Saturday, January 31, 2009
What I would do instead is use a "qualified custodian." According to NASAA, a "qualified custodian" includes:
(i)A bank or savings association that has deposits insured by the Federal Deposit Insurance Corporation under the Federal Deposit Insurance Act;
(ii) A registered broker-dealer holding the client assets in customer accounts;
(iii) A registered futures commission merchant register under Section 4f(a) of the Commodity Exchange Act, holding the client assets in customer accounts, but only with respect to clients’ funds and security futures, or other securities incidental to transactions in contracts for the purchase or sale of a commodity for future delivery and options thereon and
(iv)A foreign financial institution that customarily holds financial assets for its customers, provided that the foreign financial institution keeps the advisory clients’ assets in customer accounts segregated from its proprietary assets.
So, unless you're a bank or a custodial broker-dealer, I'm not sure why you'd want to be "deemed to maintain custody." You don't want to maintain the $35,000 minimum net capital, take on the awesome responsibility of the all the record keeping, deal with the annual surprise audit, etc. This is why your exam will likely ask a question or two about custody issues. For example, you might see one like this:
In which of the following cases would an investment adviser be deemed to maintain custody of client assets and, therefore, be required to maintain a higher minimum net capital?
A. the adviser forwards a client’s third-party check to the payee within 24 hours
B. the adviser inadvertently receives a client’s securities in the mail from the client and promptly forwards them to the custodian.
C. the adviser inadvertently receives a client’s securities in the mail from the client and returns the securities two days later, keeping records of the receipt and return
D. the adviser sends the qualified custodian a billing statement and also a statement to the client but does not deliver quarterly account statements to the client directly
Pretty tough question. As always, let's take them one at a time, attempting to eliminate each answer choice until we find one that can't be eliminated. If the adviser forwards a check written to a third-party within 24 hours, the firm does not need to maintain higher net capital requirements. If the adviser receives client securities, they need to be returned to the sender within 3 business days, with detailed records of what happened, when and how they were returned, etc. If the adviser does that, he/they do not have to maintain the higher net capital requirements, the annual audit, etc. Even though the adviser in choice "D" is considered to have custody, since the adviser can appropriate money from the client's account, as long as certain "safeguards" are in place, the adviser does not have to meet the higher net capital, etc. Choice "D" describes those safeguards pretty well--send a billing statement to the custodian and to the client; the custodian will send the account statements. Why is the answer "B"? The adviser should have returned the securities to the sender, as opposed to forwarding them to another party. Because the adviser forwarded the securities, the firm, therefore, had possession of the securities (at least for purposes of an exam question).
Yes, unfortunately, your exam can get at least this detailed, even though "custody" is but one of many, many testable points. Welcome to the world of the Series 65/66. Don't worry--it will all be over soon.
Friday, January 30, 2009
Which of the following represent(s) an accurate statement(s) concerning the registration of investment advisers?
I. an investment adviser may not be organized as a sole proprietor
II. an investment adviser may not conduct business at a private residence
III. Form ADV is used for either federal or state registration
IV. Form ADV Part 1 must be updated annually
A. I only
B. II only
C. III, IV only
D. I, II, III, IV
Step one is to look at how the roman numerals have been distributed--what could you eliminate that would quickly eliminate one or two choices? Basically, once you decide on "I," you either eliminate A and D, or you eliminate B and C. Either the answer has a "I" in it, or it doesn't, right?
So, what about the statement that advisers can't operate as sole proprietors, implying that they must be partnerships, LLC's, or corporations? Did anyone ever try to hammer that point home? An adviser can't operate as a sole proprietor? Why not? It's untrue. Check out a Form ADV, and you'll see spaces to indicate whether the adviser is a sole proprietor. So, "I" is out, knocking out anything with a "I" in it. A and D are gone.
Now, your answer either has a "II" in it, or it doesn't. Does an adviser have to have a business address, or could a sole proprietor operate from a residence? Again, a cursory familiarity with Form ADV will show you that the form asks if the address given is, in fact, a private residence. And, why not? If you're just managing a few portfolios, why couldn't you enter trades through one computer in your basement, den, attic, etc.?
