NASAA Series 63 — All Questions

A customer instructs, 'Buy 1,000 shares of XYZ today, but you choose the best time and price.' The agent executes later that afternoon without a signed discretionary agreement. The agent has:

• a.Acted properly, because the customer specified the security, the action, and the amount, leaving only time and price✓
• b.Violated the act, because discretion over timing and price is still discretion and requires the customer's signed authorization before the order is entered
• c.Acted properly only because the account was a cash account; the same instruction in a margin account would have required a signed discretionary agreement
• d.Acted improperly unless a principal of the firm approved the order in writing before execution, since only management can accept a time-and-price instruction

Time-and-price discretion, where the customer names the security, the action, and the quantity and leaves only the timing and execution price, does not require a written discretionary agreement and is generally good only for the day given. The rule itself exempts discretion that relates solely to time and price, so signed authorization is not needed. A margin agreement is a separate requirement that has nothing to do with discretion, and a principal's sign-off is not the trigger. Discretion over the security, the amount, or whether to buy or sell would require prior written authorization.NASAA Model Rule on Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended 2025-04-07), 1.g

A state-registered investment adviser is granted discretion over a client's account. Under NASAA rules, the adviser may generally:

• a.Never exercise discretion without SEC approval
• b.Exercise discretion indefinitely on a purely oral understanding
• c.Rely on oral discretionary authority for a limited initial period, provided written authorization is obtained within a short time (commonly ten business days) after the first discretionary trade✓
• d.Exercise discretion only over institutional accounts

Unlike a broker-dealer agent, who needs prior written authorization before any discretionary trade, an investment adviser may act on oral discretion during a brief initial window but must obtain written authorization within roughly ten business days of the first discretionary transaction. It is not indefinite, not limited to institutional accounts, and needs no SEC sign-off. Note this is a heavily tested BD-versus-IA distinction.NASAA Model Rule

Several traders enter a rapid series of prearranged buy and sell orders in a stock just before the close to create the appearance of heavy demand and a rising price. This is:

• a.Legitimate closing-price discovery, because heavy late-day activity is the ordinary way a closing price is established
• b.Market manipulation, sometimes called painting the tape or marking the close, a prohibited practice✓
• c.Permissible so long as all the orders are reported to the tape, because reported trades are treated as bona fide market activity
• d.Permissible market making

Prearranged trades designed to create misleading activity or move the closing price (painting the tape, marking the close) are manipulative and prohibited. Heavy trading is not a legitimate means of discovering a price when the orders are staged, reporting the orders does not legitimize the deception, and genuine market making involves bona fide two-sided quotations rather than staged trades intended to mislead other investors.NASAA Model Rule on Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended 2025-04-07), 1.p(2)-(3)

Regarding written customer complaints, a broker-dealer is generally required to:

• a.Discard complaints once they are resolved, because only complaints that remain open need to be kept in the firm's records
• b.Keep complaints only if litigation is filed or a regulator asks for them, because other complaints are treated as ordinary correspondence
• c.Record, retain, and make available for inspection written customer complaints and the firm's responses✓
• d.Forward every written complaint to the SEC within 24 hours of receipt, with the firm's own record limited to the date it was forwarded

Firms must record and retain written customer complaints, with the disposition of each, for the prescribed retention period and produce them on examination. Complaints are not discarded when resolved, retention does not depend on litigation or on a regulator's request, and ordinary complaints are not automatically sent to the SEC on a 24-hour clock in place of the firm's own record.SEC Rule 17a-3(a)(18) (17 CFR 240.17a-3); retention under SEC Rule 17a-4

An agent conducts securities business with customers through his personal email account, bypassing the firm's servers. This is:

• a.A violation, because business communications must go through the firm's supervised and retained systems✓
• b.Acceptable, because email is not a firm record
• c.Acceptable if he forwards a copy of each message to the firm at month-end, because retention is then satisfied after the fact
• d.A concern only for investment advisers, because broker-dealer recordkeeping rules cover trade tickets and statements but not correspondence

Business communications with customers must be conducted through channels the firm can supervise and retain; using an unmonitored personal account defeats the firm's supervisory and recordkeeping obligations. Business email is a firm record, a belated forward does not give the firm the supervision or complete retention it is required to have, and the duty to keep communications relating to the business applies to broker-dealers as well as advisers.SEC Rule 17a-4(b)(4) (17 CFR 240.17a-4); NASAA BD model rule on conduct not inclusive

A product sponsor offers an agent an expensive vacation as a reward for selling a large amount of its mutual fund. Accepting this undisclosed compensation:

• a.Is always permissible between professionals, because the sponsor and the agent are both registered and understand the arrangement
• b.Is permissible if the fund was suitable for the buyers, because suitability is the only test applied to a recommendation of a fund
• c.Creates an undisclosed conflict of interest and may be a prohibited sales-incentive practice✓
• d.Is a concern only when its value exceeds the annual per-person gift limit, because that limit is the only rule restricting what sponsors may give

Non-cash rewards tied to selling a particular product create a material conflict of interest that biases recommendations; accepting them is restricted for investment company shares and, undisclosed, can be a prohibited practice. Suitability of the fund does not cure the undisclosed conflict, being registered professionals does not make such rewards acceptable, and the annual gift limit applies to ordinary gifts, not to rewards for selling a specific product.FINRA Rule 2341(l)(5) (non-cash compensation); NASAA Model Rule on Dishonest or Unethical Business Practices

A state-registered investment adviser is acquired and wants to transfer its existing client contracts to the buyer. Under NASAA rules, the adviser must:

• a.Do nothing, because advisory contracts pass automatically to a buyer that acquires the adviser's business
• b.Obtain the clients' consent to the assignment of their advisory contracts✓
• c.Only notify the Administrator of the sale
• d.Refund all prepaid fees before transferring the contracts, because a new adviser may not hold fees clients paid to the old one

An investment advisory contract may not be assigned without the client's consent, and a transfer of a controlling block of the adviser, which counts as an assignment, triggers that requirement. Contracts do not pass automatically to an acquirer, notifying the Administrator is not a substitute for client consent, and a refund of prepaid fees is not the mechanism for a valid assignment.Uniform Securities Act (1956, as amended) 102(c)(2) and 102(d)

An investment adviser organized as a partnership must, under NASAA rules, ensure its advisory contracts provide that:

• a.Each client must give prior written consent before a new partner is admitted, failing which the contract terminates automatically
• b.The adviser will notify the Administrator, rather than the clients, whenever the membership of the partnership changes
• c.The adviser will notify clients of any change in the membership of the partnership within a reasonable time✓
• d.The adviser will notify clients only when a partner with a majority interest withdraws; admitting a new partner requires no notice

A partnership adviser's contracts must require that clients be notified of any change in the membership of the partnership within a reasonable time after the change. The duty runs to the clients, not to the Administrator, it is a notice duty rather than a consent requirement, and it covers any change in membership, not just a majority partner's withdrawal. The Act does not require fee freezes, guaranteed returns or waivers of client rights.Uniform Securities Act (1956, as amended) 102(c)(3)

Which provision in a state-registered investment adviser's contract would violate NASAA rules?

• a.A clause charging a fee based on a share of capital gains to a client who does not meet the net-worth or assets thresholds✓
• b.A clause stating the advisory fee is $2,000 per year
• c.A clause setting the fee as a percentage of the total value of the client's account, measured as of a definite date each quarter
• d.A clause stating that the adviser may not assign the contract without the client's consent and will tell clients of any change in the partnership's membership

Performance-based fees measured by a share of capital gains or appreciation are prohibited except where the Administrator permits them, such as for clients who meet defined net-worth or assets thresholds; charging one to an ineligible client violates the rule. A flat annual fee is an ordinary provision, a fee computed on the total value of the account as of definite dates is expressly not treated as a share of gains, and a no-assignment-without-consent clause is itself a required provision.Uniform Securities Act (1956, as amended) 102(c)(1) and 102(d)

A state-registered investment adviser collects advisory fees well in advance. Under NASAA rules, if it collects substantial prepaid fees six or more months ahead, it generally must:

• a.Do nothing special
• b.Register with the SEC instead of the state
• c.Include a current balance sheet in its brochure, because collecting more than $500 per client, six or more months in advance, is treated like custody✓
• d.Post a one-million-dollar surety bond

Collecting prepaid fees of more than $500 per client six or more months in advance is treated as a form of custody and triggers the requirement to disclose the adviser's financial condition through a balance sheet in the brochure. It is not an SEC-registration trigger, and the million-dollar bond figure is invented.NASAA Model Rule

A firm offers a 'wrap' program charging one asset-based fee that covers advice and all transaction costs. With respect to this program, the firm must:

• a.Charge a separate commission on each trade on top of the wrap fee, because the wrap fee covers only the advice
• b.Disclose the wrap-fee arrangement, because bundling advice and execution into one fee generally brings the program within the advisory rules✓
• c.Deliver only its general Part 2A firm brochure, because a wrap program needs no separate brochure of its own
• d.File the fee schedule with the Administrator for approval before offering the program to any client

