18 Ethics, Fiduciary Duty & Remedies Practice Questions & Answers

1. 1. A state Administrator concludes that an investment adviser is engaged in an ongoing fraudulent practice and wants both to halt the conduct immediately and to freeze the firm's assets pending a hearing. Under the Uniform Securities Act, how may the Administrator proceed?

   • A.The Administrator may freeze the assets administratively but must ask a court to enter any order halting the conduct.
   • B.The Administrator may issue both the cease-and-desist order and the asset freeze order directly, as administrative remedies.
   • C.The Administrator may issue a cease-and-desist order without a prior hearing but must petition a court for an asset freeze.✓ Answer
   • D.The Administrator may obtain both remedies only after a full hearing, since neither may be ordered before the respondent is heard.

   The Administrator's own authority extends to cease-and-desist orders, which are effective on issuance and may be entered before any hearing, with the hearing following on request. Equitable relief such as an injunction, an asset freeze, or the appointment of a receiver is judicial power, so the Administrator must petition a court of competent jurisdiction to obtain it. For the same reason the Administrator cannot prosecute crimes; those matters are referred to the attorney general or prosecuting authority.

   Source: Uniform Securities Act (2002) Sections 603 and 604Report a problem with this question

2. 2. An investment adviser served with a final order of the state Administrator files a petition for judicial review in the appropriate court within the statutory period. Under the Uniform Securities Act, what is the effect of filing that petition?

   • A.Filing leaves the order in full force unless and until the reviewing court grants a stay of it.✓ Answer
   • B.Filing suspends the order automatically until the reviewing court rules on the merits.
   • C.Filing suspends the order for the 60-day window the statute allows for seeking judicial review.
   • D.Filing voids the order, so the Administrator must issue a new one after the court rules.

   A person aggrieved by a final order may obtain judicial review by petitioning the court within the period the Act allows, generally 60 days after entry of the order. The Act expressly provides that the commencement of proceedings for review does not, of itself, stay the Administrator's order, so the order continues to bind the respondent while the appeal is pending; a party who wants it suspended must ask the reviewing court for a stay.

   Source: Uniform Securities Act (1956) Section 411, judicial review of ordersReport a problem with this question

3. 3. An individual acts as an investment adviser in a state without being registered and without any available exemption, and collects advisory fees from a client for two years. If the client sues under the Uniform Securities Act, what may the client recover?

   • A.The advisory fees paid, plus treble damages, court costs and attorneys' fees, without interest.
   • B.The client's trading losses for the period, plus interest at the legal rate and court costs.
   • C.The advisory fees paid, plus interest at the legal rate, court costs and reasonable attorneys' fees.✓ Answer
   • D.The advisory fees paid, reduced by any investment gains the account earned over the period.

   The civil-liability provision gives a client who received advice from an unregistered adviser the right to recover the consideration paid for that advice — the fees — together with interest at the legal rate, court costs and reasonable attorneys' fees. The measure of damages is what the client paid for unlawful services, not what the portfolio lost in the market, and the Uniform Securities Act provides no treble-damages remedy.

   Source: Uniform Securities Act (2002) Section 509(e), civil liability for unlawful advisory activityReport a problem with this question

4. 4. A person who sold a security in violation of the Uniform Securities Act sends the purchaser a written rescission offer describing the violation and offering to repay the purchase price plus interest at the legal rate, less any income received on the security. The purchaser takes no action. Under the Uniform Securities Act of 1956 as commonly tested, what follows?

   • A.The purchaser must accept within 10 business days, after which the seller's liability is discharged.
   • B.The purchaser may still sue for three years, since a rescission offer cannot cut off a statutory remedy.
   • C.The purchaser may no longer sue on that sale once 30 days have passed without an acceptance.✓ Answer
   • D.The purchaser may no longer sue once the Administrator has approved the terms of the written offer.

   A rescission offer is the seller's statutory cure for a violation. If the written offer states the relevant facts and tenders the consideration paid plus interest at the legal rate less any income received, and the recipient does not accept it within the period the Act allows — 30 days from receipt under the 1956 Act — the buyer loses the private right of action arising from that sale. No approval of the offer by the Administrator is required for it to have that effect.

   Source: Uniform Securities Act (1956) Section 410(f), offers of rescissionReport a problem with this question

5. 5. A state-registered investment adviser is about to enter into an advisory contract with a new individual client and has not yet delivered its written disclosure brochure. Under the NASAA model brochure rule, which approach satisfies the delivery requirement?

   • A.Delivering it when the contract is signed, if the client may terminate penalty-free within 48 hours of signing.
   • B.Delivering it within 10 business days after the contract is signed, together with the first itemized fee invoice.
   • C.Delivering it within 120 days after the adviser's fiscal year ends, along with a summary of material changes.
   • D.Delivering it at the moment the contract is signed, if the client may terminate penalty-free within five business days.✓ Answer

   The state model rule gives the adviser two ways to comply: deliver the written disclosure statement at least 48 hours before entering into the contract, or deliver it at the time of entering into the contract provided the client has the right to terminate without penalty within five business days. The 48-hour figure is a lead time before signing, not a cancellation window, and the 120-day annual timetable belongs to the SEC brochure rule for federal covered advisers.

   Source: NASAA Model Rule 411(g), investment adviser brochure delivery; compare SEC Rule 204-3Report a problem with this question

6. 6. An investment adviser representative's marketing email tells prospects that the firm is "registered with the state Administrator, who has reviewed and approved our advisory program." Under the Uniform Securities Act, how is that statement treated?

   • A.The statement is prohibited, since implying that registration means official approval is unlawful.✓ Answer
   • B.The statement is prohibited unless the same language also appears in the firm's disclosure brochure.
   • C.The statement is permitted if the Administrator's staff reviewed the program during registration.
   • D.The statement is permitted, because the firm is in fact registered and the claim is literally accurate.

   The Act makes it unlawful to represent that the registration of a person or a security, or the effectiveness of a registration statement, means that the Administrator or any other agency has passed upon, approved or recommended the merits of the offering or the qualifications of the registrant. Registration is a filing and review process, never an endorsement, so the representation is prohibited even though the firm genuinely is registered and staff genuinely read the filing.

   Source: Uniform Securities Act Section 506 (1956 Act Section 404), unlawful representations concerning registrationReport a problem with this question

7. 7. A client tells her investment adviser that she is anxious about market losses. Which of the following statements by the adviser is consistent with the NASAA model rule on prohibited practices?

   • A.Telling the client that the adviser will share equally in any gains and losses the account produces.
   • B.Telling the client that a fixed annuity's minimum rate is set by contract with the issuing insurer.✓ Answer
   • C.Telling the client that the recommended strategy is guaranteed to return at least 6% each year.
   • D.Telling the client that the adviser will personally reimburse any loss the account shows this year.

   Guaranteeing that a specific result will be achieved with the advice rendered is a prohibited practice, and that covers promising a minimum return and promising to make good on losses from the adviser's own funds; sharing in the profits and losses of a client's account is separately prohibited for advisers with no proportionate-contribution exception. Accurately describing a contractual feature of a product is different: a fixed annuity's minimum rate is an obligation of the insurer, not a promise by the adviser about investment results.

   Source: NASAA Model Rule 502(b), unethical business practices of investment advisersReport a problem with this question

8. 8. Under the NASAA model rule governing investment advisory contracts, which provision must appear in a state-registered adviser's written contract with a client?

   • A.A provision that the adviser's fee may be based on a share of the account's capital appreciation.
   • B.A provision that the contract may not be assigned or transferred without the client's consent.✓ Answer
   • C.A provision that the client may cancel at any time and receive a refund of all fees paid.
   • D.A provision that the client waives any claim arising out of the adviser's ordinary negligence.

   The model rule requires the advisory contract to be in writing and to state the services, the term, the fee and the formula for computing it, any prepaid fee to be refunded on termination, and any grant of discretionary authority. It must also provide that the contract will not be assigned without the client's consent, that the adviser will not be compensated on a share of capital gains or capital appreciation, and that a partnership adviser will notify clients of changes in its membership. Any clause purporting to waive compliance with the Act is void.

   Source: NASAA Model Rule 502(c), investment advisory contracts; Investment Advisers Act Sections 205 and 215Report a problem with this question

9. 9. An SEC-registered investment adviser pays a marketing company to post a favorable endorsement of its advisory services on a public website. Under the SEC's marketing rule for investment advisers, what must the adviser do?

   • A.Limit the endorsement to claims the adviser can substantiate about its past profitable recommendations.
   • B.Obtain the state Administrator's prior written approval of the endorsement before the marketing firm posts it.
   • C.Remove the endorsement, since paying any third party to promote advisory services is prohibited outright.
   • D.Disclose clearly and prominently that the promoter is paid, is not a client, and has material conflicts.✓ Answer

   The marketing rule permits testimonials and endorsements in adviser advertisements rather than banning them, but it conditions their use on disclosure: the advertisement must state clearly and prominently whether the person giving it is a client, whether compensation was paid, and any material conflicts arising from the relationship. The adviser must also have a written agreement with a compensated promoter and may not compensate an ineligible person, and no regulator pre-approves advertising.

