NASAA Series 65 — All Questions

If an adviser delivers its brochure at the same time the advisory contract is signed rather than at least 48 hours before, the client generally must be given:

• a.A five-business-day period to rescind the contract without penalty✓
• b.A performance-based fee discount
• c.Nothing further; the timing is irrelevant
• d.A guarantee against loss

The brochure delivery rule requires delivery at least 48 hours before entering the contract, or at the time of entering the contract if the client is given the right to rescind within five business days without penalty. This ensures the client has time to review disclosures. Advisers commonly use the five-day rescission option to meet the requirement.Investment Advisers Act of 1940

When an adviser pays a cash fee to a third-party solicitor for referring clients, the arrangement generally requires:

• a.That the client pay the solicitor directly in cash
• b.That the solicitor personally guarantee investment results
• c.A written agreement and disclosure of the solicitor's compensation to the client✓
• d.No disclosure of any kind to the referred client

Cash referral or solicitation arrangements generally require a written agreement between the adviser and solicitor and disclosure to the prospective client of the solicitor's relationship with the adviser and the compensation paid. This transparency lets clients weigh the conflict of interest behind a referral. Undisclosed paid referrals are prohibited.Investment Advisers Act of 1940

Which use of a professional designation or registration status by an adviser would be considered misleading?

• a.Listing genuine professional credentials the adviser holds
• b.Truthfully describing the adviser's years of experience
• c.Implying that registration means the Administrator has approved the adviser's qualifications or endorsed the firm✓
• d.Accurately stating the adviser is registered with the state

It is misleading, and prohibited, for an adviser to imply that being registered means a regulator has approved or endorsed its abilities or the merits of its services. Registration signifies compliance with legal requirements, not government endorsement. Accurately stating registration status and genuine credentials, however, is permissible.Uniform Securities Act

Which professional is most likely excluded from the definition of investment adviser when advice about securities is incidental to their practice and no special compensation is received?

• a.A person holding themselves out as a financial planner
• b.A firm charging a separate fee for portfolio management
• c.An individual publishing paid stock recommendations
• d.A lawyer or accountant whose securities advice is solely incidental to their profession✓

Lawyers, accountants, teachers, and engineers (the 'LATE' exclusions) are generally excluded from the investment adviser definition when their securities advice is solely incidental to their profession and they receive no special compensation for it. Charging a separate fee for advice or holding oneself out as a financial planner removes the exclusion. The exclusion recognizes advice that is truly ancillary.Investment Advisers Act of 1940

An adviser's obligation to protect clients' nonpublic personal information and provide a privacy notice arises principally from which requirement?

• a.Privacy rules (such as Regulation S-P) governing the safeguarding of customer information✓
• b.The custody rule's surprise examination conducted once each year by an independent public accountant
• c.The Marketing Rule's limits on testimonials and endorsements
• d.The Code of Ethics rule's requirement that access persons report their personal securities holdings to the chief compliance officer

Regulation S-P requires covered firms, including SEC-registered investment advisers, to protect customers' nonpublic personal information and to deliver privacy notices describing their information-sharing practices. The custody rule addresses how client assets are held and verified, the Marketing Rule governs advertising, testimonials and endorsements, and the Code of Ethics rule covers employees' personal trading reports. None of these creates the duty to safeguard client information or give a privacy notice.Regulation S-P (17 CFR Part 248, Subpart A)

Under the Uniform Securities Act, a willful violation of the act by an adviser or agent can result in which of the following?

• a.Criminal penalties, including fines and imprisonment, in addition to civil liability✓
• b.Only an administrative reprimand, since the act contains no criminal penalties
• c.Civil liability only, because criminal penalties arise only under federal law
• d.Automatic revocation of registration, but no fine or prison term

A willful violation of the Uniform Securities Act is a crime: on conviction the violator can be fined and imprisoned (the 1956 Act sets up to $5,000 and three years, and the 2002 Act leaves the amounts to each state), in addition to civil liability and administrative sanctions such as revocation of registration. Administrative and civil remedies do not replace the criminal penalty, and state criminal liability exists independently of federal law.Uniform Securities Act, Section 409 (1956 Act) and Section 508 (2002 Act)

Under the Uniform Securities Act, an individual who represents a broker-dealer in effecting securities transactions is defined as which of the following, and must generally register?

