Chapter 04 - Investment Advisors Act Of 1940

Front 1

Under IAA of 1940, definition of IA

Back 1

• Person who receives compensation for advising others
• providing written or oral advise or issuing reports or analyses with regard to securities
• Engaging in the business of providing such services. Primarily engaged in the business means more than 50% of IAs total sales and revenues before tax come from advisory services for the most recent 3 fiscal years
• Receiving compensation for these advisory services

Front 2

Under IAA of 1940, compensation definition includes:

Back 2

• Managment fees
• wrap fees
• commissions
• hourly rates
• any other economic benefit

Front 3

Under IAA of 1940, a "Federal Covered Advisor" is ___

Back 3

Any IA who is an advisor to an investment company or who manages an investment portfolio of $25 million or more. Such an IA must register with SEC only

Front 4

Under IAA of 1940, registration is accomplished by:

Back 4

Filing "Form ADV"

Front 5

If information in Form ADV becomes inaccurate, an amended Form ADV must be filed ....

Back 5

• immediately if change is material
• within 90 days of the end of the advisor's fiscal year if no material
• Prompt amendment for changes in:

1. ​Name
2. location
3. type of organization
4. takeovers
5. control
6. disciplinary actions
7. custody
8. compensation​

Front 6

SEC generally grants registration within ___ of the the filing of Form ADV

Back 6

45 days

Front 7

Registration is denied to any person who has spent ____ in prison

Back 7

1 year or more

Front 8

Under IAA of 1940, exclusions from definition of IA include:

Back 8

1. any bank or holding company
2. LATE professionals (if incidental to practice of their profession)
3. Any BD whose advisory services are incidental and no special compensation for advisory services
4. any publisher of any bona fide newspaper, news magazine, business or financial publication or general or regular circulation
5. any person whose advice or services is related only to US government securities

*Under USA, an advisor must be registered to give advice regardless the type of securities

Front 9

Under IAA of 1940, exemptions from registration include:

Back 9

1. An IA whose clients are all residents of the state the IA maintains is principal place of business and advisor does not furnish advice, analyses or reports with respect to securities listed on a national exchange (this would never happen)
2. An IA whose only clients are insurance companies
3. Any IA who has fewer than 15 clients during past 12 months, and does not advertise as an IA nor act as IA to investment company

Front 10

Under IAA of 1940, "associated person of IA" includes

Back 10

• officers, partners or directors
• employees providing advice to clients of the IA

*Shareholders and clerical employees are not associated persons

Front 11

Within 90 days after end of fiscal year, the IA must file ___

Back 11

Annual Updating Ammendment

Front 12

Under IAA of 1940, a registration with the SEC remains in effect until

Back 12

• revoked by SEC OR
• a withdrawal is filed by the IA and is accepted by the SEC

Front 13

SEC can revoke and IAs registration for:

Back 13

• willful misstatements in an SEC filing
• Failure to reasonably supervise employees
• Insolvency (inability to pay one's debts)

Front 14

The following books and records must be kep by IA under IAA of 1940

Back 14

• journals of cash receipts and disbursements and other records of original entry
• ledgers showing assets, liabilities, reserves, capital, income, expenses
• a memorandum of each order
• checkbooks, bank records, and bills relating to the business (not a telephone log)
• originals of all communications received and copies of all communications sent to public or clients relating to any investments or recommendations
• discretionary authorizations and powers of attorney
• written agreements between the IA and customers
• copy of each notice, circular, advertisement, or other communication circulated to 10 or more persons
• a record of every transaction in which the IA acquires beneficial ownership of a security
• a copy of all written disclosure statements sent to customers and signed written receipts received from customers
• all records pertaining to the calculation of performance or rate of return where recommendations are distributed to 10 or more persons

Front 15

Under IAA of 1940, if an IA has custody of client funds or securities, the IA must keep the following records:

Back 15

• a journal of separate ledger showing all purchases, sales, receipts and deliveries of securities
• copies of all confirmations
• a record showing the name of the customer, amount of interest, and the location of the security

Front 16

Books and records must be maintained for ____ (length of time)

Back 16

5 years

Records are subject to SEC examination at any time

Front 17

IA must keep a copy of records for ____ (length of time) after termination

Back 17

3 years

Front 18

Under IAA of 1940, records may be kept in electronic format as long as:

Back 18

• they can be read
• copies can be made, and
• a duplicate copy is stored in a separate location

Front 19

True or False: IAA of 1940 requires investment advisory contracts to be in writing?

