Saturday, October 31, 2009

Private Placements

If the topic of "private placements" is confusing to you, you're in good company. Under the Securities Act of 1933, the maximum number for non-accredited investors is 35. For a private placement made in a particular state the maximum number is 10 under the Uniform Securities Act. In the real world there is a lot of controversy over these "Reg D offerings," and the state regulators often fight to control these things that the SEC does not require to be registered. However, don't be too quick in your understanding of a test question. For example, how would you answer this one:

Which of the following represents an accurate statement of private placements under the Reg D exemption to the Securities Act of 1933's registration requirements?
A. securities are subject to holding period requirements
B. underwriters may solicit a maximum of 35 non-accredited investors
C. suitability requirements do not apply to institutional investors
D. all choices listed

EXPLANATION: the "private placement" can not have it both ways--it can't be private if the underwriters are soliciting investors. There must be a pre-existing relationship between these investors and the underwriters. Also, broker-dealers do have suitability requirements, even when dealing with institutional investors. FINRA has sent notices to member firms reminding them that if an investment is too complex for an institutional investor, or the institution does not have the resources to do due diligence on, for example, a mortgage derivative, then the firm should not offer and sell it, no matter how "sophisticated" institutional investors might be in other areas.

Sunday, October 25, 2009

Registration of Persons

The Series 65/66 exam usually asks several questions about registration issues for broker-dealers, investment advisers, and their agents/IARs. It helps to keep a little flow chart in your head, like the ones we published at

For now, let's work through it with words. When you get a question about registration issues for "persons" in the securities business, the first question to ask is, "Do they have a place of business in the state?" If the answer is "yes," then the broker-dealer, agent, or investment adviser representative has to register in that state.
If the investment adviser has a place of business in the state, the adviser has to register with that state, unless they can claim eligibility for federal registration. If the adviser has $25 million or more under direct management, or if they manage investment company portfolios, or if they can click another of about a dozen reasons, they will register with the SEC. The state(s) where they have a place of business or more than 5 non-institutional clients will receive copies of the SEC paperwork, called "notice filings."
So, the first question is, "Do they have a place of business in the state?" If the answer is "no," the next question is, "Do they have non-institutional investors in that state?" If not, the agent, broker-dealer, investment adviser and investment adviser representative are excused from registration. If they want to start soliciting clients in the other state, they have to register, but if their only clients in the other states are institutional investors--pension funds, mutual funds, banks, insurance companies, advisers, broker-dealers--then they do not have to register in the other state. However, if the agent or broker-dealer have any non-institutional clients in the state, they have to register in that state, even if they don't have a place of business there. The adviser or IAR, on the other hand, can have up to 5 non-institutional clients in the other state without registering, as long as they're not soliciting new clients or "holding themselves out to the public as investment advisers."

Believe it or not, that's about as simple as we can make it. Although a picture may be clearer. Click that link above and check out the three Word Documents.

Wednesday, October 21, 2009

5 out-of-state clients

On the Series 65 or 66 exam there will likely be at least one question about registration issues for investment advisers with clients in other states. Maybe something like this:

Barry Mundy is a financial planner with a place of business in State A. Recently, three of his clients moved to State B. Barry has recently placed a billboard in State B offering a "total financial check-up, free of charge" with an 800-number and a link to a website. Therefore
A. Barry must register in State B because he is holding himself out to the public as an investment adviser in State B
B. Barry must register in State B because the clients who moved there were existing clients
C. Barry is exempt from registration requirements in State B because the number of clients there is 3
D. Barry is eligible for federal covered status due to the multi-state adviser exemption

You might have memorized the number 5 and decided that an out-of-state adviser with no more than 5 clients in State B is exempt from registration requirements there. And he is. Except when he isn't. See, that exemption is based on the fact that he is not holding himself out as an adviser in State B. Barry Mundy is definitely holding himself out as an investment adviser in State B, and right there he has to register in State B. He doesn't get to solicit clients and then stop when he gets to 5 . . . or solicit 5 clients. He's either soliciting clients in State B or he isn't. If he is, he has to register there. If he isn't, he can have 5 clients in that state without registering there. Most likely, they're existing clients or referrals . . . but if he wants to drum up business in State B, he needs to register there.

So the answer above is A.

Monday, October 19, 2009

Advances to Partners, Officers

As I've written, I'm not sure why investors would allow their investment adviser to also maintain custody of the account assets. I mean, if the investments are doing poorly, what's to stop the adviser from making up his own numbers, or--worse--making withdrawals out of dividend and interest income that the client never finds out about?

But, some advisers do have custody. If so, the firm has to maintain a minimum net worth. NASAA says in one of their model rules that the minimum net worth for such an adviser is $35,000. They then define "net worth" in frightful legalese. I'll include a link to the model rule at the bottom of this post, but for now, let's imagine what a test question might look like on the Series 65/66 exam:

Hickory Stick Advisory Partners are deemed to have custody of client assets. When filing their balance sheet, the firm should include in its assets which of the following items?
A. prepaid expenses
B. loans to a senior partner
C. loans to a silent partner
D. marketable securities

EXPLANATION: the NASAA model rule on minimum financial requirements for advisers specifically tells advisers not to include prepaid expenses or loans to partners--if the firm is a partnership--or to officers or stockholders--if the firm is a corporation. Seems like a good idea to me. If the advisory business is doing poorly, what are the chances that the partners are doing well enough to repay the loan they took out? Talk about some shaky assets. Marketable securities have a value--they are an asset.

