An investment adviser wishes to charge a client a performance-based fee (a share of capital gains or appreciation in the account). Under the regulatory framework applicable to state-registered advisers, this is generally permissible only if:

The client is a 'qualified client' meeting minimum assets-under-management or net worth thresholds specified by rule

A prospective client wants to understand exactly how her investment adviser is compensated — including fee schedule, whether fees are negotiable, and any conflicts tied to compensation. Where is this information required to be disclosed to her?

In the adviser's brochure (Form ADV Part 2), which must be delivered to the client

A trust account at a broker-dealer names a corporate trustee and an adult beneficiary. The beneficiary phones the agent and instructs him to sell a large position so she can pay a personal expense. How should the agent respond?

Decline the order, because the trustee holds authority over the trust assets, and refer the beneficiary to the trustee.

A client calls her agent and says, 'Buy me 100 shares of whatever tech stock you think looks good this week, at whatever price makes sense, whenever you think the timing is right.' For the agent to exercise this kind of discretion going forward on an ongoing basis, what must be obtained first?

Prior written discretionary authorization from the client, on file with the firm

Series 63 Client Types and Compensation Practice Questions

Question 1
An investment adviser wishes to charge a client a performance-based fee (a share of capital gains or appreciation in the account). Under the regulatory framework applicable to state-registered advisers, this is generally permissible only if:
- A. The client is a 'qualified client' meeting minimum assets-under-management or net worth thresholds specified by rule
- B. The adviser discloses the arrangement to the client verbally before the first billing cycle
- C. The client is any retail investor, as long as the fee is disclosed in Form ADV
- D. The adviser is a federal covered adviser, since state-registered advisers are barred from charging performance fees to their clients
Show answer and explanation
Correct answer: A. The client is a 'qualified client' meeting minimum assets-under-management or net worth thresholds specified by rule
Performance-based compensation is generally restricted to 'qualified clients' who meet specified net worth or assets-under-management thresholds, reflecting the added risk-taking incentives such fees can create; disclosure alone doesn't make the arrangement permissible for an ineligible client.
- A. Correct.
- B. Incorrect — verbal disclosure doesn't satisfy the qualified-client eligibility requirement.
- C. Incorrect — 'any retail investor' ignores the qualified-client threshold.
- D. Incorrect -- state-registered advisers can charge performance fees to qualified clients; the ability is not limited to federal covered advisers.
- Source: SEC Rule 205-3 (exemption from the performance-fee prohibition; qualified clients)
Question 2
A prospective client wants to understand exactly how her investment adviser is compensated — including fee schedule, whether fees are negotiable, and any conflicts tied to compensation. Where is this information required to be disclosed to her?
- A. It need not be disclosed unless the client specifically requests it in writing
- B. Verbally, at the discretion of the adviser, with a written summary available if the client later asks
- C. In the adviser's brochure (Form ADV Part 2), which must be delivered to the client
- D. Within the account opening agreement's fine print, which satisfies the disclosure requirement without a separate disclosure document
Show answer and explanation
Correct answer: C. In the adviser's brochure (Form ADV Part 2), which must be delivered to the client
Investment advisers are required to provide clients with a written disclosure brochure (Form ADV Part 2, along with any relevant supplements) describing the adviser's fee structure, compensation arrangements, and material conflicts of interest, delivered before or at the time of entering into an advisory relationship.
- A. Compensation and conflict disclosures must be provided regardless of whether the client specifically requests them.
- B. Verbal disclosure at the adviser's discretion, with a written summary only on request, doesn't satisfy the requirement for a delivered written brochure.
- C. Correct. This information belongs in the adviser's brochure (Form ADV Part 2), which must be delivered to the client.
- D. Placing compensation terms in the account-opening fine print without a dedicated disclosure document doesn't meet the brochure delivery requirement.
Question 3
A trust account at a broker-dealer names a corporate trustee and an adult beneficiary. The beneficiary phones the agent and instructs him to sell a large position so she can pay a personal expense. How should the agent respond?
- A. Execute the sale, since the beneficiary holds the economic interest in the trust assets.
- B. Decline the order, because the trustee holds authority over the trust assets, and refer the beneficiary to the trustee.
- C. Execute the sale after the beneficiary confirms the request in writing and signs a standard order ticket.
- D. Execute the sale because adult beneficiaries are permitted to direct activity in the accounts that benefit them.
Show answer and explanation
Correct answer: B. Decline the order, because the trustee holds authority over the trust assets, and refer the beneficiary to the trustee.
A trust account is controlled by the trustee, who holds legal authority over the assets under the trust agreement. A beneficiary has no authority to place orders unless the trust documents grant it, so the agent should take instructions from the trustee.
- A. Holding the economic interest does not give a beneficiary authority to trade; legal control belongs to the trustee.
- B. Correct. Only the trustee, acting under the trust agreement, may direct trades in the trust account.
- C. A written confirmation from the beneficiary does not create trading authority she does not hold.
- D. Age of the beneficiary is irrelevant; authority comes from the trust document, not from being an adult beneficiary.
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Question 4
A client calls her agent and says, 'Buy me 100 shares of whatever tech stock you think looks good this week, at whatever price makes sense, whenever you think the timing is right.' For the agent to exercise this kind of discretion going forward on an ongoing basis, what must be obtained first?
- A. A verbal instruction from the client, noted on the order ticket, is sufficient
- B. Supervisory approval from the broker-dealer, without separate client documentation
- C. Prior written discretionary authorization from the client, on file with the firm
- D. Verbal authorization renewed every 90 days
Show answer and explanation
Correct answer: C. Prior written discretionary authorization from the client, on file with the firm
Choosing the security, the amount, and/or the timing/price at the agent's own discretion on an ongoing basis makes this a discretionary account, which requires prior written authorization from the client (a limited power of attorney) accepted by the firm before discretion may be exercised.
- A. A verbal instruction noted on a ticket doesn't authorize ongoing discretionary trading — written authorization is required for that.
- B. Internal supervisory approval doesn't substitute for the required client-signed written authorization.
- C. Correct. To exercise this kind of open-ended discretion on an ongoing basis, the agent must obtain prior written discretionary authorization from the client, on file with the firm.
- D. There's no rule allowing ongoing discretion to be renewed verbally every 90 days in lieu of written authorization.

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