NASAA Series 66 — All Questions

Under the Investment Advisers Act of 1940, an advisory contract generally may NOT:

• a.Disclose the adviser's fee schedule, the specific services to be rendered, and each and every material conflict of interest known to the adviser at the time the contract is signed
• b.Be assigned to another adviser without the client's consent, or fail to notify the client of a change in the partnership's membership✓
• c.Be terminated by the client without any penalty at all during the first twelve months of the advisory relationship
• d.Provide for compensation based on a fixed percentage of the client's assets under management measured over time

IAA §205 requires that an advisory contract prohibit assignment without client consent and, for partnerships, require notice to clients of any change in the membership within a reasonable time. It also restricts performance-based fees. Asset-based fees and fee disclosure are permitted and expected.

Under the Investment Advisers Act, a 'performance-based fee' (a fee based on a share of capital gains or capital appreciation of client assets) is generally prohibited UNLESS the client is:

• a.Any client who invests through an IRA or other tax-qualified retirement account, since those accounts are outside the fee restrictions
• b.A qualified client meeting the net-worth or assets-under-management thresholds set by SEC Rule 205-3✓
• c.A client who has been advised by the firm for at least one full year and who signs a written acknowledgment of the risks
• d.A natural person whose income exceeded $200,000 in each of the last two years, whatever the person's net worth or assets

Section 205(a)(1) and Rule 205-3 bar performance-based fees except for qualified clients, who meet the rule's assets-under-management or net-worth test (the dollar figures are indexed for inflation). Holding an IRA gives no exemption. A year of history with the firm and a signed risk acknowledgment are not tests in the rule. A $200,000 income test is the accredited-investor income test under Regulation D, not the qualified-client test.Investment Advisers Act of 1940 §205(a)(1); 17 CFR 275.205-3

The dollar thresholds that define a 'qualified client' for performance-fee purposes under the Investment Advisers Act are:

• a.Set each year by FINRA, which publishes the qualified-client net-worth and assets-under-management figures in a Regulatory Notice
• b.Determined solely by each state Administrator, with no uniform federal standard governing them at all
• c.Adjusted for inflation by SEC order, which Section 205(e) requires about every five years✓
• d.Fixed permanently by statute in 1940 and changeable only by an Act of Congress, so they have never been indexed

Section 205(e) requires the SEC to adjust the dollar tests it uses under Section 205, including the qualified-client thresholds in Rule 205-3, for inflation by order about every five years. FINRA does not set them; they are federal Advisers Act figures, and the SEC issues the adjustments, not FINRA. States do not set their own federal thresholds. The Act of 1940 did not fix them in the statute: they appear in the SEC's rule, and the rule is indexed.Investment Advisers Act of 1940 §205(e); 17 CFR 275.205-3(e)

Under the Investment Advisers Act, an adviser is generally deemed to have CUSTODY of client assets when it:

• a.Recommends one unaffiliated bank as qualified custodian, then reviews and reconciles the statements the bank sends
• b.Holds client funds or securities, or has any authority to obtain possession of them, such as through a general power of attorney or by directly deducting advisory fees✓
• c.Bills its advisory fee each quarter by sending the client an invoice that the client pays by writing a check
• d.Sends the client periodic quarterly performance reports that it prepares from data supplied by the client's custodian

Rule 206(4)-2 defines custody as holding client funds or securities, directly or indirectly, or having any authority to obtain possession of them, including an arrangement such as a general power of attorney, or authority to withdraw fees from the client's account. Recommending a custodian and checking its statements, billing by invoice that the client pays, and reporting from data the custodian supplies do not give the adviser possession or authority over the assets. Custody triggers the qualified-custodian, account-statement, and (often) surprise-examination safeguards.17 CFR 275.206(4)-2(d)(2)

Under the Investment Advisers Act custody rule (Rule 206(4)-2), an adviser with custody generally must:

• a.Hold client funds and securities in the adviser's own name at a bank, provided the adviser posts a fidelity bond covering the full value of the accounts
• b.Maintain client funds and securities with a qualified custodian and have account statements sent, and typically arrange a surprise annual examination by an independent public accountant✓
• c.Use only itself as custodian and file an audited balance sheet with the SEC each year in place of any independent examination
• d.Have a qualified custodian hold the assets and send the client statements, but only once a year after the fiscal year closes

Rule 206(4)-2 requires an adviser with custody to keep client funds and securities with a qualified custodian, to see that the client receives account statements at least quarterly, and, unless an exception applies (for example custody solely through fee deduction), to be examined by an independent public accountant by surprise each year. A fidelity bond does not replace a qualified custodian. Self-custody with a balance sheet does not replace the surprise examination. Statements are due at least quarterly, not annually.17 CFR 275.206(4)-2(a)

Under the Investment Advisers Act, a person who provides advice about securities and also about real estate, coins, and rare art:

• a.Is not an investment adviser, because most of the advice concerns real estate, coins and art rather than securities
• b.Is an investment adviser only when the person has discretionary authority over client accounts, since advice alone does not meet the definition
• c.Is an investment adviser as to the securities advice, since giving securities advice for compensation as part of a business meets the definition regardless of other services✓
• d.Is an investment adviser only if securities advice is the person's principal business, because the definition leaves out anyone whose securities advice is a secondary activity