Money Purchase Plan

The Series 65/66 exam may ask a question like the following:

In a "money purchase plan" contributions are
I. discretionary on the part of the employer
II. discretionary on the part of the employee
III. mandatory on the part of the employer
IV. mandatory on the part of the employee

A. I, IV
D. I, II

EXPLANATION: someone who really knows a lot about retirement plans would probably be unable to answer this question. Since I'm just a test-prep expert, I know how the test question writers think, and I know they want me to say that the money-purchase plan involves a mandatory contribution by the employer, and the employee can also contribute (discretionary). So, I choose "C."

If you vehemently disagree with this and can explain why, send me an email

Wednesday, October 14, 2009

Out-of-State Adviser with 5 clients

A former Pass the 65(c) customer wrote me an email this evening that touches on a few important testable points. He wrote:

I used your program to pass the 65 test in AZ. Thanks so much.

One of my coworkers and I have a disagreement on the number of clients you can have vs. the number of people you can solicit outside of the state you are registered. I say you can have 5 clients outside the state. He says you can only solicit to 5 outside the state and once you solicit 5, you cannot solicit or have more clients even if you get none. Who is right?

Thanks for the help!


Great job on passing a tough test!
Basically, the de minimis exclusion for an out-of-state adviser with no more than 5 clients in another state accomodates financial planners who might have a few clients who end up moving to various states. So, if a few of your clients move to Florida, you can be their adviser without paying licensing fees to Florida. As always, there is a catch. Remember that this exclusion is predicated on the fact that you are not soliciting new clients in the other state. If you're going to solicit clients, or "hold yourself out as an adviser," the other state is going to want you to register. Plus, how can you solicit five clients? To get five clients, I think you'd better call more than 5 people--more like 500 people. Right? The state laws generally say that an adviser can commit fraud even when just soliciting clients, so they like to get people registered if they're "holding themselves out as being an investment adviser in their state." So, your co-worker isn't quite right, either. It's not that you can solicit five people. It's a question of, are you soliciting and "holding yourself out to the public as being an adviser," or not? If you are, you have to register. If you're not, you can have up to 5 clients, as long as you have no physical presence/place of business in that other state.

Here is a snippet from a state law, Pennsylvania's. Their Act states that you're not an investment adviser if you/your firm are: a person who has no place of business in this State and, during the preceding twelve-month period has had not more than five clients in or out of this State and does not hold himself out generally to the public as an investment adviser.

The bold statements are why your buddy is partly right--in general most states won't grant you the de minimis exclusion if you're holding yourself out as being an adviser to the public in their state, which is what you'd be doing by calling or writing to potential clients, or advertising, or even handing out brochures or business cards at a garage sale. In fact, if you sat at a local tavern or diner and simply talked to anyone too slow or lonely to walk away from you about your advisory services, you would be "holding yourself out to the public as an investment adviser."

You both would probably like an absolute answer, but it would depend on the state, the wording of their own statutes, their reading of their own statutes, and their list of priorities. To be on the safe side, get registered before you start soliciting advisory clients in any state. The de minimis exclusion really only works when you have existing clients who happen to move to another state. Once you "hold yourself out to the pubic as being an investment adviser," that state likes to make you register.
And, I'd be on the safe side with all state licensing issues. You're usually talking about an annual fee of a few hundred dollars to get registered and renew each year.

Sunday, October 11, 2009

Annuity Payout

If you're studying for the Series 65, I highly recommend purchasing one or more of the recorded classes at Maybe you already have materials that your firm provided--these recorded classes will make sense of that stuff in a hurry.

I'm going to write a practice question on variable annuity payouts now since it's still too cold to walk the dog this morning in Chicagoland. Cody can wait--you, on the other hand, are studying for a very difficult and serious exam. Here you go then:

An annuitant chooses life with a 10-year period certain. If the annuitant lives 12 years, what happens?
A. the beneficiary receives two years of payments
B. the annuity pays out for just 10 years
C. the annuity pays out for 12 years
D. annuity units are converted back to accumulation units

EXPLANTION: with a 10-year "period certain" the annuity company will pay for at least 10 years but will also pay as long as the annuitant lives. Whichever turns out to be longer--that's how long they pay.


Wednesday, October 7, 2009

IRA Contributions

Let's look at a practice question concerning IRA contributions.

Which of the following could reduce the amount that an individual may contribute to a Traditional IRA?
A. Roth IRA contributions made for the year
B. High income level
C. Participation in an employer-sponsored plan
D. All of the choices listed

EXPLANATION: if you were going too fast, you might have been tricked by this one. The other choices only affect how much can be deducted from the contribution, but anyone with earned income can contribute to their Traditional IRA.


Thursday, October 1, 2009

Unregistered, non-exempt securities

Even a phrase as annoying and opaque as "soliciting sales of unregistered, non-exempt securities" relates to the so-called "real world." Just two days ago a federal court issued an injunction on some people who were, allegedly, trying to issue securities without bothering to get them registered. If you read the announcement at the link at the bottom of this post, you'll see that the SEC is just an army of attorneys--no criminal charges are being discussed here. The SEC is seeking all that they can, which is "permanent injunctions, disgorgement of ill-gotten gains, and civil penalties against all defendants." In other words, they would like to use the permanent injunction as a reason to deny these people any opportunity to work the securities business or offer securities in the future. They want them to give up the money they took (disgorge). And, they want the courts to hand down a stiff monetary penalty against them. You'll notice that specific sections of the Securities Act of 1933 are referenced, and it will do you good to read it all in the native tongue. Enjoy: