Laws, Regulations, and Guidelines, Including Prohibition on Unethical Business Practices — Series 65 practice questions

Under Rule 206(4)-2, an IA with custody must use a:

1. Qualified custodian under the applicable rule.
2. Related broker-dealer under the applicable rule.
3. Bank of the adviser's choice under the applicable rule.
4. State-registered trust bank under the applicable rule.

Answer: A — Qualified custodian under the applicable rule.

A) Correct — the Custody Rule requires a qualified custodian (bank, BD, futures commission merchant, or foreign financial institution). B) Not required and may raise conflicts. C) Bank status alone is insufficient. D) Overly narrow — several custodian types qualify.

Which is an exempt transaction under the USA?

1. Sale to an accredited investor.
2. Sale to an institutional buyer.
3. Public television advertising.
4. Unsolicited retail purchase.

Answer: D — Unsolicited retail purchase.

A) Accredited-investor status alone doesn't create a USA exempt transaction; it does for Reg D federally. B) Institutional-buyer sales are exempt federally (Rule 144A); different state analysis. C) General advertising can defeat exemption. D) Correct — unsolicited (non-issuer) transactions are exempt under the USA.

An 'exempt reporting adviser' (ERA) under applicable federal and state frameworks is an adviser that:

1. Is fully exempt from any filing obligations whatsoever.
2. Qualifies for an exemption from full registration (e.g., as a private fund or venture capital fund adviser) but must still file certain reports, such as portions of Form ADV.
3. Must always register fully with the SEC regardless of activities.
4. Is exclusively a term used for broker-dealers, not advisers.

Answer: B — Qualifies for an exemption from full registration (e.g., as a private fund or venture capital fund adviser) but must still file certain reports, such as portions of Form ADV.

B) Correct — ERAs (such as certain private fund or venture capital fund advisers) avoid full registration but still owe baseline reporting obligations to maintain the exemption. A) Some reporting obligation persists even under exempt reporting status; it isn't a total filing exemption. C) The entire premise of ERA status is avoiding full SEC registration while meeting the exemption's conditions. D) 'Exempt reporting adviser' is an investment adviser concept, not a broker-dealer term.

A client who donates a long-term appreciated stock directly to a qualified charity, rather than selling the stock and donating the cash proceeds, generally:

1. Must recognize and pay capital gains tax on the appreciation before the deduction applies.
2. Avoids recognizing the capital gain while still potentially deducting the stock's fair market value.
3. Loses any deduction entirely, since only cash gifts are deductible.
4. Must donate the stock through a broker-dealer specifically licensed for charitable transfers.

Answer: B — Avoids recognizing the capital gain while still potentially deducting the stock's fair market value.

B) Correct — donating appreciated securities directly generally avoids capital gains recognition while still allowing a deduction based on fair market value, subject to applicable limits. A) Requiring gain recognition first would undercut the tax advantage that makes this strategy attractive. C) Donations of appreciated securities are deductible, not excluded from deduction eligibility. D) There's no requirement to route the donation through a specially licensed broker-dealer for the tax treatment to apply.

Under the USA, dishonest or unethical business practices include:

1. Charging any advisory fee.
2. Recommending index funds.
3. Providing account statements.
4. Guaranteeing against loss.

Answer: D — Guaranteeing against loss.

A) Fees themselves aren't unethical. B) Product neutrality is not the issue.C) Statements are required, not unethical. D) Correct — guarantees against loss are prohibited.

Misappropriating client funds is:

1. A minor administrative infraction.
2. Criminal fraud under the applicable rule.
3. Permitted if repaid under the applicable rule.
4. Allowed with disclosure under the applicable rule.

Answer: B — Criminal fraud under the applicable rule.

A) It's a serious violation. B) Correct — misappropriation is fraudulent and violates fiduciary duty. C) Restitution doesn't cure the violation. D) It cannot be disclosed away.

Form ADV Part 1 is filed primarily with the:

1. SEC and/or state securities Administrators through the IARD system, as a regulatory disclosure filing.
2. Client directly, as the firm brochure.
3. IRS, as a tax filing.
4. FDIC, as a deposit insurance filing.

Answer: A — SEC and/or state securities Administrators through the IARD system, as a regulatory disclosure filing.

A) Correct — Form ADV Part 1 is filed electronically through IARD with the SEC and/or applicable states, capturing regulatory, business, and disciplinary information. B) Part 1 is a regulatory filing; the narrative brochure delivered to clients is Part 2. C) It has no tax-filing function with the IRS. D) The FDIC has no role in adviser registration filings.

Front-running by an IA involves:

1. Trading ahead of a client's pending order.
2. Executing at the market open under the applicable rule.
3. Buying and holding long-term under the applicable rule.
4. Placing limit orders only under the applicable rule.

Answer: A — Trading ahead of a client's pending order.

A) Correct — trading personally ahead of a client's known pending order. B) Open executions are timing, not front-running. C) Buy-and-hold has no timing conflict. D) Order type is unrelated.

A fiduciary must place the client's interest:

1. Equal to the adviser's.
2. Behind the custodian's.
3. Behind regulator interests.
4. Ahead of the adviser's.

Answer: D — Ahead of the adviser's.

A) That's suitability, not fiduciary. B) Custodian interest is not the reference point.C) Regulator interest is not the reference point. D) Correct — the fiduciary duty places the client's interest ahead of the adviser's.

Selling away by a BD agent means:

1. Executing away from the firm without approval.
2. Placing trades on the primary market only.
3. Choosing a lower-cost venue under the applicable rule.
4. Trading only in dark pools under the applicable rule.

Answer: A — Executing away from the firm without approval.

A) Correct — selling securities outside the scope of employment without firm approval. B) Venue choice is not selling away. C) Cost selection is unrelated. D) Dark pool routing is a venue issue.

What is the IA code of ethics?

Written policies on personal trading, insider trading, gifts, outside activities, and confidentiality. Must be provided to clients upon request.

What generally happens to an IAR's registration when the sponsoring firm undergoes a merger or acquisition?

The IAR's registration typically must be updated/re-filed to reflect the new or surviving firm, often requiring an amended Form U4 and, depending on the state, a successor registration filing by the firm itself.

What must be disclosed when an advertisement includes a paid testimonial or endorsement?

Whether the person is a client, whether compensation was provided, and a description of any material conflicts of interest resulting from the relationship between the adviser and the endorser, per the Marketing Rule's testimonial/endorsement provisions.

When can a pooled investment vehicle satisfy the Custody Rule's audit requirement without a surprise exam?

If the fund is audited annually by a PCAOB-registered, independent public accountant and distributes audited financial statements to investors within 120 days (180 for funds of funds) of the fiscal year end, the adviser can rely on the audit in lieu of a surprise examination.