Unit 1

Question 1

Definition of a “Person”

Easier - What are the 3 non-persons?

Answer 1

Non-Persons:

• A minor
• A deceased individual
• An individual declared mentally incompetent by the courts

Question 2

3 Prong Test for Investment Advisers

Answer 2

• Gives advice to others on securities (general newsletter and non-specific securities are excluded)
• Does so as part of a regular business activity; and
• Receives compensation for performing this activity

Question 3

Investment Counsel Criteria (2)

Answer 3

• IA’s principal business must be giving investment advice. This basically excludes financial planners or tax ppl.
• Provide investment supervisory services.

Question 4

IA-1092

Answer 4

Interprets the definition of an Investment Adviser to include:

• Financial planners (states there is no such thing as a comprehensive financial plan that does not involve securities).
• Pension consultants (consultants who advise employee benefit plans on how to fund their plans with securities; and any consultants who advise employee benefit plans on the selection performance and retention of investment managers), and
• Others who offer investment advice as part of their financial practice.

Question 5

Definition of “Investment Adviser” Exclusions per the State (7)

Answer 5

• Any Bank or bank holding company, savings institution, or trust company. Generally limited to U.S. banks and bank holding companies. Exclusion is unavailable to credit unions and investment adviser subsidiaries of banks or bank holding companies.
• LATE - lawyer, accountant, teacher, engineer and advice is incidental.
• Any broker-dealer whose performance of such services is solely incidental to the conduct of business and receives no special compensation. Also applies to broker dealer representatives (agents)
• Publisher of any bona fide newspaper, magazeine or business or fin. publication of general and regular circulation. (*Must be on a regular basis and not in response to specific timed market events, impersonal in nature, bona fide or genuine. Offering 5 securities weekly may be ok)
• Certain individuals employed by Investment Advisers (Investment Adviser Representatives)
• Any person who is a federal covered adviser
• Any person whose advice, analysis, or reports are related only to securities that are direct obligations of the U.S. governemnt
• Any other person the Administrator specifies is excluded

Question 6

Investment Adviser Exemptions (Federal Law only) (2) State Law is separate) (Exempt from registration) *

Answer 6

Federal Exemptions:
- Intrastate Advisers (excludes investment advisers to any private fund) (clients are residents of the state where adviser principal office (and only place of business) is located, and do not give advice on securities listed on an exchange.)

• *Advisers whose only clients are insurance companies are exempt.

Question 7

Investment Adviser Exemptions (State Law Only) (…Federal Law is separate question) (Exempt from registration)

How long to register if violating the exemptions?

Answer 7

State Exemptions:

• IA’s who have no place of business in the state (a hotel could be considered a place of business if its a new client), but are registered in another state, provided their only clients in the state are:
• registered broker dealers,
• other IAs,
• banks and insurance companies
• large employee benefit plans
• Institutional investors,
• existing clients who are only temporarily in the state (snowbird)
• limited to 5 or fewer clients, other than those previously listed, resident in the state during the preceding 12 month period (de minimus exemption),
• any others the administrator exempts by rule or order

(if the rules are violated, IA must register within 30 days - like registering your car)

Question 8

Investment Adviser Registration Exemption (Federal Law) (3) (Private Funds)

Answer 8

• (Private fund adviser exemption) An exemption for advisers soleyly to private funds with less than $150MM in AUM in the U.S.)
• (Foreign private adviser exemption) - Non-U.S. advisers with no place of business in the U.S. and minimal AUM (less than $25MM) attributable to U.S. clients and investors. Less than 15 U.S. clients.
• (Venture capital Fund exemption) - Advisers soleyly to venture capital funds (venture capital funds have limited leverage and do not offer redemption rights).

Question 9

**Investment Adviser Registration Exemption (State Law differences from Federal Law exemptions) (2) (Private Funds)

Answer 9

• If qualifying as 3c1 (less than 100 investors), NASAA requires all investors be “qualified clients” (assets of $1mm+ with IA, or have $2.1MM+ net worth excluding primary residence.
• Neither the private fund, nor any of it’s advisors affiliates are subject to the “bad actor” provisions. Those provisions disqualify anyone who has certain criminal convictions (generally felonies), certain SEC disciplinary orders or suspension or expulsion from membership in an SRO such as FINRA.

