NASAA Series 63 — All Questions

A broker-dealer buys a thinly traded stock for its own inventory at $10 and sells it to a retail customer the same day at $13, when the current market price is $10.10. What is the concern under the policy?

• a.The price is not reasonably related to the current market price, and the profit may be unreasonable.✓
• b.The concern is that the broker-dealer did not hold the stock for at least 30 days before offering it to a customer.
• c.There is none, because a dealer acting as principal may charge any price the customer accepts when the order is confirmed.
• d.The only concern is that the dealer should have charged a commission rather than a markup for acting as principal.

Entering into a transaction with or for a customer at a price not reasonably related to the current market price, or receiving an unreasonable commission or profit, is unethical. A $2.90 markup on a $10.10 market price is hard to defend as reasonable. A customer's acceptance does not make an unreasonable price acceptable, and no minimum holding period is stated in the policy.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.k

An agent lost an arbitration brought by a customer and was ordered to pay $40,000. He has made no payment and has no written payment arrangement with the customer. How does the policy treat that?

• a.It is unethical only if the agent also transfers assets to someone else to keep them out of the customer's reach.
• b.Leaving a final customer arbitration award unpaid is unethical unless the customer agreed to other terms in writing.✓
• c.It is acceptable until the agent's registration is next renewed, when the Administrator will review any open awards.
• d.It is acceptable, because an arbitration award is enforceable only through a court, not through a registration action.

The policy lists failing to pay and fully satisfy a final judgment or arbitration award from an investment-related, customer-initiated proceeding as unethical, unless alternative payment arrangements were agreed in writing and are being followed. Attempting to avoid payment is a separate item. The Administrator can act on the unpaid award without awaiting a court proceeding.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.w

An agent registered only as a broker-dealer agent prints business cards that read 'Senior Financial Advisor'. She is not registered as an investment adviser representative. How does the policy treat the card?

• a.It is acceptable, as long as the card also states in smaller print that the agent is registered as a broker-dealer agent.
• b.It is unethical only if the agent actually gives continuing investment advice to clients for a separate advisory fee.
• c.It is acceptable, because 'advisor' is a general descriptive word rather than a protected professional designation or credential.
• d.It is unethical, because an 'adviser' title may not be used without licensure as an investment adviser or representative.✓

The policy lists using a title, purported credential or designation containing any variant of 'adviser' or 'advisor' without licensure as an investment adviser or an investment adviser representative, unless otherwise permitted by law, as unethical. Adding a disclosure about the agent's actual registration does not cure the title. The conduct is judged by the title, not by the fee arrangement.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.e

An agent tells a prospect that a mutual fund is 'no load' and describes it as having 'no sales charge'. The fund has no front-end or deferred load, but it charges a Rule 12b-1 fee of 0.30% and a service fee of 0.15% of average net assets per year. Is the description permitted?

• a.No, because a fund charging any 12b-1 fee at all may never be described as no-load in any circumstances.
• b.Yes, because each fee is below one percent, which is the point at which a fund must stop describing itself as no-load.
• c.Yes, because 'no load' refers only to the absence of front-end and deferred sales charges, and annual fees are separate.
• d.No, because a no-load fund's 12b-1 and service fees may total no more than 0.25% of average net assets a year.✓

The investment company shares policy treats it as unethical to state or imply that shares are no-load or carry no sales charge if there is a front-end or contingent deferred load, or a 12b-1 or service fee that exceeds 0.25% of average net fund assets per year. Here the total is 0.45%, so the description is misleading. A 12b-1 fee at or below the cap is compatible with the term.NASAA Statement of Policy on Investment Company Shares §A.2

A customer plans to invest $48,000 in a fund family whose sales charge falls at a purchase of $50,000. The agent does not mention the discount or the option to commit to buying more. What problem arises?

• a.No problem, since a discount need be disclosed only after the customer invests at or above the breakpoint.
• b.The agent should have recommended a closed-end fund instead, because those funds charge no sales load.
• c.The agent may not recommend a fund family with more than one sales charge level for any purchase.
• d.The agent failed to disclose the breakpoint discount and any letter of intent that could lower the sales charge.✓

Failing to disclose any relevant sales charge discount at or above a breakpoint, or a letter of intent feature, which would reduce the sales charge is unethical in connection with soliciting investment company shares. A customer near a breakpoint must be told so that the customer can decide whether to invest more. Closed-end funds have their own underwriting costs.NASAA Statement of Policy on Investment Company Shares §A.3

An agent persuades a customer to redeem shares of a growth fund in one fund family and use the proceeds to buy a growth fund with the same objective in another family, generating a new front-end load, without any analysis of costs. Why is this a concern?