A wrap-fee sponsor must deliver a wrap fee program brochure, prepared under Part 2A Appendix 1 of Form ADV, to its wrap fee clients, and Rule 204-3 governs delivery of the brochure. A single fee that covers advice and execution does not remove the disclosure duty. Charging separate commissions on top of the wrap fee would contradict the program's design, delivering only the general firm brochure leaves out the wrap-specific disclosure, and the Administrator does not approve fee amounts before a program is offered.Form ADV Part 2 General Instructions and Part 2A Appendix 1 (wrap fee program brochure); 17 CFR 275.204-3

A customer sells securities and is owed the proceeds. The agent delays sending the funds and briefly uses them for the firm's short-term needs. This is:

• a.Acceptable if the customer is eventually paid in full, because no customer is harmed by a short delay in receiving funds
• b.Acceptable because the firm has custody of the account, and the customer is taken to have allowed the firm to hold the funds when the account was opened
• c.A permitted practice if the firm credits the customer with interest for the days the funds were held back
• d.A prohibited failure to promptly pay funds owed and an improper use of customer money✓

Failing to pay or deliver promptly the funds or securities owed to a customer, and using customer money for the firm's own purposes, are prohibited practices. Eventual payment does not cure the misuse, holding an account does not authorize borrowing customer funds without permission, and paying interest afterward does not make the delay or the use proper.NASAA Model Rule on Dishonest or Unethical Business Practices of Broker-Dealers and Agents (amended 2025-04-07), 1.a and the conduct-not-inclusive paragraph

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

An investment adviser representative wants to share directly in the profits and losses of a client's account. Under NASAA rules for advisers, this is generally:

• a.Restricted to performance-fee arrangements meeting the qualified-client thresholds, not the proportionate sharing allowed to broker-dealer agents✓
• b.Permitted like any agent's proportionate sharing
• c.Freely permitted with only the client's oral consent, provided the customer is furnished the required written confirmation and the details are recorded on the books the firm must maintain
• d.Permitted for any client who signs a waiver

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

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

• a.Permitted up to $100 per referral
• b.Permitted because it is a flat fee rather than a commission, a conclusion the NASAA model rules are commonly understood to support for a person already registered and in good standing elsewhere
• c.Prohibited, because transaction-related compensation for securities business may not be paid to an unregistered person✓
• d.Permitted if the acquaintance reports it as income

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Under the brochure rule, after the initial delivery a state-registered adviser must deliver to each client annually:

• a.The current brochure, or a summary of material changes with an offer to provide the full brochure, free of charge✓
• b.A brochure only if the fee changes
• c.Nothing further once the contract is signed, provided the firm files the required consent to service of process and the Administrator does not enter an order to the contrary
• d.A brand-new signed advisory contract

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

Under NASAA model rules, an investment advisory contract must:

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

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

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

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

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

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

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

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

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

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

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

An adviser consistently allocates profitable trades to its own account and its favored clients, giving losing trades to smaller clients. This is:

• a.A prohibited breach of the duty of fair and equitable trade allocation✓
• b.Acceptable portfolio management, because an adviser may allocate trades however it chooses once clients have signed discretionary agreements
• c.Acceptable if the allocation policy is disclosed in writing to the larger clients, who are the only accounts receiving the profitable trades
• d.A concern only for broker-dealers, because the duty to allocate trades fairly arises under the agent-conduct rules and not the adviser rules

An adviser is a fiduciary with a duty to act primarily for the benefit of its clients, so it must allocate trades fairly among them. Giving the profitable trades to itself and favored clients and the losing ones to smaller clients (cherry-picking) breaches that duty. Discretion does not allow unfair allocation, disclosure to the favored clients alone does not cure it, and the duty applies to advisers.NASAA Model Rule 102(a)(4)-1 (introduction: fiduciary duty to act primarily for the benefit of clients)

A state-registered adviser with discretionary authority learns of a net-worth deficiency that could impair its ability to meet commitments to clients. Under NASAA rules it must:

• a.Keep it confidential while it works to cure the shortfall, since disclosure is required only after the adviser fails to cure it within the time the Administrator allows
• b.Disclose it only at the next annual updating amendment to Form ADV, since a temporary net-worth shortfall is not a material change needing interim notice
• c.Promptly disclose the financial condition to clients and notify the Administrator, because it is material to the advisory relationship✓
• d.Disclose it only to prospective clients in the brochure, since existing clients are protected because a qualified custodian holds their assets

A financial condition reasonably likely to impair the adviser's ability to meet its commitments to clients is material to the advisory relationship, so an adviser with discretionary authority or custody must disclose it promptly to clients and notify the Administrator. It cannot wait for a cure period or the next annual amendment, and it cannot be limited to prospective clients.