Back 19

False - do not have to be in writing according to IAA of 1940, but do according to USA

Front 20

Under IAA of 1940, performance based fees are __

Back 20

allowed for qualified clients only

Front 21

Qualified clients under IAA of 1940

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$750,000 under management or has a net worth of $1,500,000

Front 22

Under IAA of 1940, assignment of new advisor

Back 22

Must be with client consent (If a minority partner sells their interest, it would not be considered to be an assignment of the contract).

Must not fail to advise clients of changes in partners

Front 23

Under IAA of 1940, performance based fees rules

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1. Defined periods used to measure performance
2. Formulas for determining when increases and decreases in fees shall occur must be disclosed
3. Performance on managed accounts is calculated after deducting advisory fees and expenses
4. Performance fees may induce an IA to take higher risk
5. IA must be sure the client understands the method of compensation and the risks

Front 24

Under IAA of 1940, any change in fees ___

Back 24

requires that a client sign a revised contract showing the change in fees

Front 25

Written disclosure statements are also known as

Back 25

• Part II of Form ADV
• The Brochure (of the Brochure Rules)

Front 26

Under IAA of 1940, timing rules for written disclosure statements

Back 26

• the IA must provide clients with written disclosure statements no less than 48 hours prior to entering into such a contract OR
• The client has the right to terminate the contract without penalty within 5 business days after entering into the contractU

Front 27

Under IAA of 1940, written disclosure statements rules for existing clients

Back 27

Must be delivered or offered at least annually. Offer to deliver does not have to be filed with the SEC. Part II Form of ADV will satisfy the Brochure Rule

Front 28

Under IAA of 1940, exception to the brochure rule

Back 28

The brochure does not have to be delivered to or offered to an existing or prospective client in connection with an investment company contract or a contract for impersonal (general, not specific) advisory services

Front 29

Under IAA of 1940, if an IA changes fees or requires prepayment of over $500 of fees 6 months in advance ____

Back 29

they must provide clients and SEC with audited balance sheet

Front 30

Anti-fraud provisions under IAA of 1940 (summary)

Back 30

The IA must make full and fair disclosure, particularly with regards to conflicts of interest. Failure to make required disclosures is fraud. Some conflicts of interest problems can be solved by disclosure, but others must be completely avoided.

Front 31

Under IAA of 1940, when IA acts as broker dealer in any capacity ____

Back 31

must disclose in writing when they act as a BD in any capacity before the completion of the transaction and must obtain written consent of the client for the transaction.

*This is different than the USA (under USA, consent doesn't have to be written)

*Exceptions if acting as advisor by means of public distribution to more than 35 persons, statements don't attempt to meet investment objectives of individuals or accounts, or statistical information only

Front 32

Under IAA of 1940, definition of agency cross transaction

Back 32

IA acts as broker for both the advisory client and for another person on the other side of the transaction.

Front 33

Under IAA of 1940, agency cross transactions are allowed if:

Back 33

• IA is acting in best interest of advisory client regarding price
• IA must receive written consent from the client that the client understands the advisor:

1. receives commissions from both parties
2. that potential exists for conflict of interest

• Not later than completion of transaction the client must receive written confirmation
• Advisor sends both clients annually a written statement identifying:

1. total agency cross transactions in that period
2. the commissions received in that period

• No transactions are permitted if the IA recommended the transaction to both buyer and seller
• The client upon written notice may revoke consent for the transaction
• the IA must disclose if their personal securities transactions are inconsistent with the advice given to clients

Front 34

Under IAA of 1940, all potential conflicts of interest ___

Back 34

Must be disclosed in writing, including:

• incentive packages
• all compensation
• any affiliations with recommended issuers and get the written consent of the client before any trade takes places

Front 35

Under IAA of 1940, IAs must disclose financial and disciplinary information including:

Back 35

• precarious financial condition
• legal and disciplinary events
• proceedings causing the loss of registration

Front 36

Under IAA of 1940, advertisement is defined as

Back 36

any notice, circular, letter or written communication sent to more than one person or any publication, radio or television, which offers analyses to be used in determining which security to buy or sell or when. (includes graphs, charts, formulas, or similar devices)

Front 37

Under IAA of 1940, use of past recommendations

Back 37

may not be used in advertisements, unless the IA offers to furnish a list of all recommendations made within the previous year. Such ads must also state that "it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in the list provided"

Front 38

Under IAA of 1940, if advertisement makes the claim that IA is "fee only"

Back 38

they cannot use performance based fees (because ad is directed to general public and performance based fees are only allowed for qualified clients.

