NASAA Series 66 — All Questions

A person acting as an investment adviser makes a materially false statement to a client to induce advisory business. Under the Uniform Securities Act this conduct is addressed by:

• a.Section 202, which prescribes the detailed registration procedure and annual filing schedule for persons in the state
• b.Section 402, which lists the exempt securities and the exempt transactions recognized under the Act
• c.Section 102, prohibiting fraud and deceit in connection with rendering investment advice✓
• d.Section 301, which governs the registration of securities offerings by coordination and by qualification

USA §102 specifically prohibits fraudulent, deceptive, or manipulative conduct by a person who advises others about securities for compensation. It is the advisory analogue to §101 and applies regardless of whether the adviser is state-registered, federal covered, or exempt.

Under the Investment Advisers Act of 1940 as amended by Dodd-Frank, an investment adviser with $110 million or more in regulatory assets under management generally must:

• a.Register with the SEC as a federal covered adviser✓
• b.Register with its home state only, because SEC registration is not required until assets reach $150 million
• c.Register with the SEC only if it advises a registered investment company, and otherwise with its home state
• d.Register with the SEC and also with every state in which it has a client, since federal registration does not preempt the states

An adviser with $110 million or more in regulatory assets under management generally must register with the SEC and becomes a federal covered adviser, subject to the usual exceptions. The $110 million figure, not $150 million, is the registration threshold. The investment-company route is a separate basis for SEC registration at any size and is not a precondition above $110 million. Once an adviser is federal covered, states may not require it to register, so it does not also register in every state with a client.Investment Advisers Act of 1940 Section 203A(a); 17 CFR 275.203A-1(a)

A 'mid-size' investment adviser under the Investment Advisers Act generally has assets under management between $25 million and $100 million and:

• a.Registers with the SEC, because every adviser with over $25 million of assets under management is federal covered
• b.Registers with the SEC only if it advises a registered investment company, and otherwise needs no registration at all
• c.Registers with the SEC if it would otherwise have to register in at least five states, and with its home state if not
• d.Registers with the state (rather than the SEC) if the adviser's home state requires registration and subjects it to examination, and the adviser is not otherwise required to register with the SEC✓

A mid-sized adviser, with between $25 million and $100 million in assets, is generally prohibited from registering with the SEC if its home state requires it to register and examines it, unless an exception applies, such as advising a registered investment company. The $25 million figure is the floor for being eligible for the SEC, not an automatic requirement. The investment-company exception does not make every other mid-sized adviser exempt, and the multi-state exception is triggered by registration in 15 or more states, not five.Investment Advisers Act of 1940 Section 203A(a)(2)

An investment adviser is registered with the SEC and its regulatory assets under management decline. Under SEC rules, to avoid switching between SEC and state registration on small fluctuations, an adviser must generally withdraw from SEC registration only when its AUM falls below:

• a.$100 million, the cutoff for state registration, with withdrawal required at once when assets fall under it
• b.$90 million, a buffer below the $110 million registration threshold✓
• c.$25 million, the statutory floor for SEC registration, the only figure that matters on the way down
• d.$110 million, the same figure that triggers registration

To avoid switching back and forth on small fluctuations, the rule requires an SEC-registered adviser to withdraw only when its assets fall below $90 million. The $110 million figure is where registration becomes required, and $100 million is the point at which an adviser may register, so an adviser does not leave at either figure. The $25 million figure is the old floor and plays no role in the withdrawal buffer.17 CFR 275.203A-1(a)(1)

Under the Investment Advisers Act, which adviser is generally EXEMPT from SEC registration under the 'private fund adviser' exemption?

• a.An adviser to a registered open-end investment company (a mutual fund) as well as to several closed-end funds offered publicly
• b.An adviser solely to private funds with less than $150 million in private-fund assets under management in the United States✓
• c.An adviser that holds itself out to the general public and actively takes on retail separately managed accounts across many states
• d.An adviser managing $500 million in a single publicly offered fund composed entirely of retail investors and pensioners

IAA §203(m) and Rule 203(m)-1 exempt an adviser that acts solely as an adviser to private funds and manages less than $150 million in private-fund assets in the U.S. Advisers to registered investment companies or to retail SMAs do not qualify for this private-fund exemption.

