An IAR of a state-registered investment adviser recommends that a client invest $75,000 in a mutual fund advised by the adviser's affiliate. The fund's expense ratio is 1.35%, while several comparable funds with similar strategies and performance records have expense ratios below 0.60%. The adviser receives a fee from the fund. Before the purchase, the IAR discloses the affiliation and the fee arrangement to the client in writing, and the client consents. The fund is consistent with the client's risk tolerance and investment objective.
Under the fiduciary duty of an investment adviser, which statement is correct? Answer: The recommendation violates the fiduciary duty because the higher-cost fund has comparable performance, and disclosure does not cure a recommendation that is not in the client's best interest.
The fiduciary duty of an investment adviser (Investment Advisers Act § 206 and Uniform Securities Act § 102) requires the IAR to act in the client's best interest, not merely to make suitable recommendations. The affiliated fund's 1.35% expense ratio is more than double the expense ratios of comparable funds with similar strategies and performance, so the recommendation is not in the client's best interest; the adviser's receipt of a fee from the fund is a conflict that does not change that conclusion. Written disclosure and the client's consent address the conflict-of-interest disclosure requirement, but they do not make a recommendation that is not in the client's best interest permissible. The statement that suitability is the governing standard confuses the suitability floor with the fiduciary ceiling. The statement that affiliated funds may never be recommended is too broad; such funds may be recommended when the recommendation is in the client's best interest and the conflict is properly disclosed.
A registered representative recommends a complex options strategy to the treasurer of a manufacturing company, acting on behalf of the company. The company maintains a $50 million short-term investment portfolio. The representative has not reviewed the company's investment policy or assessed its capacity to bear loss. The company has not claimed it is capable of independently evaluating the strategy.
Which statement is correct under Regulation Best Interest and FINRA Rule 2111? Answer: The retail-customer standard does not apply because the customer is a company, but suitability obligations still apply to the recommendation.
Regulation Best Interest defines a retail customer as a natural person, or the legal representative of a natural person, who receives a recommendation primarily for personal, family, or household purposes. A company acting through its treasurer is not a retail customer, so Regulation Best Interest does not apply. Broker-dealer suitability obligations under FINRA Rule 2111 still apply to recommendations to customers, including institutional customers. An institutional customer's sophistication does not automatically satisfy customer-specific suitability unless the customer affirmatively indicates that it is exercising independent judgment and the representative has a reasonable basis for that belief. Neither the treasurer's status as a natural person nor the treasurer's financial expertise eliminates the representative's suitability analysis.
A registered representative of a broker-dealer recommended a large-cap growth mutual fund to a retail customer in March, and the customer purchased it. In November, the customer's investment objectives changed from growth to current income, but the customer has not contacted the representative. The representative does not review the account and takes no further action with respect to it.
Under the federal standard of conduct for broker-dealer recommendations to retail customers, which statement is correct? Answer: The representative has not violated the standard because no new recommendation was made and the rule does not impose a continuing duty to monitor.
Regulation Best Interest attaches to recommendations made to retail customers and does not impose a freestanding duty to monitor or review an account after a recommendation is made. Because the representative made no new recommendation and took no action that could reasonably be understood as recommending that the customer hold the fund, the later change in the customer's objectives does not create a violation. The statement that the changed circumstances themselves violate the standard treats suitability as a continuous account-level duty, which Regulation Best Interest does not create. The statement that the original purchase was an implicit hold recommendation is wrong: a hold recommendation requires affirmative conduct, and mere inaction after a purchase is not a recommendation. The statement about an updated customer relationship disclosure is wrong because continued holding is not an event that triggers delivery of a relationship summary.
- Under the Uniform Securities Act, which of the following statements regarding the suitability obligation of a broker-dealer or agent is true?
Answer: A broker-dealer or agent who recommends a security without reasonable grounds to believe it is suitable, based on the facts the customer disclosed about other holdings, financial situation, and needs, has committed an unethical practice.
Governing authority: NASAA Model Rule on Unethical Business Practices of Broker-Dealers and Agents, adopted under the Uniform Securities Act. The rule makes it unethical to recommend the purchase, sale, or exchange of a security without reasonable grounds to believe the recommendation is suitable, based on the facts, if any, disclosed by the customer about other security holdings and financial situation and needs. The statement that complete disclosure makes a recommendation conclusively suitable is wrong: the reasonable-grounds analysis must still be performed, and a recommendation can be unsuitable even with full information. The statement that a signed risk acknowledgment and release satisfies the obligation is wrong: customers cannot waive suitability protection, and an acknowledgment is not a substitute for the required analysis. The statement that the obligation does not apply to recommendations to exchange one security for another is wrong: the rule expressly covers purchase, sale, and exchange recommendations.
- Which of the following statements is true regarding the standards of conduct that apply to an individual registered both as an agent of a broker-dealer and as an investment adviser representative?
Answer: In the brokerage capacity, Regulation Best Interest applies to recommendations to retail customers; in the advisory capacity, the individual owes a fiduciary duty under the Investment Advisers Act and state law.
Governing authority: SEC Regulation Best Interest and Investment Advisers Act of 1940 § 206, together with state fiduciary standards for investment adviser representatives. The standard of conduct depends on the capacity in which the individual acts: when making recommendations to retail customers as a broker-dealer agent, Regulation Best Interest applies; when providing investment advice as an IAR, the client relationship is governed by the adviser's fiduciary duty. The statement that the dual registrant owes a fiduciary duty in all interactions is wrong because brokerage recommendations are governed by Regulation Best Interest, not by the Advisers Act fiduciary duty, even for a dual registrant. The statement that Regulation Best Interest applies to advisory services and the fiduciary duty to brokerage recommendations is wrong because the two standards are assigned to the opposite capacities. The statement that complying with Regulation Best Interest satisfies the fiduciary duty because the standards are identical is wrong: Regulation Best Interest is a best-interest standard implemented through the four obligations of Disclosure, Care, Conflict of Interest, and Compliance, while the fiduciary duty is a broader principles-based duty of loyalty and care.
- Which of the following statements regarding the Conflict of Interest obligation under Regulation Best Interest is true?
Answer: A broker-dealer must adopt written policies and procedures to identify and disclose, or eliminate, all conflicts of interest and to mitigate conflicts that create an incentive to put the firm's interest ahead of the customer's.
Governing authority: SEC Regulation Best Interest, the Conflict of Interest obligation. Under that obligation, a broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and disclose, or eliminate, all conflicts of interest associated with its recommendations, and to identify and mitigate conflicts that create an incentive to place the broker-dealer's interest ahead of the retail customer's interest. The statement that every conflict must be eliminated before any recommendation is wrong: the rule permits disclosure as an alternative and requires mitigation, not elimination, of incentive conflicts. The statement that disclosing conflicts in the customer relationship summary constitutes consent and relieves the firm of any duty to mitigate is wrong: disclosure does not operate as customer consent and does not displace the obligation to maintain and enforce policies to mitigate incentive conflicts. The statement that only research-department or affiliate-product conflicts must be disclosed is wrong: the obligation covers all conflicts associated with recommendations, not only conflicts involving proprietary products or the firm's own research.
An individual is registered as both an agent of a broker-dealer and an investment adviser representative of a state-registered investment adviser. The individual recommends that a retail customer roll over $200,000 from a former employer's 401(k) plan into a traditional IRA at the affiliated broker-dealer and invest the proceeds in a diversified portfolio of mutual funds. The customer will pay commissions on the mutual fund purchases and an annual advisory fee of 0.75% of assets under management, and signs a written advisory agreement.
Under Regulation Best Interest and the fiduciary duty of an investment adviser, which statement is correct? Answer: The individual is subject to Regulation Best Interest for the mutual fund purchase recommendations and to the fiduciary duty for the advisory relationship, and both standards apply to the same recommendation.
Regulation Best Interest (SEC Rule 15l-1) and the fiduciary duty an investment adviser owes to advisory clients under the Investment Advisers Act of 1940 and applicable state law govern. Because the individual is registered in both capacities, the customer is a retail customer receiving recommendations of securities transactions (the mutual fund purchases), which triggers Regulation Best Interest, and the customer is entering a written advisory relationship with an ongoing fee, which places the recommendation within the fiduciary duty. Under SEC guidance, a recommendation to roll over employer-plan assets into an IRA is an investment strategy involving securities, and a dually registered person making the recommendation in both capacities is subject to both standards; both standards apply to the same recommendation. The statement that the individual acts solely as an IAR ignores the agent capacity and the commissions. The statement that only Regulation Best Interest applies ignores the written advisory agreement and the ongoing advisory fee. The statement that the standards are split by transaction is wrong because Regulation Best Interest also applies to the rollover recommendation and the fiduciary duty covers the advisory relationship as a whole, including the mutual fund recommendations.
- Which of the following statements is true regarding a broker-dealer's duty of care when recommending a security or investment strategy to a retail customer?
Answer: A broker-dealer must exercise reasonable diligence to understand the risks, rewards, and costs of a recommendation and reasonably believe it is in the customer's best interest, without placing the firm's interest ahead of the customer's interest.
