Series 63 Unethical Practices: Investment Advisers Practice Questions

Correct answer: B. The client must receive the adviser's disclosure brochure along with a separate written disclosure document describing the solicitation arrangement and the compensation paid, and must acknowledge receiving both before or at the time the advisory contract is entered into

Cash referral/solicitor arrangements are permissible only with proper disclosure: the client must receive the adviser's brochure plus a separate solicitor's disclosure document describing the relationship between adviser and solicitor and the nature/amount of compensation, and the client must acknowledge that disclosure before or when entering into the advisory agreement. There is no requirement that the solicitor be an employee/IAR of the firm, no percentage cap under this rule, and no requirement of Administrator pre-approval.

• A. The cash solicitor rule specifically contemplates independent third-party solicitors who are not employed by the firm — that's the very scenario it governs.
• B. Correct. The client must receive the adviser's disclosure brochure plus a separate written disclosure describing the solicitation arrangement and compensation, and must acknowledge receiving both before or at the time the advisory contract is entered into.
• C. There's no fixed cap limiting the referral fee to 10% of the client's first-year advisory fee under the rule, so no cap needs to be disclosed.
• D. The rule doesn't require advance Administrator pre-approval of the solicitation arrangement, so there is no approval notice to give the client.

Correct answer: A. Borrowing money from a client who is not in the business of lending money

Borrowing money from a client is generally prohibited unless the client is a financial institution in the business of lending, or is an affiliate of the adviser — borrowing from an ordinary retail client raises serious conflict-of-interest and abuse concerns.

• A. Correct.
• B. Incorrect — fully disclosed fees are standard, compliant practice.
• C. Incorrect — reasonable due diligence is expected, not unethical.
• D. Incorrect — brochure disclosure of conflicts is required, compliant practice.

• Source: NASAA Model Rule 102(a)(4)-1 (Unethical Business Practices of Investment Advisers, IARs and Federal Covered Advisers)

Correct answer: B. No, an undisclosed referral fee arrangement creates a conflict of interest that must be disclosed to the affected clients regardless of the dollar amount involved

A referral fee creates a conflict of interest because it may bias the IAR's recommendation of a particular professional; disclosure obligations for such compensation arrangements are not conditioned on the amount being 'large enough to matter' — clients need the information to evaluate whether the referral was made in their own interest. C mischaracterizes referral arrangements as categorically exempt from disclosure, which is incorrect.

• A. There's no automatic small-dollar exemption from disclosure — any compensation arrangement creating a conflict of interest must be disclosed regardless of size.
• B. Receiving referral fees from the attorney creates a financial incentive that could bias the IAR's referrals, and this conflict must be disclosed to affected clients no matter how modest the amount.
• C. Referral arrangements between an IAR and outside professionals are absolutely subject to disclosure obligations when compensation changes hands — this isn't an exempt category.
• D. Disclosure is required because of the conflict of interest inherent in the referral fee itself, not contingent on whether the attorney later overcharges the client.

• Source: NASAA Model Rule 102(a)(4)-1 (Unethical Business Practices of Investment Advisers, IARs and Federal Covered Advisers)
• Source: NASAA Model Rule 502(b) (Prohibited Conduct of Investment Advisers, IARs and Federal Covered Investment Advisers)

Correct answer: B. It is a materially false and misleading statement in a regulatory filing, since it fails to disclose known, existing conflicts of interest

Form ADV is a regulatory disclosure document, and affirmatively stating there are 'no conflicts of interest' while revenue sharing and proprietary-product incentive compensation actually exist is a materially false statement — clients rely on the brochure precisely to learn about such conflicts before deciding whether to engage the firm. A is wrong because the falsity of the filing is the violation, independent of whether specific harm can later be shown; D is wrong because disclosure only 'upon request' to regulators does not satisfy the obligation to proactively disclose to clients in the brochure.

• A. Whether clients are actually harmed doesn't determine whether a regulatory filing is materially false — the misstatement itself is the violation.
• B. Correct. Claiming to have no conflicts of interest while receiving revenue sharing and paying IARs more to favor proprietary products is a materially false and misleading statement in a regulatory filing.
• C. Conflicts of interest must be disclosed whether or not they arise from a formal written contract — informal compensation incentives still count.
• D. Disclosing arrangements to regulators only upon request doesn't make the ADV's blanket "no conflicts" statement accurate for clients.

• Source: NASAA Model Rule 102(a)(4)-1 (Unethical Business Practices of Investment Advisers, IARs and Federal Covered Advisers)
• Source: Investment Advisers Act Section 206, 15 U.S.C. 80b-6 (prohibited transactions by investment advisers)