• a.Switching is prohibited outright, and an agent may never recommend moving money between funds of any kind or family.
• b.Switching is acceptable if the new fund's recent return is higher than the old fund's over the last twelve months.
• c.Switching is acceptable if the customer signs a form acknowledging that new sales charges will apply to the purchase.
• d.Such a switch needs reasonable grounds of suitability that weigh the customer's objectives and the added transaction charges.✓

The policy treats recommending the redemption of investment company shares to buy a different portfolio with similar objectives and policies, without reasonable grounds to believe that this is suitable in light of the customer's objectives, financial situation, other holdings and the transaction charges, as unethical. It is not an outright ban. A signed acknowledgment or last year's return does not establish suitability.NASAA Statement of Policy on Investment Company Shares §B.2

An investment adviser representative will receive a bonus from a fund company whenever clients buy its funds on the representative's advice, but charges an advisory fee. When must the representative disclose this conflict, and in what form?

• a.In the annual brochure update delivered after the close of the fiscal year.
• b.Orally, at the time of the client's first purchase of the fund.
• c.In writing, and before the representative gives the client any advice.✓
• d.In writing, within thirty days after the client opens the account.

Model Rule 102(a)(4)-1(k) treats failing to disclose in writing, before any advice is rendered, any material conflict of interest that could reasonably be expected to impair unbiased and objective advice, including compensation in addition to the client's fees, as an unethical practice. Oral disclosure, later disclosure and annual updates all arrive after the advice has been given.NASAA Model Rule 102(a)(4)-1 (k)

A client's brother, who has no written authority from the client, phones an investment adviser and tells it to sell all of the client's technology stocks. The adviser places the sell order the same day. What did the adviser do wrong?

• a.Nothing, because relatives of an advisory client are presumed to have the authority to give instructions.
• b.It placed an order on a third party's instruction without first obtaining the client's written trading authorization.✓
• c.It placed an order without waiting ten business days for the client to confirm the instruction by telephone.
• d.It placed an order without the brother's written consent, though the client's own authorization was not necessary.

Placing an order for a client's account on the instruction of a third party without first having obtained a written third-party trading authorization from the client is an unethical practice under Model Rule 102(a)(4)-1(e). The authority must come from the client and be in writing. The ten-business-day period applies to discretionary authority, and family ties create no presumption of authority.NASAA Model Rule 102(a)(4)-1 (e)

An investment adviser drafts a new advisory contract that states the services, the term, the fee and the fee formula, and says whether the adviser has discretion, but is silent about refunds of prepaid fees and about assignment. Why is the contract a problem?

• a.It must also state the adviser's total assets under management and the names of its ten largest clients by account size.
• b.It must also be notarized by the client and filed with the Administrator within ten days after the client signs it.
• c.It must also state the prepaid fee to be returned on termination and that no assignment may occur without consent.✓
• d.It is acceptable, because the other required terms may be added by oral agreement after the contract is signed.

Model Rule 102(a)(4)-1(p) makes it unethical to enter into, extend or renew an advisory contract unless it is in writing and discloses the services, term, fee, fee formula, prepaid fee to be returned on termination or non-performance, whether discretion is granted, and that no assignment may be made without the consent of the other party. The contract here omits two of those items. Notarization and filing are not required.NASAA Model Rule 102(a)(4)-1 (p)

A financial planner at an investment adviser mentions to a friend at a dinner party that a wealthy client of the firm recently moved a large sum into municipal bonds. The client had not agreed to the disclosure. How is the remark classified?

• a.It is acceptable, because the planner did not name the client, and the investment details are not confidential.
• b.It is unethical, since client affairs may not be disclosed unless required by law or consented to by the client.✓
• c.It is acceptable, because comments made in a social setting are not treated as business conduct by the Administrator.
• d.It is unethical only if the friend acts on the remark by buying the same bonds and earns a profit on them.

Model Rule 102(a)(4)-1(n) lists disclosing the identity, affairs or investments of any client, unless required by law or consented to by the client, as an unethical practice. Describing a client's investments to a third party falls within it, and the rule does not depend on whether the friend trades or whether the setting was social. Even a partial description can identify a client.NASAA Model Rule 102(a)(4)-1 (n)

An agent describes a new bond issue to a customer and leaves out that the issuer defaulted on its previous bond. Which provision does the omission violate?

