20 Regulation of Advisers & Representatives Practice Questions & Answers

1. 1. Under the Uniform Securities Act, which combination of facts establishes that a person is an investment adviser?

   • A.She advises others about securities, holds a professional designation, and exercises discretion over accounts.
   • B.She advises others about securities, is compensated, and maintains custody of client funds and securities.
   • C.She advises clients about real estate and securities, keeps an office in the state, and has several clients.
   • D.She advises others about securities, does so as a regular business, and is compensated for that advice.✓ Answer

   The definition rests on a three-part test — advice about securities, given as part of a business, for compensation — and all three prongs must be satisfied. Discretion, custody, a professional designation or an in-state office may follow from being an adviser, but none of them is an element of the definition, and advice limited to real estate is not advice about securities.

   Source: Uniform Securities Act Section 401(f); Investment Advisers Act of 1940 Section 202(a)(11)Report a problem with this question

2. 2. An adviser tells a regulator that it need not register. Which statement correctly distinguishes an exclusion from the definition of investment adviser from an exemption from registration?

   • A.An excluded person is free of the antifraud provisions, while an exempt person remains subject to them.
   • B.An excluded person meets the definition but need not register, while an exempt person never meets it.
   • C.An excluded person never meets the definition, while an exempt person meets it but need not register.✓ Answer
   • D.An excluded person files a notice with the Administrator, while an exempt person registers without a fee.

   An exclusion operates at the definitional stage: the person is simply not an investment adviser, so the registration provisions never reach him. An exemption presupposes that the definition is met and then relieves that adviser of the duty to register. Neither one lifts the antifraud provisions, which reach every person and every transaction.

   Source: Investment Advisers Act of 1940 Sections 202(a)(11) and 203(b); Uniform Securities Act Section 401(f)Report a problem with this question

3. 3. A CPA prepares tax returns and, as part of that work, sometimes tells a client whether to keep or sell a particular stock, charging nothing beyond the tax fee. The following year she begins charging a separate fee to prepare written securities recommendations. How is her status best described?

   • A.She stays excluded in both years, provided she discloses the separate fee in writing before the engagement starts.
   • B.She stays excluded in both years, because the accountant exclusion attaches to her license rather than to her activity.
   • C.She was an adviser in both years, because advice naming a specific security always defeats the professional exclusion.
   • D.She was excluded while the advice stayed incidental, and the separate securities fee ends the exclusion.✓ Answer

   The professional exclusion for lawyers, accountants, teachers and engineers holds only while the securities advice is solely incidental to the profession and no special compensation is received for it. Charging a distinct fee for a securities recommendation is special compensation, so the activity test — not the license — decides, and disclosure does not restore the exclusion.

   Source: Investment Advisers Act of 1940 Section 202(a)(11)(B)Report a problem with this question

4. 4. A firm mails a securities market letter to paying subscribers every week. It comments on general market conditions and names stocks it considers attractive, and every subscriber receives the same issue. The firm later begins sending some subscribers individualized advice about their own holdings. Which statement is correct?

   • A.The letter is excluded only if the firm gives it away and earns its revenue from advertising rather than subscriptions.
   • B.The letter was advisory from the start, because charging subscribers supplies the compensation element of the adviser definition.
   • C.The letter fell within the publisher exclusion while it stayed regular and impersonal, and the tailored advice ends that.✓ Answer
   • D.The letter is excluded in both phases, because material distributed in writing is never advice about securities.

   The publisher exclusion covers a bona fide publication of general and regular circulation whose contents are impersonal and not tailored to any subscriber's situation. Charging for a subscription does not defeat it. Once the firm starts fitting advice to an individual subscriber's own portfolio, the publication is no longer impersonal and the exclusion is lost.

   Source: Investment Advisers Act of 1940 Section 202(a)(11)(D); Lowe v. SEC, 472 U.S. 181 (1985)Report a problem with this question

5. 5. A broker-dealer's registered representatives routinely discuss which securities a customer should buy, and the firm is paid only the commissions on the resulting trades. The firm then launches a service charging customers a separate annual fee for financial planning advice. What is the effect on the firm's status?

   • A.The firm must now register as an investment adviser, because a separate fee for advice is special compensation.✓ Answer
   • B.The firm keeps the exclusion as long as the planning advice is delivered by the same representatives who take orders.
   • C.The firm loses the exclusion only once advisory fees exceed the commission revenue it earns from the same customers.
   • D.The firm keeps the broker-dealer exclusion, because a registered broker-dealer can never also be an investment adviser.

   A broker-dealer is excluded from the adviser definition only while its advice is solely incidental to the brokerage business and it receives no special compensation for the advice. A separate, stand-alone fee for planning is exactly that special compensation; the test turns on how the firm is paid, not on the proportion of its revenue or on who delivers the advice.

