NASAA Series 63 — All Questions

An agent receives a written customer complaint and personally negotiates a settlement, never telling the firm. This is:

• a.A prohibited practice, because complaints must be reported to the firm, which has supervisory and recordkeeping duties✓
• b.Acceptable if the agent pays from his own funds, since the customer is made whole and no firm money is spent
• c.Acceptable if the amount is small enough that the firm would not have had to report the complaint anyway
• d.Acceptable if the customer signs a release and the agent keeps a copy of it for his own records

A written complaint must go to the firm so that it can be recorded, supervised and retained. Settling it privately, even with the agent's own money, conceals it from the firm's supervisory system, and a small amount or a signed release does not change the duty to report the complaint.

A broker-dealer buys bonds from a customer as principal and applies a markdown far larger than justified by market conditions and services. This is:

• a.A prohibited practice, because unreasonable markdowns are as improper as unreasonable markups✓
• b.Permitted because principals set their own prices
• c.Permitted for unlisted bonds
• d.Permitted if the markdown appears on the confirmation

Charging an unreasonable markdown when buying from a customer as principal is an unethical practice, judged against the prevailing market and the services rendered (NASAA unethical practices – fair prices).

A broker-dealer recommends and sells a security issued by the firm's own parent company without disclosing the affiliation. This nondisclosure is:

• a.Governed only by the adviser conflict rules, not by the broker-dealer rules
• b.Acceptable if the affiliation is disclosed only after the sale settles
• c.Cured by disclosure in the firm's Form BD on file with the Administrator
• d.A prohibited failure to disclose a material control or affiliate relationship✓

A broker-dealer must disclose that it is controlled by, controlling, affiliated with or under common control with the issuer before entering into the contract with the customer, and written disclosure must be given at or before completion of the transaction. A fair price, disclosure only after settlement, a regulatory filing or adviser-specific rules do not excuse the nondisclosure.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (1.t)

When a broker-dealer publishes a research report recommending a stock in which it makes a market, it must disclose:

• a.Only the security's current price
• b.That it makes a market in the security, a material conflict of interest✓
• c.The names of its customers who hold the stock
• d.Nothing, to avoid influencing readers

A firm publishing research on a security it makes a market in or holds a position in must disclose that conflict; concealing it is a prohibited practice (NASAA unethical practices – conflicts disclosure).

A broker-dealer receives a valid court subpoena for a customer's account records. The firm:

• a.Must first obtain the customer's written consent, because a subpoena cannot override a customer's privacy rights
• b.May release the records only to the customer's own attorney, since confidentiality admits no exception for third parties
• c.May release the records in response to the lawful subpoena, a recognized exception to the confidentiality rule✓
• d.Must give the customer an opt-out period first, and may release the records only if no objection is made

Under the Gramm-Leach-Bliley Act, the privacy restrictions do not stop a financial institution from disclosing customer information to comply with a properly authorized subpoena or summons, 15 U.S.C. 6802(e)(8). The firm does not need the customer's consent first, and it does not have to hold off for an opt-out period, because the exception exists precisely so legal process can be answered. The duty of confidentiality is not absolute, since records may go to a party with legal authority, but a subpoena opens the door for that party only, not for anyone who asks.15 U.S.C. 6802(e)(8) (Gramm-Leach-Bliley Act)

A customer delivers a stock certificate to an agent to sell. The agent must:

• a.Sell it through his own personal account
• b.Store it in his personal safe-deposit box indefinitely
• c.Keep it in his desk until the price improves
• d.Promptly forward the certificate to the firm for handling, not hold or divert it✓

Agents must promptly transmit customer funds and securities to the firm or proper party; holding or diverting them is prohibited (NASAA unethical practices – prompt transmittal).

A mutual fund wholesaler gives an agent expensive sporting-event tickets as a reward for sales. Under prohibited-practice principles, the concern is that:

• a.Undisclosed sales incentives create a conflict of interest that can bias recommendations✓
• b.There is no concern because the customer pays nothing extra
• c.Only cash gifts raise any concern
• d.Gifts are always illegal regardless of value or disclosure

Sales-contest prizes and gifts tied to selling a product create conflicts that may bias recommendations; such compensation must be disclosed and is subject to gift limits and firm supervision (NASAA unethical practices; SRO gift rules).

An agent conducts securities business with customers through a personal messaging app the firm cannot monitor or archive. This is:

• a.A concern only for investment advisers
• b.Acceptable if he screenshots the messages
• c.A violation, because business communications must occur through the firm's supervised, retained channels✓
• d.Acceptable because messaging is informal

Securities communications must run through channels the firm can supervise and retain; using an unmonitored app defeats supervision and recordkeeping (NASAA; recordkeeping rules).

