Wednesday, December 29, 2010

Do You Need a Private Tutor?

Even though your firm may have provided you with materials and even a live class, you might need some extra help in passing the Series 65/66 exam. If so, consider getting some online private tutoring from yours truly.

We've helped many people get over the hump, and you can see testimonials/case studies by either clicking the title of this post or:

It's not "cheap," but our fees are reasonable. And, WHEN you pass the test, you'll consider it money well spent.

Wednesday, December 8, 2010

Series 65 Question

Let's kick off December with a practice question that could easily show up on your Series 65 or Series 66 exam:

A state-registered investment adviser must do all of the following except
A. file an audited balance sheet with the Administrator if the adviser uses a qualified custodian
B. file an audited balance sheet with the Administrator if the adviser maintains custody
C. file an unaudited balance sheet with the Administrator if the adviser has discretion but not custody
D. file an audited balance sheet with the Administrator if the adviser accepts prepayment in excess of $500 six or more months in advance

EXPLANATION: NASAA tends to pull some factoids from their own model rules and policy statements that no normal human could have expected. I could easily see them expecting you to have read their model rule called "Financial Reporting Requirements for Investment Advisers," and, even though they swear their exams don't reward memorization . . . well, whatever. Turns out, if the adviser has custody or accepts prepayment, they need to file an audited balance sheet, complete with an opinion by the CPA, with the Administrator. If the adviser has discretion but not custody, the balance sheet must be filed, but it does not have to be audited, saving the adviser the expense of paying a CPA firm to review the adviser's books. If the adviser does not have custody, we assume it does not have to file an audited balance sheet.


Tuesday, November 30, 2010

Investment Risks

The Series 65/66 exams don't frequently reward test takers for the little factoids they've managed to memorize. Rather, the exams expect test takers to know the factoids only so that they can use them to think their way through some rather challenging questions. Like this one:

An investor is considering an opportunity to invest in wireless spectrum now that the FCC has forced large carriers to auction off a percentage of their capacity. Minimum investment is $50,000. The check will be payable to WiredAmerica, LLC, who will act as a representative for investors, negotiating charges for spectrum and helping to find equipment contractors and re-selling opportunities for investors once the deals have been finalized. Investors are advised to prepare for a 12 to 18-month waiting period before monetization opportunities commence. If the spectrum is not available, investors will receive their initial investment, less a 4% administrative fee. Which of the following statements is accurate?
A. the investment would not meet the definition of a "security"
B. the major risk to investors is loss of purchasing power
C. regulatory risk is not significant in this scenario
D. investors face regulatory and obsolescence risk

EXPLANATION: just reading this crazy question will set you back a few minutes at the testing center and probably increase your blood pressure a few points. If you're flabbergasted by something like this, choose "C" and mark it for review. Come back later after you get through the exam. Of course, you eventually have to deal with monsters like this, so, as always, see what you can eliminate. It's never crystal clear whether something is/is not a "security," but how can we rule this one out? It's an investment of money in which the investor plays only a passive role--sounds like the Howey Decision would apply. Eliminate Choice A. I guess if you turn your money over to these folks for a year/year-and-a-half, and then you get back only 96% of your principal, you've lost purchasing power. But, is that the major risk? Frankly, I'd be a lot more worried about waiting 18 months, then making a phone call only to discover the number has been disconnected. I don't like Choice B enough to choose it. The whole premise of this "investment opportunity" is that the FCC has required large wireless carriers to auction off spectrum that they currently hold--any chance that a Republican controlled House of Representatives might try to block that ruling? I would think so. Notice how it's hard to be certain on any of these three choices--your job is to see if you can eliminate Choice D. If so, you'll have to start all over. If not, choose it, confirm it, and keep moving. There definitely seems to be regulatory risk, and with wireless technology changing so rapidly, isn't there at least a chance that in 18 months the spectrum you thought was worth X is now only worth Y or maybe even worthless? Tough to eliminate Choice D. So, as often happens, you're not 100% sure of your answer, but it would still seem that D is the best choice.


Wednesday, November 24, 2010

Nobody Ever Makes any $ in Stocks, Right?

People often try to convince me that "nobody ever makes any money investing in stocks." What I take this to mean is that this dude has never made any money in the stock market and doesn't know anyone any smarter or luckier than himself.
Bulls*** nobody makes money in the stock market! I'm not just talking about geniuses like Warren Buffett or Jim Cramer; even folks who barely know what they're doing have been known to earn some decent returns. Like me, for example. The fact that I know the information likely to be tested on your Series 65/66 exam is not really an indicator that I know how to invest. But, apparently, I do. I mean, like all investors, I make some really bad judgment calls here and there, and often I simply can't remember what I was smoking when I hit the "buy" button, but, overall, I have made some pretty good returns in the stock market. This morning--a slow pre-Thanksgiving day--I'm looking through my various investment accounts and can not help but pat myself on the back a little. About 10 years ago, I invested $609 in a fallen "dot-com" stock known as Priceline-dot-com. Many of my friends figured I was crazy, but by ignoring their uninformed pessimism, I was able to look at the company's finances objectively, pull the trigger, and hang on for the next decade. Guess what the current value of that six hundred-and change is today?
$9,533. That's a paper gain (unrealized gain) of about 1,400%.
Now let's pause for the naysayers: what about your losses, though?
In this account, I am sitting on a couple of embarrassments. Why I ever purchased shares of DELL, I'll never understand and why I didn't SELL as soon as the shares swooned, I'll also never know. But, the fact is I'm sitting on an unrealized loss of about $1,966. There is also a paper loss of about $128 on GE, proving that big "blue chip" companies can suck just as much as unknown small caps. Fine, let's go ahead and subtract the two losses from the gain on Priceline, and I'm still up about $7,439 or about 1,220%. What about the other losses? There aren't any. The other positions show gains of:
ABT $515 (12%)
HSP $993 (53%)
ORCL $800 (134%)
HGT $27 (5%)