   Source: Investment Advisers Act of 1940 Section 202(a)(11)(C)Report a problem with this question

6. 6. An investment adviser is registered with the SEC as a federal covered adviser and maintains an office and clients in a particular state. What may that state's Administrator require of the adviser, and what authority does the Administrator keep?

   • A.No filing of any kind and no authority over the adviser, because federal registration preempts the state entirely.
   • B.A notice filing with a copy of the adviser's federal filing and a fee, plus authority to act against fraud.✓ Answer
   • C.A notice filing plus a state minimum net worth requirement higher than the one the SEC applies to the adviser.
   • D.Full state registration with an examination of the adviser's books, plus authority to act against fraud.

   Federal law bars a state from requiring a federal covered adviser to register or from imposing its own financial or recordkeeping requirements, but it expressly preserves two things: the state may require the adviser's SEC-filed documents and a consent to service to be filed for notice purposes with a fee, and the state keeps full authority to investigate and bring actions for fraud or deceit.

   Source: Investment Advisers Act of 1940 Section 203A(b); National Securities Markets Improvement Act of 1996Report a problem with this question

7. 7. A newly formed advisory firm has a small amount of assets under management, far below the level at which advisers ordinarily register with the SEC. Its only client is a registered investment company. Where must the firm register?

   • A.With the state, because the firm's assets under management are below the federal registration threshold.
   • B.With the SEC, because an adviser to a registered investment company is federal covered regardless of its assets.✓ Answer
   • C.With both the SEC and the state, because advising a fund is a dual activity subject to each regulator.
   • D.With neither, because an adviser whose only client is an investment company has an institutional exemption.

   Assets under management are only one route to federal covered status. An adviser to an investment company registered under the Investment Company Act of 1940 must register with the SEC no matter how small it is, because the fund's own shareholders are the protected interest. Once the adviser is federal covered, the state cannot also require registration.

   Source: Investment Advisers Act of 1940 Section 203A(a)(1)(B); SEC Rule 203A-1Report a problem with this question

8. 8. Assume the state in question applies the usual de minimis standard: an adviser with no place of business in the state may serve up to five non-institutional clients there in any twelve-month period without registering, and institutional clients are not counted. An adviser with no office in that state advises three individuals and nine banks located there. Which statement is correct?

   • A.The adviser may rely on the de minimis exemption, because only the three individual clients count toward the limit.✓ Answer
   • B.The adviser must register in that state, because the exemption is lost as soon as any client resides within the state.
   • C.The adviser must register in that state, because the nine bank clients are counted along with the three individuals.
   • D.The adviser may rely on the exemption only after it files a notice claiming it with that state's Administrator.

   The de minimis test has two limbs that must both hold: no place of business in the state, and no more than the stated number of non-institutional clients there. Banks are institutional clients and are outside the count entirely, so three individuals leaves the adviser within the limit. The exemption operates by force of the statute and is not claimed by filing.

   Source: Investment Advisers Act of 1940 Section 222(d); Uniform Securities Act Section 401(f)Report a problem with this question

9. 9. An investment adviser applies for registration in a state. Among the items included in the application is a consent to service of process. What does that document accomplish?

   • A.It waives the adviser's right to a hearing before the Administrator issues an order against its registration.
   • B.It obligates the adviser to accept the Administrator's jurisdiction over disputes with clients in other states.
   • C.It authorizes the Administrator to inspect the adviser's books without prior notice at any office it operates.
   • D.It appoints the Administrator as the adviser's attorney to receive legal process in actions arising under the act.✓ Answer

   The consent is an irrevocable appointment of the Administrator as the applicant's agent for service of process in any noncriminal suit or proceeding arising under the act, so a client or the state can serve the Administrator and obtain the same effect as personal service on the adviser. It neither waives a hearing nor confers inspection powers, which come from other provisions.

   Source: Uniform Securities Act Section 414(g)Report a problem with this question

10. 10. A state-registered adviser is assembling the disclosure documents it will hand to prospective clients. What is the role of the brochure supplement, as distinct from the brochure itself?

    • A.The supplement describes the education, experience and discipline of the individuals who advise the client.✓ Answer
    • B.The supplement reports the adviser's assets under management and the types of clients the firm serves.
    • C.The supplement records the adviser's custody arrangements and the qualified custodian holding client assets.
    • D.The supplement lists the fees the adviser charges each class of client and how those fees are calculated.

    The brochure describes the advisory firm — its services, fees, conflicts and business practices — while the supplement is person-specific: it covers the background, qualifications and disciplinary history of the individual or individuals who actually give advice to that client, so the client can judge the people as well as the firm.