• a.The advertising provision, which bars oral statements about a security before a prospectus is sent
• b.The agent-supervision provision, which makes the firm liable for any statement an agent makes to customers
• c.The registration provision, which bars any offer of a security before the issuer's default history is filed
• d.The antifraud provision, which bars omitting a material fact needed to keep a statement from misleading✓

Section 101 makes it unlawful, in connection with an offer, sale, or purchase of a security, to make an untrue statement of material fact or to omit a material fact needed to make the statements made not misleading. Registration deals with whether a security may be sold, and the filing rules in §403 deal with literature, so neither is the source of the violation. Firm supervision is a separate duty and does not define the omission itself.Uniform Securities Act (1956) §101

A registered agent borrows $5,000 from a long-time customer and signs a note. This conduct is:

• a.Permitted if the customer has traded through the agent for more than a year and raised no complaint
• b.Prohibited only when the amount borrowed is greater than the balance in the customer's account at the firm
• c.Permitted if the loan is documented in a signed note and repaid at the prevailing bank rate of interest
• d.A dishonest or unethical practice, because an agent may not lend or borrow money or securities from a customer✓

The policy lists as unethical an agent lending or borrowing money or securities from a customer, or acting as a custodian for the customer's money, securities, or an executed stock power. A signed note and a market interest rate, a long relationship without complaints, and the size of the loan relative to the account balance do not remove the problem, because the conflict arises from the debtor relationship itself.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.a

An agent places an order for a customer through an outside account and does not record it on the books of the firm. When is this acceptable?

• a.Whenever the agent reports it to the firm within thirty days after settlement
• b.Only if the broker-dealer authorizes the transaction in writing before it is executed✓
• c.Whenever the transaction is smaller than the firm's minimum commission schedule
• d.Whenever the customer consents in writing after the transaction has been executed

An agent may not effect transactions that are not recorded on the regular books of the employing broker-dealer unless the firm authorizes them in writing before execution. Later consent, a small transaction size, or a delayed report to the firm does not cure an unrecorded trade.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.b

An agent proposes to share in 20 percent of the profits and losses in a customer's account. The customer agrees in writing. What else is required?

• a.Nothing more, since the customer's written agreement alone permits the arrangement
• b.Written authorization from the broker-dealer, in addition to the customer's✓
• c.Advance approval from the administrator, who reviews each profit-sharing agreement
• d.A written opinion from the firm's counsel that the arrangement suits the customer

An agent may share in the profits or losses of a customer's account only with the written authorization of both the customer and the broker-dealer. The customer's consent alone is not enough, and the Act does not require advance administrator approval or a legal opinion.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.d

Agent Park wants to split commissions on a customer account with a friend who has a securities license but works for an unaffiliated broker-dealer. Is that permitted?

• a.No, because commissions may never be divided between individual agents, even at the same firm, under any facts
• b.Yes, since any person holding a securities license in the state may share in the commissions
• c.No, because splitting is allowed only with agents of the same broker-dealer or a commonly controlled one✓
• d.Yes, if Park first discloses the split to the customer in writing and the firm keeps a copy

The policy prohibits dividing an agent's commissions, profits, or other compensation with any person who is not also registered as an agent for the same broker-dealer, or for a broker-dealer under direct or indirect common control. A securities license at an unrelated firm does not qualify, and written disclosure to the customer does not substitute for common registration. Splitting is not banned outright, because it is allowed among agents of the same firm.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §2.e

A broker-dealer's agent has no written discretionary authority from a customer, but the customer says, "Buy 500 shares of ABC whenever the price drops to $40." The agent buys at $40. This is:

• a.Unethical, since every trade that the agent initiates requires prior written discretionary authority
• b.Acceptable, since discretion limited to the time or price of an order needs no written authority✓
• c.Unethical unless the firm's compliance officer approves the order in advance of its entry
• d.Acceptable only if the customer signs written authority within ten business days after the trade occurs

A discretionary power exercised without written authority is unethical unless it relates solely to the time or price at which an order is executed. The customer chose the security and quantity, and the agent only chose the moment, so no written authority is needed. The ten-business-day signature rule belongs to the investment adviser model rule and does not apply to this exception, and a compliance officer's approval is not the test.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.g

A customer gives an agent a hot tip and says, "I may want to buy 200 shares of Zeta tomorrow." The next morning, without calling, the agent buys 200 shares. This conduct is:

• a.Acceptable, since the customer had clearly signaled interest in the exact stock bought
• b.Unethical, because expressing interest in a purchase is not authorization to trade✓
• c.Unethical only if the stock declines in value by the time the customer reviews the confirmation
• d.Acceptable if the confirmation is sent promptly and the customer does not object within five days

Executing a transaction on behalf of a customer without authorization is listed as unethical. Interest in a possible purchase is not an order, and a confirmation or silence afterward does not supply the missing authority. The violation occurs when the trade is placed and does not depend on the stock's later price.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.f

A customer with a $40,000 account and modest income has an agent who places 60 trades in a month, generating $3,000 in commissions. Which practice does this describe?

• a.Cross trading, meaning a match of two customer orders at the same price outside the market
• b.Hypothecation, meaning the pledge of a customer's securities to secure a broker-dealer's own loan
• c.Front running, meaning trading for the firm's own account ahead of a large pending customer order
• d.Excessive trading, meaning trading that is excessive in size or frequency for the account's resources✓

Inducing trading that is excessive in size or frequency in view of the customer's financial resources and the character of the account is listed as unethical, commonly called churning. Sixty trades and $3,000 in commissions on a $40,000 account fit that description. Pledging a customer's securities, trading ahead of a customer order, and matching two customer orders are different practices that the facts do not describe.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.b

An agent assures a customer, "If this fund loses money in the first year, I will make up the difference." The statement is:

• a.Allowed, if the agent's firm confirms the assurance to the customer in writing
• b.Prohibited only if the fund actually loses money during its first year of ownership
• c.Allowed, because the agent personally assumes the risk and the customer is protected from loss
• d.A prohibited guarantee against loss, which is unethical whether or not the agent can honor it✓

Guaranteeing a customer against loss in an account or a transaction is listed as unethical for a broker-dealer, and agents are bound by the same item. The promise is improper when made, whether or not the agent could pay, and does not depend on the fund's result. Firm confirmation does not make a guarantee proper.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.q

A customer opens a margin account and buys on margin. The firm intends to pledge the customer's securities to a bank loan. What does the policy require?

• a.A verbal margin agreement, with a written consent to hypothecation obtained before the account is opened
• b.Nothing more, since margin rules are set entirely by the exchange where the securities trade
• c.A written margin agreement and written consent to hypothecation, each promptly after the first trade✓
• d.A written margin agreement only, since hypothecation consent is implied when the margin account is opened

A broker-dealer may not execute transactions in a margin account without a properly executed written margin agreement promptly after the initial transaction, and may not hypothecate a customer's securities without a lien on them unless it obtains a properly executed written consent promptly after the initial transaction, except as the SEC rules permit. A verbal margin agreement is not sufficient, consent to hypothecation is not implied by opening the account, and exchange rules do not displace the written requirements.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.h, §1.j

A customer buys shares in a new offering. By when must the broker-dealer give the customer a final prospectus, or a preliminary prospectus with an additional document containing the remaining information?

• a.Within the first full calendar quarter that begins after the offering has ended
• b.Within thirty days after the settlement date of the customer's transaction
• c.No later than the due date of the confirmation of the customer's purchase✓
• d.Before the customer pays, but never earlier than the effective date of the offering

The policy lists as unethical failing to furnish a customer purchasing securities in an offering, no later than the due date of the confirmation, either a final prospectus or a preliminary prospectus plus an additional document that together include all the information in the final prospectus. The other timing choices have no basis in the policy.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.l

A customer wins a $60,000 arbitration award against an agent's firm arising from a complaint about investments. The firm ignores the award and no payment plan is agreed. Under the policy, this is:

• a.A concern for the state only if the award exceeds $100,000 including interest
• b.A dishonest or unethical practice and a ground for action against the firm's registration✓
• c.A concern for the state only if the customer complains to the administrator within one year
• d.Not a concern for the state, since only the arbitration forum can enforce an award

Failing to pay and fully satisfy a final judgment or arbitration award from an investment-related, customer-initiated proceeding is listed as unethical, unless alternative written payment arrangements have been agreed and followed. The administrator may act on the conduct, so the claim that only the arbitration forum has a role is wrong, and the policy sets neither a minimum award amount nor a one-year complaint deadline.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.w

A broker-dealer agent who is not licensed as an investment adviser representative uses the business card title "Senior Retirement Advisor." What is the status of this practice?

• a.Unethical, since a title with a variant of adviser requires licensure as an adviser or representative✓
• b.Unethical only if the agent charges the customer separate fees for the advice given
• c.Acceptable, since any agent may use a title that accurately describes the services the agent offers
• d.Acceptable, if the title is also reported on the firm's Form BD and the agent's Form U4

Using a title, credential, or professional designation containing any variant of adviser or advisor without licensure as an investment adviser or investment adviser representative is listed as unethical, unless otherwise permitted by law. A description of services does not make the title permissible, a Form BD or Form U4 notation does not supply the licence, and the practice does not depend on whether a separate fee is charged.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.e

An investment adviser begins trading for a client on the client's oral discretionary authority on June 1. By when must the adviser have written discretionary authority?

