Series 65 Quiz: Identify Prohibited Practices
20 questions · exam conditions
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Identify Prohibited PracticesQuestion 1 of 20

An adviser receives free analytics software from a broker for trade routing, undisclosed; what should the adviser have done to comply with regulations?

Disclose the arrangement, assess best execution, and ensure benefits primarily serve clients
Accept it silently because non-cash items are not compensation
Route more trades to increase the value received, then disclose annually
Avoid best execution reviews because the broker provides valuable research
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Series 65 Quiz

Series 65 Quiz: Identify Prohibited Practices

Practice Identify Prohibited Practices in Series 65 with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Identify Prohibited Practices, giving you a quick way to practice the rules, question types, and explanations that matter most for Series 65.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

An adviser receives free analytics software from a broker for trade routing, undisclosed; what should the adviser have done to comply with regulations?

  1. Disclose the arrangement, assess best execution, and ensure benefits primarily serve clients (correct answer)
  2. Accept it silently because non-cash items are not compensation
  3. Route more trades to increase the value received, then disclose annually
  4. Avoid best execution reviews because the broker provides valuable research
Explanation: This question tests the ability to identify conflicts of interest and prohibited practices within investment advisory scenarios (Series 65). Investment advisers must adhere to strict ethical and legal standards, avoiding conflicts of interest and ensuring transparency in all dealings. In the scenario, the adviser's actions illustrate potential violations, such as undisclosed software receipt, highlighting the need for compliance. Choice A is correct because it accurately identifies the violation requiring disclosure and best execution assessment. Choice B is incorrect because it misunderstands the nature of the adviser's obligation, often confusing non-cash items with non-compensation. To better recognize these issues, advisers should familiarize themselves with disclosure requirements and regularly review compliance protocols. Practicing case studies can enhance understanding of nuanced ethical scenarios.

Question 2

An adviser directs trades to a broker for research perks without disclosure; which action violates fiduciary duties?

  1. Seeking best execution while documenting broker selection and periodic reviews
  2. Using soft dollars for eligible research with clear client disclosure
  3. Accepting non-monetary benefits and steering trades without full and fair disclosure (correct answer)
  4. Comparing commission rates across brokers before allocating client trades
Explanation: This question tests the ability to identify conflicts of interest and prohibited practices within investment advisory scenarios (Series 65). Investment advisers must adhere to strict ethical and legal standards, avoiding conflicts of interest and ensuring transparency in all dealings. In the scenario, the adviser's actions illustrate potential violations, such as accepting undisclosed benefits for trade routing, highlighting the need for compliance. Choice C is correct because it accurately identifies the violation of fiduciary duties regarding best execution and disclosure. Choice A is incorrect because it misunderstands the nature of the adviser's obligation, often confusing documentation with the prohibition on undisclosed benefits. To better recognize these issues, advisers should familiarize themselves with disclosure requirements and regularly review compliance protocols. Practicing case studies can enhance understanding of nuanced ethical scenarios.

Question 3

An IAR is at a social gathering and overhears the CFO of a publicly traded company tell a colleague that the company's upcoming earnings report will be significantly below analysts' expectations. The IAR's firm holds a large position in this company for many clients. Before the information is made public, the IAR sells the stock from all discretionary client accounts. This action constitutes:

  1. A prudent fiduciary act to protect client assets.
  2. Unethical but not illegal behavior.
  3. Permissible use of market research.
  4. Trading on material, non-public information. (correct answer)
Explanation: The IAR has received material, non-public information and has acted on it to avoid losses. This is a classic example of insider trading, which is a violation of federal and state securities laws. A fiduciary duty does not permit breaking the law. The behavior is both unethical and illegal. The information was not market research; it was inside information obtained improperly.

Question 4

Under the Uniform Securities Act, an Investment Adviser Representative is prohibited from borrowing money from a client unless the:

  1. Client is a close family member, such as a parent.
  2. Loan is properly documented with a promissory note.
  3. Client is in the business of lending money. (correct answer)
  4. IAR's firm provides written approval for the loan.
Explanation: The practice of an IAR borrowing money from or lending money to a client is generally prohibited as it creates a serious conflict of interest. A key exception is if the client is a financial institution whose regular business includes making loans, such as a bank or a broker-dealer. The other conditions do not override the general prohibition for IARs.

