Ethical Practices and Fiduciary Obligations

One sheet: adviser pay, client-asset custody, conflicts and crimes, privacy, and continuity planning.

Which One-Liners Win Points?

• Fee-based (advisory) aligns interests; commission-based (brokerage) creates a conflict because more trades mean more income for the agent.
• A gains-only performance fee requires a qualified client (dollar thresholds, a qualified purchaser, or certain adviser insiders/employees); the fulcrum (symmetrical) structure, for a registered investment company or any client above $1M, and the BDC 20%-of-gains path are separate statutory exceptions that do NOT require meeting the qualified-client test.
• Custody isn't just holding a check. Fee deduction, a trustee role, and client login credentials with withdrawal/transfer authority all trigger the full custody rule.
• Discretion means Asset, Action, and Amount decided by the adviser; time-and-price-only direction is NOT discretion. An adviser can accept ORAL discretionary authority starting with the first trade, with written authority required within 10 business days after that trade; a BD agent needs prior written authority before any discretionary trade.

Which Numbers Matter Most?

Which Gotchas Trip Students Up?

• Performance fees are prohibited unless a statutory exception applies. "Retail" and "qualified client" aren't opposites: any client can qualify by dollar test, qualified-purchaser status, or the insider/employee path.
• 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, but a contribution made more than 6 months before someone becomes a covered associate doesn't count unless that person later solicits clients.
• 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, never tip off the client, and note these are current BROKER-DEALER duties (the parallel investment-adviser AML rule is delayed, not yet in effect).

Which Conflicts Does Each Compensation Model Create?

• 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.

When Does an Adviser Have Custody?

• Custody = holding client funds or securities, or the authority to obtain them (fee deduction, trustee role, or client login access WITH withdrawal/transfer authority, not mere view access).
• Two 3-business-day safe harbors avoid custody: funds or securities received inadvertently must be returned to the sender, and a client check payable to a third party must be forwarded to that party. A check payable to the adviser is custody immediately.

Which Conflicts Must You Guard Against?

• Loans: agents never borrow from or lend to clients; advisers may borrow only from broker-dealer clients, affiliate clients, or financial-institution clients in the lending business.
• Sharing in profits/losses: a BD agent needs written authorization from BOTH the customer and the BD; no separate proportionate-contribution test or immediate-family exemption exists. An adviser's gain-sharing is a distinct performance-fee topic.
• Vulnerable-adult duties split cleanly: reporting to APS and the Administrator is mandatory; the disbursement hold (15 business days, extendable to 25) and trusted-contact disclosure are permissive, and never go to the suspected exploiter. Immunity needs BOTH good faith AND reasonable care.

What Do the Privacy and Safeguards Rules Require?

• 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.

What Must a Continuity Plan Contain?

• 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, with no fixed review cadence (annual is a separate FINRA broker-dealer rule).
• The 5 elements: records recovery, alternate communications (customers, employees, vendors, service providers, custodians, regulators), office relocation, assignment of duties, and minimizing disruption/client harm. Succession planning and client notification are NOT separate numbered elements.
• No SEC rule requires a BCP for federal-covered advisers. A 2016 proposal was never adopted, so having one is a best practice, not a mandate.

What Is the Memory Aid for the Discretion Rules?

• 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 a conflict: fee-based aligns interests, commissions tempt over-trading. A gains-only performance fee needs a qualified client, while a symmetrical fulcrum fee applies to a registered investment company or any client above $1 million and needs no such test. Pay-to-play freezes government work for two years above the de minimis, and soft dollars buy only eligible research and brokerage. Custody, including fee deduction and withdrawal-capable login access, triggers a qualified custodian, quarterly statements, and an annual surprise exam unless the fee-deduction or pooled-vehicle exception applies. Discretion may start orally with written authority within 10 days. Guard against loans, unauthorized profit-sharing, insider trading, selling away, manipulation, and churning, protect eligible adults with mandatory reports and a fifteen-business-day hold, and meet the privacy, safeguards, and written continuity rules.

Need more than the recap? Read the full Ethical Practices and Fiduciary Obligations unit.