An agent learns material nonpublic information about a pending merger and tells his brother, who then buys the stock. The agent has:

• a.Done nothing wrong, because only the person who actually trades on inside information violates the antifraud provisions
• b.Violated only the rule on confidential client information, since family members are not covered by the insider-trading prohibitions
• c.Engaged in prohibited tipping of material nonpublic information✓
• d.Acted properly because tips to relatives are lawful so long as the agent receives no payment in return for the information

Passing material nonpublic information to someone who then trades is tipping, which the antifraud provisions prohibit even though the tipper never trades. A tip to a family member is not excused because the agent was not paid, and the violation is not limited to a breach of client-confidentiality or suitability duties.

A trader repeatedly places sell orders to hold a stock's price down while quietly accumulating shares cheaply, creating a false impression of supply. This practice is:

• a.Permitted if the trader discloses the buying afterward, because the rule against manipulation reaches only orders meant to push a price higher
• b.Permitted for registered market makers, who may enter orders on one side of the market to maintain an orderly market in the stock
• c.Legitimate price stabilization, allowed for any trader who enters bona fide orders at or below the last sale price
• d.Prohibited, because artificially capping or pegging a price through deceptive orders is market manipulation✓

Effecting a series of transactions or orders that raise or depress a security's price in order to induce others to trade is a manipulative device. Repeated sell orders that hold a price down while the trader accumulates shares, creating a false impression of supply, are an example. After-the-fact disclosure, market-maker status and the label 'stabilization' do not make it permissible.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (1.p(3))

A customer instructs an agent to sell a stock immediately, but the agent waits two days hoping for a rebound, and the price falls. The agent has:

• a.Committed a prohibited practice by failing to follow the customer's instructions✓
• b.Acted within his authority, because a sell instruction leaves the agent discretion over the day on which it is executed
• c.Violated only an internal firm order-handling policy, since the model rules regulate unauthorized trades but not delayed ones
• d.Committed no violation, because the customer never complained and the sale was eventually executed at the market price

An agent who does not execute a customer's order as instructed substitutes his own judgment for the customer's, which is contrary to the just and equitable principles of trade the model rule requires. The agent had no discretion over timing, the absence of a complaint does not excuse it, and the violation is not limited to unauthorized trades.NASAA Model Rule: Dishonest or Unethical Business Practices of Broker-Dealers and Agents (high standards of commercial honor and just and equitable principles of trade)

A customer authorizes the purchase of 100 shares; the agent buys 500 shares because he is confident in the stock. As to the extra 400 shares, the agent has:

• a.Effected an unauthorized transaction, a prohibited practice✓
• b.Acted properly if the price later rose
• c.Made a curable clerical error
• d.Acted properly because the customer wanted the stock

Buying more than the customer authorized, without prior written discretionary authority, is an unauthorized transaction; a favorable outcome does not cure it (NASAA unethical practices).

Which customer instruction gives an agent discretion that requires prior written authorization?

• a.'Invest $50,000 in whatever stocks you think are best.'✓
• b.'Buy 300 shares of DEF at the market right now.'
• c.'Buy 200 shares of XYZ; you pick the best price today.'
• d.'Sell 100 shares of ABC sometime this morning.'

Discretion over the security, the amount, or the action requires prior written authorization; choosing only time or price (with security, action, and amount specified) is time/price discretion, which does not (NASAA; USA).

Which statement correctly contrasts discretionary authority for a broker-dealer agent versus an investment adviser?

• a.A broker-dealer agent needs prior written authorization before any discretionary trade, while an adviser may rely on oral discretion for a limited period if written authorization is obtained within about 10 business days✓
• b.A broker-dealer agent may use oral discretion, but an adviser may not
• c.Neither may ever exercise discretion
• d.Both may rely on oral discretion indefinitely

This heavily tested distinction: a broker-dealer agent requires written authorization before the first discretionary trade; an adviser may act on oral discretion initially but must obtain written authorization within roughly 10 business days (NASAA; Advisers Act).

To make an unsuitable trade appear appropriate, an agent inflates the customer's net worth and risk tolerance on the new-account form. This is:

• a.Acceptable if the customer approves the trade
• b.Acceptable if the trade turns out profitable
• c.Prohibited falsification of firm records✓
• d.A harmless estimate

Falsifying customer information on firm records to disguise unsuitability is a prohibited practice that corrupts the books regulators rely on (NASAA unethical practices – falsification).