Question 10

Federal “Covered” Adviser characteristics (6))

Answer 10

Federal Covered Advisers:
- those registered with the SEC because they are eligible ($100MM AUM) or required ($110MM AUM)

• those under contract to manage an investment company (i.e. an mutual fund), registered under the Investment Company Act - regardless of AUM
• those not registered with the SEC because they are excluded from the definition of an IA. Most tested example is IA whose advice is limited to securities issued by the U.S. govt. or one of it’s agencies)
• Pension consultants with AT LEAST $200MM in AUM
• Internet Advisers
• Investment Advisers expecting to be eligibile for SEC registration within 120 days of filling the applicational

Question 11

Small, Mid, Large Size Investment Advisers and Characteristics

Large Size IA timeline to register with SEC or State

Answer 11

• Small - Less than $25MM
• Mid - $25MM - $100MM
• Large - $100MM+ ($110 REQUIRES SEC Reg)

(Small and midsize advisors required to register in 15 or more states have the OPTION of registering with the SEC)

Question 12

Investment Adviser Registration Process (Mostly Same for SEC and State)

Answer 12

Registration is accomplished using form ADV through the IARD

Registering with the State:

• Submit application
• provide consent to service of process
• pay filing fees
• post a bond (if required by Administrator); and
• take and pass an examination if required by the Administrator (could be oral, written or both)

Question 13

Form ADV Organization
(other items on pg. 23)

When must it be updated?

• Regular Requirement?
• Material Change Requirement?

Answer 13

1A - All advisers registering with the SEC or any state must fill out this portion. (location of business, form of business (partnership, etc.) etc.)

           - Asks info about direct owners and exec officers (control persons)
            - DRPs (Disclosure Reporting Pages) are schedules that ask for details about disciplinary events involving the adviser or advisory affiliates

1B- Additional questions for State Registration Only

2A- Brochures - contain info on advisory firm (investment strategy, analysis, compensation, etc.) . Apply to all registering with state and SEC. Also asks for educational and business background of principal executive officers, management persons) There are no educational requirements.

2B- Brochure Supplements - Contain info on certain supervised persons. Apply to all registering with SEC or states.

• -Must be updated within 90 days after the end of the advisers fiscal year, with the Annual Updating Amendment.
• -Material changes must be updated promptly.

Question 14

Control Person Definition(s):

• IA Control Person Definition
• Exchange Act of 1934 defintion
• Investment Company Act

Answer 14

• Investment Adviser Control Person - Owns 25% or more of a corporations voting securities; or has contributed 25%+ to a partnership
• Exchange Act Definition of Control Person - 10% of voting power
• Investment Company Act - more than 25%

Question 15

**Form ADV Fees for filing (rules)

Answer 15

No Fee If:

• Changing form of business organization (partnership to a corporation). But will need a new ADV.
• Registering as a successor firm with the State.

Fee If:
-Registering as a successor firm with the SEC

Successor firms only pay a fee with the SEC.

Question 16

Notice Filing

Answer 16

Process used when not having to file with the State because the IA is federally covered. Pay a filing fee.

Federal covered advisors must make a notice filing with the state if they are not excluded.

Question 17

Consent to Service Process

Answer 17

• Gives admin the power to act as the applicant’s attorney. Does not need renewal.

Question 18

Registration and Renewal Dates for State and SEC registration of Investment Advisers

When is State Renewal?

When are Federal and State effective?

Answer 18

• ALL IMPT*
• State Registration takes effect at noon of the 30th day. (Admin has power to shorten period by using a “rush order”
• State Renewal date is Dec. 31st., no matter what.
• SEC Registration takes effect on the 45th day after filling of a complete application.

Passing the exam does not allow you to conduct business…you first need to receive the license or registration by that state*

Question 19

*ADV-W
When is it used?
Timing for State and Federal Law?
Time period Administrator retains jurisdiction over the former registrant?