• a.Within ten business days after the first transaction made under the oral authority✓
• b.By the end of the calendar year in which the first transaction was placed
• c.Within thirty calendar days after the first transaction made under the oral authority
• d.Before the first transaction, since oral discretionary authority is never sufficient

The model rule treats exercising discretion without written discretionary authority from the client within ten business days after the date of the first transaction under oral authority as unethical, unless the discretion is limited to the price or time of an order for a definite amount of a specified security. The wait is therefore ten business days, not thirty calendar days or a year-end deadline, and oral authority is acceptable for that short period.NASAA Model Rule 102(a)(4)-1 (b)

A client's accountant calls an investment adviser and tells it to sell 1,000 shares in the client's account. The adviser has no paperwork from the client on file. What must the adviser have to place the order?

• a.Verbal confirmation from the client, received shortly after the order is entered
• b.A signed advisory contract with the accountant's firm covering the client's account
• c.A written authorization from the accountant, prepared on the accountant's letterhead
• d.A written third-party trading authorization from the client before the order✓

Placing an order for a client's account on the instruction of a third party without first obtaining a written third-party trading authorization from the client is unethical. The authority must come from the client, in writing and before the order, so the accountant's own letter, later verbal confirmation, or a contract with the accountant's firm is not sufficient.NASAA Model Rule 102(a)(4)-1 (e)

From which of the following may an investment adviser borrow money without violating the model rule?

• a.A bank that is in the business of loaning funds and is also a client of the adviser✓
• b.A client who is an individual and asks the adviser to take a loan to protect the account
• c.A client who is a long-time friend of the adviser and a financial professional
• d.A retired client who offers a low-rate loan and a signed promissory note

An adviser may not borrow money or securities from a client unless the client is a broker-dealer, an affiliate of the adviser, or a financial institution engaged in the business of loaning funds. A bank lender fits the last category. A retired individual, a friend who works as a financial professional, and an individual who asks for the loan to protect the account are not within those categories, however the loan is documented or priced.NASAA Model Rule 102(a)(4)-1 (f)

An adviser will receive a commission from a product company if it recommends that product to a client. When must the adviser disclose this to the client?

• a.Orally, when the client first asks about the adviser's compensation
• b.In writing, within thirty days after the client acts on the recommendation
• c.In writing, before the adviser gives any advice about the product✓
• d.In the next annual brochure update, after the commission is paid

The model rule treats as unethical failing to disclose to clients in writing before any advice is rendered any material conflict of interest, including compensation in addition to the client's fees. Oral disclosure when asked, disclosure after the client acts, and an annual update all arrive too late or lack the writing requirement.NASAA Model Rule 102(a)(4)-1 (k)

An adviser plans to sell a security from its own inventory to a client, acting as principal. What must happen before the transaction is completed?

• a.The adviser must obtain a written opinion that the price is fair from an independent party
• b.The adviser must file a notice of the sale with the administrator and wait ten days
• c.The adviser must tell the client orally and note the conversation in its records
• d.The adviser must disclose in writing its principal capacity and obtain the client's consent✓

An adviser who acts as principal for its own account in a transaction with a client, or as broker for someone other than the client, must disclose its capacity in writing before completion of the transaction and obtain the client's consent. A notice to the administrator, an oral explanation alone, or an independent fairness opinion is not the Act's requirement.Uniform Securities Act (1956) §102(a)(3)

Which provision must appear in an investment advisory contract?

• a.A statement that the adviser is entitled to a share of capital gains in the client's account
• b.A statement that the adviser may assign the contract to a successor without telling the client
• c.A statement that the contract may not be assigned without the client's consent✓
• d.A statement that the client may not terminate the contract during the first year

An advisory contract must provide that the adviser may not be compensated on the basis of a share of capital gains or capital appreciation of the client's funds, that no assignment will be made without the client's consent, and that the adviser, if a partnership, will notify the client of any change in membership. The wrong options reverse those provisions or add terms the Act does not provide.Uniform Securities Act (1956) §102(c)

An adviser's advertisement shows a model portfolio's gross performance. Under the model rule's advertising standard, what else is required?

• a.Net performance shown with at least equal prominence and calculated over the same period✓
• b.A statement from the administrator that the performance figures were verified as accurate
• c.Net performance for the most recent year only, shown in a footnote to the table
• d.A statement that the figures are projections and not based on actual accounts

Under the model rule's advertising alternative, gross performance may be shown only if net performance is also shown with at least equal prominence and calculated over the same period and using the same method. The administrator does not approve performance, a footnote for one year is not equal prominence, and a projection statement is not the required addition.NASAA Model Rule 102(a)(4)-1 (m) Alternative 2

An adviser's website carries a testimonial from a current client who was paid a gift card for it. What must the advertisement disclose?