An investment adviser that provides advice to registered investment companies (mutual funds) under the Investment Advisers Act must:

• a.Register with the SEC regardless of the amount of assets it has under management✓
• b.Register with its home state until it reaches $110 million, then switch to the SEC
• c.Avoid registration, because the Investment Company Act already regulates the funds it advises
• d.Register with the SEC and every state where a shareholder of the fund lives

An adviser to a registered investment company registers with the SEC whatever the size of its assets under management. No $110 million minimum applies to that route. The Investment Company Act regulates the fund, but it does not exempt the fund's adviser from Advisers Act registration. Once the adviser is federal covered, states cannot also require registration based on where fund shareholders live.Investment Advisers Act of 1940 Section 203A(a)(1)

Under the National Securities Markets Improvement Act (NSMIA), when an adviser is a FEDERAL COVERED adviser registered with the SEC, an individual state may still:

• a.Conduct a full net-capital, minimum-financial, books-and-records, and custody examination that entirely duplicates the SEC's own periodic examination, and impose its own recordkeeping rules on the adviser
• b.Set and enforce the maximum advisory fee schedule the federal covered adviser may charge to residents of that particular state
• c.Force the federal covered adviser to register with the state as an investment adviser before it may accept any client there
• d.Require the adviser to file a notice (a copy of documents filed with the SEC), pay state fees, and require IARs with a place of business in the state to register, and retain antifraud authority✓

The federal law preempts state registration, examination and recordkeeping rules for an SEC-registered adviser, but it preserves some state authority. A state may require a notice filing (a copy of the documents filed with the SEC), collect fees, license investment adviser representatives who have a place of business in the state, and enforce its antifraud provisions. It may not duplicate the SEC's examination or impose its own recordkeeping rules, set the adviser's fees, or require the firm itself to register as a state adviser.Investment Advisers Act of 1940 Section 203A(b)

An investment adviser representative works for a FEDERAL COVERED adviser and has a place of business in State X. Under the Uniform Securities Act and NSMIA, this IAR:

• a.Registers separately in every single state where any one of the employing adviser's clients happens to live, work, or maintain a mailing address
• b.Never registers anywhere at all, because the employing adviser's federal covered status fully shields each of its representatives
• c.Registers directly with the SEC as an individual investment adviser representative on Form ADV alongside the firm
• d.Registers as an IAR in State X, because states retain authority to license IARs who have a place of business in the state✓

A state may license an investment adviser representative of a federal covered adviser if the representative has a place of business in that state, so this representative registers in State X. Federal covered status of the employer does not exempt every representative from state licensing. The SEC does not register individual representatives, and a representative does not register in every state where a client of the firm lives.Investment Advisers Act of 1940 Section 203A(b)(1)(A)

Under the Investment Advisers Act, the SEC's brochure rule (Rule 204-3, delivering Form ADV Part 2) generally requires an adviser to deliver the brochure:

• a.Before or at the time of entering into the advisory contract, and then annually within 120 days of fiscal year end if there are material changes, either the brochure or a summary of changes✓
• b.Once every five years on a fixed schedule matched to the adviser's books-and-records retention period, with no delivery required when the contract is signed
• c.Only at the client's written request, made at any time after the advisory relationship begins, with no delivery required before then
• d.Before or at the time of entering into the advisory contract, and then every year whether or not anything in the brochure has changed, together with a new Form ADV Part 1

Rule 204-3(b) requires delivery of the current brochure before or at the time the adviser enters into the advisory contract. After that, the adviser delivers annually, within 120 days after the end of its fiscal year, either the current brochure or a summary of material changes, but only if there have been material changes since the last annual updating amendment. A five-year cycle appears nowhere in the rule, delivery cannot wait for a client request, and Form ADV Part 1 is not part of the brochure delivered to clients.Investment Advisers Act Rule 204-3(b), 17 CFR 275.204-3(b)

Under NASAA model rules, a state-registered investment adviser's brochure (Form ADV Part 2) must be delivered to a prospective client:

• a.Within 30 calendar days after the client's very first advisory fee payment has cleared, been credited to the adviser's operating account, and been reconciled against the custodian's statement
• b.At least 48 hours before entering into the advisory contract, OR at the time of entering the contract if the client is given a right to rescind within five business days without penalty✓
• c.Only at the client's specific written request, with absolutely no automatic delivery required at or before the contract is signed
• d.Once per calendar year, delivered on the anniversary date of the adviser's original state registration order

The NASAA state brochure rule requires delivery at least 48 hours before the contract, or at signing IF the client has a 5-business-day right to withdraw without penalty. This 48-hour/5-day feature is a key state-level distinction from the plain federal rule.

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.