• a.An agent✓
• b.An issuer
• c.An investment adviser representative acting for a bank
• d.A federal covered adviser

An individual who represents a broker-dealer in effecting or attempting to effect purchases or sales of securities is an agent under the Uniform Securities Act and generally must register in the states where they conduct business. Certain representatives of issuers in exempt transactions may be excluded. Agents are distinct from investment adviser representatives, who give advice rather than execute trades.Uniform Securities Act

State rules addressing an adviser that maintains custody or discretion over client accounts commonly require the adviser to do which of the following?

• a.Guarantee client accounts against loss
• b.Ignore any minimum financial requirements
• c.Avoid providing account statements to clients
• d.Meet minimum net worth or bonding requirements set by the Administrator, or provide required notice✓

State rules often impose minimum net worth or surety bond requirements on advisers that have custody of or discretion over client assets, scaled to the level of authority they hold. These financial safeguards help protect clients if the adviser fails or misuses assets. Advisers must also meet applicable notice, disclosure, and statement-delivery obligations.Uniform Securities Act

An adviser is granted authority to decide only the price and time at which to execute a client-specified purchase of a particular security. This is best described as:

• a.Custody of client assets
• b.Full discretionary authority requiring a written trading authorization
• c.Limited time and price discretion, which is not treated as full discretion✓
• d.A prohibited practice under all circumstances

Deciding only the price and time to execute an order that the client has already specified as to security and amount is considered limited time and price discretion, and it is generally not treated as full discretionary authority. Full discretion, choosing the security or quantity without prior client direction, requires written discretionary authorization. This distinction affects the documentation an adviser must obtain.Investment Advisers Act of 1940

Under the NASAA model rules on unethical business practices, which of the following is prohibited for an adviser or agent?

• a.Recommending securities after reasonable inquiry shows they match the client's stated objectives
• b.Guaranteeing a client against loss or churning the account to generate fees✓
• c.Charging a reasonable advisory fee that was fully disclosed to the client in advance
• d.Explaining the risks of a recommended strategy before the client decides to proceed

NASAA's model rule on unethical business practices prohibits, among other things, guaranteeing a client that a specific result (a gain or no loss) will be achieved and inducing trading that is excessive in size or frequency for the account (churning). Making suitable recommendations, charging a reasonable disclosed fee, and explaining risks are proper conduct, not violations.NASAA Model Rule 102(a)(4)-1

Fiscal policy, as distinct from monetary policy, is carried out through which of the following?

• a.Government decisions on taxation and public spending made by Congress and the President✓
• b.The SEC's registration of newly issued securities
• c.Federal Reserve open market operations and reserve requirements
• d.Commercial banks setting their prime lending rates

Fiscal policy is the use of federal taxing and spending decisions by Congress and the President to influence the economy. Monetary policy, by contrast, is the Federal Reserve's domain, using tools like open market operations and reserve requirements. The prime rate is set by banks, and the SEC oversees securities registration; the trap is mistaking the Fed's monetary tools for fiscal policy.

Demand-pull inflation is best described as rising prices caused by:

• a.Rising wages and raw-material costs that squeeze profit margins and force producers to raise prices
• b.Falling consumer confidence and reduced spending
• c.A weaker currency that makes imported goods and inputs more expensive for domestic buyers
• d.Aggregate demand outpacing the economy's productive capacity✓

Demand-pull inflation occurs when total demand exceeds what the economy can produce, pulling prices upward. Cost-push inflation, by contrast, stems from rising wages and raw-material costs, and a weaker currency raises prices through higher import costs rather than through excess demand. Falling confidence and spending would be disinflationary, not inflationary.

Using the Rule of 72, approximately how long will it take an investment earning 8% compounded annually to double in value?

• a.About 6 years
• b.About 9 years✓
• c.About 12 years
• d.About 8 years

The Rule of 72 estimates doubling time by dividing 72 by the annual rate: 72 divided by 8 equals 9 years. The trap answers come from subtracting the rate (8 years) or misdividing (72 divided by 12, or 72 divided by 6). It is a quick approximation for compound growth.

