Registration Forms

Investment advisers register electronically through IARD, which is the Investment Adviser Registration Depository. Although FINRA (formerly NASD) does not have authority over advisers, they are really good at administering a big, ever-changing database like this one. FINRA also maintains a registration system for broker-dealers and their associated persons, called the CRD, which is short for Central Registration Depository. An agent of a broker-dealer remains in the system for two years after leaving the business, so arbitration decisions and disciplinary actions will be viewable during his career, and for two years after it ends. This is why the "broker check" feature at www.finra.org is the first stop for many investors. If they see that the name on the business card is associated with all sorts of industry violations and arbitration awards to upset customers, it could be tough for that name to get his foot inside the door.
Investment advisers file a "form" called Form ADV. ADV Part 1 is filed with the regulators, and it provides the essential information about the adviser: how it does business, who its clients are, whether it has custody and/or discretion over client assets, information on the officers and directors, etc. ADV Part 2 is the adviser's disclosure brochure, which is delivered to prospects before they sign the advisory agreement. ADV Part 2 gives the prospect enough material information to decide whether to use the adviser. This is where the potential conflicts of interest are disclosed, and if there is any disciplinary activity in the past 10 years, the adviser has to add disclosure pages about that. In other words, ADV Part 2 can end up scaring some prospects away. But, that's okay. Acting as somebody's investment adviser is a very big responsibility--investors must be able to trust their adviser, or keep looking.
The adviser (the firm) registers with Form ADV. They register their investment adviser representatives through Form U-4. Form U-4 is also used by broker-dealers to register principals and agents. The firm itself registers with Form BD. When an "associated person" of a broker-dealer leaves the firm, a Form U-5 is filed. That means that a U-5 is also used when an investment adviser representative leaves the adviser. Sometimes the termination is on good terms--sometimes the individual is being fired for cause. If the agent's license is suspended over a rule violation, that must be indicated on the U-5, which means that the public can find out about it through FINRA's broker-check at www.finra.org
If you would like more information on these testable registration forms, use the NASAA website at the following link: http://www.nasaa.org//Industry___Regulatory_Resources/Uniform_Forms/

Monetary Policy in the Real World

I know I harp on this a bit, but too many candidates fail to see the real-world importance of what they're studying for the exam. I was teaching a Series 65 online class the other day, talking about monetary and fiscal policy, hoping I could tie it to something going on in the news. Boy, did I get lucky! Just after I told them that the FOMC can purchase Treasuries to help a faltering economy, I found the following news item at http://news.yahoo.com/s/ap/20090318/ap_on_bi_ge/fed_interest_rates:

Fed to buy up to $300B long-term Treasury bonds WASHINGTON – The Federal Reserve announced Wednesday it will spend up to $300 billion over the next six months to buy long-term government bonds, a new step aimed at lifting the country out of recession by lowering rates on mortgages and other consumer debt. At the same time, the Fed left a key short-term bank lending rate at a record low of between zero and 0.25 percent. Economists predict the Fed will hold the rate in that zone for the rest of this year and for most — if not all — of next year. Fed purchases should boost Treasury prices and drive down their rates. That would ripple through and lower rates on other kinds of debt. The last time the Fed set out to influence long-term interest rates was during the 1960s. The article didn't mention "fed funds rate," but it hinted at it with "a key short-term bank lending rate." As always, you have to be patient and flexible when studying the test material or the real world version thereof. Try to see the Series 65 connection in the Jim Cramer show, the morning newspaper article, maybe even the late-night comedian's monologue. The FOMC is purchasing Treasuries, which will lower their yields and probably help push down mortgage rates. It's not just a bullet point--it's going on right now. Amazing.

What are all these different licenses and exams?

