NASAA Series 63 — All Questions

Registration by coordination becomes effective simultaneously with the federal registration if certain conditions are met, including that:

• a.The Administrator has completed a merit review and found the offering fair, just, and equitable, as every state registration requires
• b.The offering is made entirely to residents of the state, because coordination is available only to issuers that sell within one state
• c.The issuer has filed under the Securities Exchange Act of 1934 and has been a reporting company for at least five years
• d.No stop order is in effect, no proceeding is pending, and the statement has been on file the required period with the required pricing information✓

Registration by coordination becomes effective automatically at the moment the federal registration statement becomes effective if no stop order is in effect, no proceeding is pending, the state statement has been on file at least ten days, and the maximum and minimum offering prices and maximum underwriting discounts have been on file for two full business days. No merit approval is needed for this to occur, coordination is for offerings federally registered under the 1933 Act (not limited to one state), and there is no operating-history or 1934 Act reporting requirement.Uniform Securities Act (1956) §303(c)

Which of the following is a 'federal covered security' whose registration a state may NOT require?

• a.An intrastate offering by a local bakery
• b.Common stock listed on the New York Stock Exchange✓
• c.A limited partnership interest sold only in one state
• d.Unregistered stock of a private start-up

Securities listed (or senior to securities listed) on the NYSE, Nasdaq, and other qualifying markets are federal covered under NSMIA; states may require only a notice filing and fees, not registration (NSMIA §18; USA §401 'federal covered security').

Securities sold under SEC Rule 506 of Regulation D are:

• a.Exempt securities, so the state may require no filing, fee or consent to service
• b.Federal covered securities, but the state may still require registration by coordination if the offering reaches more than ten residents
• c.Required to be registered by qualification unless sold only to accredited investors
• d.Federal covered securities; a state may require a notice filing and fee but not registration✓

Securities sold in compliance with SEC rules issued under the Section 4(a)(2) private-offering exemption, which include Rule 506, are federal covered securities. A state may require a notice filing (a copy of Form D), a consent to service of process and a fee, but not registration at any investor count, and it retains its antifraud authority. They are not exempt from every state filing and are not exempt from the antifraud provisions.Securities Act §18(b)(4)(F), (c)(1), 15 U.S.C. §77r

A general obligation bond issued by a county to build a courthouse is:

• a.An exempt transaction rather than an exempt security, so the sale needs its own exemption
• b.An exempt security, because obligations of a state or its political subdivisions are exempt✓
• c.A security that must be registered by notification, because only bonds issued by the state itself, not its counties, are exempt
• d.A federal covered security regulated only by notice filing

Securities issued by a state or any of its political subdivisions, a county included, are exempt securities, and the exemption attaches to the instrument itself. It is not merely an exempt transaction, the exemption is not limited to the state itself, and a municipal bond is not a federal covered security that is subject to a notice filing in the issuer's own state: federal law treats these bonds as exempt securities rather than covered securities there.Uniform Securities Act (1956) §402(a)(1); 15 U.S.C. §77r(b)(4)(E)

Under the Uniform Securities Act, securities issued by a foreign national government are exempt securities when:

• a.The issuer belongs to the United Nations
• b.The bonds are U.S. dollar-denominated and investment-grade rated
• c.The United States maintains diplomatic relations with that foreign government✓
• d.The foreign government's own securities regulator has approved the offering for sale in that country

The exemption covers securities issued or guaranteed by a foreign government with which the United States currently maintains diplomatic relations, provided the issuer or guarantor recognizes the security as a valid obligation. UN membership, the currency of the bonds, a credit rating, or approval by a foreign regulator does not decide the exemption.Uniform Securities Act (1956) §402(a)(2)

Which of the following is an exempt security under the Uniform Securities Act?

• a.Commercial paper issued for current transactions that matures in twelve months
• b.Stock of a start-up that has applied for, but not yet received, a national exchange listing
• c.A shopping-center partnership interest that is sold by a bank
• d.Securities of a public utility or common carrier regulated as to rates by a governmental authority✓

Securities of a railroad, common carrier or public utility regulated as to rates and charges by a governmental authority are exempt securities. Commercial paper is exempt only with a maturity of nine months or less, a security merely applied for listing is not exempt until it is listed or approved for listing, and the bank exemption covers securities issued or guaranteed by a bank, not securities a bank merely sells.Uniform Securities Act (1956) §402(a)(7)

Common stock issued by an insurance company organized under the laws of a U.S. state and authorized to do business there is:

• a.A security exempt only if it is also listed on a national securities exchange
• b.An exempt transaction, so each sale qualifies separately
• c.An exempt security under the Uniform Securities Act✓
• d.Required to be registered by notification, because only the company's policies are exempt