So, if "II" is false, B is eliminated, and the answer to the question has to be "C." To double check that "III" and "IV" are true statements, go to http://www.nasaa.org/content/Files/Form%20ADV%20(Parts%201A%20&%20B%20plus%20instructions).pdf and view a PDF of the paper-based Form ADV Part I. You'll quickly see that there are 4 boxes to be checked at the top. One is to indicate that you're filing with the SEC. One indicates you're filing with a state regulator. The next two boxes indicate that this is the annual update or that this is an "other than annual amendment" to report a major change that has occured rendering the information on file inaccurate or incomplete.
Try to use test-taking strategies to gain the upper hand on these annoying test questions. Use the part of the question that you know to eliminate the wrong answers. If you eliminate one answer, you go from a 25% chance of success to 33.3%. If you eliminate two wrong answers, you sit 50-50, which is pretty good when guessing. What happens when you elminate three answer choices?
Move on to the next question.
Saturday, January 24, 2009
I really don't get this securities stuff--federal covered, exempt, non-exempt. What the heck is going on here?
The state regulators are out to protect their investors from scams and offerings of worthless investments. They let the SEC sweat the big exchange-listed companies like IBM or MSFT. It's the small companies trying to pay their American Express bills by selling "preferred stock" or "promissory notes" to gullible investors that the states worry about. So, before even offering securities, you have to either register them or claim an exemption.
Go to www.passthe63.com/enforcement and click on the "Cease & Desist." The two "William Wesley" characters referenced in this administrative order demonstrate perfectly why we have state securities registration requirements. Starbucks is federal covered--register that stock with the SEC, the federal regulator. But, this crazy investment offering 120% annual interest to folks in Arkansas--the state would really have preferred that Mr. Webb register the investments first, if only to provide some overworked government employees with a really good belly laugh at two o'clock on a hot August afternoon in Little Rock.
So, if it's a "federal covered" security, the states let the SEC worry about the registration requirements. If it's a Treasury or municipal security, a bank security, a religious organization bond, etc., it's an exempt security--not required to register. Otherwise, if the investment is, in fact, a "security," it must be registered with the states before it can even be offered--let alone sold--to investors there.
But, is the thing even a "security"? If not, the securities Administrator has nothing to say about it. If so, registration and anti-fraud requirements apply. The Howey Case says that an investment contract, which is a security, is anything where the investor puts money into some enterprise and will benefit solely through the efforts of others. He doesn't work at the enterprise. He's just an investor. If so, whatever the promoters try to call the thing they're offering him, it's a 'SECURITY' and is subject to registration requirements plus the ever-present anti-fraud rules. If I go to the diner next-door to my office and try to sell "units of participation" to the other patrons, offering people a 3% profit participation in my business in exchange for, say, $10,000, I'm offering an investment contract, which is a security. So, if I do this without registration, I would be in huge trouble if the regulators found out. The IL Securities Dept would require that I register the securities and show them the disclosure documents I plan to provide to investors. They would make me print a section devoted to risk disclosures right up front in the prospectus informing investors of material facts like this:
This is a small company with limited operating history upon which to base an investment decision
This security does not trade on any active secondary market
You should not invest any funds you can not afford to lose in this enterprise
Wouldn't that sort of disclosure scare off some investors? Absolutely, which is just fine with the securities regulators. Only if investors know what the heck they're getting into can the securities markets function properly. Keep them in the dark or mislead them with deception, and you're talking about securities fraud.
So, once again, the first question a securities regulator has is this, "Does the investment meet the definition of a 'security.'?" If not, we're done talking about it. If so, it's subject to anti-fraud statutes. Does it have to be registered?
Yes. Unless it's an exempt security such as a T-bill, a church bond, bank stock, or short-term commercial paper issued by a highly-rated company, etc. Or, if the security is being offered and sold in an exempt transaction, then registration is either not required or it's completed in a fast-track, scaled-down approach that saves the issuer time and money.
Therefore, we can say with utter certainty that all securities have to be registered, except for all the securities that do not have to be registered.
Welcome to the Series 65, 66, and 63. Don't worry--it will all be over soon.