• a.That the administrator has reviewed the testimonial and approved its use in the advertisement
• b.Only that the testimonial reflects the personal opinion of the client who gave it to the adviser
• c.That the speaker is a current client, that compensation was paid, and any material conflict of interest✓
• d.Only that the client's name was withheld to protect the client's privacy, with no other disclosure

A testimonial or endorsement must disclose, clearly and prominently, whether it was given by a current client or other person, that cash or non-cash compensation was provided, and a brief description of any material conflicts of interest, among other conditions. A general statement of opinion, a privacy note, or an administrator approval statement does not meet the rule.NASAA Model Rule 102(a)(4)-1 (m) Alternative 2

An investment adviser accepts custody of client funds. Under the Act, what must the adviser do about the administrator?

• a.Register again as a broker-dealer in addition to its adviser registration, before taking custody
• b.File a fresh adviser application every quarter for as long as the custody continues
• c.Nothing, since custody by an adviser is always prohibited and notification cannot change that
• d.Notify the administrator, unless a rule bars custody, in which case it may not take custody✓

The Act makes it unlawful for an adviser to take custody of client funds or securities if the administrator's rules prohibit it or, when no rule addresses the subject, if the adviser has not notified the administrator. Custody is therefore not banned outright, which rules out the claim that notification is pointless. Neither a second registration as a broker-dealer nor a quarterly application is required.Uniform Securities Act (1956) §102(e)

An agent recommends a speculative biotech stock to a 78-year-old retiree whose stated goal is capital preservation, without asking about her finances. This practice is:

• a.Acceptable, since the customer is free to decline any recommendation the agent makes to her and no trade occurs without her consent
• b.Unethical only if the stock actually loses more than half of its value within the first year after she buys it
• c.Unethical, because a recommendation needs a suitability basis built on reasonable inquiry✓
• d.Acceptable if the agent tells her that the stock may lose value before she buys it and she then confirms the order in writing

Recommending a purchase, sale, or exchange without reasonable grounds to believe it is suitable, based on reasonable inquiry into the customer's investment objectives, financial situation, and needs, is listed as unethical. The customer's freedom to decline, a generic risk warning and a written order confirmation do not replace the inquiry, and the violation occurs at the time of the recommendation, regardless of later losses.NASAA Statement of Policy, Dishonest or Unethical Business Practices of Broker-Dealers and Agents §1.c

A customer tells her agent: "Buy 500 shares of XYZ for me this week, whenever you judge the price is best." The customer has signed no discretionary authorization. How should the agent's handling be viewed?

• a.Acceptable, but only after the agent's supervisor has approved the arrangement in writing the same day
• b.Acceptable, because the discretion covers only the time and price at which the customer's own order is executed✓
• c.A violation, because discretion over price requires written authority even where time is left to the customer
• d.A violation, because any discretion over an account requires written authority signed before the first order

Written discretionary authority is required unless the discretionary power relates solely to the time and/or price for executing orders. Here the customer chose the security and quantity, so the agent exercises only timing and price discretion. A supervisor's approval is not the test.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.g

Last week a customer mentioned to her agent that she liked ABC Corp. Today, while she is traveling and unreachable, the agent buys 200 shares of ABC in her account. The stock rises that afternoon. How is the purchase classified?

• a.A prohibited practice, because the trade was executed without the customer's authorization, whatever the later gain✓
• b.A prohibited practice only if the customer files a written complaint within 30 days after the trade date
• c.A permitted practice, because a trade that proves profitable to the customer is treated as ratified by the result
• d.A permitted practice, because the customer had already expressed interest in the stock and its price has since risen

Executing a transaction for a customer without authorization is on the list of dishonest or unethical practices. Expressed interest is not authority, and a profit does not retroactively cure the violation. Nothing makes it depend on a customer complaint.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.f

A broker-dealer opens a margin account for a new customer and executes the first purchase on margin. What does the policy require regarding the margin agreement?

• a.A written margin agreement is needed only when the customer's debit balance first exceeds $2,000 in the account
• b.A properly executed written margin agreement must be secured from the customer promptly after the initial transaction✓
• c.A written margin agreement must be filed with the Administrator within 30 days after the account is opened
• d.A written margin agreement is needed only if the customer asks for one, since oral approval otherwise suffices

Executing transactions in a margin account without securing a properly executed written margin agreement promptly after the initial transaction is a listed practice. The requirement is not triggered by a dollar threshold or by a customer's request, and it is a firm record, not an Administrator filing.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.h

A broker-dealer pledges a customer's fully paid securities as collateral for its own bank loan. The firm has no lien on the securities and the customer never signed anything about pledging them. How should this be viewed?