Securities issued by, representing an interest in, or guaranteed by an insurance company organized under state law and authorized to do business in the state are exempt securities; variable annuities whose payments depend on a segregated fund are the exception. The exemption does not depend on an exchange listing, it attaches to the security rather than to a particular sale, and it covers the company's securities, not just its policies.Uniform Securities Act (1956) §402(a)(5)

A non-issuer transaction in an outstanding security is exempt when the security and current issuer information appear in a recognized securities manual such as Standard & Poor's or Moody's. This is commonly called the:

• a.Isolated issuer exemption
• b.Commercial paper exemption
• c.Manual (secondary-trading) exemption✓
• d.Private placement exemption, assuming the applicant has satisfied the net worth, surety bonding, and qualification-examination conditions the Administrator may impose

Many states exempt non-issuer transactions in securities listed in a recognized securities manual with current published financial information—the 'manual exemption' (USA §402(b) non-issuer transactions; NASAA).

An issuer distributes additional shares to its existing shareholders through a rights offering, paying no commission for soliciting the exercise. This is most likely:

• a.A transaction requiring registration, because an offer to existing holders is still an offer to the public
• b.An exempt transaction (a transaction with existing security holders)✓
• c.An exempt security, because stock issued to current shareholders is exempt from registration in every state
• d.Exempt only if the issuer files a notice and the Administrator does not disallow it within thirty days, even when no commission is paid

An offer to existing security holders, including holders of rights, warrants or convertible securities, is an exempt transaction when no commission (other than a standby commission) is paid for soliciting them. The shares remain non-exempt securities, so the exemption is for the transaction rather than for the security. No notice or waiting period is required when no commission is paid, and the offer is not treated as a public offering needing registration.Uniform Securities Act (1956) §402(b)(11)

A bank sells stock it holds as collateral after the borrower defaults, in a bona fide effort to liquidate the pledged collateral. This sale is:

• a.A non-exempt distribution, because a lender selling collateral is treated as an underwriter of the securities
• b.An exempt transaction (a bona fide pledgee liquidating collateral)✓
• c.An exempt security, because securities held by a bank as collateral take on the bank's exemption
• d.An issuer transaction that is exempt only if the borrower consents in writing to the sale

A transaction executed by a bona fide pledgee, without any purpose of evading the Act, is an exempt transaction. The pledgee is not an underwriter, the collateral does not become an exempt security because a bank holds it, and the sale is not an issuer transaction requiring the borrower's consent.Uniform Securities Act (1956) §402(b)(7)

An unregistered corporate bond is sold only to insurance companies, banks, and registered investment companies. The sale is:

• a.Exempt only if the bond was first registered under the Securities Act of 1933
• b.An exempt transaction, because sales to institutional and financial buyers are exempt regardless of their number✓
• c.Prohibited, since the institutional-buyer exemption covers only exempt securities
• d.Exempt only if no more than ten institutions buy within twelve consecutive months

A sale to banks, insurance companies, investment companies and other institutional buyers is an exempt transaction regardless of the number of buyers, so the unregistered bond can be sold to them. The ten-offeree limit belongs to the separate private-placement exemption for non-institutional offerees, federal registration is not a condition, and the exemption does not depend on the bond being an exempt security.Uniform Securities Act (1956) §402(b)(8)

Under the Uniform Securities Act's private-placement exemption, the limit applies to the number of:

• a.States in which the offering is made, provided the firm files the required consent to service of process and the Administrator does not enter an order to the contrary
• b.Shares that may be sold
• c.Non-institutional persons to whom offers are directed in a 12-month period (offerees), excluding institutions✓
• d.Purchasers who actually buy

The exemption caps offers to non-institutional persons (commonly ten) in any 12 consecutive months; offers to institutions are not counted, and the cap is on offerees, not purchasers (USA §402(b)(9) limited-offering exemption).