Using the constant-growth dividend discount model, a stock expected to pay a $2 dividend next year, growing 4% annually, with a required return of 9%, has an estimated value closest to:

• a.$22.22
• b.$50.00
• c.$20.00
• d.$40.00✓

The constant-growth (Gordon) dividend discount model values a stock as next year's dividend divided by the required return minus the growth rate: $2 divided by (0.09 minus 0.04) equals $2 divided by 0.05, or $40. The $22.22 trap comes from forgetting to subtract growth ($2 divided by 0.09), and $50 from dividing by the growth rate alone.

A company's stock trades at $60 and reported earnings of $3 per share. Its price-to-earnings (P/E) ratio is:

• a.5
• b.0.05
• c.180
• d.20✓

The price-to-earnings ratio equals share price divided by earnings per share: $60 divided by $3 equals 20. The 0.05 trap inverts the ratio (earnings divided by price), and 180 comes from multiplying instead of dividing. A P/E of 20 means investors pay $20 for each $1 of annual earnings.

Gross domestic product (GDP) measures which of the following?

• a.The total income earned by a country's residents and firms at home and abroad, including net income from overseas investments
• b.The weighted average change in the prices of a fixed basket of consumer goods and services purchased by households
• c.The total market value of all final goods and services produced within a country during a period✓
• d.The total value of all intermediate and final goods and services produced in a country, counting each stage of production separately

GDP measures the market value of all final goods and services produced within a country's borders over a period, the broadest gauge of national output. Income earned by residents abroad belongs to gross national income rather than GDP, the change in a basket of consumer prices is the Consumer Price Index, and counting intermediate goods as well as final ones would double count the same output.

Which of the following is generally classified as a coincident economic indicator?

• a.Industrial production and personal income✓
• b.The average duration of unemployment
• c.New orders for consumer goods and materials
• d.Building permits for new private housing

Coincident indicators move in step with the overall economy; industrial production and personal income are classic examples. New orders and building permits are leading indicators that turn before the economy, and the average duration of unemployment is a lagging indicator. The trap is confusing leading indicators with coincident ones.

A closed-end fund is trading at a price below its net asset value. This is described as the fund trading at:

• a.Par value
• b.A premium
• c.Its redemption value
• d.A discount✓

Closed-end fund shares trade on an exchange at a market price that can differ from net asset value; a price below NAV is a discount, and a price above NAV is a premium. Open-end (mutual) fund shares always transact at NAV, so the trap is assuming a fund must trade at NAV.

Class A mutual fund shares are typically characterized by which of the following?

• a.A front-end sales load paid at purchase, often reduced by breakpoints✓
• b.A level load with high ongoing 12b-1 fees and no breakpoints
• c.A back-end contingent deferred sales charge that declines over time
• d.No sales charge ever and the lowest possible 12b-1 fee

Class A shares charge a front-end sales load at purchase but offer breakpoint discounts for larger investments and typically carry lower ongoing 12b-1 fees. Class B shares have a back-end contingent deferred sales charge that declines over time, and Class C shares are level-load with higher 12b-1 fees; those descriptions are the traps.

A mutual fund has $500 million in net assets and annual operating expenses of $6 million. Its expense ratio is closest to:

• a.1.2%✓
• b.2.4%
• c.0.6%
• d.8.3%

The expense ratio equals annual operating expenses divided by net assets: $6 million divided by $500 million equals 0.012, or 1.2%. It represents the yearly cost of owning the fund as a percentage of assets. Reversing the fraction produces the 8.3% trap.

A mutual fund breakpoint provides which benefit to an investor?

• a.A reduction in the sales charge on purchases spread across several different fund families through the same broker
• b.A reduced front-end sales charge for investing a larger dollar amount✓
• c.A lower management fee once fund assets pass a stated size
• d.Automatic conversion of Class B shares to Class A shares once the contingent deferred sales charge period ends

A breakpoint is a discount on the front-end sales charge granted at higher investment levels within a single fund family, which an investor can reach through rights of accumulation or by signing a Letter of Intent to invest the amount within 13 months. Failing to alert a client who is near a breakpoint (a breakpoint sale) is a prohibited practice. Breakpoints do not combine purchases across unrelated fund families, they are not a cut in management fees that follows fund size, and the Class B to Class A conversion is a separate feature of back-end load shares.