A broker-dealer must send a customer a written confirmation of a securities transaction:

• a.Only for purchases, never for sales
• b.Only if the customer requests it
• c.At or before completion (settlement) of the transaction, disclosing required trade details and the firm's capacity✓
• d.Once a year in a summary statement

Firms must send trade confirmations at or before completion of the transaction, disclosing details such as price, quantity, capacity (agent or principal), and compensation; failure is a recordkeeping and disclosure violation (NASAA; SEC Rule 10b-10).

To reassure a nervous client, a firm promises in writing to repurchase a bond at the client's original cost anytime in the next year. This is:

• a.Permitted because the firm, not the agent, made the promise
• b.Permitted for investment-grade bonds
• c.Permitted because it is in writing
• d.A prohibited guarantee against loss✓

Guaranteeing a customer against loss—including a promise to repurchase at cost—misrepresents investment risk and is prohibited whether made by the agent or the firm (NASAA unethical practices; USA §101).

An agent urges a client to buy a mutual fund in a taxable account right before its year-end capital-gains distribution 'to capture the payout.' This is:

• a.Selling dividends, a prohibited practice, because the price drops by the distribution and the client incurs an immediate tax liability with no economic gain✓
• b.Sound advice, because the client receives cash sooner
• c.Acceptable as long as the fund is suitable
• d.Acceptable because the distribution is publicly announced

Enticing a purchase just before a distribution ('selling dividends') is prohibited: the share price falls by the distribution amount and the investor merely converts principal into a taxable payment (NASAA unethical practices – selling dividends).

A client's mutual fund purchase would reach a reduced sales-charge breakpoint if a letter of intent were used, but the agent never mentions it. This omission is:

• a.Acceptable if the client did not ask about discounts, since the agent has no duty to raise them unprompted
• b.A prohibited breakpoint-related practice, because the agent must disclose letters of intent and rights of accumulation that reduce sales charges✓
• c.A concern only for purchases of $1 million or more, because that is the only breakpoint FINRA Rule 2342 covers
• d.Acceptable if the sales charge is shown in the prospectus the client receives, since delivery of the prospectus satisfies every breakpoint duty the agent owes

Breakpoint discounts, such as those available through a letter of intent or rights of accumulation, reduce the sales charge on mutual fund purchases, and FINRA Rule 2342 prohibits breakpoint sales in which the agent steers a client past a discount. Failing to mention an available discount is therefore a prohibited practice. It does not matter whether the client asked about discounts, because the burden is on the agent. The practice is not limited to purchases above $1 million, a letter of intent being optional for the client does not excuse the agent from mentioning it, and delivering the prospectus does not discharge the duty.FINRA Rule 2342; FINRA Rule 2341(d)

An agent repeatedly recommends replacing one variable annuity with another, generating new sales and surrender charges without a documented client benefit. This is:

• a.An improper switching or replacement practice, because inducing exchanges without reasonable grounds imposes needless charges✓
• b.Proper diversification, because annuities from different insurers spread the customer's credit risk across companies
• c.Acceptable because each replacement contract is suitable on its own, apart from the cost of leaving the old one
• d.Acceptable if the client signs each form and receives the new contract's prospectus

Recommending the purchase, sale or exchange of a security without reasonable grounds to believe it is suitable, or inducing exchanges that generate new sales and surrender charges without a documented benefit, is an unethical practice. A replacement must be judged with the costs of leaving the old contract, and a signature or a prospectus does not show a reasonable basis.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (1.c)

An agent recommends that a conservative client open a margin account to buy more stock but does not explain that losses and required deposits can exceed the original investment. This is:

• a.Acceptable, because a signed margin agreement already serves as the required risk disclosure
• b.Acceptable if the client is an experienced investor who has used margin before
• c.A prohibited failure to disclose the material risks of margin✓
• d.A concern only if the client later receives a margin call and actually loses money

Recommending margin to a conservative client without explaining that losses and required deposits can exceed the original investment omits a material risk, which is a prohibited practice and a suitability failure. FINRA Rule 2264's margin disclosure statement warns that you can lose more funds than you deposit, but a signed margin agreement does not replace the agent's own explanation when the agent is the one recommending margin. Prior experience with margin does not remove the duty to describe the risk to this client. The violation lies in the omission at the time of the recommendation, not in whether a loss or margin call happens later.FINRA Rule 2264 (Margin Disclosure Statement)

A broker-dealer's advertisement highlights only its most successful past stock picks and omits comparable picks that lost money. The advertisement is:

• a.Acceptable because past performance is factual
• b.Acceptable because the winning picks are real
• c.Acceptable if a disclaimer appears somewhere
• d.Misleading, because selectively presenting only favorable past recommendations is deceptive✓

Cherry-picking only profitable past recommendations while omitting losers creates a misleading impression of skill and is a prohibited deceptive practice (NASAA unethical practices; USA §101).

Which advertising practice by a state-registered investment adviser is prohibited?