The Administrator may enter a stop order denying, suspending, or revoking the effectiveness of a securities registration statement when:

• a.A risky or speculative offering is proposed, since the Administrator must stop any security that could lose investors money
• b.The statement is incomplete or misleading, or the offering would work a fraud, after notice and an opportunity for a hearing✓
• c.A competing issuer or any investor files a written protest, and the Administrator then must suspend the registration pending the outcome
• d.The issuer's stock price has fallen well below the offering price, since investors then hold securities worth less than they paid

The Administrator may issue a stop order if it is in the public interest and the registration statement is incomplete or misleading in a material respect, the offering would work or tend to work a fraud, or other statutory grounds are met, and only after notice, an opportunity for a hearing and written findings. Speculative risk alone, a competitor or investor protest, and a later price decline are not grounds for a stop order.Uniform Securities Act (1956) §306(a), (c)

A securities registration statement in a state is generally effective for:

• a.The entire life of the securities, with no renewal requirement
• b.One year from its effective date, and may be renewed for a continuing offering✓
• c.Thirty days, after which a new statement must be filed
• d.Three years from its effective date, the same term as a federal shelf registration

A state registration statement is effective for one year from its effective date, or longer while the security is still being offered or distributed in a non-exempt transaction. It does not last for the life of the security, it is not a thirty-day registration, and the three-year shelf term is a federal concept.Uniform Securities Act (1956) §305(i)

A purely intrastate offering that is not registered with the SEC would be registered in the state by:

• a.Coordination
• b.Notice filing
• c.Notification
• d.Qualification✓

Qualification is the method for offerings with no federal registration, including intrastate deals; coordination requires a concurrent federal (Securities Act of 1933) filing (USA §304).

For an offering sold in the state under Rule 506 (a federal covered security), the Administrator may require the issuer to file:

• a.Nothing, because Rule 506 offerings are preempted from every state requirement
• b.A surety bond of up to $10,000 posted by the issuer
• c.A notice filing (a copy of the SEC Form D) with a consent to service of process and a fee✓
• d.A full registration statement by qualification, because preemption covers only offerings sold by SEC-registered broker-dealers

For a Rule 506 offering the state may require a notice filing (a copy of Form D), a consent to service of process, and a fee, but not registration. Preemption is not total, so the state is not limited to nothing at all; it does not turn on the type of broker-dealer; and the surety-bond power applies to registered broker-dealers, not to issuers of covered securities.Securities Act §18(b)(4)(F), 15 U.S.C. §77r(b)(4)(F)

The key difference between an 'exempt security' and an 'exempt transaction' is that:

• a.Only exempt securities remain subject to the antifraud provisions, while an exempt transaction is excused from every provision of the Act once the Administrator is notified
• b.An exempt security's exemption depends on the circumstances of the particular sale, while an exempt transaction's exemption attaches to the instrument in any later sale
• c.An exempt security loses its exemption the first time it is resold, while an exempt transaction keeps its exemption for every later resale by any holder
• d.An exempt security's exemption attaches to the instrument in any sale, while an exempt transaction's exemption depends on the circumstances of the particular sale✓

An exempt security is exempt in any sale because the exemption attaches to the instrument, while an exempt transaction is exempt only because of the circumstances of that sale. The two are not reversed, an exempt security does not lose its status on resale, and neither exemption reaches the antifraud provisions, so both remain subject to them.Uniform Securities Act (1956) §402(a), (b)

An investment contract issued in connection with an employees' pension or profit-sharing plan is:

• a.An exempt security under the Uniform Securities Act✓
• b.Always a prohibited security
• c.A federal covered security requiring a notice filing
• d.Required to be registered by coordination

The Act exempts investment contracts issued in connection with an employees' stock purchase, savings, pension, or profit-sharing plan (USA §402(a)(11)).

Which of the following is most likely an 'isolated non-issuer transaction' exempt under the Uniform Securities Act?

• a.An issuer's one-time sale of newly issued shares to a single buyer, because a sale that occurs only once is isolated
• b.A controlling shareholder's sales of large blocks every month for a year, because each sale is made by a non-issuer
• c.An individual's one-time private sale of stock she owns to a single buyer, not part of a repeated pattern and not through a dealer✓
• d.A broker-dealer's ongoing secondary-market trading for many customers, because every individual trade is a non-issuer transaction

An isolated non-issuer transaction is a one-off resale by a holder who is not the issuer. An issuer's own sale is an issuer transaction, however rarely it occurs; repeated sales of large blocks or a dealer's continuous trading are not isolated, even though the seller is a non-issuer.Uniform Securities Act (1956) §402(b)(1)

A court-appointed conservator sells securities from the estate of an incapacitated person to pay for the person's care. This sale is:

• a.A prohibited transaction unless the conservator first registers as an agent of the estate and obtains the Administrator's consent
• b.An exempt transaction, because sales by fiduciaries such as conservators, executors, receivers, and trustees in bankruptcy are exempt✓
• c.An exempt transaction only if the conservator is also a registered agent, since the fiduciary exemption is limited to licensed persons
• d.An exempt non-issuer distribution, available only if a recognized securities manual lists the issuer's officers, directors, and a recent balance sheet

A transaction by an executor, administrator, sheriff, marshal, receiver, trustee in bankruptcy, guardian or conservator is an exempt transaction. The exemption does not require the conservator to register or be licensed, it is not the manual-based non-issuer distribution exemption with its own conditions, and the sale is not prohibited or an issuer transaction.Uniform Securities Act (1956) §402(b)(6)

As a condition of registering a speculative offering by qualification, the Administrator may require that:

• a.The offering be insured against investor loss through a state guaranty fund as a precondition to registration by qualification
• b.The underwriter enter a firm commitment to purchase every unsold share at the offering price when the offering period ends
• c.The proceeds be impounded (escrowed) until a specified minimum is raised, and may prescribe the form of subscription✓
• d.The issuer guarantee a minimum return and repurchase shares at the offering price at the request of any investor

For registration by qualification or coordination the Administrator may require that securities issued to promoters or for non-cash consideration be escrowed, that proceeds be impounded until the issuer receives a specified amount, and that the securities be sold on a specified form of subscription or sale contract. It may not require state insurance, an underwriter buy-back or a return guarantee.Uniform Securities Act (1956) §305(g), (h)

An agent tells a client that a low-priced speculative stock 'cannot lose money because it has nowhere to go but up.' This statement is:

• a.A violation only if the customer actually loses money on the purchase and then files a complaint
• b.Permissible opinion, because predictions about price movement are never statements of fact
• c.Acceptable if the stock is registered in the state, since registration shows the Administrator reviewed the risk
• d.A prohibited misrepresentation of the risk of the investment✓

Telling a customer a speculative stock cannot lose misstates a material fact about its risk and is prohibited, not mere sales enthusiasm. The violation is complete when the statement is made, so it does not depend on a later loss or complaint, and registration does not make it acceptable because the Administrator does not pass on the merits or risk of a registered security.Uniform Securities Act (1956) §101

An agent assures a prospect that a mutual fund 'will earn at least 12% per year, just like it did last year.' This is:

• a.Acceptable, because the historical return is verifiable in the fund's reports
• b.Acceptable if the agent also delivers the current prospectus
• c.Acceptable if the customer is an institutional or accredited investor who can evaluate such a claim
• d.A prohibited practice, because it guarantees or predicts specific future investment results✓

Promising that a fund will earn a specific return, or implying that past performance assures future results, misrepresents the investment even when the past figure is accurate. Delivering a prospectus or dealing with a sophisticated investor does not cure a guarantee of future results.Uniform Securities Act (1956) §101

To close a sale, an agent tells a customer 'this stock is certain to be listed on the New York Stock Exchange next month,' although no listing has been approved. This is:

• a.Acceptable if the issuer says it intends to apply for that listing
• b.Acceptable because listing applications are public record, so the customer can verify the claim independently
• c.A violation only if the stock is never listed
• d.A prohibited misrepresentation, because it states an uncertain future event as a certainty✓

Stating that a security will be listed when no listing has been approved presents an uncertain future event as a certainty, which is a misrepresentation of a material fact when it is made. An issuer's hopes or intentions, the public nature of listing records, and the later outcome do not change that.Uniform Securities Act (1956) §101

An agent tells clients that because his firm and its securities are registered in the state, 'the state stands behind these investments.' This is:

• a.Accurate only for exempt securities, since the state has reviewed the issuer when an exemption applies
• b.Unlawful, because it is prohibited to represent that registration means the Administrator has approved or guaranteed the securities✓
• c.Accurate if registered by qualification, since the Administrator reviews the offering's merits first
• d.Acceptable if the agent adds a written warning that the securities may lose value

Registration of a firm or a security, or the availability of an exemption, does not mean the Administrator has passed on the merits or approved or guaranteed anything, and it is unlawful to represent otherwise to a customer. Even a security registered by qualification is not backed by the state, the statement is not accurate for exempt securities, and a risk warning cannot cure a representation the Act prohibits.Uniform Securities Act (1956) §405(a), (b)

An agent recommends the same speculative stock to every client in his book, regardless of their differing objectives and finances. This practice is:

• a.Acceptable because each client remains free to decline the recommendation and make the final decision
• b.Prohibited, because a blanket recommendation disregards individual suitability✓
• c.Acceptable as long as the stock is registered and a prospectus is delivered with each recommendation
• d.Acceptable if the agent discloses in writing that the same recommendation is being made to all clients

Recommending the same speculative security to every client without regard to their individual objectives and finances is an unethical practice because it disregards suitability. A client's freedom to decline, registration of the security, delivery of a prospectus, and a disclosure of the blanket approach do not satisfy the agent's duty to match the recommendation to each client.

An agent recommends an unregistered stock to a customer, then marks the order ticket 'unsolicited' so the trade appears exempt. This is:

• a.Acceptable, because once the customer agrees to buy, the order is treated as customer-initiated and the ticket marking only records that fact
• b.Only a suitability problem, because the stock's registration status is the issue and ticket labels are an internal matter for the firm to police
• c.A prohibited falsification that both misstates records and improperly claims a transaction exemption✓
• d.Acceptable if a supervisor initials the ticket afterward and the customer receives a confirmation showing the unsolicited designation

Marking a recommended order 'unsolicited' falsifies the firm's records and manufactures an exemption that does not apply. The customer's agreement to buy does not make a recommended trade unsolicited, a supervisor's initials or a confirmation cannot cure a false record, and the false marking is a violation of its own, separate from any suitability question about the stock.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (conduct-not-inclusive clause; 2.b)

In selling a bond, an agent omits that it is callable at par next year even though it is trading at a premium. The omission is:

• a.Acceptable, because the call provision is disclosed in the indenture and prospectus, which the customer can read before the trade settles
• b.A prohibited omission of a material fact, because a near-term call materially affects yield and return✓
• c.A violation only if the bond is actually called before maturity and the customer loses part of the premium paid
• d.Acceptable if the agent quotes the coupon rate and current yield accurately, since yield to call need not be mentioned

A near-term call at par on a bond trading at a premium is material to yield and return. Pointing to the indenture or prospectus does not excuse an incomplete sales presentation, the violation is the misleading omission at the time of the sale rather than a later call, and accurate coupon and current-yield figures do not cure leaving out the call that cuts the real return.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (conduct-not-inclusive clause: nondisclosure or incomplete disclosure)

An adviser with discretion over a moderate-growth account trades it so frequently that commissions and costs consume much of the return, out of proportion to the client's objectives. This is:

• a.Churning, an excessive-trading violation judged against the client's objectives and resources✓
• b.Acceptable, because the client granted written discretion and the adviser's authority covers every transaction it places in the account
• c.A violation only if the adviser is paid per-trade commissions, since trading costs borne by a fee-paying client are outside the rule
• d.Acceptable active management, because discretion lets the adviser set the trading frequency so long as the account stays within its risk level

Inducing trading that is excessive in size or frequency in view of the client's financial resources, investment objectives and the character of the account is churning, an unethical practice. Written discretion gives authority to trade but not to over-trade, the rule is not limited to commission accounts because costs of any kind erode the client's return, and staying within a risk level does not make the volume of trading reasonable.NASAA Model Rule 102(a)(4)-1(c)

Knowing his firm is about to publish a strong buy recommendation on a stock, an agent first buys call options on it for his own account. This is:

• a.Only a violation of the firm's personal-trading policy, since the trade was in the agent's own account and used no customer money
• b.Acceptable, because options are separate securities from the underlying stock and the firm's recommendation is not yet a customer order
• c.Acceptable if the position is small relative to the agent's account and is closed out within the same trading day
• d.Front-running, a prohibited misuse of knowledge of an imminent firm action✓

Trading ahead of a coming firm recommendation to profit from the expected price move is front-running, a misuse of knowledge of an imminent firm action. It does not matter that the instrument is a call option instead of the stock, that the account is the agent's own, or that the position is small or short-lived. It breaches the standard of commercial honor and just and equitable principles of trade.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (high standards of commercial honor and just and equitable principles of trade)

An agent sells promissory notes of a friend's business to several firm customers without notifying his broker-dealer, keeping the commissions. This is:

• a.Permitted, because a note issued by a friend's small business is not a security and so never has to go through the firm
• b.Permitted if each customer is told in writing that the notes are not a product of the broker-dealer and are sold outside the firm
• c.A recordkeeping issue only, because the notes were sold outside the firm but no customer lost money or filed a complaint
• d.Selling away, a prohibited private securities transaction outside the firm's supervision✓

Effecting securities transactions that are not recorded on the broker-dealer's regular books, without the firm's prior written authorization, is selling away. A note can be a security, telling customers the product is outside the firm does not replace the firm's approval and supervision, and the violation exists whether or not any customer is harmed, so it is far more than a recordkeeping lapse.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (2.b)

A customer gives an agent a check payable to the firm; the agent deposits it into his own bank account, intending to forward the money later. This is:

• a.Acceptable if the agent forwards the check to the firm within 30 days and keeps a written record of the deposit
• b.Prohibited commingling and improper handling of customer funds✓
• c.Acceptable because the check is payable to the firm and the agent will remit it, so no customer property is misused
• d.Only a minor timing issue, because the customer's order is still executed once the money reaches the firm

Customer funds must be turned over to the firm promptly and may never pass through an agent's personal account. Depositing the check there is commingling and improper handling of customer money, however soon the agent means to forward it. Neither a 30-day grace period nor good intentions nor the check's payee line changes that, and the violation is not merely one of timing.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (2.a)

An agent borrows $5,000 from a customer who is also his mother, and the firm's written procedures permit borrowing from immediate family. This is:

• a.Prohibited under all circumstances
• b.Permitted only if the loan exceeds $10,000
• c.Permitted only with the Administrator's approval, on the view that the relevant exemption stays available to the party unless and until the Administrator revokes it by a formal order
• d.Generally permissible, because borrowing from an immediate family member is a recognized exception when firm procedures allow it✓

Borrowing from customers is prohibited except in narrow cases—the customer is in the lending business or is an immediate family member—and only where firm procedures permit; a parent qualifies here (NASAA unethical practices – borrowing/lending).

An agent lends his own money to an unrelated retail customer so the customer can buy more securities. This is:

• a.Prohibited, because lending to a customer creates a conflict of interest outside the narrow exceptions✓
• b.Permitted if the customer repays with interest, because a loan at a market rate is an arm's-length transaction rather than a conflict
• c.Permitted if the customer signs a promissory note and the loan terms are at least as favorable to the customer as a bank loan
• d.Permitted because it is the agent's own money rather than the firm's, and the loan is not secured by the customer's securities

The model rules bar an agent from lending money to a customer, and the adviser version allows loans to clients only by a financial institution in the lending business or to an affiliate. Charging interest, signing a note, using one's own funds or taking no collateral does not remove the conflict of interest created when the person advising the customer is also the customer's lender.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (2.a)

An investment adviser representative wants to share directly in the profits and losses of 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
• c.Freely permitted with only the client's oral consent, provided the customer is furnished the required written confirmation and the details are recorded on the books the firm must maintain
• d.Permitted for any client who signs a waiver

Unlike a broker-dealer agent, who may share proportionately with written consent of the customer and firm, an adviser's compensation from account performance is governed by the performance-fee rules and limited to qualified clients meeting net-worth or AUM thresholds (NASAA – performance fees; sharing in accounts).

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

• a.Permitted up to $100 per referral
• b.Permitted because it is a flat fee rather than a commission, a conclusion the NASAA model rules are commonly understood to support for a person already registered and in good standing elsewhere
• 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

Paying securities-related compensation to an unregistered person for soliciting or referring brokerage business is prohibited; the flat-fee label and tax reporting do not save it (USA §201; NASAA).

A state-registered investment adviser pays cash referral fees to a third-party solicitor. Under NASAA rules, permissible conditions include all of the following EXCEPT:

• a.The solicitation must be approved in advance by the Administrator for each client✓
• b.Written disclosure to the client of the solicitor's compensation, so long as written notice describing the arrangement is delivered to the Administrator within the time fixed by rule for that category
• c.A written agreement between the adviser and the solicitor
• d.The solicitor is not subject to a statutory disqualification

Cash solicitation requires a written agreement, written disclosure of the arrangement to the client, and that the solicitor not be disqualified—but not case-by-case Administrator pre-approval (NASAA/Advisers Act solicitor rule).

Under the NASAA custody rule, an adviser with custody must arrange for client funds and securities to be verified by:

• a.The client's personal accountant only
• b.The adviser's own internal staff each quarter, provided the firm files the required consent to service of process and the Administrator does not enter an order to the contrary
• c.The Administrator on a monthly basis
• d.An independent public accountant through a surprise examination at least annually✓

The custody rule requires an annual surprise verification of client assets by an independent accountant, in addition to using a qualified custodian, notifying the Administrator, and sending account statements (NASAA custody rule).

A state-registered adviser with custody must ensure account statements are sent to clients:

• a.At least quarterly, identifying the funds and securities in custody and the account activity✓
• b.Never, in order to protect confidentiality, since the Administrator generally treats this as a routine matter resolved through the state's ordinary coordination procedures
• c.Only when the client requests them
• d.Only once a year

Under the custody rule, a qualified custodian (or the adviser) must send account statements to clients at least quarterly, identifying the assets held and the transactions in the account (NASAA custody rule).