Governing authority: SEC Regulation Best Interest. The Care obligation requires a broker-dealer to exercise reasonable diligence, care, skill, and expertise to understand the potential risks, rewards, and costs of a recommended security or investment strategy and to have a reasonable basis to believe the recommendation is in the retail customer's best interest, without placing the broker-dealer's financial or other interest ahead of the customer's. The statement describing ongoing account monitoring is wrong because Regulation Best Interest applies at the time the recommendation is made and does not impose a continuing duty to monitor the account; an ongoing monitoring obligation is closer to an investment adviser's fiduciary duty. The statement requiring the lowest-cost security is wrong because cost is only one of several factors and the rule does not mandate the cheapest product, even when a higher-cost product better fits the customer's needs. The statement requiring a customer relationship summary 48 hours before the recommendation with a signed written acknowledgment is wrong because Form CRS is delivered at the earliest of a recommendation, an order, or account opening, and no written acknowledgment is required; the 48-hour timing belongs to the state-registered adviser brochure rule, not the Form CRS rule.
- Under SEC rules, when must a broker-dealer deliver its relationship summary (Form CRS) to a retail investor?
Answer: At the earliest of a recommendation of a securities transaction or investment strategy, an order to buy or sell securities, or the opening of a new brokerage account.
Governing authority: Exchange Act Rule 17a-14 (Form CRS). A broker-dealer must deliver the customer relationship summary at the earliest of a recommendation of a securities transaction or investment strategy, an order placed by the customer, or the opening of a new brokerage account. The settlement-and-statement triggers are wrong because the summary must be delivered when the relationship begins, not after the first transaction settles or the first statement is mailed. The 48-hour or at-transaction delivery with a five-business-day termination right is the NASAA brochure delivery rule for state-registered investment advisers, not the Form CRS requirement for broker-dealers. The 120-day fiscal-year updating schedule describes annual delivery of an investment adviser's brochure (Form ADV Part 2A), not the Form CRS, which is instead delivered at the three triggering events.
- Which of the following statements regarding the fiduciary duty of an investment adviser to its clients is true?
Answer: The duty of loyalty requires full disclosure of all material conflicts, and the duty of care requires the adviser to give suitable advice and seek best execution.
Governing authority: Investment Advisers Act of 1940 § 206 and Uniform Securities Act § 102. An investment adviser is a fiduciary to its clients, owing a duty of loyalty—full and fair disclosure of all material conflicts of interest and no undisclosed self-dealing—and a duty of care—suitable advice, competent account management, and best execution of client transactions. The statement that the fiduciary duty applies only when the adviser has discretionary authority is wrong: the duty attaches to the advisory relationship itself and applies whether or not the adviser has trading discretion. The statement that disclosing all material conflicts satisfies the duty of loyalty even if the adviser then places its own interests ahead of the client's is wrong: disclosure is necessary, but the duty of loyalty also prohibits the adviser from subordinating the client's interests to its own. The statement that the fiduciary duty applies only to buy and sell recommendations is wrong: the duty extends to the entire relationship, including ongoing monitoring of managed accounts and the selection of broker-dealers for execution.
- An investment adviser owes its clients a fiduciary duty of care. Which of the following statements regarding the adviser's duty of best execution is true?
Answer: The duty of best execution requires the adviser to seek the most favorable execution reasonably available under the circumstances, considering price, commission, speed, and reliability, rather than merely the lowest commission rate.
Governing authority: Investment Advisers Act of 1940 § 206 and the fiduciary duty of care. The duty of best execution requires an adviser to seek the most favorable execution reasonably available under the circumstances, weighing factors such as price, commission, speed, and reliability; it is not a duty to obtain the lowest commission in every trade. The statement that directing each transaction to the lowest-commission broker satisfies best execution because execution quality is presumed comparable is wrong: execution quality varies, and poor execution can make a low-commission trade more costly overall. The statement that disclosure and lack of client objection satisfy the duty is wrong: disclosure of a conflict does not replace the independent duty to seek best execution, and soft-dollar disclosures must be made separately. The statement that the duty generally does not apply to fixed-income or over-the-counter transactions is wrong: best execution applies to all client transactions; the absence of a central exchange affects how execution is evaluated, not whether the duty exists.
A registered representative of a broker-dealer recommends that a retail customer invest $100,000 in Class C shares of a mutual fund. The Class C shares have no front-end sales charge and a 1.00% annual 12b-1 fee. Class A shares of the same fund, offered by the same broker-dealer, have a 5.00% front-end sales charge and a 0.25% annual 12b-1 fee. The customer's time horizon is 15 years, and the share classes have no conversion features. The representative does not mention Class A shares but discloses in writing that the firm pays the representative higher ongoing compensation for Class C shares. The fund is consistent with the customer's risk tolerance and investment objective.
