Exam Weight: ~7 questions (11% of exam)
Understanding ethical practices and fiduciary obligations is essential for every securities professional. This unit covers the investment adviser's fiduciary duty, compensation rules (including performance fees, soft dollars, and pay-to-play), custody requirements, discretionary authority and trading authorizations, the prudent investor standard, agency cross transactions, anti-money laundering, conflicts of interest and prohibited activities (insider trading, market manipulation, churning, code of ethics, protection of vulnerable adults), Regulation S-P privacy and cybersecurity obligations, and business continuity and succession planning.
What You'll Learn
- Master the fee types (asset-based, hourly, fixed, commissions, wrap), the unreasonable-fee standard, performance-based fees and qualified-client thresholds ($1.4M AUM or $2.7M net worth) with the fulcrum-fee symmetry requirement, soft dollars and the soft-dollar safe harbor under the Securities Exchange Act of 1934 (eligible research and brokerage, three-step test, ineligible expenses), and pay-to-play rules (SEC pay-to-play: $350 de minimis, 2-year ban; MSRB pay-to-play: $250 de minimis)
- Understand the investment adviser's fiduciary duty (duty of care and duty of loyalty), what creates custody (physical possession, fee deduction, trustee role, signatory power) and the requirements that follow (qualified custodian, quarterly statements, Form ADV reporting, annual surprise exam), the NASAA Statement of Policy commingling prohibition and proper street-name segregation, discretionary authority (the 10-business-day written-authorization rule, time-and-price is not discretion) and third-party trading authorizations, the Uniform Prudent Investor Act's five core principles, agency cross transactions (the NASAA Model agency-cross conditions), and anti-money laundering obligations (BSA, AML program, CDD, CTR at $10K, SAR at $5K, structuring)
- Reinforce custody concepts that overlap the prior section: qualified custodian, surprise examination details (irregular timing, 120-day Form ADV-E filing, GAAP-audit exception for pooled vehicles), and NASAA minimum financial requirements ($35K with custody, $10K with discretion, positive net worth for prepaid fees of $500+ taken more than 6 months in advance)
- Apply the rules on loans to and from clients, sharing in profits and losses, client confidentiality, insider trading (the IA insider-trading-policies requirement, material nonpublic information, information barriers), selling away, market manipulation (wash trades, matched orders, painting the tape, front-running), the IA code-of-ethics rule (access persons, initial 10-day holdings report, annual holdings, quarterly transaction reports, IPO and limited-offering pre-clearance), outside securities accounts, excessive trading (churning), the NASAA Model Act protecting vulnerable adults (15-business-day disbursement delay, trusted contact person), and the residual category of unethical business practices
- Know Regulation S-P privacy notices, the opt-out mechanism for nonaffiliated third-party sharing, the safeguards rule for written policies and procedures, the Gramm-Leach-Bliley Act foundation, and cybersecurity obligations (written information security policies, incident response, breach notification as amended in 2024)
- Apply the NASAA Model business-continuity-and-succession-planning rule's requirements (disaster recovery, succession planning, client notification, key personnel backup, regulatory communication), the annual review requirement, and why succession planning is especially critical for sole-practitioner advisers