Today's "clickable" title will take you to FINRA'S run-down on the various license exams, but let's also do a quick and generalized breakdown here:

Series 6: this license exam is typically taken by insurance agents who also "want" to (have to) sell variable annuities, variable life insurance, and mutual funds in addition to their bread-and-butter business of whole/term life insurance, fixed annuities, etc . This is a securities agent/rep exam, so, by definition, the individual must be hired and sponsored by a broker-dealer. This "broker-dealer" would typically be a related subsidiary to a firm such as Met-Life, Northwestern Mutual, Country Insurance & Financial Services, State Farm, Allstate, etc (not to leave anybody out). The company strategy here goes something like this: let's hire a large crop of potential salespeople and get them selling insurance, annuities, and mutual funds as fast as possible. The Series 6 is "only" 100 questions and does not hit as hard as the other exams, although--have no doubt about this--the Series 6 is a tough exam. I'm just saying that some of the other tests I'm going to look at are longer and generally trickier. Most states require an individual to pass the Series 6 and the Series 63 before obtaining a state license to sell securities. So, let's look at the 63 next.

Series 63: this is the state law exam. It focuses on legalistic definitions, sophisticated exemptions for securities registration and registration of agents, broker-dealers, and advisory personnel. Not surprisingly, if given a choice, 74.8% of candidates recently surveyed chose to undergo oral surgery without anaesthetic than take a difficult, frustrating exam about "unregistered, non-exempt securities being offered to non-institutional investors." The exam's main focus is business practices--21 of the 60 questions focus on what is ethical, prohibited, etc. No one asked my opinion, but I've taken the exam twice, kicked its sorry ass twice, and still fail to see the point of making anyone take it. I could take 10 important points from the whole body of material, insert it into the Series 6, and call it a day. But then, the regulators would only collect one set of testing fees, and where's the fun in that. The next license we'll discuss is the Series 7--remember that the Series 63 is also required with that one.

Series 7: this is the exam to take if you want to be the traditional "stockbroker" like Charlie Sheen in "Wall Street," straddling phones, swearing up a storm, and entering buy and sell orders for commissions. With the Series 7, you can sell what a Series 6 person can sell, plus just about everything else imaginable: corporate bonds, municipal bonds, US Government bonds, options, stocks, direct participation programs, etc. The test is 250 questions long and lasts up to 6 hours for those who need the time and can also take the punishment. As with the Series 6, the individual has to be hired and sponsored by a broker-dealer just to take the test.

Is the Series 7 harder than the 6? Tough to say--the national pass rate is much higher on the Series 7, actually. But, the Series 7 is 250 questions in 6 hours, versus the Series 6's 100 questions in 2 hours and 15 minutes. That has to add to the difficulty factor. But, all I can say for sure is that the Series 7 is longer than the Series 6. Also, I find the Series 6 material to be rather boring compared to the Series 7 , which goes into many more topics that I care about and goes into them in depth. Then again, as I may have mentioned in earlier posts, when I struggled for 10 minutes to first understand a "debit call spread," I felt as if I were getting a really good brain massage, and when the breakthrough came, I actually jumped up and nearly scared my next-door neighbor, the cat lady, to death. "Ah-hah! Of course the debit call spread investor wants both options to go in-the-money! That way, he'll be forced to buy low and sell high every time! Awesome!"
Hmm? Oh, no thanks. I've already been recommended a good therapist.
Seriously, though, the Series 7 involves a lot of time to study, and that's what makes it "hard." It involves more vocabulary than the Series 6 and goes into more detail on many topics. On the other hand, the Series 6 goes deep into mutual funds, variable annuities, and taxation in a way that either rivals or exceeds the dreaded Series 7.

To sum up, then, whether you take the Series 6 to sell "packaged products" including annuities and mutual funds, or the Series 7 to sell that plus virtually every other type of security, you will also take the Series 63 in most cases. To make things more confusing, a Series 7 holder can take the Series 66 in lieu of the Series 63, but let's save the advisory side for another post. It's 6 o'clock on a Tuesday morning, and I'm afraid I'm going to over-excite us if I dig too deep into the material at this time.

Agents vs. IARs

QUESTION: What is the difference between a broker-dealer agent and an investment adviser representative?

RESPONSE:
An agent of a broker-dealer gets paid to execute securities transactions, which includes selling mutual fund shares. If somebody buys or sells a security, the agent makes a small % of the transaction in the form of a commission. Broker-dealers and their agents only get paid IF somebody buys or sells securities today.