    Source: Form ADV Part 2B; SEC Rule 204-3Report a problem with this question

11. 11. A state has adopted the standard brochure rule: the adviser must deliver its brochure at least 48 hours before the client enters into the advisory contract, or else at the time the contract is entered into if the client may terminate it without penalty within five business days. An adviser hands a new client the brochure at the moment the client signs. What must the contract give the client?

    • A.A right to receive an amended brochure 48 hours after the contract has been signed.
    • B.A right to terminate the contract without penalty within five business days of signing it.✓ Answer
    • C.A right to a full refund of the first quarter's fee if the client cancels at any point.
    • D.A right to cancel the contract without penalty at any time during the first year.

    The rule offers the adviser two mutually exclusive routes. Delivering well before signing gives the client time to read the document first; delivering at signing removes that time, so the rule substitutes a short penalty-free window in which the client may walk away after reading. Choosing the later delivery therefore obliges the adviser to write that termination right into the contract.

    Source: NASAA Model Rule 203(b)-1 (investment adviser brochure rule)Report a problem with this question

12. 12. Assume the applicable rule requires an adviser to deliver or offer its brochure to each existing client once a year, within 120 days of the end of the adviser's fiscal year. What must accompany that annual delivery, and what may the adviser charge for it?

    • A.A current list of the adviser's officers and owners, delivered free only on client request.
    • B.A summary of material changes since the last brochure, delivered to the client free of charge.✓ Answer
    • C.A written acknowledgment for the client to sign and return, delivered at no cost to the client.
    • D.A copy of the adviser's audited balance sheet, delivered at the adviser's reproduction cost.

    The annual obligation exists so that an ongoing client learns what has changed about the adviser's services, fees, conflicts or disciplinary history since the last version. A summary of material changes is therefore the required companion, and because the disclosure protects the client rather than serving the adviser, it must be provided free; no signed receipt is required.

    Source: NASAA Model Rule 203(b)-1; SEC Rule 204-3(b)Report a problem with this question

13. 13. A state-registered adviser grows until it is eligible for and elects SEC registration, and that federal registration becomes effective. What happens to the firm's state registration and to the individuals in its offices who advise clients?

    • A.The firm keeps both registrations, and the individuals register with the SEC as representatives of the firm.
    • B.The firm keeps its state registration until renewal, and the individuals file notice with the Administrator.
    • C.The firm withdraws its state registration, and the individuals stay registered with the state as representatives.✓ Answer
    • D.The firm withdraws its state registration, and the individuals become federal covered along with the firm.

    Registration at the two levels is mutually exclusive for the firm: once it becomes federal covered the state may no longer register it, so it withdraws. The preemption does not extend to individuals. The states retained the power to license investment adviser representatives who have a place of business in the state, so those people remain state-registered.

    Source: Investment Advisers Act of 1940 Sections 203A(a) and 203A(b)(1)(A); Form ADV-WReport a problem with this question

14. 14. A state-registered adviser has its principal office in one state and registers in a second state where it also has clients. The second state wants to impose recordkeeping requirements and a minimum net worth stricter than those of the adviser's home state. May it?

    • A.Yes; the stricter of the two states' requirements always governs the adviser's entire operation.
    • B.Yes; each state where the adviser registers may set the recordkeeping standards it applies there.
    • C.No; recordkeeping and minimum net worth for every adviser are set exclusively by federal law.
    • D.No; those requirements are set by the state where the adviser's principal office is located.✓ Answer

    Federal law bars any state other than the one where the adviser maintains its principal office and place of business from imposing books-and-records or capital requirements that exceed that home state's. The point is to give a multi-state adviser one consistent set of financial and recordkeeping rules, while other states still register the firm and police fraud.

    Source: Investment Advisers Act of 1940 Section 222(b)Report a problem with this question

15. 15. An adviser holds no client securities certificates and has no safe. It does, however, deduct its quarterly advisory fee directly from client accounts held at a brokerage firm, and it serves as trustee of one client's family trust. Which statement is correct?

    • A.The adviser has custody only as to the trust, because deducting a fee the client already owes is not custody.
    • B.The adviser has custody, because both fee deduction and serving as trustee give it access to client assets.✓ Answer
    • C.The adviser has no custody, because custody requires the physical possession of certificates or cash.
    • D.The adviser has no custody, because a third-party brokerage firm holds every client's cash and securities.

    Custody is defined by authority, not by possession: it exists whenever the adviser holds client funds or securities or has any authority to obtain possession of them. Deducting fees directly from the account is an authority to withdraw client assets, and acting as trustee gives legal control over trust property, so each independently creates custody.

    Source: SEC Rule 206(4)-2(d)(2); NASAA Model Rule on custody of client funds or securities by investment advisersReport a problem with this question

16. 16. A state-registered adviser that has custody of client funds and securities is reviewing its obligations. Which set of safeguards applies?