• a.A prohibited practice only if the pledge is for an amount greater than the customer's account equity
• b.A prohibited practice, since hypothecation without a lien requires the customer's written consent✓
• c.A permitted practice, since a custodian of a customer's securities may pledge them to finance its own business
• d.A permitted practice, provided the firm sends the customer an oral notice after the loan closes

A broker-dealer may not hypothecate a customer's securities without a lien on them unless it obtains the customer's properly executed written consent promptly after the initial transaction (subject to SEC rules). Oral notice does not substitute, and the violation does not depend on how large the pledge is.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.j

A broker-dealer holds customers' fully paid securities in safekeeping and mixes them with its own inventory in a single account. What is the status of this practice?

• a.It is acceptable, because the firm's books show which customer owns each position in the combined account at all times
• b.It is a violation only if the firm is later unable to deliver the securities to a customer on request
• c.It is acceptable, provided each customer has received a written notice that the securities are commingled
• d.It is a dishonest or unethical practice, because free securities and securities in safekeeping must be segregated✓

Failing to segregate customers' free securities or securities held in safekeeping is a listed practice. Bookkeeping, a notice to customers, or the lack of an actual loss does not cure commingling, because the violation is the failure to segregate, not a resulting loss.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.i

To win an account, an agent promises a prospect in writing, "If you lose money on any trade I recommend, I will make up the difference from my own funds." How should the promise be viewed?

• a.It is prohibited only if the guarantee is relied on and the customer then actually sustains a loss
• b.It is permitted, because the agent is promising to pay the loss personally and the firm has no exposure
• c.It is prohibited, because guaranteeing a customer against loss in any account or transaction is a listed practice✓
• d.It is permitted, provided the guarantee is in writing and is signed by the agent's supervising principal

Guaranteeing a customer against loss is a listed practice, and an agent is bound by it through the cross-reference in the agents' section. A personal promise, a principal's signature, or the absence of a loss changes nothing, because the guarantee itself is the violation.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.q

An agent borrows $5,000 from a long-time customer, signing a promissory note that bears interest at the prevailing bank rate. How does the policy treat the loan?

• a.It is permitted, provided the agent discloses the loan in writing to the supervising principal within five days
• b.It is prohibited only if the customer's account is discretionary or the loan exceeds 10% of the account
• c.It is permitted, because the written note and market-rate interest make it an arm's-length commercial transaction
• d.It is a prohibited practice, because an agent may not lend or borrow money or securities from a customer✓

Lending or borrowing money or securities from a customer is a listed practice for agents, and the policy lists no exception for notes or market interest. Disclosure to a supervisor does not legitimize it, and the ban does not depend on discretion or on the loan's size.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 2.a

A customer who will be abroad for two months hands her agent a signed stock power and asks him to keep it in his desk "just for convenience." What is the agent's proper course?

• a.Accept it, but only if the broker-dealer's principal is told and keeps a copy of the stock power on file
• b.Decline, because acting as custodian for a customer's executed stock power is itself a prohibited practice✓
• c.Accept it, provided he gives the customer a signed receipt and locks the document in the firm's vault until she returns
• d.Accept it, because the customer, not the agent, initiated the arrangement and it plainly benefits her while she is abroad

Acting as a custodian for a customer's money, securities or an executed stock power is a listed agent practice. The customer's initiative, a receipt, or a vault does not turn it into an acceptable arrangement.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 2.a

An agent sells a customer shares in a friend's private company. The sale does not pass through his broker-dealer, which has no record of it and was never asked about it. How should it be classified?

• a.A permitted practice, since the agent received no commission from the broker-dealer on the transaction in question
• b.A permitted practice, if the agent notifies the broker-dealer in writing within 30 days after the sale occurred
• c.A prohibited practice only if the customer is a retail investor whose annual income is under $200,000 per year
• d.A prohibited practice, unless the broker-dealer authorized the transaction in writing before it was executed✓

Effecting transactions not recorded on the regular books or records of the broker-dealer the agent represents is prohibited unless the firm authorized it in writing before execution. After-the-fact notice and the lack of a commission do not qualify, and customer income is not a factor.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 2.b

An agent proposes to a customer that he receive 20% of the profits in her account in exchange for his picking the trades. Under what condition would this arrangement avoid being a prohibited practice?

• a.The agent must reduce his share to 10% and report the arrangement quarterly to the Administrator
• b.The customer must provide written authorization, and the agent's supervising principal must approve orally
• c.Both the customer and the broker-dealer that the agent represents must give written authorization✓
• d.The broker-dealer must approve it in writing, and the customer need only be told of it orally

Sharing directly or indirectly in the profits or losses in a customer's account is prohibited without the written authorization of both the customer and the broker-dealer. An oral approval from either side, or a smaller percentage, is insufficient.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 2.d

An agent receives a $1,000 commission. With which person may he lawfully split it?