• a.Stating the adviser's fee schedule
• b.Presenting a chart or formula as able, by itself, to determine which securities to buy or sell without disclosing its limitations✓
• c.Disclosing that advisory services involve risk
• d.Describing the adviser's investment philosophy

Advertising that a graph, chart, or formula can by itself determine what or when to buy or sell, without disclosing its limitations, is a prohibited advertising practice for advisers (NASAA model advertising rule; Advisers Act Rule 206(4)-1 tradition).

An adviser recommends a proprietary product from which it earns extra compensation. To satisfy its fiduciary duty, the adviser must:

• a.Say nothing, because the product is suitable
• b.Disclose the conflict of interest, including the additional compensation, so the client can evaluate the recommendation✓
• c.Avoid all proprietary products entirely
• d.Obtain the Administrator's approval first

An adviser's fiduciary duty of loyalty requires full and fair disclosure of material conflicts, including extra compensation from proprietary products, so the client can give informed consent (Advisers Act §206; NASAA).

A state-registered adviser deposits client funds it holds into the firm's general operating account for convenience. This is:

• a.Prohibited commingling of client assets with firm assets✓
• b.Acceptable if the balance is tracked on a spreadsheet
• c.Acceptable because the adviser is bonded
• d.Acceptable if the funds are refunded later

Client funds must be segregated from firm assets with a qualified custodian; depositing them into the firm's operating account is prohibited commingling and triggers custody violations (NASAA custody rule; unethical practices).

A state-registered investment adviser advertises that its registration means it is 'recommended by' and 'approved by' the state securities regulator. This is:

• a.Acceptable for firms with a clean disciplinary record
• b.Acceptable if placed only in the brochure
• c.Acceptable because the firm is in fact registered
• d.Prohibited, because it misrepresents the meaning of registration✓

Implying that registration is an approval, recommendation, or endorsement by the Administrator is prohibited; registration is not a seal of approval (USA §404; NASAA advertising rule).

An investment adviser borrows money from an advisory client who is not a lending institution or a family member. This is:

• a.Permitted for clients with large accounts
• b.Permitted as long as interest is paid
• c.Permitted if disclosed after the fact
• d.Prohibited, because borrowing from a client outside narrow exceptions breaches the adviser's fiduciary duty✓

An adviser generally may not borrow from a client unless the client is a broker-dealer, an affiliate, or a financial institution in the lending business; borrowing from an ordinary advisory client is a prohibited conflict (NASAA unethical practices for advisers).

A state-registered adviser wants to increase advisory fees for existing clients. It must:

• a.Amend Form ADV and wait to tell existing clients until the annual summary of material changes, with no client consent needed for the new fee
• b.Apply the increase at the next billing date, because the adviser's Form ADV fee schedule already lets it change fees at will without notice
• c.Disclose the change and generally obtain the clients' agreement, because the fee is a material term of the advisory contract✓
• d.Raise the fee only for new clients, because existing clients' fees can never be changed once the contract is signed

An advisory fee is a material term of the advisory contract, so an increase has to be disclosed to the affected clients and, as a general matter, agreed by them. Telling the Administrator or updating Form ADV does not substitute for telling the client, an earlier fee schedule does not give the adviser a right to change fees at will, and the fee for existing clients is not frozen forever, since the contract can be amended with their agreement.

An agent begins selling fixed insurance products for an outside insurer for compensation without notifying his broker-dealer. Regarding this outside business activity, the agent:

• a.Must provide prior written notice to his broker-dealer, because undisclosed outside business activity is a supervisory and prohibited-practice concern✓
• b.Must notify the Administrator rather than the broker-dealer, because insurance is regulated at the state level
• c.Need not tell the firm, because a business outside the securities industry falls beyond the reach of FINRA Rule 3270
• d.May begin selling and give written notice within thirty days after the first sale, since notice is due only once the agent has actually earned compensation from the insurer

FINRA Rule 3270 bars a registered person from being employed by or compensated by another person for outside business activity unless the person gives the member firm prior written notice, and the rule is not limited to securities businesses, so selling insurance for compensation is covered. The notice goes to the employing broker-dealer, not to the Administrator, and it is due before the activity starts, not after the first sale or the first commission. Doing the work on personal time is no exception. FINRA Rule 3290, approved 2026-09-15, has no effective date yet, so Rule 3270 still applies.FINRA Rule 3270

An investment adviser that has custody of a client's investment funds deposits them into the firm's general operating account and uses part of them to pay office rent. This conduct is:

• a.Acceptable, as long as the adviser later restores the money to the client in full
• b.Permitted for any adviser that carries a surety bond covering client assets, because the bond protects the client
• c.Acceptable, because the adviser has discretionary authority over the account and that authority extends to the use of the cash
• 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. Money entrusted to the adviser for the client's account belongs to the client, so spending it on the firm's rent is misuse as well as commingling. Neither a later repayment, a surety bond, nor discretionary authority over the account makes commingling permissible. (An advisory fee paid in advance is a different matter, governed by the advisory contract and its refund terms.)NASAA Model Rule