Advisers and their IARs don't get paid to sell securities. They get paid to do financial planning, or to manage portfolios. The adviser bills a % of the assets, which has nothing to do with a level of trading. If the adviser executes 3 or 30 trades in the client's account this quarter, it makes no difference to his compensation. He's billing, perhaps, .25% of the account balance each quarter, period.

I passed my Series 65 exam close to two years ago. If I were a normal person, I would be scrambling right now to get myself registered; otherwise I'll have to take the exam again if I ever want to start an RIA or work for one as an IAR. If I were to register, it would be as an RIA--I would set up an LLC called, perhaps, "Walker Wealth Management" and either charge hourly for my financial planning advice or--more likely--charge 1% of my clients' assets each year in exchange for managing their portfolios. I don't have any clients, though, so I would pay you to go get me some clients, sharing some of the 1% with you. Now, you are my IAR (investment adviser representative), and you get paid a % of assets as opposed to getting paid when the client buys a particular mutual fund. Once you land that client, in fact, you don't have to sell anything to him going forward. You'll be getting a % of his assets while you spend time trying to find more assets for me to manage.

Most reps these days get their Series 7 and 66. This allows them to earn commissions when selling securities (7) and also a % of assets when acting as an IAR (66). Or, some firms have their agents get the 6 and 63 in order to sell mutual funds, variable annuities, and VLI/VUL policies, and then get their 65 later on in order to work the "fee-based" or "IAR" side of the business. Northwestern Mutual (NMFN) actually has different "levels" for their reps. The rep starts out in the bread-and-butter area of life insurance plus the Series 6 and 63. He or she can then sell whole life, term life, variable life, fixed annuities, variable anuities, and mutual funds. Later on, the bravest of the reps go on to take the Series 7 and the Series 66. Once those are passed, the agents can earn commissions on individual stocks, bonds, etc. (Series 7) and--more importantly--they can earn a % of their advisory clients' assets (Series 66). It ends up being four securities licensing exams, but it also gets their people out there selling a lot sooner with the shorter 6 and 63 ordeal, and only puts the ones who are dedicated long-term in front of the big, scary Series 7 and 66.

So, the difference between a securities agent and an IAR is really the same difference that exists between a broker-dealer and an investment adviser. BDs are in the transaction business--they get paid if they can sell a security to a client. Investment advisers are in the advisory business--they get paid to manage the clients' assets on their behalf. That's where their fidicuiary relationship comes from, too, by the way. Unlike a broker-dealer, the adviser does not sell securities to the client. Essentially, the adviser is the client. Seriously.

Equity Indexed Annuities

Equity Indexed Annuities are on many insurance agents' minds these days. As you probably heard, the SEC recently tweaked the definition of a "security" in the Securities Act of 1933 by re-defining the exclusion for fixed annuities. Starting in 2011, equity indexed annuities that are "more likely than not" to pay out more than the stated guaranteed return will be considered "securities" subject to registration.
Ouch. How will this affect the exams? As usual--who knows? NASAA doesn't put out memo's that help people know what will be tested. That would be, like, fair. But, if you get a question about a "fixed annuity" on your test, remember that a fixed annuity is not a security. It's a pure insurance product. It pays a guaranteed rate of return to the investor backed by the insurance company's "general account." The equity indexed annuity is the one that will be considered a "security" starting in a couple of years.
The Rule is SEC Rule 151A, which amends the Securities Act of 1933. I have NO OPINION ON THIS TOPIC WHATSOEVER, remember. I'm just trying to help prepare you for a potential exam question.