• a.A certified public accountant who referred the customer but who is not registered as an agent
• b.A friend who is registered as an agent with a broker-dealer that is unaffiliated with the agent's firm
• c.His spouse, who is not registered but did much of the research that led the customer to invest
• d.Another agent who is registered for the same broker-dealer or for one under common control✓

An agent may divide compensation only with a person who is also registered as an agent for the same broker-dealer, or for a broker-dealer under direct or indirect common control. A referral source, an agent at an unrelated firm, or a family member who is not registered cannot share in the commission.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 2.e

A conservative retiree has a $20,000 account. In six months her agent executes 90 trades, each in a suitable security, generating $9,000 in commissions. What is the best description of the agent's conduct?

• a.A prohibited practice only if the trading produced a net loss in the account over the full six months
• b.A permissible practice, because the retiree never objected to any of the confirmations or monthly statements she received
• c.Inducing trading excessive in size or frequency for the account's resources, even though each trade was suitable✓
• d.A permissible practice, provided each trade was suitable and each was confirmed to the customer promptly

Inducing trading that is excessive in size or frequency relative to the account's financial resources and character is a listed practice. Individually suitable trades can still add up to churning, and silence or the absence of an overall loss does not make the pattern acceptable.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.b

Without asking about her income, savings or objectives, an agent recommends that a retired customer put most of her savings in speculative options strategies. Which listed practice is most directly implicated?

• a.Recommending a transaction without reasonable grounds to believe it suits the customer after reasonable inquiry✓
• b.Failing to segregate the customer's securities, because the strategy involves moving positions between accounts
• c.Entering a discretionary transaction without written authority, because the agent chose the strategy for her
• d.Guaranteeing against loss, because speculative strategies implicitly promise the customer a return

Recommending a security or strategy without reasonable grounds to believe it is suitable, after reasonable inquiry into objectives, financial situation and needs, is the listed practice. A recommendation is not a discretionary trade, and nothing here involves segregation or a guarantee.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.c

An agent registered only as a broker-dealer agent prints business cards reading "Senior Financial Advisor." He holds no investment adviser or IAR registration. How should the title be treated?

• a.Prohibited, since using a form of "adviser" or "advisor" without adviser licensure is a listed practice✓
• b.Permitted, because holding an agent registration entitles him to use any title that suggests financial expertise
• c.Permitted, if a disclaimer in small print on the card states that he is not an investment adviser
• d.Prohibited only if he actually charges an advisory fee separate from the commissions on the account

Using a title, credential or designation containing a variant of "adviser" or "advisor" without licensure as an investment adviser or IAR is a listed practice, unless otherwise permitted by law. A disclaimer or the absence of a separate fee does not cure it.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.e

A broker-dealer sells a customer 100 shares from its own inventory at 12% above the price at which the stock is trading in the market, with no explanation. Which listed practice is implicated?

• a.Executing a transaction without the customer's authorization, since the price was not agreed in advance
• b.Representing that a security is offered at the market when the only market is the firm's own quotes
• c.Entering into a transaction at a price not reasonably related to the current market price✓
• d.Failing to make a bona fide public offering of the securities allotted to the firm for distribution

Dealing with a customer at a price not reasonably related to the current market price, or taking an unreasonable commission or profit, is the listed practice. The facts do not involve an underwriting allotment, a market the firm itself creates, or an unauthorized trade.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.k

Shares in a new public offering are sold to a customer through a broker-dealer. What delivery deadline does the policy set for the final prospectus, or for a preliminary prospectus plus a supplemental document carrying the final information?

• a.No later than the due date of the confirmation of the transaction✓
• b.Only when the customer requests it in writing after the transaction
• c.No later than the day the offering is declared effective by the SEC
• d.Within thirty days after the settlement date of the transaction

The listed practice is failing to furnish a final prospectus (or a preliminary prospectus plus an additional document) to a customer purchasing in an offering no later than the due date of the confirmation. A 30-day period or a request requirement is later or conditional, and the effective date is not the measuring point.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.l

A broker-dealer advertises that it will buy 1,000 shares of XYZ at $20. When a customer calls to sell 500 shares at $20, the firm declines. Which listed practice is implicated?

• a.Offering to buy at a stated price without being prepared to buy at that price and on the stated conditions✓
• b.Using advertising that is deceptive because it relies on unfounded or unrealistic claims about expected returns
• c.Publishing a report of a purchase or sale that the firm does not believe was a bona fide transaction
• d.Charging unreasonable fees for services such as safekeeping, collection of dividends or transfer

A broker-dealer that offers to buy or sell at a stated price must be prepared to trade at that price and on the stated conditions. Declining a 500-share order within the advertised 1,000 shares is the violation. The other practices concern return claims, fictitious reports, and service fees.NASAA Statement of Policy on Dishonest or Unethical Business Practices of Broker-Dealers and Agents 1.n