An agent proposes to share in the profits and losses of a customer's account. Under the NASAA model rule on unethical practices and FINRA Rule 2150, 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 permitted for an agent with only the customer's written authorization, since the employing broker-dealer has no role in an agent's arrangement with a customer
• c.Is permitted with the written authorization of both parties, and the agent may take whatever share of the profits the customer agrees to, regardless of the agent's own contribution
• d.Is prohibited outright for every agent, because a registered person may never share in the profits or losses of a customer's account

The NASAA model rule treats an agent's sharing in the profits or losses of a customer's account as unethical unless both the customer and the employing broker-dealer have authorized it in writing, and FINRA Rule 2150(c) adds that the sharing must be in direct proportion to the financial contributions made to the account (with an exception for the agent's immediate family). The customer's consent alone is not enough, because the employing broker-dealer must also approve in writing. Written consent from both sides does not let the parties pick any ratio they like. The arrangement is not banned outright, since the rules set the conditions under which it is allowed.NASAA Model Rule on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.d; FINRA Rule 2150(c)(1)

Under the Uniform Securities Act of 1956, 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 the agent to pass an examination that the Administrator reviews
• 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 as to the agent's qualifications, but prohibited as to the investments recommended
• d.Accurate if the firm is also registered, because the Administrator reviews the firm and the agent together

Section 405 of the 1956 Act says that neither the filing of an application nor the fact that a person or security is effectively registered means the Administrator has passed on the merits or qualifications of, or recommended or approved, any person or security, and Section 405(b) makes a contrary representation to a prospective customer unlawful. The agent's statement therefore breaks the Act. Passing an examination does not turn registration into an endorsement, the rule covers the agent's qualifications and the recommended investments alike, and the firm's own registration does not change the analysis.Uniform Securities Act (1956) §405(a)-(b)

A broker-dealer decides to raise its account maintenance and transfer fees substantially. Under the NASAA dishonest or unethical practices rule, the firm:

• a.May charge any amount it chooses for these services, provided the new fee schedule is disclosed to customers in advance of the change
• b.Must obtain each customer's signed written consent to every fee before it may begin charging the higher amount
• c.May not charge unreasonable and inequitable fees for services, even if the new fee schedule has been disclosed to customers✓
• d.Is subject to no limit on its fees, because fee levels are a matter of contract between the firm and each customer, who may take the account elsewhere

The rule lists charging unreasonable and inequitable fees for services performed, including transfer, safekeeping, and similar services, as an unethical practice. Disclosure alone does not make an excessive fee reasonable, so a firm cannot raise its fees to any level merely by announcing the change or printing the charge on a confirmation. Written consent for every fee is not required, and fees are not unregulated just because they are set by contract.NASAA Broker-Dealer and Agent Dishonest or Unethical Business Practices Model Rule, §1.m

An investment adviser pays an accountant a cash fee for every client the accountant refers. Under the NASAA model rule on solicitors (Rule 401(g)(4)-1 under the 1956 Act), this arrangement requires that:

• a.Nothing be disclosed, because the client pays no fee beyond the normal advisory fee
• b.The arrangement be in writing and disclosed to the client in writing, so the client knows the referral was compensated✓
• c.The accountant register as a broker-dealer agent in each state where a referred client lives, because the fee works like a commission on a securities sale
• d.The accountant be an employee or officer of the adviser, because the rule bars an adviser from paying outside solicitors for client referrals

Under the NASAA model solicitor rule the fee must be paid under a written agreement between the adviser and the solicitor, and the client must receive the adviser's disclosure document and a separate written statement of the solicitor's compensation, acknowledged in writing. Disclosure is required even when the client pays nothing extra, because the statement must say whether any added charge exists and describe the referral fee. The rule sets no percentage cap, and it does not bar outside solicitors. The solicitor must be registered as an investment adviser representative (or be exempt), not as a broker-dealer agent; the written-agreement and disclosure steps are waived only for the adviser's own partners, officers and employees.NASAA Model Rule 401(g)(4)-1(b), (c) (solicitors)

Under the NASAA model rule on dishonest or unethical business practices, an agent who wants to pay half of his commissions to a friend who referred several clients, and who holds no securities registration of any kind, may:

• a.Not do so, because commissions may be shared only with appropriately registered persons✓
• b.Do so freely, because commissions are the agent's own compensation, and the registration rules apply only to payments made by the broker-dealer
• c.Do so if the payments are limited to the clients the friend actually referred, because a referral fee is not a division of securities compensation
• d.Do so up to ten percent of each commission

Dividing or splitting an agent's commissions or other securities compensation with a person who is not also registered as an agent for the same broker-dealer, or for a broker-dealer under common control, is a prohibited practice. Splitting transaction-based compensation with an unregistered person is effectively paying that person for securities activity. The source of the funds, the fact that the friend referred clients, and an arbitrary percentage cap do not make it permissible.NASAA Model Rule, Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended April 7, 2025), Section 2.e