Test-Taking Strategy, A Facebook Confession

Facebook has been a great thing for me so far. I can place links to these blogs and other websites, and I can also update my status with "Robert is blogging for his Series 65 students at 5:30 on a cold morning in March," in order to mention my business as often as possible. Another connection to the business comes from all the quizzes that I receive from my old high school friends challenging me to "name that 80's band" or "name that 80's tune." I'm flattered that they think of me as someone to challenge to a quiz, and I also see an opportunity to put my test-taking strategies to the test. The first quiz I took was called "name that 80s band," and I have to admit, I was a little nervous. The first question had me up against the wall--it was a picture of a heavy metal band, and that was really not my forte. I actually thought of my customers at the testing center panicking over the very first question. In honor of them I took a deep breath and said, what are the four choices? We had: Scorpions, Black Sabbath, Dio, Judas Priest. Wow--talk about an advantage! Okay, first, the difficulty level of this facebook-based quiz can not be that freaking high; they would not put a picture of Black Sabbath here unless Ozzy were clearly visible--Sabbath was eliminated. A Judas Priest photo would have to have at least one guy on a motorcycle or wearing motorcycle garb, so Judas Priest was eliminated. Now I'm down to Dio and the Scorpions? What's the name of this quiz? "name that 80's band." Who was a bigger force in the 80's, the Scorpions or Dio? The Scorpions--I win. I now have a comment on my "wall" from the friend who sent me the challenge after seeing the score of 100%. He wrote, "How on earth did you know the name of the guy from the Split Enz?" Of course, I didn't. I just eliminated the wrong choices and then asked--who was a true "80's band"? And, what would this test want me to say? I also just got a 100% on a "name that 80's tune" challenge. On the first 9, I simply knew the answer. But I would have only gotten a 90% if I had not used process of elmination on the last one, avoiding "The Bangles" and choosing "Debbie Gibson," not because I have a clue what Debbie Gibson actually sang or looked like, but because "The Bangles" had one or two hits, and the title of the song in the question wasn't one of them. Always use the multiple choice format to your advantage. Always focus on eliminating wrong answers to improve your odds. Never indicate "single" for your facebook status unless your spouse has a really good sense of humor.

Test-Taking Strategy

You have to use whatever advantages the exam gives you. The test does not involve any fill-in-the-blank, short-answer, or essay questions. That means that you don't have to use the more difficult skill of recall. You only have to use the much easier skill of recognition. Of course, the exam can use lots of synonyms, so even recognition will fail you on some questions, which is why you have to resort to process of elimination at that point. If you don't see the word you were hoping to see among the four answer choices, you can use logic and reasoning to start eliminating the wrong answers. You might only eliminate two answer choices, but that raises your odds from 25% to 50%. And, if you only have to use this method of extreme test-taking on, say, 50 questions, you'll probably get 25 or more of them right, and that is often the difference between being among the 66% of candidates who pass the test that day and the 33% who wish they had.
Of course, we now have to apply it to a potential exam question:

Which of the following types of contractual provisions may exist between an adviser and a client?
A. waiver of compliance
B. exculpatory provision
C. performance-based compensation for certain institutional investors
D. none of the above

Wow, maybe it's the earliness of the hour, but I was just hit with a flash of recognition myself--these exams bite! No wonder some of you are a little cranky. Anyway, we still have to use the advice given above to try to gain the upper hand on this question. A "contractual provision" just means that an investment adviser has the client sign an agreement/contract that spells out what the adviser will do for the client, how much the adviser will charge, how they figure that charge, whether the adviser has discretion to place trades, etc. In that contract, can an adviser have the client sign a waiver that allows the adviser to do something that does not comply with securities rules and regulations? Probably not, right? So, we eliminate "A," waiver of compliance. What if you don't know what an "exculpatory provision" is? You might be in trouble. Or, you might be a creative and analytical thinker who says (quietly at the testing center, please), "Well, 'culpability' has to do with blame or fault. 'Ex-' means without. So the adviser has the client sign a provision that whatever happens, the adviser is without fault." No way. So, we eliminate "B," exculpatory provision. Now we either determine that "C" is okay, or we choose "D."
Careful now. Too many people feel the momentum now and jump straight to "D." We can't afford that luxury. Choice "C" is saying that it's okay to charge performance-based compensation for certain institutional investors. Is that true? Yes. Why would the test want us to know that the usual prohibition against sharing capital gains/appreciation is actually okay in some cases? It likes to see us sweat. Whatever its reasons, the answer is "C."
Exhausting, isn't it? Oh well. The Series 65 and 66 exams are just a weeding out process. They want to flunk about 33% of all test takers on any given day. Of course, many of those 33% come back in 30 days or so and join the 66% who pass. Brutal, yes. Frustrating, surely. And, as much as I've grown to hate the phrase, unfortunately, it is what it is.

