with notice forwarded to the firm✓
• b.Served only at the firm's out-of-state headquarters, because a state's securities act cannot reach a broker-dealer that has no office in the state
• c.Served only if the firm still has an office or a registered agent in the state when the suit is filed, because the consent ends once the firm withdraws
• d.Treated as effective only after the firm acknowledges receipt, because a consent to service gives the Administrator no power to accept papers for the firm

The consent to service of process appoints the Administrator as the registrant's attorney to receive service of process in any noncriminal action arising under the act, and service on the Administrator carries the same force as personal service. The Administrator then forwards a copy to the last known address. The consent is irrevocable and survives the firm's departure from the state, and service does not depend on the firm acknowledging it, having a local office, or agreeing to appear.Uniform Securities Act (1956) Section 414

After an investigation, the Administrator concludes that a person has willfully violated the act and that criminal charges are appropriate. The Administrator may:

• a.File criminal charges directly in court in the Administrator's own name, without involving the attorney general or a district attorney
• b.Do nothing further, because criminal enforcement of securities violations belongs exclusively to the SEC and the U.S. Department of Justice
• c.Refer the evidence to the attorney general or the appropriate prosecuting attorney, who may institute criminal proceedings✓
• d.Impose a prison sentence directly

The Administrator may refer the evidence gathered in an investigation to the attorney general or the proper district or prosecuting attorney, who has discretion to bring criminal proceedings in court. The Administrator has no power to prosecute in his or her own name, to sentence anyone, or to convene a grand jury. State securities acts create state criminal offenses, so the matter is not exclusively federal.Uniform Securities Act (1956) Section 409(b)

An applicant for agent registration has passed the required examination and has no disciplinary history, but the Administrator considers her inexperienced. Under the Uniform Securities Act, the Administrator:

• a.May consider training, experience, and knowledge of the securities business, but may not deny a registration solely on the ground that the applicant lacks experience✓
• b.Must deny the application because experience is a statutory prerequisite
• c.May grant the registration only on the condition that the applicant waive the right to a hearing
• d.May deny the application solely because of the applicant's lack of experience

The act allows the Administrator to weigh an applicant's training, experience, and knowledge of the securities business as part of the qualification determination, but it expressly forbids denying a registration to an individual solely for lack of experience. Experience is therefore a factor rather than a prerequisite. Any provision purporting to waive compliance with the act, including hearing rights, is void.Uniform Securities Act