A client terminates an advisory contract midway through a prepaid annual period. Under NASAA rules, the adviser's contract should provide that:

• a.Refunds of prepaid fees require the Administrator's prior approval and are limited to terminations within the first 30 days
• b.The client owes the full annual fee, because advisory fees are earned when the contract is signed rather than as services are rendered
• c.Any prepaid but unearned fee will be refunded to the client on a pro-rata basis✓
• d.The client receives back only the amount above the first quarter's fee, with the first quarter retained as an early-termination charge

The model rule requires an advisory contract to disclose the amount of any prepaid fee that will be returned if the contract is terminated or not performed; the accepted standard is a pro-rata refund of the unearned portion. Advisory fees are earned as services are rendered, so a client is not charged the whole year or a fixed termination charge, and no Administrator approval is needed for the refund.NASAA Model Rule 102(a)(4)-1(p)

Under NASAA rules, a performance-based advisory fee may generally be charged only to a client meeting net-worth or assets-under-management thresholds. This restriction exists because performance fees:

• a.Create an incentive for the adviser to take greater risk, so eligibility is limited to clients able to bear it✓
• b.Are illegal for every client of a state-registered adviser, because Section 102(c)(1) of the 1956 Act contains no exception for qualified clients
• c.Are charged on unrealized appreciation only, so the thresholds are meant to ensure the client can absorb a later reversal of paper gains
• d.Always cost the client more than a flat asset-based fee, so the thresholds screen out clients who could not afford the higher cost

A fee based on a share of capital gains can push the adviser toward riskier or more speculative investments, so the model rule allows it only for qualified clients and requires written disclosure of that incentive. Section 102(c)(1) does prohibit such fees in general, but Rule 102(f)-3 provides the exemption. They are not limited to unrealized gains, and they do not always cost more than a flat fee.NASAA Model Rule 102(f)-3; Uniform Securities Act (1956) Section 102(c)(1)

Which soft-dollar benefit would fall OUTSIDE the recognized research safe harbor and be improper without more?

• a.Research reports and market data used by the adviser in making investment decisions for its clients, provided by the executing broker
• b.Payment of the adviser's office rent and staff salaries out of client brokerage commissions✓
• c.Attendance at a broker-sponsored seminar on the investment research techniques the adviser's analysts use for client accounts
• d.Analytical software that evaluates client securities portfolios, supplied by the executing broker as part of its commission

The Exchange Act section 28(e) safe harbor protects an adviser who pays more than the lowest commission if it determines in good faith that the commission is reasonable in relation to the value of the brokerage and research services provided. Research, seminars on research and portfolio-analysis software that aid investment decisions qualify. The adviser's office rent and staff salaries are its own overhead and fall outside the safe harbor.Securities Exchange Act of 1934 Section 28(e)(1) (15 U.S.C. 78bb(e)(1))

In an agency cross transaction, a state-registered adviser may act for both buyer and seller only if, among other conditions:

• a.The adviser recommends the trade to both sides, as long as it discloses its dual role and the cross is executed at the current market price
• b.The Administrator approves each cross trade in advance and the adviser gives both clients a written statement of the commission it receives
• c.The adviser discloses its role orally to the client at the time of each trade, since written consent is required only for principal transactions
• d.The adviser did not recommend the transaction to both parties and obtains client consent after disclosing its role and compensation✓

Rule 206(3)-2 requires the client's prospective written consent after full written disclosure of the adviser's dual role, a written confirmation of each transaction with the remuneration received, an annual statement of the number of cross trades and the total commissions, a conspicuous notice that consent can be revoked, and that the adviser not have recommended the trade to both buyer and seller. Regulator pre-approval and oral disclosure are not the test.Investment Advisers Act Rule 206(3)-2 (17 CFR 275.206(3)-2)

Under the Advisers Act framework adopted at the state level, which event is treated as an 'assignment' of an advisory contract requiring client consent?

• a.Hiring a new portfolio manager who will take over the day-to-day management of a majority of the adviser's current client accounts
• b.Relocating the adviser's principal office to a different state, which requires each client to consent before services may continue
• c.A transfer of a controlling block of the adviser, or for a partnership a change in a majority of the partnership interests✓
• d.Amending the fee schedule to a higher rate, which the Act treats as a transfer of the contract and so requires each client's prior consent

Under the Advisers Act an assignment includes a direct or indirect transfer of the advisory contract or a transfer of a controlling block of the adviser's voting securities, and for a partnership the withdrawal or admission of only a minority of the members is not an assignment. Hiring staff, moving offices or changing the fee are not transfers of the contract, even though a fee increase needs its own agreement. The contract must provide that no assignment occurs without the client's consent.Investment Advisers Act of 1940 Section 202(a)(1) (15 U.S.C. 80b-2(a)(1)); Section 205(a)(2)

A minority partner leaves a partnership that is a state-registered investment adviser. Under NASAA rules, the adviser must:

• a.Obtain each client's consent before the departure takes effect, because any change in the membership of an adviser partnership is an assignment
• b.Notify clients of the change in partnership membership within a reasonable time, because a minority change is not an assignment✓
• c.Do nothing, because the departure of a minority partner is not an assignment and the Act requires no notice to clients of membership changes
• d.Terminate and re-paper every client contract within thirty days, because the departing partner's interest is treated as a transfer of the contracts

The withdrawal of a minority of the members of an adviser partnership is not an assignment, so client consent is not needed and the contracts continue. The advisory contract must, however, provide that a partnership adviser will notify the client of any change in the membership of the partnership within a reasonable time after the change. Doing nothing therefore falls short, and termination is not required.Investment Advisers Act of 1940 Section 205(a)(3) (15 U.S.C. 80b-5(a)(3)); Section 202(a)(1)

Under the brochure rule, after the initial delivery 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.A brochure only if the fee changes
• c.Nothing further once the contract is signed, provided the firm files the required consent to service of process and the Administrator does not enter an order to the contrary
• d.A brand-new signed advisory contract

Beyond delivery at or before contracting, advisers must annually deliver the current brochure or a summary of material changes with an offer to provide the full brochure, without charge (Advisers Act Rule 204-3; NASAA).

Under NASAA model rules, an investment advisory contract must:

• a.Include a clause waiving the client's right to sue under the securities laws, in exchange for a lower advisory fee stated in the contract
• b.Guarantee the client a minimum annual return in writing, with the adviser absorbing any losses that fall below that stated level
• c.Be oral during the first year, with a written contract required only once the account passes the qualified-client asset threshold
• d.Be in writing and describe the services, term, and fee, and provide that it will not be assigned without the client's consent✓

The model rule requires an advisory contract to be in writing and to disclose the services, the term, the fee and the formula for computing it, the prepaid fee to be returned on termination, whether the adviser has discretion, and that the contract will not be assigned without the client's consent. A waiver clause, a guaranteed return and an oral arrangement are each prohibited or non-compliant.NASAA Model Rule 102(a)(4)-1(p)

An advisory contract contains a clause stating that the client waives any right of action against the adviser for the adviser's conduct. Under the Uniform Securities Act and NASAA rules, this clause is:

• a.Enforceable if the client initials it next to the clause, since a knowing and specific written consent cures a hedge clause
• b.Enforceable for sophisticated clients such as qualified clients, since the nonwaiver provision protects only retail investors
• c.Enforceable if the adviser's brochure also discloses it, because the disclosure shows the client was told before signing
• d.Void, because any condition purporting to waive compliance with the Act is unenforceable✓

An advisory contract may not contain any condition, stipulation or provision binding a person to waive compliance with the Act, the Advisers Act or their rules, so such a clause is void whether the client initials it, is sophisticated, or has been told about it in the brochure. Hedge clauses that suggest the client has given up legal rights are also prohibited.NASAA Model Rule 102(a)(4)-1(s); Investment Advisers Act of 1940 Section 215

A firm sponsoring a wrap-fee program must provide clients with:

• a.Only a trade confirmation for each transaction, because the single wrap fee covers execution and no separate disclosure is needed
• b.The Administrator's written approval of the wrap fee amount, which must be on file before any client is enrolled in the program
• c.The ordinary brochure with the wrap fee shown on the fee schedule, because Form ADV has no separate disclosure for wrap programs
• d.A specialized wrap-fee brochure disclosing the single bundled fee and the services and conflicts involved✓

A sponsor of a wrap fee program must deliver a wrap fee program brochure containing all the information required by Part 2A, Appendix 1 of Form ADV, in place of the ordinary brochure. It discloses the bundled fee, the services, and the conflicts involved. A trade confirmation alone, regulator approval of the fee and the ordinary brochure do not satisfy the rule.17 CFR 275.204-3(d)(1)

An investment adviser directs all client trades to a broker charging higher commissions than comparable brokers, with no offsetting benefit to clients. The adviser has likely violated its duty of:

• a.Suitability, which requires the adviser to match each recommended security to the client's objectives, financial situation and risk tolerance
• b.Disclosure of conflicts, which requires the adviser to deliver the Form ADV brochure to each client before the advisory contract is signed
• c.Best execution, which requires seeking the most favorable terms reasonably available for client transactions✓
• d.Confidentiality, which requires the adviser not to reveal a client's identity, affairs or investments without consent unless required by law

An adviser is a fiduciary and must seek best execution, meaning the most favorable terms reasonably available for client transactions in the circumstances. Sending all orders to a costlier broker with no offsetting benefit to clients breaches that duty. Nothing in the facts involves the suitability of any recommendation, brochure delivery or the disclosure of a client's information.