ADV Part 2, Disclosure Brochure

A Series 65 customer just emailed a great question:

What is the practical application of this rule?
New Clients: The brochure must be provided at least 48 hours before entering into an advisory contract, OR at the time of entering into a contract, if the client has the right to terminate the contract without penalty within five business days.

RESPONSE:
The practical application is this: give the prospect at least two business days to review the brochure (ADV Part 2) before he comes in and signs the advisory agreement/contract. Why? As you see at www.passthe65.com/extra, AdV II gives the prospect important info on your firm--who you are, what you do, how you charge compensation, who your other clients are, your disciplinary history, whether you have discretion, etc. So, the prospect needs time to review it before signing the contract.

The latest that the brochure can be provided is at the time the client signs, IF he can cancel within 5 days without losing any prepayment to the adviser. Some advisers accept a "prepayment" or upfront fee before doing any actual advising. If they take, say, $1,000 just to sit down and start looking at the client's situation, then they could give ADV 2 to the client when they sign, IF the client could cancel in 5 days and get all her money back.
Most advisers avoid the prepayment because if you take >$500 six or more months in advance, you have "custody" and you have to provide the client and the Administrator with your balance sheet, and if the liabilities EVER exceed the assets for even ONE DAY, you have big problems on your hands.

So, like most things, it's simpler than it sounds--give the client 2 business days to consider your brochure before they sign the advisory agreement. If you want to give them the brochure when they sign, you have to know that they might cancel in 5 days, and any prepayment you took has to be paid right back out.

Capital Gains

Mary Ann purchased 1,000 shares of ABC on January 1st, 2009. On December 31st, 2009, she sells the shares for a $500 capital gain. If the trade settles on January 4th, 2010, which of the following accurately describes the tax consequences?
A. the gain will be considered long-term
B. the gain will be considered short-term
C. the gain will be treated as dividend income
D. Mary Ann will report the gain or loss for tax year 2010

EXPLANATION: a long-term gain happens when you hold securities for one year plus one day. As the IRS explains at http://www.irs.gov/, your holding period starts the day after you buy the stock and stops with (and includes) the day you sell it. So, if Mary Ann buys stock on January 1st, 2009, she needs to sell it no sooner than January 2nd, 2010 if she wants a long-term capital gain. Settlement has nothing to do with holding period. When you execute the sale, you no longer hold the stock. The answer is B, the gain will be considered short-term.

Unregistered, Non-Exempt Securities

The titles to these blog posts are "click-able" links. Usually, I take you to one of our websites, but today the title takes you to FINRA's February roundup of disciplinary actions. This is the sort of thing I read Friday mornings in order to stay on top of what is important to regulators and, therefore, what types of questions the exams might begin to ask.

This morning I'm on the third disciplinary action and I see more proof that the seemingly useless information you learn concerning the Uniform Securities Act is actually as real-world as a heart attack. Even a crazy-sounding phrase such as "unregistered non-exempt securities" has a place in the day-to-day workings of the securities business. Check out this snippet from the action against Cambria Capital, LLC:


Cambria Capital, LLC (CRD #133760, Salt Lake City, Utah) submitted a Letter of Acceptance,Waiver and Consent in which the firm was censured and fined $40,000. Without admitting or denying the findings, the firm consented to the described sanctions and to the entry of findings that it conducted sales of unregistered securities that were not exempt from registration. The findings stated that the firm failed to establish a supervisory system or establish, maintain and enforce written supervisory procedures reasonably designed to achieve compliance with Section 5 of the Securities Act of 1933 to detect or prevent the sale of securities that were neither registered, exempt from registration by the firm or its representatives or to determine that securities received into customer accounts could be sold without restriction.

The Friday Free Broadcast on March 20th covers "Industry Rules & Regulations," and we'll look at several real-world disciplinary actions that illustrate testable points. I encourage you to take a look at the February summary of FINRA disciplinary actions for several reasons. One, you will see all kinds of test topics in action. Two, it will stretch your mind and give you an edge over the other test-takers who are just memorizing bullet points and hoping to wing it at the testing center. Third, this is the industry you are entering. Even if you're only on the advisory side, outside of FINRA's reach, please know that the SEC, FINRA, and the state regulators are all pretty much on the same page. An adviser would get in just as much trouble with the SEC or state regulators if they put clients into unregistered non-exempt securities or sold securities that were restricted. If it violates securities law, it's a problem.

Enough for now. Gotta get to the office and finish up Pass the 6 3rd Edition . . . or perhaps you're all waiting for the movie.

Practice Question on Registration of Broker-Dealers and Advisers

Let's look at another practice question. This one is somewhat difficult just because of the laborious language. Careful now.

Which of the following is not true concerning the registration requirements of securities professionals?
A.Broker-dealers with no place of business in a state and a limited number of non-institutional clients in a state must register.
B.Broker-dealers with no place of business in a state who limit their agents to selling exempt securities in a state need not register.
C.Investment advisers with no place of business in a state and whose only clients are institutional investors in a state need not register.
D.Investment advisers with no place of business in a state and a limited number of non-institutional clients need not register.

You've probably noticed that practice questions don't necessarily express things the way you learned them. You have to read some meaning into the words so that you think, "Oh yeah--the de minimis exemption. That's only for advisers, not broker-dealers." Once that fundamental concept comes to mind, you're half-way done. Broker-dealers need to be licensed in the state if they have any non-institutional (retail) investing clients. But, for advisers who are out-of-state, it's okay to have 5 non-institutional clients without being registered in that state. And, the out-of-state adviser can have as many institutional clients as it wants without having to register. Therefore, the answer is . . . B. The fact that the securities are exempt isn't going to relieve the broker-dealer of having to register, not if they have agents selling securities of any kind in the state.

Uniform Prudent Investor Act

Here is a question that looks very similar to something you might see on the Series 65 or 66:

According to the Uniform Prudent Investor Act, when may a trustee choose not to diversify the assets of the trust?
A. During a prolonged bear market for stocks
B. When choosing not to diversify best meets the needs of the beneficiaries
C. Under no circumstances
D. When the assets are 100% cash

Notice how a person who has not studied could easily talk himself into any of the four answers. Under no circumstances looks very tempting on a regulatory exam. Putting the assets all in cash seems pretty darned prudent, too. Hmm. Unfortunately, the Series 65/66 will pull sections out of various actual and model acts and expect candidates to be familiar with them. This question is pulling a section almost verbatim from the Uniform Prudent Investor Act, which states:

A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.

And that pretty well answers the practice question above, doesn't it? The answer, according to Section 3 of the Uniform Prudent Investor Act, is B, "When choosing not to diversify best meets the needs of the beneficiaries." As usual, the exam material seems to talk from both sides of its mouth. What it just told us is that a fiduciary/trustee should always diversify the assets of a trust, except when he shouldn't.

Oh well. That's what we're dealing with here on these exams. No need to get frustrated--we just have to deal with the exams on their own terms. Pass the test, and move on with your life.

Traditional and Roth IRA contributions

If an individual earns a high income, she can not make a contribution to a Roth IRA. That does not mean that her Roth IRA has to be closed, but, unlike with a Traditional IRA, a contribution simply can not be made if the individual makes $120,000 or more, or if the married couple filing jointly earns $176,000 or more for 2009. But, many people do not realize that there are no income limits for the Traditional IRA. Don’t worry about how much money somebody makes in the test question, or if she’s covered by an employer plan. All that would change is the amount she can deduct from her contribution. If she’s covered by an employer plan and makes a certain amount of money (say, $53,000 or more), she’d just have to keep track of how much of her contribution went in after-tax, so she doesn’t get taxed twice on that money when it comes out with everything else. But, if she has earned income, she can contribute to her Traditional IRA, either pre- or after-tax. She might not deduct 100%, or even any percent, of it, but it can still go in there. And, don’t forget this: if she’s not covered by an employer plan, she can deduct all of her contribution, regardless of her income. If you disagree with any of this, see IRS Publication 590 at http://www.irs.gov/pub/irs-pdf/p590.pdf