A warrant differs from a preemptive right primarily because a warrant:

• a.Is a short-term right, usually expiring within weeks, issued to existing shareholders at a subscription price below the current market price
• b.Carries the voting and dividend rights of the underlying common stock from the day it is issued, as a common shareholder would have
• c.Obligates the holder to buy the underlying stock at the stated price if the stock trades above that price on the expiration date
• d.Is a long-term instrument, often attached as a sweetener, allowing purchase of stock at a set price for years✓

A warrant is a long-term right, often lasting years, to buy stock at a fixed price, frequently attached to bonds or preferred stock as a sweetener, with a strike usually above the market price at issuance. A preemptive (subscription) right is short-term, lasts weeks, and goes to existing shareholders at a price below market, which describes the first option rather than a warrant. A warrant holder has no vote or dividend until exercise, and a warrant entitles but never obligates the holder to buy.

A municipal revenue bond differs from a general obligation (GO) bond because a revenue bond is:

• a.Always exempt from federal and state tax for every investor
• b.Backed by income generated from a specific project or facility rather than by general taxes✓
• c.Guaranteed by the U.S. Treasury
• d.Backed by the full faith, credit, and taxing power of the issuer

A revenue bond is repaid from the revenues of a specific project such as tolls, utilities, or an airport, and is not backed by the issuer's taxing power. A general obligation bond is backed by the issuer's full faith, credit, and taxing power (the trap in the second option) and often requires voter approval. Municipal interest is generally federally tax-exempt but not Treasury-guaranteed.

A Government National Mortgage Association (GNMA / Ginnie Mae) pass-through security is best described as:

• a.A security representing an interest in a pool of mortgages that passes through principal and interest, backed only by the credit of the issuing agency and not by the full faith and credit of the federal government
• b.A debt security issued by a local housing authority and secured by one project's rents, paying fixed semiannual interest that is exempt from federal income tax and returning principal in full at maturity
• c.A mortgage-backed security issued by a private bank holding company from its own loans, backed by the full faith and credit of the issuing bank rather than by the federal government
• d.A security representing an interest in a pool of mortgages that passes through principal and interest, backed by the full faith and credit of the U.S. government✓

A Ginnie Mae pass-through gives investors an interest in a pool of federally insured or guaranteed mortgages, passing through monthly principal and interest, and is backed by the full faith and credit of the U.S. government. Pass-throughs issued by Fannie Mae or Freddie Mac are backed by the issuer rather than by the full faith and credit of the government, a private-label mortgage security rests on the credit of its private issuer, and a housing-authority bond is a conventional tax-exempt bond with no pass-through of principal. Ginnie Mae interest is fully taxable and carries prepayment risk.

Treasury Inflation-Protected Securities (TIPS) protect investors against inflation by:

• a.Paying a fixed coupon that automatically rises each year
• b.Guaranteeing investors a fixed 10% real return
• c.Being fully exempt from federal income tax
• d.Adjusting the principal value up or down with changes in the Consumer Price Index✓

TIPS protect against inflation by adjusting their principal with the CPI; the coupon rate is fixed but is applied to the adjusted principal, so the dollar interest paid rises with inflation. The annual increase in principal is taxable even though not received in cash, known as phantom income. TIPS are not tax-exempt and carry no guaranteed 10% return.

A negotiable (jumbo) certificate of deposit differs from an ordinary bank CD because it:

• a.Can be redeemed at the issuing bank at any time before maturity at full face value, with no early-withdrawal penalty, because it is a demand deposit
• b.Has a large face value, often $100,000 or more, and can be traded in the secondary market before maturity✓
• c.Is fully guaranteed by the U.S. Treasury no matter how large it is, so the holder bears no credit risk from the issuing bank
• d.Is a short-term unsecured promissory note that a corporation sells at a discount to face value and that is not a bank deposit at all

A negotiable (jumbo) CD carries a large denomination, typically $100,000 or more, and unlike an ordinary bank CD it can be sold in the secondary market before maturity. It is not redeemable on demand at face value, which is why a market exists for it. FDIC insurance covers deposits only up to at least $250,000 at each insured bank, so amounts above that depend on the issuing bank's credit, and the Treasury does not guarantee the CD. Commercial paper is a corporate note, not a bank deposit.