Section 202(a)(11) defines an investment adviser as anyone who, for compensation and as part of a business, advises others about securities. Giving other advice on real estate, coins or art does not remove the securities advice from the definition, and no majority-of-advice test exists. Discretion over accounts is not required; advice alone is enough. The statute excludes specific groups, such as professionals whose advice is solely incidental to their profession, but it has no general exclusion for securities advice that is merely a secondary activity.Investment Advisers Act of 1940 §202(a)(11)

Under the Investment Advisers Act, an adviser that pays a third party a cash fee for soliciting or referring advisory clients (a solicitor/promoter arrangement) generally must:

• a.Comply with the marketing/solicitation rule, including a written agreement and clear disclosure to the client of the solicitor's compensation and any conflict✓
• b.Pay the third-party solicitor only in restricted securities of the adviser rather than in cash, an approach said to remove the referral arrangement from the marketing rule entirely
• c.Obtain the SEC's advance written approval of each and every individual client referral before any fee may be paid
• d.Keep the referral arrangement strictly confidential so as not to influence the referred client's decision to invest

IAA Rule 206(4)-1 (the amended marketing rule, which absorbed former Rule 206(4)-3) requires a written agreement and disclosure to clients that the solicitor/promoter is compensated and describing the conflict. Advance SEC approval of each referral is not required, but disclosure is mandatory.

Under the Investment Advisers Act, the SEC marketing rule (Rule 206(4)-1) governs advertisements. A testimonial or endorsement in an adviser's advertisement is:

• a.Permitted without any accompanying disclosure whatsoever, so long as the underlying statement is technically true, not fabricated, and the promoter genuinely holds the opinion expressed
• b.Permitted only in connection with federal covered securities offerings and never for the promotion of advisory services
• c.Prohibited under each and every circumstance, without any exception, exactly as the rule stood before it was amended
• d.Permitted only with required disclosures, including whether the promoter is a client and whether they were compensated, plus oversight and, where compensated, a written agreement✓

The amended IAA Rule 206(4)-1 (effective in the early 2020s) permits testimonials and endorsements subject to conditions: disclosure of client/non-client status and compensation, adviser oversight, and a written agreement for compensated promoters. It replaced the old blanket testimonial ban.

Under the Investment Advisers Act, Section 204A requires investment advisers to:

• a.Disclose each piece of material nonpublic information it learns to all of its clients at the same moment, so that none of them can trade at an advantage over the others
• b.Establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information✓
• c.Bar its employees from owning any security that the firm recommends to clients, with no exception for any account, any size of holding, or any holding period
• d.File each employee's personal trade confirmations with the SEC within ten days after every transaction the employee makes in any reportable account

Section 204A requires an adviser to establish, maintain and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information by the adviser or its associated persons. Passing inside information along to clients would itself be misuse. The section does not bar employees from owning recommended securities; personal trading is handled through the code of ethics and reporting. Employees' trade confirmations go to the firm's compliance staff, not to the SEC.Investment Advisers Act of 1940 §204A

Under the Investment Advisers Act, the recordkeeping rule (Rule 204-2) generally requires an SEC-registered adviser to preserve required books and records for a minimum of:

• a.Three years total, but that limited retention period is said to apply only to records that specifically relate to advertising, marketing, and client testimonials
• b.One year from the date each individual record is first created, and it may be kept in any location the adviser chooses
• c.Five years from the end of the fiscal year in which the last entry was made, the first two years in an easily accessible place✓
• d.Ten years for absolutely all records, without any exception, exclusion, or shorter category

IAA Rule 204-2 requires records to be kept five years from the end of the fiscal year of the last entry, with the first two years in an appropriate office of the adviser. NASAA's model rule imposes a comparable five-year requirement on state advisers.

Under the Investment Advisers Act, an adviser relying on the exemption for advisers whose only clients are insurance companies is:

• a.Exempt from SEC registration only while all of its insurance-company clients are domiciled in one state, as with the intrastate adviser exemption
• b.Required to register with the SEC, because the exemption reaches only advisers that are themselves insurance companies
• c.Exempt from SEC registration under Section 203(b), because its only clients are insurance companies✓
• d.Exempt from SEC registration, but only if each insurance-company client is itself registered under the Investment Company Act of 1940

Section 203(b)(2) exempts from SEC registration any investment adviser whose only clients are insurance companies. The exemption turns on who the clients are. It has no single-state condition; that is a feature of the separate intrastate-adviser exemption. It does not depend on the adviser being an insurer, and it does not require the clients to be investment companies. Antifraud provisions still apply to an exempt adviser.Investment Advisers Act of 1940 §203(b)(2)

An agent, knowing a large customer buy order is about to be entered that will likely move the stock up, buys the same stock for the agent's own account first. This practice is:

• a.A permissible personal trade, because the agent used only personal funds and not any customer's money
• b.Front-running, a prohibited practice that breaches the duty to the customer and the market✓
• c.Acceptable so long as the agent later discloses the personal trade on a routine monthly account statement
• d.Lawful, because the large customer's order had not yet been formally confirmed on the firm's books

Front-running, trading for one's own account ahead of a known customer order that is expected to move the price, exploits the customer's order flow and breaches the agent's duty to the customer. NASAA's rule requires agents to observe high standards of commercial honor and just and equitable principles of trade, and its list of violations is expressly not exclusive. Using personal funds, disclosing the trade on a later statement, or pointing out that the customer order is not yet confirmed on the firm's books does not excuse it.