Front 39

Under IAA of 1940, if IA has custody of client funds, the IA must provide client with statements ____ (frequency)

Back 39

minimum of quarterly, or monthly if there has been activity in the account.

Front 40

Under IAA of 1940, if IA has custody of client funds, the must arrange with independent CPA to do an unannounced exam to verify clients' funds and securities in custody at least ____ (frequency)

Back 40

once a year

Front 41

Does "custody" include prepayment of advisory fees?

Back 41

No

Front 42

If IAR is trustee of a client's trust account, does IAR have custody?

Back 42

Yes

Front 43

An IA may pay a cash fee to a person soliciting advisory clients only if:

Back 43

• the advisor is registered with the SEC
• the solicitor is not subject to SEC suspensions or limitations, AND
• there is a written agreement between the advisor and solicitor

Front 44

An IA may pay a cash fee to affiliated solicitors (partner, officer, director or employee of the advisor) if _____

Back 44

complete disclosure of the relationship with the IA is made to the client

Front 45

Requirements of unaffiliated solicitors:

Back 45

Solicitor must:

• perform his duties in a manner consistent with the instructions of the advisor
• deliver a current copy of the IA's disclosure statement and a separate written disclosure document of the solicitor
• not later than the time a written or oral agreement is entered into, the IA must receive a signed and dated acknowledgement from the client stating the client has received both

1. IA's written disclosure statement
2. solicitor's written disclosure statement

• IA must make a bona fide effort to ascertain whether the solicitor has complied with the provisions of the agreement

Front 46

Solicitor's written disclosure statement must disclose:

Back 46

1. Name of solicitor and services to be provided
2. the name of the IA
3. nature of the relationship between solicitor and advisor
4. a statement that the solicitor will be compensated and such compensation agreement
5. amount, if any that client will be charged in addition to the advisory fee

*name of BD to execute trades would not have to be disclosed

*business background of solicitor would not have to be disclosed

Front 47

Under IAA of 1940, the term "Investment Counsel" may not be used unless the following conditions are met:

Back 47

• the advisor's principal business consists of being an IA, AND
• a substantial part of the IA's business consists of providing investment supervisor services

Front 48

Maximum penalties under IAA of 1940

Back 48

$10,000 fine and/or 5 years in prison

*Note: Under USA, maximum penalty is $5000/3 years

Front 49

Does giving advice with regard to fixed annuities require registration under IAA of 1940?

Back 49

No - fixed annuities not considered securities

Front 50

Appeals to orders issued against advisors under IAA of 1940 are filed with ____

Back 50

US Court of Appeals

Front 51

Under IAA of 1940, wrap fee clients must receive ___

Back 51

written statement containing Schedule H of Form ADV

Front 52

According to SEC Release IA-1092, is a person who gives investment advice on "rare and isolated instances" considered to be "in the business"?

Back 52

No - not if "rare and isolated"

Front 53

Under SEC Release IA-1092, the following people would be deemed an IA and required to register if they hold themselves out (advertise) as offering such services, including:

Back 53

• Financial Planners
• Pension Consultants
• Advisors to athletes and entertainers
• Advisors to employee benefits plans
• Advisors to clients regarding the selection or retention of an Investment Manager

Front 54

Under SEC Release IA-1092, lawyers, accountants, and BDs (acting beyond the scope of brokerage business) do not qualify from the exclusion from registration if they:

Back 54

• advertise themselves as advisors and/or
• charge a separate fee for investment advice

Front 55

Under SEC Release IA-1092, IAs must disclose compensation from what sources?

Back 55

from any sources

Front 56

Under SEC Release IA-1092, advisors must disclose their positions to clients, whether _____

Back 56

consistent or inconsistent to what they recommend.