Under Form ADV Part 2A Item 18, a state-registered investment adviser that collects substantial prepaid fees six or more months in advance generally must:

• a.Include a balance sheet in its brochure only if prepayments exceed $1,200 per client, the same threshold that applies to SEC-registered advisers
• b.Register with the SEC instead of the state, because collecting prepaid fees six months or more ahead is an SEC registration trigger
• c.Include an audited balance sheet for its most recent fiscal year in its brochure, because prepaying more than $500 per client six or more months ahead triggers Item 18.A✓
• d.Disclose any impairing financial condition but omit the balance sheet, since the balance sheet applies only to advisers with custody

Form ADV Part 2A Item 18.A requires an adviser that requires or solicits prepayment of more than $1,200 per client, six months or more in advance, to include a balance sheet for its most recent fiscal year, audited by an independent public accountant. For advisers registered with state securities authorities the threshold is more than $500 per client. The $1,200 figure therefore does not apply to a state-registered adviser, collecting prepaid fees is not a trigger for SEC registration, and the separate Item 18.B disclosure of an impairing financial condition does not replace the balance sheet.Form ADV Part 2A, Item 18.A and 18.B (SEC Form 1707, 08-22)

Under FINRA Rule 3240 (not the NASAA model rule on agents' dishonest or unethical practices), a registered person borrows $5,000 from a customer who is his mother, and the firm's written procedures allow borrowing from immediate family. This arrangement is:

• a.Prohibited in all circumstances, because the NASAA model rule bars borrowing from any customer
• b.Permitted only if the mother is a financial institution or other person who regularly makes loans in the ordinary course of business
• c.Permitted only if the Administrator approves the loan in writing before the funds change hands
• d.Generally permissible, because borrowing from an immediate family member is a recognized exception when firm procedures allow it✓

FINRA Rule 3240 bars a registered person from borrowing money from or lending money to a customer unless the member has written procedures allowing it and the arrangement fits a listed condition. One condition is that the customer is a member of the registered person's immediate family, which includes parents, and the member's procedures may even waive notice and approval for family loans. The NASAA model rule on agents' unethical practices has no family exception and bars borrowing from any customer, which is why an absolute prohibition is the right answer under that rule but not under this one. The lender-in-business condition is a separate category that does not apply to a parent, and no state Administrator approval is part of the FINRA rule.FINRA Rule 3240(a)(1), (a)(2)(A), (b)(2); NASAA Model Rule on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, 2.a

An investment adviser representative wants to be paid a share of the capital gains in a client's account. Under NASAA rules for advisers, this is generally:

• a.Restricted to performance-fee arrangements meeting the qualified-client thresholds, not the proportionate sharing allowed to broker-dealer agents✓
• b.Permitted like any agent's proportionate sharing, because the 1956 Act treats advisers and broker-dealer agents the same way for sharing in client profits
• c.Permitted with only the client's oral consent, because the written-authorization requirement applies to broker-dealer agents and not to advisers or their representatives
• d.Permitted for any client who acknowledges the risks in writing, since the qualified-client thresholds apply only to private funds and pooled vehicles

A broker-dealer agent may share in a customer's profits and losses only with the written authorization of the customer and the firm. An adviser who wants a share of capital gains or appreciation is governed by the performance-fee rule: the client must be a qualified client and must receive written disclosure of the risks, including the incentive toward riskier investments. Oral consent and a signed risk acknowledgment do not meet that rule, and its thresholds are not limited to pooled vehicles.NASAA Model Rule 102(f)-3; Uniform Securities Act (1956) Section 102(c)(1)

A broker-dealer agent pays a flat cash referral fee, out of his own commissions, to an unregistered acquaintance for each new brokerage customer sent to him. This is:

• a.Permitted if the total paid to that person stays at or below $1,000 in a 12-month period, the de minimis threshold for compensating endorsements
• b.Permitted because it is a flat fee rather than a commission, and the rule against splitting compensation reaches only percentage-based commission sharing
• c.Prohibited, because transaction-related compensation for securities business may not be paid to an unregistered person✓
• d.Permitted if the acquaintance reports it as income and the agent discloses the referral arrangement to each new customer in writing

An agent may not split commissions, profits or other compensation from securities transactions with anyone who is not also registered as an agent of the same broker-dealer (or one under common control). A flat referral fee paid for each brokerage customer is still compensation for securities business, so labeling it a flat fee, capping it, reporting it as income or disclosing it to customers does not make it permissible.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (2.e)

A state-registered investment adviser pays cash referral fees to a third-party solicitor. Under the NASAA model solicitor rule (Rule 401(g)(4)-1 under the 1956 Act), permissible conditions include all of the following EXCEPT:

• a.The solicitation must be approved in advance by the Administrator for each client✓
• b.The solicitor gives each client a separate written disclosure statement describing the solicitor's compensation
• c.A written agreement between the adviser and the solicitor describing the referral activities and the fee to be paid
• d.The solicitor has not been convicted of a felony within the previous ten years or become subject to a securities-industry bar order

The model solicitor rule lets an adviser pay a cash referral fee when the solicitor is registered as an investment adviser representative or exempt, is not disqualified, and acts under a written agreement with the adviser, and when the client receives the adviser's disclosure document and a separate written statement of the solicitor's compensation. Nothing in the rule requires the Administrator to approve each solicitation in advance, so that is the one item that is not a condition.NASAA Model Rule 401(g)(4)-1(b), (c) (solicitors)

Under the NASAA custody rule, an adviser with custody of client funds and securities (and no exception such as fee-deduction-only custody) must arrange for them to be verified by:

• a.The client's own personal accountant, who reviews the quarterly statements and reports any discrepancy to the Administrator
• b.The adviser's own compliance staff through a quarterly internal reconciliation that is then filed with the Administrator
• c.The Administrator's own examiners, who must examine the adviser's custody of client assets once every calendar year
• d.An independent public accountant through a surprise examination at least annually✓

Under the custody rule an adviser with custody must have client funds and securities verified by actual examination at least once each calendar year by an independent certified public accountant, at a time chosen by the accountant without prior notice and irregular from year to year. A client's personal accountant, the adviser's own staff and the regulator's examiners are not the required independent verifier.NASAA Model Rule 102(e)(1)-1(a)(6)

A state-registered adviser with custody must have a reasonable basis for believing that the qualified custodian sends each client account statements:

• a.At least quarterly, identifying the funds and securities in custody and the account activity✓
• b.At least annually, listing the securities held at year-end and the advisory fees the adviser deducted during the year
• c.Only when the client requests them in writing, because delivery is optional once the adviser has notified the Administrator of its custody
• d.Semiannually, listing each security held at period-end but not the individual transactions that occurred during the period

The custody rule requires the adviser to have a reasonable basis, after due inquiry, for believing that the qualified custodian sends each client an account statement at least quarterly, identifying the amount of funds and of each security at period-end and setting out all transactions in the period. Annual or semiannual statements, statements omitting the transactions, and statements only on request all fall short.NASAA Model Rule 102(e)(1)-1(a)(4)

Under the brochure rule, after the initial delivery, if there have been material changes since the last annual updating amendment, a state-registered adviser must deliver to each client annually:

• a.The current brochure, or a summary of material changes with an offer to provide the full brochure, free of charge✓
• b.Only a revised fee schedule, since a change in fees is the one material change that triggers annual delivery of the brochure
• c.Nothing further once the contract is signed, because the brochure must be delivered only at or before the time the client signs
• d.A new signed advisory contract plus a brochure supplement for every supervised person, whether or not anything has changed

After the initial delivery, the adviser must deliver annually, within 120 days after fiscal year-end and without charge, either a current brochure or a summary of material changes that offers the full brochure, when there have been material changes since the last annual updating amendment. A fee change is not the only trigger, delivery is not limited to the signing, and a new contract and unlimited supplements are not required.17 CFR 275.204-3(b)(2)

Under the Uniform Securities Act of 1956, a state-registered investment adviser advertises that its registration means it is 'recommended by' and 'approved by' the state securities regulator. This is:

• a.Acceptable for firms with a clean disciplinary record, since they have in effect been approved
• b.Acceptable if it appears only in the brochure delivered to clients and not in public advertising
• c.Acceptable because the firm is in fact registered and the statement is therefore literally true
• d.Prohibited, because it misrepresents the meaning of registration✓

Section 405 of the 1956 Act says that being registered does not mean the Administrator has passed on the merits or qualifications of, recommended or approved a person, and Section 405(b) makes any contrary representation to a prospective customer or client unlawful. A clean disciplinary record does not turn registration into approval, limiting the claim to a brochure does not help because the rule reaches any representation to a client, and the claim is not literally true merely because the firm is registered, since the point is what registration means.Uniform Securities Act (1956) §405(a)-(b)

A 74-year-old client of an agent has a conservative account of $90,000 and wants modest income. Over three months the agent places 45 purchases and sales that leave the holdings almost unchanged but generate large commissions. How is this conduct classified?

• a.It is unethical, because it induces trading that is excessive in size or frequency in view of the account's financial resources and character.✓
• b.It is acceptable, because each confirmation was sent to the client, and a client who receives confirmations is deemed to approve the trading.
• c.It is acceptable, because the trading was within the agent's authority as long as every individual purchase or sale was a suitable security.
• d.It is unethical only if the agent shares the profits with the client, since the policy addresses profit sharing rather than account activity.