A key characteristic of a direct participation program (DPP), such as a limited partnership, is that it:

• a.Passes income, gains, losses, and deductions through directly to the investors✓
• b.Guarantees investors a fixed annual dividend
• c.Is a highly liquid, exchange-traded security
• d.Is taxed as a separate corporation before making distributions

A direct participation program such as a limited partnership is a flow-through entity: there is no tax at the entity level, and income, gains, losses, and deductions pass directly to the limited partners. DPPs offer limited liquidity and limited liability but no guaranteed return. Corporate-level taxation, the trap in the second option, is exactly what a DPP avoids.

An index mutual fund is designed primarily to:

• a.Outperform its benchmark through active security selection
• b.Replicate the performance of a specified market index at low cost✓
• c.Guarantee a positive return each year
• d.Invest only in tax-free municipal bonds

An index fund passively tracks a benchmark, aiming to match rather than beat it, with low turnover and low expenses. Active management, the trap in the first option, tries to outperform through security selection and typically costs more. No fund can guarantee a positive yearly return.

The semi-strong form of the Efficient Market Hypothesis (EMH) holds that security prices fully reflect:

• a.Only past price and trading-volume data, so technical analysis cannot earn excess returns but fundamental analysis of public data can
• b.All public and private information, so that not even insiders trading on confidential data can earn excess returns
• c.Prices adjust to new information slowly over several months, so investors acting on public news can consistently earn excess returns
• d.All publicly available information, so analysis of public data cannot consistently produce excess returns✓

The semi-strong form of the EMH holds that prices already reflect all public information, implying that fundamental analysis of public data cannot reliably beat the market. The weak form covers only past prices and volume, which would undermine technical analysis but still leave room for fundamental analysis, and the strong form adds private or inside information. A view that prices adjust slowly to news is a rejection of market efficiency, not a form of it.

Compared with active management, passive (index) management generally offers:

• a.Frequent security selection to exploit perceived mispricing
• b.Higher portfolio turnover and higher costs than active management
• c.A guarantee of beating the benchmark
• d.Lower costs, lower turnover, and greater tax efficiency, with returns that track a benchmark✓

Passive (index) management seeks to match a benchmark at low cost, producing low turnover and greater tax efficiency. Higher turnover, higher costs, and active security selection describe active management, the traps in the first and last options. No strategy can guarantee outperformance.

A value investing style typically favors stocks that:

• a.Are chosen solely by their beta
• b.Pay no dividends and reinvest all earnings
• c.Have high price-to-earnings and price-to-book ratios with rapid earnings growth
• d.Trade at low price-to-earnings or price-to-book ratios relative to fundamentals and appear underpriced✓

A value style favors stocks trading at low price-to-earnings or price-to-book ratios relative to their fundamentals, on the view that they are underpriced, and such stocks often pay higher dividends. High multiples with rapid growth and little or no dividend describe a growth style, which is the trap in the first and third options.

An investor who owns 100 shares of a stock and sells (writes) one call option against those shares has established a:

• a.Covered call, earning premium income while capping gains above the strike✓
• b.Protective put
• c.Long straddle
• d.Naked call carrying unlimited risk

Owning 100 shares and writing one call against them is a covered call: the premium adds income and a small downside cushion, but upside is capped at the strike price. Because the shares are owned, the written call is covered, not naked, which is the trap that would carry unlimited risk. A protective put involves buying, not selling, an option.

An investor holding a long stock position buys a put option on that stock. The primary purpose is to:

• a.Obligate the investor to buy more shares at the strike price if the stock falls, which lowers the average cost of the position
• b.Set a floor selling price for the stock, functioning like insurance against a decline✓
• c.Profit if the stock rises by more than the premium, because the put gains value as the price of the stock increases
• d.Earn extra income from the option premium while agreeing to sell the stock at the strike price if it is called away

Buying a put on stock already owned is a protective put: the put's right to sell at the strike sets a price floor, limiting downside much like insurance, at the cost of the premium paid. A put buyer has a right, never an obligation, to trade, so the buyer is not forced to buy more shares. A put loses value as the stock rises, and earning premium income while accepting a sale at the strike describes writing a covered call, not buying a put.

Qualified dividends received by an individual investor are generally taxed at:

• a.Ordinary income tax rates, the same as interest from a bank account or corporate bond, whatever the holding period
• b.A flat 15% rate for every taxpayer, whatever the holding period or the investor's taxable income
• c.The long-term capital gains rate only if the dividends are automatically reinvested; cash dividends are taxed at ordinary rates
• d.The lower long-term capital gains rates, provided holding-period requirements are met✓

Qualified dividends are ordinary dividends that qualify to be taxed at the lower long-term capital gains rates, provided the holding-period requirements are met. Non-qualified dividends are instead taxed at ordinary income rates, interest-like treatment that is the trap in the first option. The favorable rate does not depend on reinvesting the dividend, and it is not one flat rate for everyone, because the capital gains rates step up with taxable income.