Question 5

An investment adviser wants to sell a security from its own inventory to a client's advisory account. To execute this principal trade ethically and legally, the adviser must:

  1. Obtain written client consent prior to the completion of the transaction. (correct answer)
  2. Ensure the price is better than any other available market price.
  3. Disclose the capacity in which it acted on the trade confirmation.
  4. Get verbal permission from the client at the time of the order.
Explanation: For a principal trade, where the adviser sells from its own account or buys for its own account from a client, the adviser must disclose the conflict of interest in writing and obtain written client consent before the completion (settlement) of the transaction. While providing a fair price is part of the fiduciary duty and disclosure on the confirmation is also required, neither substitutes for the specific requirement of prior written consent. Verbal permission is insufficient.

Question 6

An investment adviser acting as a broker for both an advisory client and another person on the other side of a securities transaction is engaging in an agency cross transaction. All of the following statements regarding these transactions are true EXCEPT:

  1. The client must provide prior written consent to allow the adviser to act in this capacity.
  2. The adviser must disclose that it will receive compensation from both parties to the trade.
  3. The adviser may recommend the transaction to both the buyer and the seller. (correct answer)
  4. The adviser must send the client an annual summary of all agency cross transactions.
Explanation: An investment adviser cannot recommend an agency cross transaction to both parties involved (the buyer and the seller). This is a specific prohibition designed to mitigate the inherent conflict of interest. The adviser must obtain prior written consent from the client for such transactions, disclose the dual compensation, and provide an annual summary of all agency cross transactions that occurred in the client's account.

Question 7

An IAR who is eligible to vote for a candidate for mayor in their city makes a $200 campaign contribution. The mayoral candidate, if elected, will have influence over selecting investment advisers for the city's employee retirement fund. The IAR's firm currently manages a portion of that fund. How does this contribution affect the advisory firm under the "pay-to-play" rule?

  1. The firm is barred from receiving compensation from the city's fund for two years.
  2. The firm is not impacted because the contribution is covered by the de minimis exemption. (correct answer)
  3. The firm must report the contribution to the SEC within 48 hours.
  4. The IAR is personally barred from communicating with any city officials for two years.
Explanation: The SEC's pay-to-play rule (Rule 206(4)-5) includes a de minimis exemption. It allows a 'covered associate' (like an IAR) to contribute up to $350 per election to an official for whom they are entitled to vote, without triggering the two-year time-out for the advisory firm. Since the $200 contribution is below this $350 threshold, the firm's advisory relationship with the city is not affected. If the IAR was not entitled to vote for the official, the de minimis limit would be $150.

Question 8

An investment adviser directs a large volume of its clients' trades to a specific broker-dealer. In return, the broker-dealer provides the adviser with research reports, analytical software, and subscriptions to financial newsletters. The use of client commissions to pay for these services is permissible under the safe harbor of Section 28(e) of the Securities Exchange Act of 1934 if the:

  1. Services benefit the adviser by helping it attract new clients.
  2. Broker-dealer offers the lowest commission rates available.
  3. Services assist the adviser in its investment decision-making process for its clients. (correct answer)
  4. Adviser discloses the arrangement on the annual updating amendment to its Form ADV.
Explanation: The 'soft dollar' safe harbor of Section 28(e) allows advisers to use client commissions to pay for research and brokerage services. The critical test is that the services must provide a demonstrable benefit to the clients whose commissions are being used and assist the adviser in its investment decision-making capacity. Using soft dollars for services that primarily benefit the adviser's business operations, such as marketing, office furniture, or salaries, is a prohibited misuse. Disclosure is required, but the primary condition for falling within the safe harbor is that the services benefit clients.

Question 9

An IAR is preparing to place a block trade to purchase 100,000 shares of XYZ Corp for a large institutional client. The IAR knows this large purchase is likely to drive up the stock's price. Before placing the client's order, the IAR buys 1,000 shares of XYZ for their own personal account. This prohibited practice is best described as:

  1. Selling away.
  2. Front-running. (correct answer)
  3. Churning.
  4. Arbitrage.
Explanation: Front-running is the unethical practice of a securities professional trading on their own behalf based on advance knowledge of a large pending transaction that is expected to affect the price of the security. The IAR is using non-public information about an imminent client trade to their own advantage, which is a breach of fiduciary duty.

Question 10

An Investment Adviser firm is experiencing a short-term cash flow problem. To meet payroll, the firm's principal asks a wealthy client for a three-month, interest-bearing loan. The client agrees and the loan is fully documented. This action is:

  1. Permissible because the loan is made to the advisory firm, not an individual IAR.
  2. A prohibited practice that creates a significant conflict of interest. (correct answer)
  3. Acceptable if the interest rate on the loan is at or below prevailing market rates.
  4. Allowed if the firm discloses the loan as a material event on its Form ADV.
Explanation: Borrowing money from a client is a prohibited practice for both an IAR and the investment adviser firm itself, unless the client is a financial institution in the business of making loans. The practice creates a major conflict of interest, as the adviser's financial obligation to the client could compromise its ability to provide impartial advice. The fact that the loan is to the firm, is documented, has a fair interest rate, or is disclosed does not cure the fundamental prohibition.