Under Regulation Best Interest, which statement is most accurate? Answer: The recommendation violates the Care obligation because the higher-cost share class is not in the customer's best interest when a lower-cost alternative is available.
Regulation Best Interest (SEC Rule 15l-1) — the Care obligation. The Care obligation requires a broker-dealer to exercise reasonable diligence, care, and skill, including considering costs and reasonably available alternatives. On a simplified cost comparison, the 5.00% load plus the 0.25% annual 12b-1 fee is about 8.75% of the initial investment over 15 years, while Class C's 1.00% annual 12b-1 fee is about 15%; the absence of a conversion feature means Class C remains more expensive for the full horizon. Recommending the more expensive class when the cheaper class of the same fund is available is not in the customer's best interest and places the representative's higher compensation ahead of the customer's interest. Suitability plus written disclosure of the compensation conflict is insufficient because the recommendation must also satisfy the Care obligation. The failure to account for the available Class A alternative is a Care failure, not a Disclosure failure; the Disclosure obligation concerns material facts about the relationship and conflicts, not the existence of every alternative. Reg BI obligations do not depend on a customer's request for information.
An IAR of a state-registered investment adviser provides advice under a non-discretionary advisory agreement. The IAR recommends Fund A, which pays the IAR's firm a 12b-1 fee. Fund B has the same objective and portfolio manager, lower expenses, and no 12b-1 fee. The IAR does not tell the client about the fee difference or the 12b-1 payment. The client approves the purchase of Fund A.
Which statement is correct under the fiduciary standard that applies to investment advisers? Answer: The IAR has a fiduciary duty despite the non-discretionary agreement, and the undisclosed 12b-1 conflict is a breach even if the fund is suitable.
Under Investment Advisers Act § 206, an investment adviser is a fiduciary, and that duty applies whether or not the adviser has discretion over the account. The duty of loyalty requires disclosure of material conflicts, including a 12b-1 fee paid to the adviser's firm, and the adviser must not place its own interest ahead of the client's. The non-discretionary nature of the agreement does not remove the duty; the client's approval is not informed consent where the material conflict was not disclosed; and the fact that the fee is paid to the firm rather than to the IAR personally does not eliminate the conflict. A suitable recommendation and the client's final decision do not satisfy the duty.
A retail customer opens a brokerage account online and, on the firm's account form, represents that he is 39 years old, employed, has $800,000 in investable assets, and has a high risk tolerance. The registered agent of the broker-dealer recommends a growth-oriented ETF based on that profile. The representations are false: the customer is actually 68, retired, and has $120,000 in investable assets, and he supplied the false information to obtain the recommendation. The agent had no reason to know the form was inaccurate.
Under federal law, which statement is most accurate? Answer: The agent has not violated the applicable standard because the recommendation was based on the customer's signed profile and no facts suggested that the profile was inaccurate.
Regulation Best Interest, care obligation. A broker-dealer and its associated persons may reasonably rely on the retail customer's investment profile information unless they know or have reason to know it is inaccurate. Here the agent had no reason to doubt the online account form, so the recommendation is evaluated against the profile the customer supplied. The statement that the agent must independently verify every element is wrong; Reg BI does not create a general audit duty. The statement that suitability is measured by actual, undisclosed facts is wrong because customer-provided information is the baseline when reliance is reasonable, although knowledge or obvious red flags would change the result. The statement that the best-interest obligation is based only on the stated objective is wrong; the agent must consider the customer's relevant age, financial situation, liquidity needs, time horizon, and risk tolerance.
A prospective retail customer who has no account with a broker-dealer calls one of its registered representatives and asks whether she should sell shares of a technology sector fund she holds elsewhere and buy shares of a healthcare sector fund. The representative discusses both funds and replies, "Yes, I recommend the switch." The customer says she will decide after reviewing her budget, does not place an order, and has not opened an account. She has never received the firm's Form CRS.
Which statement is correct regarding the Form CRS delivery requirement? Answer: The Form CRS had to be delivered at or before the recommendation, so the failure to deliver it is a violation.
Under Exchange Act Rule 17a-14(c)(1) (the Form CRS rule), a broker-dealer must deliver Form CRS to a retail investor before or at the earliest of a recommendation of an account type, a securities transaction or an investment strategy involving securities; the placing of an order; or the opening of an account. The prospective customer received a recommendation to sell one fund and buy another, so the Form CRS was due at or before that recommendation. The absence of an order or an account does not matter because the recommendation came first. The customer's initiation of the call does not matter because the representative still made an affirmative recommendation. The 30-day period in the rule applies to delivering Form CRS when a customer requests it, not to the initial delivery, which needs no request.