An investment adviser borrows $50,000 from an advisory client who is an individual and not in the business of lending money. Under NASAA model rules this is:

• a.An unethical practice, because an adviser may not borrow from a client unless the client is a broker-dealer, an affiliate of the adviser, or a financial institution in the business of lending✓
• b.Permitted if the client gives informed written consent after the adviser discloses the loan terms and the conflict
• c.Permitted whenever the adviser simply discloses the borrowing in the very next annual amendment to its Form ADV
• d.Permitted as long as the loan is properly documented with a signed promissory note bearing a market rate of interest

NASAA Model Rule 102(a)(4)-1(f) prohibits an adviser from borrowing 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. An individual who does not lend money for a living does not qualify, and neither the client's written consent, a later Form ADV amendment, nor a signed promissory note at a market interest rate cures the conflict.NASAA Model Rule 102(a)(4)-1(f)

An agent of a broker-dealer lends money to a retail customer to help the customer meet a margin call. Under NASAA model rules, lending to or borrowing from customers by agents is:

• a.Always permitted without any further condition, because a short-term loan of this kind helps the retail customer avoid a forced liquidation of the margined position at an unfavorable price
• b.Permitted whenever the customer signs a simple written acknowledgment memorializing the terms of the loan
• c.Permitted only where the lending broker-dealer earns absolutely no interest or fee on the money advanced
• d.Generally prohibited, unless the customer is a lending institution or the two are in a defined family or business relationship meeting the rule's conditions✓

NASAA's model rule on dishonest and unethical practices of agents generally prohibits lending to or borrowing from customers, with narrow exceptions (e.g., the customer is a financial institution in the lending business, or there is a qualifying personal/business relationship and the firm permits it). A simple acknowledgment is not enough.

An investment adviser recommends a complex, illiquid alternative product to an elderly client with a short time horizon and a stated need for income and safety, without a reasonable basis to believe it fits. This is best described as:

• a.A suitable recommendation, because the product's higher expected return offsets the client's short time horizon and need for safety
• b.A permissible diversification recommendation that broadens the elderly client's overall asset allocation beyond traditional holdings
• c.Acceptable, provided the client signs a written risk-acknowledgment form and the adviser discloses the product's fees before settlement
• d.An unsuitable recommendation that violates the adviser's fiduciary duty and NASAA's unethical-practices rule✓

NASAA Model Rule 102(a)(4)-1(a) bars an adviser from recommending a security without reasonable grounds to believe it is suitable, based on reasonable inquiry into the client's objectives, financial situation, and needs; it is also inconsistent with the adviser's fiduciary duty of care. A complex, illiquid product for a client with a short horizon and a need for income and safety fails that test. A higher expected return does not offset the mismatch, diversification does not justify an unsuitable product, and a signed risk form or fee disclosure does not cure it.NASAA Model Rule 102(a)(4)-1(a)

Under the Investment Advisers Act Section 206(3), an adviser that arranges an AGENCY CROSS transaction (acting as broker for both its advisory client and the other party) generally must:

• a.Obtain the client's consent orally at the time of each cross and then confirm it in the next quarterly statement, with no annual summary required
• b.Avoid agency crosses entirely, since Section 206(3) bars an adviser from acting as broker for both sides under any circumstances, even with consent
• c.Obtain prior written consent for agency cross transactions, disclose the adviser's role and any compensation from the other side, not recommend the transaction to both parties, and provide an annual summary of such transactions✓
• d.Recommend the transaction to both the buyer and the seller, provided each receives a written confirmation of the commission earned

Rule 206(3)-2 gives a safe harbor for agency cross transactions if the client has given written consent in advance after full written disclosure, a written confirmation goes out for each trade, the client receives an annual summary of the number of crosses and the commissions earned, each notice says the consent may be revoked, and the adviser did not recommend the trade to both the buyer and the seller. Oral consent is not enough. Section 206(3) does not forbid agency crosses outright; it requires disclosure and consent. Recommending the trade to both sides defeats the safe harbor, whatever confirmation is sent.Investment Advisers Act of 1940 §206(3); 17 CFR 275.206(3)-2

An adviser combines several clients' securities with the adviser's own securities in a single account so that ownership cannot be distinguished. This practice is called:

• a.Hypothecation, the pledging of a client's securities as collateral for the adviser's own borrowing
• b.Commingling, a prohibited practice that endangers client assets and violates custody and antifraud rules✓
• c.Aggregation, a permitted practice of bunching client orders in a single block trade to seek best execution
• d.Allocation, a permitted practice of dividing a completed block trade among client accounts at an average price

Mixing client securities with the adviser's own so that ownership cannot be told apart is commingling. It is prohibited because client property must be segregated and held by a qualified custodian. Hypothecation is pledging securities as collateral, which is a different act. Aggregating orders and allocating fills at an average price are permitted, but both keep each client's holdings separately identified and do not put the adviser's own securities in the same account.