    • A.Client assets at any bank the adviser chooses, with an annual summary of holdings mailed to each client.
    • B.Client assets at a qualified custodian, with the adviser's own performance report replacing custodial statements.
    • C.Client assets in the adviser's own bank account, with an internal reconciliation performed each quarter.
    • D.Client assets at a qualified custodian, written notice of the account, and account statements sent to clients.✓ Answer

    The custody safeguards are built so that someone other than the adviser can be checked against the adviser. Client assets sit with a qualified custodian in a properly titled account, the client is told in writing where the account is, and the custodian's own statements reach the client so they can be compared with what the adviser reports; an independent surprise verification backs this up.

    Source: SEC Rule 206(4)-2(a); NASAA Model Rule on custody of client funds or securities by investment advisersReport a problem with this question

17. 17. An advisory firm organized as a partnership signs a written contract with a new client. Two years later the firm wants to transfer that client's account to another advisory firm buying its business, and one of the partners retires. What must the contract provide?

    • A.That the contract is not assigned without the client's consent and that partner changes are reported to clients.✓ Answer
    • B.That the contract is assignable at the adviser's discretion and that partner changes are reported to clients.
    • C.That the contract is assigned only with the Administrator's approval and that partner changes are made public.
    • D.That the contract ends automatically on any assignment and that partner changes are reported to the state.

    An advisory contract is personal to the adviser the client chose, so the law requires a provision that it may not be assigned without the client's consent, and where the adviser is a partnership, a provision that clients will be notified within a reasonable time of any change in the membership of the partnership. Consent comes from the client, not from the regulator.

    Source: Investment Advisers Act of 1940 Section 205(a)(2) and (a)(3)Report a problem with this question

18. 18. An adviser proposes to charge a client a fee equal to a share of the capital gains in the account. Why is this arrangement restricted, and when is it permitted?

    • A.It can obscure the adviser's costs, so it is allowed only after the Administrator approves the fee schedule.
    • B.It can push the adviser to trade too often, so it is allowed only if the client also pays a fixed annual fee.
    • C.It can push the adviser to take excess risk, so it is allowed only for clients meeting a wealth or asset test.✓ Answer
    • D.It can create a conflict with the custodian, so it is allowed only where the adviser has no custody at all.

    A share-of-gains fee gives the adviser the upside of a winning bet while the client alone bears the downside, which is an incentive to take risk the client did not ask for. The law therefore prohibits it except with clients who can absorb that risk and evaluate it — those who meet an assets-with-the-adviser or net worth test, or who are qualified purchasers or certain knowledgeable employees.

    Source: Investment Advisers Act of 1940 Section 205(a)(1); SEC Rule 205-3Report a problem with this question

19. 19. A state-registered advisory firm employs four people besides its owner: one who meets prospects and sells the firm's advisory services, one who decides which securities go into client portfolios, one who supervises those two, and one who schedules meetings and files paperwork. Who must register as an investment adviser representative?

    • A.The salesperson and the portfolio decision-maker, but neither the supervisor nor the scheduling employee.
    • B.All four employees, since everyone compensated by a registered advisory firm is a representative of it.
    • C.The salesperson, the portfolio decision-maker and the supervisor, but not the scheduling employee.✓ Answer
    • D.The portfolio decision-maker alone, since only choosing securities is the giving of investment advice.

    A representative is a supervised person who makes or determines recommendations, manages accounts, solicits or sells advisory services, or supervises anyone who does those things. Selling the advisory relationship and supervising advice-givers both count. Purely clerical and ministerial staff who never touch advice or solicitation are expressly outside the definition.

    Source: SEC Rule 203A-3(a); Uniform Securities Act Section 401Report a problem with this question

20. 20. An individual gives investment advice to clients from an office in a state, on behalf of an advisory firm registered with the SEC as a federal covered adviser. Where, if anywhere, must that individual register?

    • A.With the state where the office is located, because representatives register with states rather than the SEC.✓ Answer
    • B.Nowhere, because federal registration of the firm covers everyone who gives advice on its behalf.
    • C.With the SEC, because a representative takes the registration status of the adviser that employs him.
    • D.With the state and the SEC, because each regulator licenses the individuals who deal with clients.

    Federal preemption of adviser registration stops at the firm. Congress expressly preserved the states' authority to license, register and qualify investment adviser representatives who have a place of business in the state, and the SEC does not register individuals at all, so the representative of a federal covered adviser still registers with each state where he keeps an office.

    Source: Investment Advisers Act of 1940 Section 203A(b)(1)(A); Uniform Securities Act Section 201Report a problem with this question

Practice questions written from the NASAA Series 65 Test Specifications and the Uniform Securities Act. Not affiliated with or endorsed by NASAA, FINRA or Prometric. Dollar thresholds, fee figures and contribution limits change; where one matters the question supplies it. Confirm current requirements with NASAA before testing. NASAA exam content outline →