The Statement of Policy lists inducing trading that is excessive in size or frequency in view of the financial resources and character of the account as a dishonest or unethical practice. The test looks at the pattern of activity and the account's purpose, so a series of individually suitable trades can still be churning. Sending confirmations does not cure it, and profit sharing is a separate prohibition.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.b

A broker-dealer agent recommends a highly speculative, thinly traded stock to a retired client who has told the agent that she lives on a fixed pension and cannot afford to lose principal. The agent made no inquiry beyond that conversation. What is the problem?

• a.The agent should have obtained the client's written discretionary authority before recommending any speculative security.
• b.The agent breached no duty, since a retiree who rejects a recommendation is protected and one who accepts it assumes the risk.
• c.The agent should have waited ten business days after the conversation before making any recommendation of a stock.
• d.The agent lacked reasonable grounds to think the recommendation was suitable for the client's stated goals and finances.✓

The policy treats recommending a security without reasonable grounds to believe it is suitable for the customer, based on reasonable inquiry into objectives, financial situation and needs, as an unethical practice. A recommendation that contradicts what the client has stated fails that test. Discretionary authority is irrelevant to a recommendation the client is free to decline, and the customer's acceptance does not cure unsuitability.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.c

An agent is sure that a stock will rise, and buys 200 shares in a customer's account without calling the customer. The customer, who had not given any discretionary authority, learns of the purchase the next day. The stock then rises. Is the agent's conduct a problem?

• a.Yes, because executing a transaction for a customer without authorization is unethical even if it later profits.✓
• b.Yes, but only if the stock had dropped in value, since a violation requires a loss to the customer's account.
• c.No, because the customer gained from the transaction and so was not harmed by the lack of prior consultation.
• d.No, because an agent may place trades without asking so long as the customer is told about them within one business day.

Executing a transaction on behalf of a customer without authorization is listed as an unethical practice, and no showing of loss is required. A later gain does not supply the missing authority, and after-the-fact notice is not consent. Only authority that the customer has granted can support a trade, whether the authority is for a single order or a discretionary one.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.f

A customer tells an agent by phone, 'Buy whatever you think is best and I will not need to approve each one.' The customer signs nothing. Which statement is correct?

• a.The agent may choose the securities and the amounts without written authority, but not the time or the price of an order.
• b.The agent may begin exercising discretion now and must obtain written authority from the customer within ten business days.
• c.The agent's discretion is valid because a customer's oral instruction is enough for a broker-dealer's agent to trade freely.
• d.The agent needs the customer's prior written discretionary authority, except over the time or price of an order.✓

For broker-dealers and agents, the policy treats exercising any discretionary power without first obtaining written discretionary authority as unethical, with an exception when the discretion relates solely to the time or price for executing orders. The ten-business-day grace period is a rule for investment advisers, not for agents. Choosing securities and amounts is exactly what requires the written authority.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.g

An investment adviser representative begins trading a new client's account on the client's oral discretionary instruction. There is a written discretionary agreement in the file only at 14 business days after the first trade. What is the status under the rule?

• a.It complies, because the written agreement arrived before the client's first account statement was ever sent out.
• b.It complies, because the adviser has until the end of the first calendar quarter to obtain the written authority.
• c.It violates the rule, because written authority has to be in place before the first trade is made on any oral instruction.
• d.It violates the rule, because the written authority was due within ten business days of the first trade on oral authority.✓

Model Rule 102(a)(4)-1(b) treats exercising discretion without written discretionary authority obtained within ten business days after the first transaction placed under oral authority as an unethical practice, unless the discretion concerns only the price or time for an order involving a definite amount of a specified security. Fourteen business days is too late. The advance-writing requirement applies to broker-dealers.NASAA Model Rule 102(a)(4)-1 (b)

An agent opens a margin account for a customer and executes the first margin purchase on Monday. The customer has not yet signed any margin agreement. By when must the agent obtain the executed written margin agreement?

• a.Only when the customer's equity falls below the maintenance level.
• b.Within 30 days after the account's first statement is issued.
• c.Promptly after the initial transaction in the account.✓
• d.Before the first transaction in the account is executed.

The policy lists executing a transaction in a margin account without securing a properly executed written margin agreement promptly after the initial transaction as unethical. The agreement is therefore due promptly after the first trade, not beforehand and not only after a margin call. Timing tied to statements or maintenance levels does not appear in the policy.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.h

A broker-dealer wants to pledge a customer's fully paid securities as collateral for its own bank loan, though it holds no lien on them. What does the policy require?

• a.No consent at all, because securities held in a customer account belong to the firm for margin.
• b.The customer's properly executed written consent, unless SEC rules permit the pledge.✓
• c.Written notice to the Administrator and to the customer within five days after the pledge.
• d.Only the customer's oral approval, given at any time before the firm pledges the securities.