An investment adviser has a policy of always executing its own firm's proprietary trades ahead of client orders in the same security. This practice of trading ahead of clients is:

• a.A prohibited conflict — an adviser must place client interests first and may not systematically trade ahead of client orders✓
• b.Permissible, because the firm may trade its own account first as long as clients later receive the same price that the firm obtained
• c.Allowed if the firm discloses the practice in its Form ADV Part 2A brochure and the client signs the advisory contract
• d.Acceptable, so long as the firm's own trades are below five percent of the security's average daily trading volume

An adviser owes clients a fiduciary duty of loyalty under Section 206, and a standing policy of trading the firm's own account ahead of client orders is front-running. Matching the price later does not cure it, because the clients lose the benefit of the timing. Disclosing the practice in the brochure and having the client sign the contract does not turn a self-dealing priority into loyalty. There is also no volume threshold below which trading ahead of clients is acceptable.

An IAR exercises time-and-price discretion for a client (deciding only the price or time of a specified trade the client authorized that day). Under NASAA rules, this limited discretion:

• a.Requires the IAR to obtain prior written discretionary authority in exactly the same manner that full trading discretion always requires, with no exception for same-day price-or-time decisions
• b.Automatically converts the customer's account into a custody account subject to the surprise-examination rule
• c.Is generally permitted for that day without prior written authority, because deciding only the price or time of an otherwise-specified order is not full discretion✓
• d.Is prohibited in each and every circumstance as a form of unauthorized trading in the customer's account

NASAA and industry rules distinguish full discretion (choosing the security, amount, and action — requiring prior WRITTEN authority) from mere time-and-price discretion over an order the client already specified, which may be exercised for that trading day without written authority. Full discretion needs written authorization.

An investment adviser exercises FULL discretion over a client's account. Under the Uniform Securities Act and NASAA rules, the adviser generally must obtain:

• a.The state Administrator's individual advance approval of each and every discretionary trade before it may be entered, together with a separate written consent from the client for that specific order
• b.A written performance guarantee from the firm before any single discretionary trade may be placed in the account
• c.Written discretionary authorization from the client; for advisers, oral discretion may be used for a limited initial period (commonly the first 10 business days) if written authority follows✓
• d.Nothing more than the client's informal oral instruction given once at the time the account is first opened

For investment advisers, NASAA rules permit oral discretionary authority for a limited period (commonly up to 10 business days from the first discretionary transaction) provided written authorization is obtained thereafter. For broker-dealers, prior written authorization is required before the first discretionary trade.

An agent effects a securities transaction for a client but deliberately fails to follow the client's specific instructions in order to obtain a better commission. This is best characterized as:

• a.An unauthorized transaction and a prohibited/unethical practice under NASAA model rules✓
• b.An acceptable practice, provided that the resulting execution price turned out to be favorable to the client
• c.A merely ministerial error that is not subject to any regulatory discipline or sanction
• d.A permitted exercise of the agent's professional judgment in the client's best interest

Failing to follow a customer's explicit instructions, or effecting transactions the customer did not authorize, is unauthorized trading — a dishonest and unethical practice under NASAA's model rule, and a breach of the agent's duties, regardless of whether the price happened to be favorable.

An agent tells a customer that a mutual fund's past 20% return is 'what you will earn next year, guaranteed.' This statement is:

• a.A prohibited practice: predicting or guaranteeing specific future performance and implying past results guarantee future returns is misleading✓
• b.Acceptable, provided the fund really returned 20 percent last year and the customer initials a written illustration
• c.Acceptable if the agent first delivers the fund's current prospectus, since delivering the prospectus cures an oral projection of future returns
• d.Permitted when the customer is an institutional investor, because the ban on guarantees protects retail accounts only

Telling a customer that a past return is what will be earned next year, guaranteed, is a guarantee of future performance and implies that past results assure future returns. That is misleading under the Uniform Securities Act's antifraud provision and the state dishonest-practices rules. A truthful past figure and a customer's initials do not make the guarantee true. Delivering the prospectus does not cure it, since the prospectus itself warns that past performance is no guarantee. The ban is not limited to retail customers.

An investment adviser directs client brokerage to a firm that charges higher commissions in exchange for soft-dollar benefits that do not qualify under the research safe harbor. Under fiduciary principles this is:

• a.Acceptable, because the adviser earns additional revenue from the arrangement, and any extra revenue can in theory be reinvested into research and technology that ultimately benefits the very clients paying it
• b.Always permissible without limit, because the duty of best execution is concerned only with the speed of execution
• c.Wholly irrelevant to the adviser's fiduciary duties, because the commissions are ultimately the client's own expense
• d.A potential breach of the duty of best execution and loyalty, requiring disclosure and a determination that the arrangement benefits clients within the Section 28(e) safe harbor✓

An adviser owes a duty of best execution and loyalty (IAA §206). Soft-dollar arrangements are permitted only within the Section 28(e) research safe harbor and must be disclosed; directing client commissions for the adviser's own benefit outside the safe harbor breaches fiduciary duty.

An adviser 'churns' a discretionary advisory account. In the advisory context, excessive trading to generate transaction-based compensation is:

• a.A prohibited practice — excessive trading inconsistent with the client's objectives breaches the fiduciary duty and NASAA's unethical-practices rule✓
• b.Permitted, because the adviser already holds full written discretionary trading authority over the account in question and may trade it as actively as it wishes
• c.Acceptable, as long as each individual trade is separately suitable when it is viewed in isolation
• d.Entirely outside the Act, because churning is a concept that applies only to commission brokerage accounts

Churning — trading excessively relative to the client's objectives and resources to generate compensation — is prohibited for advisers and agents alike under NASAA model rules and IAA §206. Having discretion does not license excessive trading, and 'each trade suitable' does not excuse an unsuitable overall pattern.

Under fiduciary principles and the Investment Advisers Act, when an adviser has a material conflict of interest that cannot be eliminated, the adviser must at minimum:

• a.Increase the client's ongoing advisory fee by a stated percentage in order to compensate the client financially for having to bear the unavoidable conflict of interest
• b.Keep the material conflict entirely confidential in order to avoid needlessly worrying or alarming the client
• c.Immediately resign from all advisory engagements the moment any material conflict of interest is identified
• d.Provide full and fair disclosure of the conflict so the client can give informed consent, consistent with the duty of loyalty✓

The fiduciary duty of loyalty under IAA §206 requires an adviser to eliminate or, if that is not possible, fully and fairly disclose material conflicts so the client can provide informed consent. Concealment breaches the duty; disclosure is the baseline, and the advice must still be in the client's best interest.

An adviser learns material nonpublic information through a client relationship and, rather than trading, 'tips' a friend who then trades on it. Under securities law the adviser has:

• a.Has a complete legal defense, because it was the friend and not the adviser who actually executed the securities trade, and the adviser received no share of the resulting profits at all
• b.Done nothing wrong at all, because the adviser personally refrained from trading in the security in question
• c.Engaged in unlawful tipping — conveying material nonpublic information to another who trades on it violates insider-trading prohibitions and Section 204A duties✓
• d.Acted entirely properly by simply keeping the sensitive information out of the firm's own client accounts

Tipping — passing material nonpublic information to another who trades — violates insider-trading law even if the tipper does not trade, and breaches the adviser's §204A duty to prevent misuse of inside information. Both tipper and tippee can face liability.

An agent backdates order tickets and alters trade confirmations to conceal a late execution. Falsifying firm records in this way is:

• a.Acceptable, provided that a branch office supervisor verbally approved the after-the-fact correction to the order tickets and confirmations before they were re-filed
• b.Permitted, so long as the affected customer ultimately suffers no measurable financial loss from the late fill
• c.A minor clerical matter that falls entirely outside the scope of the state and federal securities laws
• d.A prohibited and fraudulent practice — falsifying books, records, or confirmations violates the antifraud and recordkeeping provisions✓

Falsifying, backdating, or altering firm books, records, order tickets, or confirmations is a prohibited and fraudulent practice under USA §101 and the recordkeeping rules. Accurate records are essential to supervision and investor protection; supervisor approval or absence of loss is no defense.

An adviser deducts advisory fees directly from client accounts held at a qualified custodian. To avoid being subject to the full surprise-examination requirement in many states, the adviser typically must:

• a.Send the client and the custodian an itemized fee invoice showing the calculation at the same time it deducts the fee, per NASAA guidance✓
• b.Never take any advisory fees directly out of client accounts under any facts or circumstances whatsoever, and instead bill every client separately by paper invoice
• c.Deduct advisory fees only once every three years in order to minimize its overall custody exposure
• d.Obtain the state Administrator's written pre-approval before making each individual fee deduction

Direct fee deduction is a form of custody, but NASAA guidance provides relief from certain custody requirements when the adviser sends the client (and the custodian) an itemized invoice showing how the fee was calculated at the time of deduction. Documenting the calculation is the safeguard.

An adviser guarantees a client that the client 'cannot lose money' because the adviser will personally cover any losses. Under the Investment Advisers Act and NASAA rules this is:

• a.Permitted for qualified clients who first sign a written acknowledgment accepting the personal guarantee
• b.Acceptable when the guarantee is limited only to the client's original principal and never to any gains
• c.A prohibited practice — an adviser may not guarantee a client against loss or guarantee any specific result✓
• d.Permitted, provided the adviser maintains sufficient personal net worth to actually honor the guarantee if invoked

Guaranteeing a client against loss or guaranteeing a specific result is a prohibited practice under NASAA model rules and IAA §206 antifraud principles. The adviser's own net worth or a signed acknowledgment does not make a performance guarantee permissible.

An adviser fails to disclose that it receives 12b-1 fees and revenue sharing from the mutual funds it recommends to clients. This omission is:

• a.Permissible, so long as the recommended mutual funds are otherwise suitable for the client's stated objectives and time horizon at the moment of the recommendation
• b.Immaterial, because 12b-1 fees and revenue sharing are extremely common throughout the mutual fund industry
• c.Acceptable, provided the compensation is disclosed only to the adviser's larger institutional clients
• d.A breach of the fiduciary duty of loyalty and the antifraud provisions — compensation-driven conflicts must be fully disclosed to clients✓

Undisclosed compensation such as 12b-1 fees and revenue sharing creates a material conflict that must be disclosed under IAA §206 and the fiduciary duty of loyalty. Failing to disclose payments that could bias the adviser's recommendations is a violation even if the funds are otherwise suitable.