Advisers register electronically through a system called the "IARD," which stands for "Investment Adviser Registration Depository." It's administered by NASD, which is now called FINRA since people were actually starting to understand what the heck is going on, which is never tolerated long in this industry. Form ADV contains basic information on the adviser, which is usually a firm and occasionally an individual. Either way, the regulators want to know the name of the business, the ownership structure, how the firm operates, who the principals are, how much control the adviser has over client accounts and client assets, etc. If there have been disciplinary problems or lawsuits against the principals, there may be some explaining to do on Form ADV Part 1 and Part 2. If any of the information filed is misleading or false, the person filing it is subject to disciplinary action, civil penalties, and, in some cases, criminal prosecution. The "form" is filed with the initial registration, and it must be updated each year within 90 days of the close of the firm's fiscal year. Also, if a "material change" in any of the information on file occurs at any point, the firm must file an updated Form ADV promptly. So, there's the annual update that all advisers perform, and there is also the requirement to update any material information that has changed since their last filing. For example, if the firm moves, or acquires a financial planning company, or suddenly starts using discretion over client accounts, their ADV Part 1 would need to be updated promptly.
Form ADV Part 2 is the adviser's "disclosure brochure" given to prospects 48 hours before they sign an advisory contract or "at the time of signing, if the client has 5 days to cancel without financial penalty." In other words, give the prospect time to consider your advisory firm, warts and all, before he or she lets you take over the awesome responsibility of managing their money.
You could easily request a copy of a paper-based Form ADV on any adviser registered with the SEC. And, most advisers would be happy to send you a PDF of Form ADV. If you would like to view an actual Form ADV Part 2, I have one at www.passthe65.com/extra. Notice how this adviser avoids virtually all potential conflicts of interest and goes out of his way to avoid being "deemed to have custody." Notice how he clearly explains how fees are charged, and how minimum investments and advisory fees are negotiable. I'll let you take it from here. As always, if you have questions, post a comment. Chances are, if it's on your mind, other test-takers are wondering about it, too.
Friday, January 23, 2009
Speaking of Wyoming, though, if you set up shop as an adviser in, say, Cheyenne or Laramie, Wyoming, you would actually not have to take the Series 65 or Series 66 exam. Why not? Because these exams are only required by state regulators, what the exams call the "Administrator." As it turns out, the State of Wyoming sees no reason to make investment advisers register. But, as usual, there's a catch. Since the State of Wyoming has no adviser registration requirement, the SEC steps in and asserts their authority under the Investment Advisers Act of 1940 to make that adviser register with them.
But, luckily, the SEC couldn't care less about some silly exam called the "Series 65" or "Series 66." So, I guess if you really, really couldn't pass, or didn't want to take, the Series 65 or 66 exam but really, really did want to be an adviser, you could move to Wyoming, set up shop there, and register with the SEC, which does not require any license exam. You would be a "federal covered adviser" once you submitted Form ADV, paid your fees, and had your registration accepted by the Securities and Exchange Commission. If you kept all your activities in Wyoming, you would be done with the whole registration process. Just pay your renewal fees each year to the SEC, and you're good to go. If you set up shop in any other state, or if you pick up more than 5 clients in another state, you won't quite "register" in that state, but you will provide a "notice filing" and notice filing fees to that state. You actually have an "IARD" account that is funded, and the notice filing fees for, say, Tennessee would be deducted to cover it. A notice filing is a copy of the information you provided to the SEC. If you had any representatives with places of business or more than 5 clients in another state, you need to provide that state with a U-4 for each rep, the same form used for agents of broker-dealers.
It's a little frustrating to wade through this information, as it seems to be an extreme example of "splitting hairs." And, it is. I mean, if I have to provide paperwork to the State, and I have to pay a fee, in what sense am I as a federal covered adviser not registering with the State?
In the lawyerly sense that you are not subject to that state's "books & records or net capital requirements." You notify them of your presence, but you follow the SEC's books & records and net capital requirements under the Investment Advisers Act of 1940. Also, remember that the firm might be federal covered, but investment adviser representatives working for that firm still have to register with the state--not the SEC. The SEC does not register IARs. Investment Adviser Representatives register with the states where they have a place of business and/or more than 5 individual clients.