Hypothecating a customer's securities without having a lien on them is unethical unless the broker-dealer secures the customer's properly executed written consent promptly after the initial transaction, or the SEC's rules permit it. Oral approval is not a properly executed consent, and notice to the Administrator does not substitute. Customer securities do not become the firm's property.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.j

To win an account, an agent promises a prospect, 'If the fund you buy loses money in your first year, I will make you whole out of my own pocket.' What does the policy say about this promise?

• a.It is permitted if the agent puts the guarantee in a signed writing and gives the prospect a copy to keep.
• b.It is permitted if the agent's broker-dealer approves the promise in advance and records it in the account file.
• c.Guaranteeing a customer against loss in an account is an unethical practice, regardless of who offers to cover it.✓
• d.It is permitted if the guarantee is limited to losses suffered during the first year the prospect holds the investment.

The policy lists guaranteeing a customer against loss in any securities account or transaction as dishonest or unethical. A written promise, a time limit or firm approval does not change the character of the guarantee. Even a sincere offer to cover losses breaches the standard, which is aimed at the misleading assurance of safety.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.q

A customer offers to lend her agent $15,000 for a down payment on a house, and promises that she will not tell the broker-dealer. The customer is not a financial institution. May the agent accept?

• a.No, but only if the loan is secured by securities held in the customer's own account with the agent.
• b.Yes, since the practice is unethical only when the loan is not repaid within the agent's current registration year.
• c.Yes, since the agent may accept loans from customers who are not broker-dealers if the terms are put in writing.
• d.No, because lending or borrowing money or securities from a customer is an unethical practice for an agent.✓

The policy classifies an agent's lending or borrowing money or securities from a customer, or acting as custodian for a customer's money, securities or executed stock power, as unethical. The prohibition does not depend on a writing, a repayment date or collateral. Hiding the loan from the firm only compounds the conflict of interest.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.a

An agent executes a trade for a friend through another firm's account and keeps the order off the books of his own broker-dealer. His employer did not know about the trade. How does the policy treat this?

• a.It is unethical, because trades must be on the firm's regular books unless it authorized them in writing beforehand.✓
• b.It is unethical only if the agent earned a commission, since uncompensated trades are outside the scope of the policy.
• c.It is acceptable, because the other firm will report the trade to the Administrator and so the employer need not record it.
• d.It is acceptable, because a trade in a friend's account is a personal matter and falls outside the employer's supervision.

Effecting securities transactions not recorded on the regular books or records of the broker-dealer the agent represents is unethical unless the broker-dealer authorized the transactions in writing before execution. This is a form of selling away, which prevents the firm from supervising its agent. Whether the agent earned a commission does not matter.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.b

An agent proposes to a customer that they share 20% of the gains in the customer's account, and 20% of any losses. What must happen before the arrangement is acceptable under the policy?

• a.Only the broker-dealer must approve, since the arrangement is a matter of the agent's compensation.
• b.Both the customer and the agent's broker-dealer must give written authorization.✓
• c.Only the customer must agree, and an oral agreement is enough between the two of them.
• d.Nothing further, since sharing in an account's profits is permitted if losses are also shared.

The policy treats sharing directly or indirectly in the profits or losses in a customer's account without the written authorization of the customer and the broker-dealer that the agent represents as unethical. Both authorizations are needed in writing. Sharing losses as well as gains does not remove the requirement.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.d

An agent registered with Firm A wants to pay half of her commissions on a sale to a friend who works for an unrelated firm and referred the customer. The friend is not registered with Firm A. Is that allowed?

• a.No, because an agent may never share compensation with anyone, including others at the same broker-dealer.
• b.No, because splitting compensation is allowed only with agents of the same or a commonly controlled broker-dealer.✓
• c.Yes, because the policy limits only the percentage of a commission an agent may split, and half is within the limit.
• d.Yes, because a referral fee to any registered agent of any broker-dealer is allowed if the customer is told.

Dividing or otherwise splitting the agent's commissions, profits or other compensation from securities sales with a person not also registered as an agent for the same broker-dealer, or for one under common control, is unethical. The restriction depends on who receives the payment and not on the percentage. Agents of the same firm may share compensation.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.e

A broker-dealer is a wholly owned subsidiary of an issuer, and its agent is about to recommend the issuer's new debentures to a customer. When and how must the affiliation be disclosed?

• a.Only in the confirmation, which suffices because the customer then has a chance to cancel in writing within three days.
• b.Before the customer agrees to buy, followed by written disclosure at or before completion if the first one was oral.✓
• c.Only if the customer asks, since the broker-dealer need not volunteer corporate relationships that appear in public filings.
• d.Only if the issuer's debentures are speculative, because affiliation matters little for investment-grade securities.

Failing to disclose that the broker-dealer is controlled by, controlling, or under common control with the issuer before entering into any contract with or for a customer is unethical, and if the disclosure is not made in writing, it must be supplemented by written disclosure at or before completion of the transaction. A customer is entitled to know about this conflict before deciding, whatever the issuer's quality.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.t