An adviser recommends that a client liquidate a diversified portfolio and invest everything in a single stock that the adviser also owns, without disclosing the adviser's position. The undisclosed personal holding is:

• a.Acceptable, so long as the adviser does not itself sell any of its own shares of that stock at the same moment the client is buying, and holds its position for the long term
• b.Permitted, because advisers are generally expected and even encouraged to invest right alongside their clients
• c.Irrelevant, because the adviser genuinely and sincerely believes in the long-term prospects of the single stock
• d.A material conflict that must be disclosed; recommending a security the adviser owns without disclosure breaches the duty of loyalty and antifraud rules✓

An adviser who recommends a security in which it has a personal position has a material conflict that must be disclosed under IAA §206 and NASAA rules (scalping/undisclosed interest). Failing to disclose the holding — and any intent to trade around the client's order — breaches the duty of loyalty.

An adviser publishes a recommendation to buy a security while intending to sell its own holdings into the demand the recommendation creates. This practice is known as:

• a.Scalping, a fraudulent practice prohibited under the Investment Advisers Act✓
• b.Rebalancing, an ordinary and routine portfolio-management activity performed for clients
• c.Coordination, a recognized method of registering securities in a state
• d.Best execution, a core fiduciary obligation owed to advisory clients

Scalping — recommending a security to clients or the public while intending to trade against that recommendation for the adviser's own benefit — is a fraudulent practice under IAA §206 (SEC v. Capital Gains Research Bureau). It breaches the duty of loyalty by exploiting the advice for personal gain.

An agent splits commissions with an unregistered individual who referred several customers to the agent. Under the Uniform Securities Act, sharing commissions is generally permitted only when the other person is:

• a.An unregistered marketing consultant who was hired specifically to generate qualified sales leads
• b.Any individual at all, provided only that the customer consents in writing to the commission split
• c.Properly registered as an agent, and both agents work for the same or affiliated broker-dealers✓
• d.A member of the agent's own immediate family, regardless of that person's registration status

USA §201 and NASAA rules permit splitting commissions only with another properly registered agent of the same broker-dealer or an affiliated broker-dealer under common control. Paying transaction-based compensation to an unregistered person for securities activity is prohibited.

An adviser's client dies. The adviser continues to place discretionary trades in the account for two weeks under the existing discretionary authority. This is:

• a.Acceptable, as long as the discretionary trades placed during that two-week period after the death all happened to turn out profitable for the account and its eventual beneficiaries
• b.Proper, because a grant of discretionary authority is permanent and continues in force once it has been given
• c.Permitted right up until the estate formally notifies the firm in writing several months later
• d.Improper — discretionary authority and the advisory relationship generally terminate on the client's death, and continued trading is unauthorized✓

Under agency law and NASAA model rules, a grant of discretionary authority (like a power of attorney) generally terminates upon the death or incapacity of the client. Continuing to trade the account after death is unauthorized activity and a prohibited practice; the adviser should cease discretionary trading and await instructions from the estate's legal representative.

Under NASAA model rules, an agent who wishes to open a personal securities account at ANOTHER broker-dealer generally must:

• a.Obtain the state securities Administrator's advance written consent before the outside personal brokerage account may lawfully be opened at the other firm
• b.Trade only in mutual funds and municipal bonds within the outside personal brokerage account
• c.Do nothing at all, because personal brokerage accounts are private and entirely unregulated
• d.Notify the employing broker-dealer and, in most cases, the executing firm of the association, so the accounts can be supervised✓

Under NASAA and industry rules, an agent opening an outside brokerage account must notify the employing broker-dealer, and the executing firm must be told of the agent's association so duplicate confirmations/statements can be provided and the activity supervised. This prevents undisclosed, unsupervised trading.

An investment adviser representative accepts an appointment as trustee for a client's trust and begins paying the adviser's own advisory fees out of the trust to itself without independent oversight. This arrangement:

• a.Is automatically valid and entirely proper, because a duly appointed trustee lawfully controls all of the trust's assets and may pay itself reasonable compensation without any outside review
• b.Creates serious conflicts of interest and custody issues that must be disclosed and independently safeguarded under fiduciary and custody rules✓
• c.Requires no disclosure whatsoever, because the IAR is acting purely in the capacity of trustee and not as an adviser
• d.Is clearly beneficial to the client and therefore raises no conflict of interest at all under the rules

Serving as trustee while also charging advisory fees gives the IAR control over client assets (custody) and a self-dealing conflict. Under IAA §206 and Rule 206(4)-2, such arrangements demand full disclosure, informed consent, and custody safeguards; unchecked self-payment breaches fiduciary duty.

An adviser recommends a variable annuity with a large surrender charge and long surrender period to a client who will need access to the funds within a year. The primary problem is that the recommendation is:

• a.Perfectly suitable, because a deferred variable annuity offers valuable long-term tax deferral of gains and a menu of professionally managed subaccounts
• b.Entirely beyond the Act, because variable annuities are regulated only as insurance products
• c.Unsuitable given the client's short liquidity horizon, a violation of the suitability/best-interest and fiduciary standards✓
• d.Acceptable, because the annuity carries a guaranteed death benefit payable to the client's heirs

A recommendation must fit the client's time horizon and liquidity needs. Placing a client who needs funds within a year into a product with a long surrender period and steep charges is unsuitable, breaching NASAA suitability rules and the fiduciary duty of care. Variable annuities are securities and within the Act.