The federal annual gift tax exclusion allows an individual to:

• a.Give up to an inflation-adjusted amount per recipient each year without using the lifetime exemption or filing a gift tax return✓
• b.Give a fixed $10,000 to each recipient every year, a statutory amount that is never adjusted for inflation, without using any lifetime exemption
• c.Give up to the lifetime exemption amount to any one recipient in a single calendar year without filing a gift tax return or owing any gift tax
• d.Deduct gifts up to the annual exclusion amount on the donor's income tax return, with larger gifts carried forward to later tax years

The annual gift tax exclusion lets a donor give up to a set, inflation-indexed amount per recipient each year with no gift tax, no gift tax return, and no reduction of the lifetime exemption. The statute started at $10,000 per recipient but has been adjusted for inflation since 1998, so a fixed $10,000 is out of date. The lifetime exemption is a separate, much larger amount that a return is needed to use, and gifts are not deductible from income tax.Internal Revenue Code Section 2503(b) (26 U.S.C. 2503(b))

Under ERISA, a fiduciary managing a qualified retirement plan must invest plan assets in accordance with which standard?

• a.The prudent-man rule of state trust law, under which a trustee may invest only in a list of securities approved by the state
• b.The safe-harbor rule, under which plan assets may be held only in guaranteed insurance contracts and Treasury securities to avoid any loss
• c.The business judgment of the plan sponsor, so plan assets may be invested in the employer's own stock whenever that supports the company's share price
• d.The prudent-expert rule, acting solely in participants' interest and diversifying to minimize the risk of large losses✓

ERISA Section 404(a)(1) holds plan fiduciaries to a prudent-expert standard: they must act solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits, with the care, skill and diligence of a prudent person familiar with such matters, and must diversify investments to minimize the risk of large losses unless it is clearly prudent not to. A state legal-list rule is not the ERISA standard, nothing in ERISA confines plan assets to guaranteed products, and serving the sponsor's share price over participants' interests would breach the duty of loyalty.ERISA Section 404(a)(1) (29 U.S.C. 1104(a)(1))

A bond portfolio immunization strategy seeks to:

• a.Match the portfolio's duration to the investor's time horizon so that price and reinvestment risks offset✓
• b.Spread bond maturities evenly across short, intermediate and long terms so that a rate change affects only part of the portfolio at a time
• c.Eliminate credit and default risk by holding only the highest-rated government and agency bonds, whatever their duration
• d.Increase the portfolio's duration whenever the investor expects interest rates to fall, to maximize short-term trading gains

Immunization matches a bond portfolio's duration to the investor's time horizon so that a rate change's effect on price is offset by its opposite effect on reinvestment income, locking in a target return. Spreading maturities evenly is a ladder, which dilutes rate risk without matching duration to a horizon. Holding only government bonds addresses credit risk, not interest-rate risk, and lengthening duration on a rate forecast is an active bet that immunization is designed to avoid.

The Treynor ratio measures a portfolio's excess return per unit of:

• a.Total risk, using standard deviation
• b.Unsystematic (company-specific) risk only
• c.Liquidity risk
• d.Systematic risk, using beta✓

The Treynor ratio divides a portfolio's excess return by its beta, measuring reward per unit of systematic (market) risk. The Sharpe ratio instead uses standard deviation, measuring reward per unit of total risk, which is the trap in the second option. The two ratios differ only in the risk measure used in the denominator.

Dollar-weighted return (internal rate of return) is most appropriate when an analyst wants to measure:

• a.The portfolio manager's performance independent of client cash-flow timing
• b.The return calculated with all dividends ignored
• c.Only the benchmark index's return
• d.The investor's actual return, reflecting the timing and size of cash flows into and out of the account✓

Dollar-weighted return, the internal rate of return, accounts for the timing and size of deposits and withdrawals, capturing the investor's actual experience. Time-weighted return removes cash-flow effects to isolate the manager's skill, which is the trap in the first option. The choice depends on whether you are judging the investor's result or the manager's.