Question 11

An IAR has discretionary authority over the account of an elderly client whose primary objective is income and preservation of capital. The IAR engages in frequent trading of bonds within the account. Although the individual trades are suitable, the high frequency of transactions generates significant commissions for the IAR while providing no discernible benefit to the client. This is an example of:

  1. Reverse churning.
  2. Strategic asset allocation.
  3. Churning. (correct answer)
  4. Time-horizon modification.
Explanation: Churning is the prohibited practice of excessive trading in a client's account, primarily to generate commissions or fees. The key elements are the adviser's control over the account (e.g., discretion) and trading that is excessive in size or frequency in light of the client's objectives. Even if each individual security is suitable, the overall pattern of trading can be abusive. Reverse churning is the opposite: charging a wrap fee to an account with very little trading activity.

Question 12

An investment adviser firm primarily recommends mutual funds from a specific fund family because the adviser's parent company is the fund family's primary distributor. This relationship creates a significant conflict of interest. Under the adviser's fiduciary duty, what is the most important action the adviser must take?

  1. Only recommend funds from this family that have the lowest expense ratios.
  2. Obtain a signed waiver from the client acknowledging the relationship.
  3. Fully and fairly disclose the conflict of interest to the client before or at the time of providing advice. (correct answer)
  4. Ensure that the fund family's performance is consistently above its benchmark.
Explanation: The cornerstone of managing conflicts of interest is full and fair disclosure. An investment adviser has a fiduciary duty to disclose all material conflicts of interest to clients, such as the relationship between the adviser and a recommended fund family. This allows the client to make an informed decision and evaluate the adviser's recommendations with knowledge of the potential bias. While selecting low-cost or high-performing funds is good practice, it does not substitute for the legal requirement of disclosure.

Question 13

An Investment Adviser Representative (IAR) has a client who is interested in a private placement real estate venture that is not an approved product of the IAR's firm. The IAR personally believes it's a good investment and facilitates the transaction for the client, receiving a finder's fee from the venture's sponsor. This transaction is not recorded on the books of the advisory firm. This practice is known as:

  1. Front-running.
  2. Selling away. (correct answer)
  3. A private securities transaction.
  4. An agency cross transaction.
Explanation: Selling away is the prohibited practice of effecting securities transactions for compensation that are not recorded on the books and records of the employing advisory firm. Front-running involves trading ahead of a large client order. While this is a private securities transaction, the term 'selling away' specifically describes the prohibited nature of the activity when conducted outside the firm for compensation. An agency cross transaction involves an adviser representing both sides of a trade.

Question 14

An investment adviser makes a political contribution to the campaign of a state governor. The governor has influence over the selection of advisers for the state's public pension plan. Under the SEC's "Pay-to-Play" rule, for what period of time is the adviser prohibited from receiving compensation for providing advisory services to that state's pension plan?

  1. Six months.
  2. One year.
  3. Two years. (correct answer)
  4. Five years.
Explanation: The SEC's Pay-to-Play rule (Rule 206(4)-5) imposes a two-year 'time out' on an investment adviser that makes a political contribution to an official of a government entity who is in a position to influence the award of advisory business. During this two-year period, the adviser is barred from receiving compensation for providing advisory services to that government entity.

Question 15

An IAR's firm has developed a new proprietary structured product with a complex payout structure and high internal fees. The IAR receives a higher commission payout for selling this product compared to traditional ETFs. The IAR recommends this product to a retired client with a low risk tolerance and a need for simple, income-producing investments. This action is a prohibited practice primarily because the:

  1. Recommendation is unsuitable and driven by a conflict of interest. (correct answer)
  2. Product is proprietary and developed by the IAR's firm.
  3. IAR failed to provide a prospectus for the structured product.
  4. Client is retired and should only be invested in government bonds.
Explanation: Recommending an investment must be based on the client's best interests and suitability. In this case, a complex, high-fee product is unsuitable for a conservative, retired client. Furthermore, the recommendation appears to be driven by the higher compensation for the IAR, which is a clear conflict of interest that has compromised the adviser's judgment. It is not prohibited to recommend proprietary products, but the recommendation must still be suitable. Stating a retiree can only own government bonds is overly restrictive.