Answer 19

• Application to Withdraw - leaving the business as an Investment Adviser
• Covered Advisers - Withdrawal takes 60 Days
• State Advisers - Withdrawal takes 30 Days after filing.
• Admin has 1 year jurisdiction after IA leaves

Question 20

**ERA’s - Exempt Reporting Advisers

Answer 20

**Advisers exempt from registering (ERAs) still must file an abbreviated ADV part 1, but not a part 2.

Question 21

Substantial Pre-Payment of Fees :

• Amount (Federal and State Amounts)
• Balance Sheet Requirements (Federal and State)

Answer 21

Federal - More than $1200 in pre-payments from a client, 6 months or more in advance.

–(Federal) Balance Sheet required if IA requires these substantial pmts from clients must include a balance sheet with the ADV2A for the most recent fiscal year. Balance sheet must be prepared and audited by a public accountant.

State - More than $500 in pre-payments from a client, 6 months or more in advance.

• -(State) Balance Sheet required if:
• IA requires substantial pre-pmts
• IA has custody of client funds/securities.
• The custodian is affiliated broker-dealer
• If IA has discretion over client accounts (does not have to be audited and has within 90 days of the end of the fiscal year)

*- An IA that accepts pre-payment of fees of more than $500 must maintain a positive net worth at all times.

Question 22

Surety Bond and Net Worth Requirements ***

• Who requires them and for what situations?
• Amounts Required for those situations?
• What happens if you do not maintain the min. net worth?

Answer 22

State Administrator may require a Surety Bond (or require a minimum net worth) if having custody or discretion over client funds.

IA Surety Bond Requirements:
- $35,000 - Regardless if having custody of funds, or only discretionary authority.

IA Net Worth Requirements:

• IA’s with Custody of Client Funds: $35,000
• IAs with Discretionary Authority: $10,000

*Any IA requesting sub. pre-payement of fees must maintain a positive net worth at all times.

*** Some States have higher net worth or bonding requirements. If you meet the requirements of your principal office’s state, that is sufficient in any other state you are registered.

***Federal bonding requirements have jurisdiction over State ones (if they contradict each other)

• -If net worth falls below min. (State Rule) By close of the NEXT business day, you must notify the Administrator you are below the min. By close of the following business day you must file a financial report. Also must include number of client accounts.
• When below the min, IA must acquire a bond in amount of defiency rounded up to nearest $5000.

Question 23

Scalping

Answer 23

practice whereby an investment adviser, before teh dissemtnation of a securities recommendaiton, trades on the anticipated short-run market activity that may result from the recommendation.

Question 24

Record Retention (State and Federal)

• Books and Records
• Other (Articles of Incorporation or partnership articles)

Answer 24

Books and Records (Federal and State) - 5 Years from end of fiscal year the record was generated, and readily accessible. Initial 2 years must be kept in principal office. (Can be suprised audited by Admin)

Additional State Rule - partnership articles and/or articles of incorporation must be maintained in principal office for at least 3 years after the termination of the interprise.

Question 25

IARs

Answer 25

IARs Do not have a bond/surety requirement File a U4 to register with the State and must update within 30 days for material changes. Have the deminimus exemption

Question 26

Wrap fee program

Answer 26

A specified fee or fees not based directly upon transaction of the clients account is charge for investment advisory services and the execution of client transactions. *You cannot be excluded from being an IA. You would be providing IA and brokerage execution services.

Question 27

Special compensation

Answer 27

Extra compensation. Exist where there is clearly a definable charge for investment advice

Question 28

Time lines Days to file with SEC when assets go above $110 Days to file with state when assets go below $90M Deadline to file ADV annual updating amendment Material changes

Answer 28

Days to file with SEC when assets go above $110 - 180 days Days to file with state when assets go below $90M - 90 days Deadline to file ADV annual updating amendment - 90 days after the end of the advisers fiscal year Material changes - prompt

Question 29

Automatic registration of partners, officers, directors or others already acting as IARs.

Answer 29

When IA registers