Under the Uniform Securities Act, which of the following is an exempt security (exempt from state registration)?

• a.A newly issued corporate stock offered broadly to state residents
• b.A U.S. government or municipal bond✓
• c.A limited partnership interest sold through general solicitation
• d.A private start-up's common stock sold to the general public

Exempt securities under the Uniform Securities Act include U.S. government and municipal bonds, bank securities, and certain others; they need not be registered with the state, though the antifraud provisions still apply. The trap is confusing an exempt security, based on what the instrument is, with an exempt transaction, based on how it is sold.Uniform Securities Act

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

• a.An unsolicited order from a customer to buy a specific security✓
• b.A solicited sale of an unregistered security to a retail customer
• c.A public advertising campaign for a new issue
• d.A cold-call solicitation of the general public

An unsolicited customer order is the classic exempt transaction because the customer initiated it. Other exempt transactions include private placements, isolated non-issuer transactions, and sales to institutional or accredited buyers. An exempt transaction turns on how the sale occurs, not on the security itself, so the solicited public sales are the traps.Uniform Securities Act

Registration by coordination under the Uniform Securities Act is available to an issuer that is:

• a.A state-chartered bank not otherwise required to register
• b.Simultaneously registering the same offering with the SEC under the Securities Act of 1933✓
• c.Registering an offering solely within one state with no federal filing
• d.Exempt from all federal registration and selling only intrastate

Registration by coordination is used when a security is registered federally under the Securities Act of 1933 at the same time as at the state level; the state registration becomes effective concurrently with the federal one. Registration by qualification is for offerings with no federal registration, the trap in the last option, and notification is for certain established issuers.Uniform Securities Act

When filing an initial registration application, a broker-dealer, agent, or investment adviser must include a consent to service of process, which:

• a.Waives the applicant's right to a hearing before the Administrator and to judicial review of any order denying, suspending, or revoking the registration
• b.Must be re-filed with the Administrator each time the registration is renewed, because the consent expires whenever the registration lapses or is withdrawn
• c.Appoints the Administrator as agent for service only in criminal prosecutions brought against the applicant, and only if the applicant is located outside the state
• d.Appoints the Administrator as the applicant's attorney to receive legal papers in actions under the act, with the same effect as personal service✓

A consent to service of process, filed with an initial application, is an irrevocable appointment of the Administrator to receive process in noncriminal suits and proceedings under the act, with the same force and validity as personal service. It is filed once: under the 2002 Act a consent already filed with a previous application need not be filed again. It does not waive hearing or review rights, it is not limited to criminal cases or to out-of-state applicants, and it does not promise approval.Uniform Securities Act, Section 414(g) (1956 Act) and Section 611(a) (2002 Act)

Under the Uniform Securities Act, a purchaser's right to bring a civil suit for a violation is generally subject to a statute of limitations of:

• a.No time limit on such suits
• b.Thirty days after the transaction
• c.Ten years from the transaction in every case
• d.The earlier of two years after discovery or three years after the sale✓

Under the Uniform Securities Act, a purchaser generally must bring a civil suit within the earlier of two years after discovering the violation or three years after the sale or contract of sale. This uniform two-and-three-year figure is the level the exam tests, even though some federal fraud claims carry longer periods; there is a definite limit, so the first and third options are wrong.Uniform Securities Act

A broker-dealer with no place of business in a state deals only with an existing client who is on vacation in that state for two weeks. Under the Uniform Securities Act, the firm:

• a.May be exempt from registration in that state under the provision for a firm with no place of business there dealing with an existing, temporarily present client✓
• b.Must open a branch office in the vacation state
• c.Must fully register as a broker-dealer in the vacation state immediately and open a supervised branch office there before it may contact the client even once about existing holdings
• d.Automatically commits securities fraud

The Uniform Securities Act does not require a broker-dealer with no place of business in a state to register there when it deals only with an existing client who is not a resident but is merely temporarily present, the so-called snowbird or vacation rule. Establishing an office or soliciting new state residents would, by contrast, trigger registration.Uniform Securities Act

Under the soft-dollar safe harbor, an investment adviser may use client brokerage commissions to pay for which of the following without breaching its duty?

• a.Brokerage and qualifying research services that benefit clients✓
• b.Office rent, equipment, and salaries for the adviser's administrative staff
• c.Travel and entertainment expenses for the adviser's portfolio managers
• d.Marketing materials used to attract new advisory clients

The Section 28(e) soft-dollar safe harbor lets an adviser with investment discretion pay a broker more than the lowest available commission if it determines in good faith that the commission is reasonable in relation to the value of the brokerage and research services provided. Overhead such as rent, equipment, and staff salaries, travel and entertainment, and marketing materials fall outside the safe harbor and create an undisclosed conflict of interest.Securities Exchange Act of 1934 Section 28(e)

An agent proposes to share in the profits and losses of a customer's account. Under NASAA rules this is generally permitted only if:

• a.The agent and customer agree to it verbally
• b.It is never permitted under any circumstances
• c.The agent obtains written approval from both the customer and the broker-dealer and shares only in proportion to the agent's own capital contribution✓
• d.The agent personally guarantees the customer against any loss and promises to reimburse the customer for any decline in the account's value below its agreed starting balance

An agent may share in the profits and losses of a customer's account only with the written approval of both the customer and the employing broker-dealer, and only in proportion to the agent's own financial contribution. A verbal agreement is insufficient, and guaranteeing a customer against loss is separately prohibited; those are the traps. Investment advisers face stricter limits still.Uniform Securities Act

Which of the following is a prohibited market manipulation practice?

• a.Entering matched orders or wash trades to create a false appearance of active trading✓
• b.Recommending a suitable, diversified portfolio
• c.Disclosing a material conflict of interest to a client
• d.Executing a client's order at the best available price

Creating a false or misleading appearance of active trading through wash trades, matched orders, or 'painting the tape' is market manipulation, prohibited under the antifraud provisions; front-running client block orders is likewise banned. Best execution, conflict disclosure, and suitable recommendations are proper conduct, so they are the traps.Uniform Securities Act

Under the NASAA model act addressing suspected financial exploitation of vulnerable adults, a qualified firm that reasonably suspects exploitation is generally permitted to:

• a.Notify a state regulator or adult protective services and place a temporary hold on a suspicious disbursement, with the required notices✓
• b.Freeze the whole account for as long as the firm considers necessary, with no time limit, and without telling the account owner or anyone else authorized on the account
• c.Delay a suspicious disbursement for up to 60 business days on its own authority, and extend that delay whenever its own compliance officer sees fit
• d.Disclose the suspicion to the account owner's relatives and local police, but not to the state securities regulator or adult protective services, which become involved only after a court order

Under the NASAA model act on financial exploitation of vulnerable adults, a qualified individual who reasonably believes exploitation has occurred must notify adult protective services and the state securities regulator, and the firm may delay a disbursement it reasonably believes would result in exploitation for up to 15 business days, notifying the people authorized on the account (unless they are suspected) and reviewing the matter internally. The regulator or adult protective services can request a further 10 business days, and anything longer needs a court order. The model act does not allow an open-ended freeze, a self-extended delay, or leaving out the regulator and adult protective services.NASAA Model Act to Protect Vulnerable Adults from Financial Exploitation

A broker-dealer that offers a wrap-fee program, charging a single asset-based fee that covers advice, execution, and custody, generally must:

• a.Register as an investment adviser only if the wrap program holds more than $110 million, since smaller programs fall within the broker-dealer exclusion
• b.Register as (or place the account with) an investment adviser, because a bundled asset-based fee for advice is not 'solely incidental' compensation✓
• c.Deliver Form CRS to wrap clients in place of registering, because the relationship summary meets all of the conditions of the broker-dealer exclusion
• d.Avoid investment adviser registration entirely, because bundling the advisory fee with brokerage commissions keeps the advice solely incidental to brokerage

The broker-dealer exclusion from the investment adviser definition applies only when advice is solely incidental to the conduct of the brokerage business and the firm receives no special compensation for it. A wrap fee is a single asset-based charge covering advice, execution and custody, which is special compensation, so the activity calls for investment adviser registration or placing the account with an adviser. Program size does not create or remove the exclusion, delivering Form CRS is a disclosure duty rather than a substitute for registration, and bundling the fee with commissions does not make the advice incidental.Investment Advisers Act of 1940, Section 202(a)(11)(C) (15 U.S.C. 80b-2(a)(11)(C))