Question 16

An IAR observes that an elderly client with mild cognitive impairment is requesting an unusually large wire transfer to a third party whom the IAR does not recognize. The client seems confused about the purpose of the transfer. Under the NASAA Model Act to Protect Vulnerable Adults, the IAR is permitted to:

  1. Refuse the transaction and immediately close the client's account.
  2. Place a temporary hold on the disbursement of funds from the client's account. (correct answer)
  3. Execute the transaction as instructed because the client has legal capacity.
  4. Contact the client's children to ask for permission to stop the transfer.
Explanation: The NASAA Model Act allows a qualified individual (like an IAR) who reasonably believes that financial exploitation of an eligible adult has been attempted or has occurred to place a temporary hold on a transaction or disbursement. This provides time to investigate the situation and report it to the proper authorities (Adult Protective Services and the state securities Administrator). Closing the account is an extreme step. Executing a suspicious transaction could violate the adviser's fiduciary duty. Contacting third parties without prior authority would violate client confidentiality.

Question 17

Two IARs at different firms coordinate to buy and sell shares of a thinly traded stock among their discretionary accounts at the same time and for the same price. Their goal is to create the appearance of active trading volume to attract other investors. This prohibited practice is known as:

  1. Pegging.
  2. Front-running.
  3. Churning.
  4. Matched orders. (correct answer)
Explanation: Matched orders are a form of market manipulation where parties collude to enter buy and sell orders for the same security at similar times and prices to create a false appearance of trading activity, thereby manipulating the stock's price or volume. Pegging is an attempt to stabilize a price. Front-running is trading ahead of a client's order. Churning is excessive trading in a client's account to generate commissions.

Question 18

An IAR may disclose confidential information about a client's account without the client's consent in which of the following situations?

  1. When a prospective client asks for a reference and wants to speak with a current client.
  2. When the IAR's spouse asks about a prominent local business owner's investments.
  3. When complying with a legally enforceable subpoena from a court. (correct answer)
  4. When sharing portfolio details with another IAR at the firm to get a second opinion.
Explanation: An IAR has a strict duty to maintain client confidentiality. This duty can only be breached under specific circumstances, such as with the client's consent or when required by law. A court-issued subpoena or an official request from the IRS or SEC are examples of legal requirements to provide information. Disclosing information for any of the other reasons listed would violate the duty of confidentiality.

Question 19

An adviser recommends a stock while secretly negotiating employment with the issuer; how does the scenario exemplify a conflict of interest?

  1. Employment talks create incentives that must be disclosed as material conflicts (correct answer)
  2. The conflict is irrelevant because employment is not a financial interest
  3. It is acceptable if the adviser plans to resign after clients invest
  4. Conflicts only exist when the adviser receives cash compensation immediately
Explanation: This question tests the ability to identify conflicts of interest and prohibited practices within investment advisory scenarios (Series 65). Investment advisers must adhere to strict ethical and legal standards, avoiding conflicts of interest and ensuring transparency in all dealings. In the scenario, the adviser's actions illustrate potential violations, such as undisclosed employment negotiations, highlighting the need for compliance. Choice A is correct because it accurately identifies the violation of material conflict disclosure. Choice B is incorrect because it misunderstands the nature of the adviser's obligation, often confusing non-financial incentives with irrelevance. To better recognize these issues, advisers should familiarize themselves with disclosure requirements and regularly review compliance protocols. Practicing case studies can enhance understanding of nuanced ethical scenarios.

Question 20

An adviser routes trades to a broker for personal travel perks and hides it; what best describes the prohibited practice illustrated in the scenario?

  1. Undisclosed soft dollar conflict and breach of duty of loyalty (correct answer)
  2. Permissible best execution because perks do not affect execution quality
  3. Wash trading because trades were executed through the same broker
  4. Scalping because the adviser published research before trading personally
Explanation: This question tests the ability to identify conflicts of interest and prohibited practices within investment advisory scenarios (Series 65). Investment advisers must adhere to strict ethical and legal standards, avoiding conflicts of interest and ensuring transparency in all dealings. In the scenario, the adviser's actions illustrate potential violations, such as undisclosed perks for trade routing, highlighting the need for compliance. Choice A is correct because it accurately identifies the violation of soft dollar and loyalty duties. Choice B is incorrect because it misunderstands the nature of the adviser's obligation, often confusing perks with execution quality. To better recognize these issues, advisers should familiarize themselves with disclosure requirements and regularly review compliance protocols. Practicing case studies can enhance understanding of nuanced ethical scenarios.