Unfortunately, we can only allow ourselves so much excitement per post, and if I drill down any further on this topic I'm afraid we may end up over-exciting the community. Please know that I would never write about something so boring and mind-numbingly detailed unless I was sure it's a likely topic for the Series 65 and Series 66.
Thursday, January 22, 2009
We'll be rolling out a combined Series 65 and 66 online class very soon. The 65 will meet across eight 1.5-hour sessions. The 66 will meet along with the Series 65 candidates for 5 of those sessions. Still working out the scheduling details. As always, content is my focus. Putting things into a schedule--well, still working on it, as I say.
Actually, it does.
I've attended several disciplinary hearings at the IL "Administrator's" office, and--trust me--there is much overlap between the "real world" and the test world in these cases. The first hearing centered on the definition of "investment contract" that you've seen from the Howey Case. The respondent's attorney kept arguing that what his client had offered and sold was "not even a security," but, alas, he failed to persuade the hearing officer of this, and his client ended up in hot water. He had defrauded several investors by taking their money and depositing it into one of his many business accounts, without ever, like, investing it in the program he was selling.
Oopsie. Try not to do that if you can help it, especially if you might get caught.
At another hearing, an agent had borrowed money from a client to be used toward a real estate deal that went sour. In other words, a bullet point like "borrowing money from clients" is not just a memorization point--it's a problem that many agents (and principals) run into all the time in the so-called "real world."
If you'd like to see how "real world" the test world actually is, check out some of the enforcement orders at www.passthe63.com/enforcement
Also, go to your state's securities website and look for "enforcement" or "administrative actions." Most states are happy to name names, CRD and IARD numbers, etc. and tell the world to watch out for this particular agent, principal, investment adviser, adviser rep, or issuer of securities.
You'll probably enjoy studying a lot more once you see that what you're learning is, contrary to popular belief, COMPLETELY focused on the so-called "real world."
Wednesday, January 21, 2009
Tuesday, January 20, 2009
Which of the following can be determined by looking at a corporation's balance sheet?
II. net income
III. quick ratio
IV. shareholders equity
A. I, II
B. II, III
C. III, IV
D. I, II, III, IV
Step one, read the answer choices A, B, C, and D just to see how the little Roman Numerals have been distributed. Right away, you see that this question either has a "I" in it, or it doesn't. Once we make that decision, two answer choices will be eliminated.
Or, for the extreme strategists, notice that three answers have a "II" in it and three have a "III" in it. If you could eliminate either "II" or "III," then, you would be done.
I know, some of you are thinking--but that has nothing to do with learning the information!
So what? Neither does the friggin' Series 65 or Series 66. It's just a hazing ritual that the regulators use to keep a certain percentage of folks out of the business and, thereby, claim to be "providing necessary protection to investors."
It's a game, people. Play it with strategy, win it, and move on with your lives.
So, as an extreme strategist myself, I have to go for the knockout punch here. I'm looking at choice "II" and choice "III" first.
Choice "II" says "net income."
Where would net INCOME be found? Perhaps on the other financial statement called the INCOME STATEMENT?
A-ha! This question is just a bully and is about to get its butt kicked. There is a balance sheet, and there is an income statement. Net income is on the INCOME STATEMENT, not on the balance sheet. So, let's eliminate any answer choice with a "II" in it.
Let's see, that eliminates Choice A, B, and D.
Leaving us with the right answer, C.
People who say they "hate the Roman Numeral questions" aren't using strategy. These so-called "multiple multiples" are, by far, the easiest type of question to answer. You just have to be patient and analytical.
Send in a hard Series 65/66 question, and I'll break it down for the community step-by-step.
Don't do that.
Your job is not to look for the right answer; your job is to eliminate the three wrong answers.
In fact, you might want to start reading the four answer choices before reading the question itself. This helps you to see where the question is leading and may, therefore, help you to eliminate the extranneous information.
I'll be posting examples of questions broken down step-by-step, but for now, try to apply this simple but important strategy of eliminating wrong answers. Even if you only eliminate two answer choices, your odds will at least be 50-50 on even the most difficult questions.
Send me an example of a "difficult" Series 65 or 66 question, and I'll break it down step-by-step for the whole community.