Ethical Practices and Fiduciary Obligations

The whole unit on one sheet: how advisers get paid, who holds client assets, the conflicts and criminal acts, privacy, and continuity planning.

The One-Liners That Win Points

• Fee-based (advisory) aligns interests; commission-based (brokerage) creates a conflict because more trades mean more income for the agent.
• Performance fees require TWO things: a qualified client AND a fulcrum (symmetrical) fee that shares in both gains AND losses.
• Custody isn't just holding a check. Deducting fees directly from a client account, acting as trustee, or holding client login credentials all trigger the full custody rule.
• Discretion means Asset, Action, and Amount decided by the adviser; time-and-price-only direction is NOT discretion, and discretion needs written authorization.
• Under the prudent-investor standard a single risky holding isn't automatically imprudent; it is judged in the context of the total portfolio, and diversification is required.
• Insider trading applies to ANYONE with material nonpublic information (MNPI), not just corporate insiders, and both the tipper and the tippee are liable.
• Churning is measured by turnover rate and cost-to-equity ratio, and requires adviser control; a high trade count alone doesn't prove it.
• Agents may NEVER borrow from or lend to a client; investment advisers get only the financial-institution carve-out.
• The privacy rule requires BOTH an initial AND an annual privacy notice, plus an opt-out from sharing with non-affiliated third parties.
• The safeguards rule and continuity plans must be in WRITING; verbal or informal is a violation.

Numbers to Lock In

Top Gotchas

• Performance fees are prohibited for retail clients; without both a qualified client and a fulcrum structure the arrangement is barred.
• Pay-to-play de minimis figures depend on voting eligibility ($350 if you can vote for the official, $150 if you cannot), not on account size or the adviser's assets under management. Liability is strict: the donor's intent doesn't matter.
• Office rent and furniture are NOT eligible under the soft-dollar safe harbor; research reports and analytical software are. Soft dollars are disclosed on the adviser's brochure.
• SAR is $5,000 (suspicious activity); CTR is $10,000 (cash); don't swap them, and never tip off the client that a SAR was filed.
• Sharing in a client's profits or losses needs proportionate contribution AND written consent; family members are exempt only from the proportionate-contribution part, not the written consent.
• Reporting suspected exploitation to Adult Protective Services and the Administrator is mandatory; notifying the trusted contact is permissive, and the suspected exploiter is never notified.
• Vulnerable-adult protection is a temporary HOLD on disbursements only, not a full account freeze, and immunity requires both good faith AND reasonable care.
• The continuity rule is a NASAA model rule for state-registered advisers only; federal-covered advisers follow the SEC instead, and succession planning is a mandatory element, not an add-on.

Compensation

• Asset-based (percentage of assets under management) is the most common advisory fee and aligns adviser and client; flat, hourly, and planning fees are low-conflict.
• Performance-based fees need a qualified client (assets under management of $1.4 million or more, or net worth of $2.7 million or more excluding the primary residence) plus a fulcrum fee sharing gains AND losses versus a benchmark.
• Pay-to-play bars compensated advisory work for a government entity for 2 years after a covered contribution above the de minimis ($350 if the contributor can vote for the official, $150 if not).
• Soft dollars direct client brokerage to a broker in exchange for eligible research or brokerage services under a good-faith reasonableness safe harbor; disclosed on the adviser's brochure.
• All compensation must be disclosed: fees, commissions, referral fees, soft dollars, revenue sharing, and distribution fees. Failure to disclose violates fiduciary duty.

Client Funds and Securities

• Custody = holding client funds or securities, or the authority to obtain them (fee deduction, trustee role, or client login access).
• Custody safeguards: a qualified custodian (bank, broker-dealer, or trust company), at least quarterly custodian statements, a reasonable belief the statements are timely and accurate, and an annual surprise exam by an independent public accountant (Form ADV-E filed within 120 days).
• Audit exception: advisers to pooled vehicles can skip the surprise exam with an annual GAAP audit and audited statements to investors within 120 days of fiscal year-end.
• Discretionary authority (deciding Asset, Action, and Amount) needs written authorization; suitability and best execution still apply.
• Prudent-investor standard: judge each holding in total-portfolio context, require diversification, and allow delegation to qualified agents (a shift from the old prudent-man rule).
• Suitability has two layers: reasonable-basis (good for at least some investors) and customer-specific (good for this client).
• Anti-money-laundering program: a customer identification program, SARs at $5,000 of suspected crime, CTRs for cash over $10,000 per day, and no tipping off.

Conflicts of Interest and Fiduciary Considerations

• Loans: agents never borrow from or lend to clients; advisers only under the financial-institution carve-out.
• Sharing in profits/losses: requires proportionate contribution and written consent (family exempt from the contribution part only).
• Client information is confidential unless disclosure is compelled by law.
• Criminal acts: insider trading on MNPI (anyone can be liable, tipper and tippee both), selling away (transactions outside the employing broker-dealer), and market manipulation (wash trading, matched orders, painting the tape).
• Code of ethics requires access persons to report holdings and transactions; violations go promptly to the chief compliance officer.
• Churning is excessive trading for commissions, measured by turnover and cost-to-equity, and requires adviser control.
• Vulnerable-adult protection: an eligible adult is age 65 or older or impaired; a qualified individual (defined by supervisory, compliance, or legal role) must report to Adult Protective Services and the Administrator, may notify a trusted contact, and may place a temporary hold up to 15 business days.

Cybersecurity and Privacy

• The privacy rule (implementing the federal privacy law for SEC-registered firms) requires written privacy policies, an initial AND an annual privacy notice, and an opt-out from sharing nonpublic personal information with non-affiliated third parties.
• Opt-out exceptions: service providers, account servicing, fraud protection, and legal compliance.
• The safeguards rule demands WRITTEN administrative, technical, and physical protections; verbal policies fail.
• Cybersecurity programs cover risk assessment, access controls, encryption, incident response, training, and vendor management.
• Data-breach notification varies by state; there is no single federal standard.

Business Continuity Plans

• The NASAA continuity and succession model rule applies to state-registered advisers only and requires a WRITTEN plan scaled to the firm's size, services, and locations.
• Required elements: protecting and recovering books and records, alternate communications (clients, employees, AND regulators), office relocation, assignment of duties, succession planning, and client notification of material disruptions.
• Maintenance: review and update at least annually and test the plan periodically.
• Succession planning is mandatory, covering who takes over, client continuity, and ongoing compliance during a transition.

Memory Aid: AAA Discretion

• An order is discretionary if the adviser decides any of Asset (which security), Action (buy or sell), or Amount (how many shares). Time-and-price-only direction is not discretion.

One-Breath Recap

Every compensation model carries its own conflict, so fee-based aligns interests, commissions tempt over-trading, performance fees demand a qualified client plus a symmetrical fulcrum fee, pay-to-play freezes government work for two years above the de minimis, and soft dollars buy only eligible research. Custody (fee deduction, trustee, or login access counts) triggers a qualified custodian, quarterly statements, and an annual surprise exam, while discretion needs written authority and the prudent-investor standard judges holdings in total-portfolio context. Guard against loans, uncontributed profit-sharing, insider trading by anyone with material nonpublic information, selling away, manipulation, and churning, and protect eligible adults with mandatory reports plus a permissive hold up to fifteen business days. Finally, the privacy rule wants both initial and annual notices with an opt-out, the safeguards rule wants written protections, and NASAA's continuity rule wants a written, annually reviewed plan with succession built in.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Ethical Practices and Fiduciary Obligations unit for the complete lesson.