   Source: SEC Rule 206(4)-1 under the Investment Advisers Act of 1940 (marketing rule)Report a problem with this question

10. 10. A state-registered investment adviser wants to publish a newsletter highlighting three stock recommendations that produced large gains last year. Under the traditional NASAA model rule on investment adviser advertising, what makes that permissible?

    • A.Furnishing every reader a written statement that the Administrator has reviewed and cleared the newsletter.
    • B.Furnishing the three recommendations only to clients who ask for them in writing within 30 days.
    • C.Furnishing the firm's audited performance for that same period, certified by an independent accountant.
    • D.Furnishing a list of all recommendations made over at least the prior year with a cautionary legend.✓ Answer

    The traditional state advertising rule treats a reference to past specific recommendations as inherently misleading unless the adviser furnishes, or offers to furnish, a list of all recommendations made within at least the immediately preceding period of not less than one year, together with a prominent legend stating that it should not be assumed that future recommendations will be as profitable. Selecting only the winners is precisely the abuse the rule is aimed at, and no regulator clears advertising in advance.

    Source: NASAA Model Rule 502(b), investment adviser advertising (past specific recommendations)Report a problem with this question

11. 11. Which arrangement causes a state-registered investment adviser to be deemed to have custody of client funds or securities?

    • A.Holding written discretionary authority to choose the securities bought and sold in the account.
    • B.Deducting the advisory fee directly from the client's account at the qualified custodian each quarter.✓ Answer
    • C.Accepting a client check payable to an unaffiliated third party and forwarding it within 24 hours.
    • D.Receiving duplicate copies of the custodian's monthly account statements for the adviser's records.

    Custody means holding client funds or securities directly or indirectly, or having any authority to obtain possession of them, which includes any arrangement that lets the adviser withdraw assets from the client's account on the adviser's own instruction. Automatic fee deduction is therefore custody, and it is permitted only with written client authorization, an invoice to the custodian and an itemized invoice to the client, and disclosure on Form ADV. Authority to decide what to trade is discretion, not custody.

    Source: NASAA Model Rule on Custody of Client Funds or Securities by Investment Advisers; SEC Rule 206(4)-2Report a problem with this question

12. 12. A client telephones her investment adviser and authorizes him to manage her account on a discretionary basis, and the adviser places the first discretionary trade that afternoon. Under the NASAA model rule, what is required?

    • A.The adviser must obtain written discretionary authority within 10 business days after that first trade.✓ Answer
    • B.The adviser must obtain the Administrator's written consent before exercising oral discretionary authority.
    • C.The adviser must obtain the client's written ratification of each trade placed during the first 30 days.
    • D.The adviser must obtain written discretionary authority before placing any trade under that authority.

    An investment adviser may act on a client's oral grant of discretion, but the model rule gives the adviser only a short grace period: written discretionary authority must be obtained within 10 business days after the initial discretionary transaction, and trading beyond that without the writing is unauthorized. A broker-dealer, by contrast, needs written authorization before the first discretionary order, which is why candidates frequently apply the wrong deadline to the adviser.

    Source: NASAA Model Rule 502(b), unethical business practices of investment advisers (discretionary authority)Report a problem with this question

13. 13. An investment adviser directs client brokerage business to a firm that provides the adviser with various items in return. Which item falls inside the Section 28(e) safe harbor for soft-dollar arrangements?

    • A.Third-party research reports and portfolio analytics used in making investment decisions.✓ Answer
    • B.Payments of the adviser's office rent and part of its employee salary costs.
    • C.Travel and entertainment costs for the adviser's annual client appreciation dinner.
    • D.Computer hardware and office furniture used by the adviser's administrative staff.

    Section 28(e) protects an adviser who pays more than the lowest available commission rate only when the brokerage and research services received provide lawful and appropriate assistance in the investment decision-making process; research reports, market and financial data, and analytical or portfolio-analysis software qualify. Overhead that benefits the adviser rather than the client — hardware, furniture, rent, salaries, travel and entertainment — falls outside the safe harbor and must be paid with the adviser's own money.

    Source: Securities Exchange Act of 1934 Section 28(e), safe harbor for research and brokerage servicesReport a problem with this question

14. 14. An investment adviser needs short-term financing. Under the NASAA model rule on unethical business practices, from which client may the adviser borrow money?