An adviser wishes to assign its advisory contracts to an acquiring firm following a change in control. Under the Investment Advisers Act, a change in control of the adviser is treated as:

• a.A matter solely for the SEC to review and approve behind the scenes, without any notice to, or consent from, the adviser's existing advisory clients before it takes effect
• b.Legally irrelevant, because only a formal transfer of the actual contract paper counts as an assignment
• c.A routine corporate event that requires no client notice, no client consent, and no filing of any kind
• d.An assignment of the advisory contracts, which requires client consent (positive or negative depending on structure) before it is effective✓

IAA §205 and §202(a)(1) treat a change in control of the adviser (e.g., a majority ownership change) as an 'assignment' of the advisory contracts, requiring client consent. The personal nature of the advisory relationship is why consent is needed when control changes hands.

Under NASAA model rules, an agent who exercises discretion in a customer's account without prior written authorization has:

• a.Done nothing wrong at all, provided that the customer's account happened to increase in value afterward
• b.Acted entirely properly under the rule, because informal verbal authority given by the customer is fully sufficient for an agent of a broker-dealer to exercise discretion
• c.Committed a prohibited practice — an agent must have prior written discretionary authority before exercising discretion✓
• d.Engaged in a permitted practice, provided only that each resulting trade was individually suitable

Unlike investment advisers (who may use limited oral discretion briefly), a broker-dealer agent must obtain PRIOR WRITTEN discretionary authorization before exercising discretion. Trading discretion without it is a prohibited practice under NASAA model rules, regardless of suitability or profit.

A broker-dealer effects a transaction and charges a markup that is excessive relative to the prevailing market price and the services provided. Charging an unfair, excessive markup is:

• a.Acceptable, provided that the customer never specifically asks the firm about the price or the size of the markup charged, and the confirmation lists only the net price
• b.A prohibited practice — markups, markdowns, and commissions must be fair and reasonable in relation to the market and the services rendered✓
• c.Always permissible in any principal transaction, because the firm is trading from its own inventory
• d.Beyond any regulation at all, because securities pricing is set entirely by open market forces alone

Charging unfair or excessive markups, markdowns, or commissions is a prohibited practice under NASAA model rules and the antifraud provisions. Compensation must be fair and reasonable considering the market price, the security, and the services provided; concealing an excessive charge compounds the violation.

An adviser tells clients it is 'registered with and approved by the SEC,' implying the SEC has endorsed the quality of its services. This representation is:

• a.Accurate, because SEC registration means the Commission has reviewed and approved the adviser's qualifications and the quality of its services
• b.Permitted for SEC-registered advisers, because the Commission itself examines them, though not for advisers registered only with a state
• c.A prohibited misrepresentation — stating or implying that registration means the regulator approved or endorsed the adviser's abilities is misleading and unlawful✓
• d.Permitted, because Section 208(b) allows an adviser to say it is registered, and 'approved by' is another way of saying so

Section 208(a) makes it unlawful for a registered adviser to represent or imply that it has been sponsored, recommended or approved, or that its abilities or qualifications have been passed upon, by the United States or any agency or officer. Section 208(b) permits a true statement that the adviser is registered only if the effect of registration is not misrepresented, so 'approved by' goes beyond what it allows. Registration is not approval, for SEC registrants or anyone else, and the SEC's examinations do not amount to an endorsement.Investment Advisers Act of 1940 §208(a)-(b)

An adviser accepts a gift of significant value from a client and does not disclose it, later favoring that client's interests over others in allocation decisions. The failure here most directly implicates:

• a.The registration-by-coordination timing requirements that govern exactly when a federal securities offering may become effective at the state level
• b.The fiduciary duty to treat clients fairly and to disclose conflicts, since undisclosed benefits can bias allocation and breach loyalty✓
• c.The statutory exemption for isolated non-issuer transactions effected through a broker-dealer
• d.The recordkeeping rule's five-year document retention period for advisory books and records

Accepting undisclosed benefits that bias how the adviser allocates opportunities or trades among clients breaches the fiduciary duties of loyalty and fair dealing under IAA §206. Advisers must allocate fairly among clients and disclose conflicts that could influence their impartiality.

An agent, to boost year-end production numbers, recommends that several clients switch mutual-fund families, incurring new sales charges without a meaningful benefit. This practice is:

• a.Encouraged as sound practice, because moving assets among different fund families usefully diversifies the client's overall fund-family exposure and manager risk across the portfolio
• b.Permitted without concern, as long as the client signs a written switch-acknowledgment letter beforehand
• c.Improper switching (a form of churning) — recommending fund switches that generate charges without a legitimate benefit to the client is a prohibited practice✓
• d.Acceptable, because each newly recommended replacement fund is individually suitable for the client

Recommending mutual-fund switches that impose new sales charges without a genuine benefit to the client ('switching' or fund churning) is a prohibited practice under NASAA model rules. It exists to generate charges/commissions and breaches suitability and best-interest obligations.

Under the Uniform Securities Act and NASAA rules, an agent who effects transactions in an account based on inside information provided by a client who is a corporate director has:

• a.Has a valid and complete legal defense, because the agent did not personally originate the material nonpublic information but merely acted on a tip from a corporate insider
• b.Committed only a suitability violation and not any kind of fraud or insider-trading violation
• c.Violated insider-trading prohibitions — trading on material nonpublic information is unlawful regardless of its source✓
• d.Acted lawfully, because the information came directly from the client rather than from the firm itself

Trading on material nonpublic information is prohibited no matter how the information was obtained; the client-source does not create a defense. This violates the antifraud provisions (USA §101) and insider-trading law, and firms must maintain §204A controls to prevent it.

An adviser provides a client with a hypothetical performance illustration that omits the effect of fees and cherry-picks the best historical period. Under the marketing rule and antifraud provisions, this presentation is:

• a.Allowed for accredited investors and qualified purchasers without any further conditions, disclosures, or netting of fees, since sophisticated clients can evaluate the figures themselves
• b.Acceptable, provided the client is simply told that the figures shown are 'for illustration only'
• c.Permitted, because hypothetical performance illustrations are inherently understood to be disclaimed
• d.Misleading and prohibited — performance advertising must be fair and balanced, present net-of-fee results, and not cherry-pick favorable periods✓

IAA Rule 206(4)-1 (marketing rule) and the antifraud provisions require performance advertising to be fair and balanced, to show net-of-fee results, and to avoid misleading cherry-picking of favorable periods. Omitting fees and selecting only the best period is a prohibited, misleading presentation.

An investment adviser wants to keep a client's securities in the adviser's own name 'for convenience.' Holding client securities registered in the adviser's name is:

• a.Acceptable, so long as the adviser sends the client a detailed annual summary listing all of the securities being held registered in the adviser's own name for the client's convenience
• b.A custody arrangement raising misappropriation risk — client securities must be held by a qualified custodian, generally in the client's name, not the adviser's✓
• c.Permitted for any adviser that has filed a current Form ADV Part 2 with its regulator
• d.Encouraged, because registering the securities in the adviser's name streamlines trade settlement

Registering client securities in the adviser's own name is a dangerous form of custody that exposes clients to misappropriation and the adviser's creditors. IAA Rule 206(4)-2 and NASAA custody rules require a qualified custodian and generally that assets be held in the client's name with account statements sent to the client.

A client instructs an agent to buy a security, but the agent, believing a different security is better, buys the different security instead. Regardless of outcome, this is:

• a.Proper and defensible, because the agent used sound professional judgment to buy what it sincerely believed was the better security for the client's benefit and long-term returns
• b.An unauthorized transaction — substituting a different security than the client ordered is a prohibited practice absent discretionary authority✓
• c.Permitted, so long as the substitute security was actually suitable and happened to perform well afterward
• d.A merely ministerial substitution that falls entirely outside the reach of the securities laws

Buying a security other than the one the client specified, without discretionary authority, is an unauthorized transaction and a prohibited practice under NASAA model rules. The agent must follow the client's instructions; good intentions or favorable results do not cure the lack of authorization.

Under the Investment Advisers Act, an adviser that exercises discretion and directs client brokerage owes clients a duty of best execution, which means the adviser must:

• a.Seek the most favorable terms reasonably available under the circumstances, considering price, execution quality, and total cost — not merely the lowest commission✓
• b.Direct every single client trade to whichever broker-dealer happens to pay the adviser the most in soft-dollar credits and other back-end rebates, without regard to price
• c.Ignore execution quality entirely, because commissions are ultimately the client's own responsibility
• d.Always route the order to the broker offering the very lowest commission, regardless of all other factors

Best execution under IAA §206 requires the adviser to seek the most favorable overall terms reasonably available, weighing execution quality, price, speed, and total transaction cost — not simply the lowest headline commission. Directing trades for the adviser's own soft-dollar benefit outside the safe harbor breaches this duty.

An adviser's employee overhears material nonpublic information in an elevator and the firm has no written policies to prevent its misuse. The firm's failure violates:

• a.The exempt-transaction provisions covering isolated non-issuer trades effected through a broker
• b.The registration-by-qualification disclosure requirements applicable to new securities offerings
• c.The civil-liability and rescission provisions found in the Uniform Securities Act, which let a buyer recover the purchase price whenever a security was sold in violation of the Act
• d.Section 204A of the Investment Advisers Act, requiring written policies reasonably designed to prevent the misuse of material nonpublic information✓

IAA §204A requires advisers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information (information barriers, restricted lists, training). A firm lacking such controls violates §204A even before any trade occurs.

An investment adviser that is registered in a state moves its principal office and place of business permanently to a different state. Under NASAA rules the adviser generally must:

• a.Register in the new state and comply with that state's requirements, since a place of business there triggers registration (subject to the federal/state division)✓
• b.Do nothing at all until its next scheduled annual registration renewal date comes around on the calendar, at which point it may simply file an address change with the old state
• c.Automatically become a federal covered adviser the moment it relocates across the state line
• d.Cancel all of its existing advisory contracts and start the client relationships over in the new state

Under USA §201 and NASAA rules, maintaining a place of business in a state generally triggers state registration for a state-covered adviser. Relocating the principal office requires registering in the new state and meeting its requirements; relocation alone does not convert a state adviser into a federal covered adviser.