    • A.A client that is a retired accountant holding substantial liquid assets.
    • B.A client that is a commercial bank in the business of lending money.✓ Answer
    • C.A client that is a charitable foundation governed by an independent board.
    • D.A client that is the adviser's brother-in-law and a longtime customer.

    The model rule bars 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 money. A commercial bank fits the last category, so the loan is an ordinary arm's-length commercial transaction rather than an exploitation of the advisory relationship. The family-member exception that applies to broker-dealer agents does not extend to investment advisers.

    Source: NASAA Model Rule 502(b), unethical business practices of investment advisers (loans to and from clients)Report a problem with this question

15. 15. An investment adviser proposes to effect an agency cross transaction, acting as broker for both its advisory client and the person on the other side of the trade. Under the Advisers Act rule governing agency cross transactions, what is required?

    • A.The adviser must hold prospective written consent and must not have recommended the trade to both sides.✓ Answer
    • B.The adviser must take the client's oral consent before each cross and confirm it in writing afterward.
    • C.The adviser must obtain the Administrator's written approval of the cross and report annual totals to it.
    • D.The adviser must disclose its capacity to the client at any point before the next quarterly statement.

    The agency cross rule allows an adviser to act as broker for both sides only under strict conditions: prospective written consent from the advisory client after written disclosure of the conflict, disclosure of the capacity on each trade confirmation, an annual statement of the number of such transactions and the compensation received, a conspicuous statement that consent may be revoked at any time, and the requirement that the adviser not have recommended the transaction to both the buyer and the seller.

    Source: Investment Advisers Act Rule 206(3)-2, agency cross transactionsReport a problem with this question

16. 16. The spouse of an advisory client telephones the investment adviser and asks for a list of the securities held in the client's individual account. Under the NASAA model rule on unethical business practices, how should the adviser respond?

    • A.Release the holdings, because a spouse is presumed to share an interest in marital property.
    • B.Release the holdings once the spouse has verified her identity with two forms of identification.
    • C.Release the holdings after the client has given consent for the information to be shared.✓ Answer
    • D.Release the holdings in summary form, omitting position sizes and the account's total value.

    Disclosing the identity, investments or financial situation of a client or former client is a prohibited practice unless the client consents or the disclosure is required by law, such as a subpoena, court order or a regulator's request. Marriage, joint tax filing or general knowledge of the account does not create authority over another person's individual account, and a summary disclosure is still a disclosure of confidential client information.

    Source: NASAA Model Rule 502(b), unethical business practices of investment advisers (client confidentiality)Report a problem with this question

17. 17. An investment adviser recommends a mutual fund whose distributor pays an ongoing service fee to an affiliate of the adviser. What does the adviser's fiduciary duty require in respect of that payment?

    • A.Disclosing the arrangement in the annual updating amendment filed after the fiscal year.
    • B.Disclosing the arrangement if the payment exceeds the adviser's own advisory fee.
    • C.Disclosing the arrangement orally at the next scheduled portfolio review with the client.
    • D.Disclosing the arrangement in writing to the client before the advice is rendered.✓ Answer

    An adviser is a fiduciary owing duties of loyalty and care, and the model rule requires written disclosure of any compensation received from a source other than the client in connection with giving advice, made before the advice is rendered, so that the client can weigh the conflict and give informed consent while the recommendation is still open. Disclosure buried in a later filing or made at a subsequent review comes too late, and the size of the payment does not determine whether the conflict is material.

    Source: NASAA Model Rule 502(b), unethical business practices (compensation from sources other than the client); SEC Interpretation Regarding Standard of Conduct for Investment AdvisersReport a problem with this question

18. 18. A firm's qualified individual reasonably believes that an elderly advisory client is being financially exploited and delays a requested disbursement from the client's account. Under the NASAA model act on the protection of vulnerable adults, what applies?

    • A.The delay may run until the firm completes its internal review, provided the client is notified in writing.
    • B.The delay may run up to 15 business days, with notice to the securities regulator and adult protective services.✓ Answer
    • C.The delay may run up to 10 business days, with notice going to the client's designated third party.
    • D.The delay may run up to 15 calendar days, after which the firm must obtain a court order to keep it in place.

    The model act lets a qualified individual delay a disbursement or transaction when there is a reasonable belief that financial exploitation of an eligible adult has occurred, is occurring or is being attempted. The delay expires 15 business days after it began, may be extended by 10 additional business days at the request of the securities regulator or adult protective services and further by court order, and prompt notification must go to both agencies as well as to parties authorized to transact on the account, except any party suspected of the exploitation. Good-faith action carries immunity.

    Source: NASAA Model Act to Protect Vulnerable Adults from Financial ExploitationReport 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 →