Maybe the point would be clearer if we put it this way: the Roth IRA (which I have not been able to contribute to for a while) is now worth over $20,000 . . . even though my total deposits into the account equal just $10,000. Sure, some would say, but it took eight years for your money to double. That's correct. And, it's also a compounded return of around 9% . . . in a period when the S & P 500 has shown absolutely miserable returns and interest rates on Treasuries remain around 2 flippin' percent!
So, I'm not ready to hang out a shingle and start managing other people's money. But if somebody tries to tell me that "nobody ever makes any $ in the stock market," I look forward to showing them this blog post. I'm just an English major who did a lot of homework. Imagine if I actually knew something about investing!

Tuesday, November 23, 2010

Exemptions for Persons

This is a follow-up to the previous post, so you might want to read "What's the Deal With Exempt Securities?" before reading this one . . . assuming you actually "want" to read anything connected to the Series 65/66 exam, that is. As we discussed in the previous post, an exempt security is simply a security that doesn't have to be registered. US Treasury securities, municipal bonds, insurance company debt obligations, etc. are all excused/exempted from the registration requirements of the Uniform Securities Act. They're still subject to anti-fraud rules, of course, but the issuers don't have to waste as much time and money completing the typical registration process. If there's nothing special about the security--it's non-exempt--the security always has to be registered.
Except when it doesn't. If it's offered and sold through an exempt transaction, then the security would not have to be registered in the typical manner. For example, if the issuer offers the investment to only 10 persons in the state, or offers it only to institutional investors, registration of the security is not required. And, if the individual in the test question represents the ISSUER of an exempt security, or represents the ISSUER in an exempt transaction, that individual does not have to register.
But, if the individual represents a broker-dealer by selling any securities, that individual has to register in any state where he has a place of business or any non-institutional clients. That seems to imply that the agent does not have to register in order to work with institutions, but that is not correct. The agent has to register with FINRA through the member firm to sell securities to any customer. Also, he has to register with every state in which he has a place of business or any non-institutional customers. If he has a place of business in New York and wants to open an account for a retail customer in Indiana, he has to be registered in Indiana. He would not have to register if he had no place of business in Indiana and the only customers there were institutions. No need for the additional registration in Indiana in that case, but that doesn't mean the agent doesn't have to be registered anywhere. Right?
If a broker-dealer has a place of business in Arkansas, they must register there. Period. If they want to serve retail customers in Louisiana, they have to register with Louisiana. If all their customers were institutions in Louisiana and the firm had no place of business there, no registration would be required by the state of Louisiana. No additional registration required in that case.
So, as always, read the questions carefully and think through them analytically. Also, hang onto the big concepts below:
  • If an agent represents a broker-dealer, he has to register, period
  • If an agent or broker-dealer has a place of business in the state, they have to register in the state
  • If an agent or broker-dealer have no place of business in the state and no non-institutional customers, they do not have to register in that state

What's the Deal with Exempt Securities?

Maybe you've sat through one of the live classes that remain the bread and butter of the bigger vendors. If the instructor tried to teach the fundamentals of the Uniform Securities Act to you, chances are he made a lot of noise about "exempt securities" and "exempt transactions" but never quite explained what the terms mean and--more important--what they don't mean. When I used to teach for a big vendor in this industry, I had to use the sorry materials I was handed, and no matter how I tried to spin it, I could tell that many students walked out thinking the following:
  • if the security is exempt, it is not subject to the Uniform Securities Act's anti-fraud statutes
  • if the security is exempt, the agent doesn't have to be registered
  • if it's an unsolicited order, an unregistered person at a broker-dealer can accept it
  • if the customers are all institutions, the agent of the broker-dealer does not have to be registered

What the above four bullet points have in common is this: they aren't true. But, in the confusion of a four-hour Series 63 class or maybe a two-hour segment of a Series 65/66 class, it's very easy to understand why students would come out thinking that way. So, let's clear up some big points here. First, not every investment meets the definition of a "security," but if it is a "security," it is subject to the Uniform Securities Act's antifraud regulations, whether it has to be registered or not. A US Treasury note doesn't have to be registered, but if an agent offers one to me under false pretenses, that is still securities fraud. Second, all securities have to be registered except for all the securities that don't have to be. A security that does not have to be registered is an "exempt security," which means it's still a "security" subject to antifraud regulations. It just doesn't have to be registered. For example, US Government securities, municipal securities, bank securities, and highly rated commercial paper do not have to be registered. What about the agents selling them? If they work for a broker-dealer, they have to register. I mean, if agents selling municipal securities didn't have to be registered, why would there be a Series 52 for people selling municipal securities? A Treasury note doesn't have to be registered, but an agent of a broker-dealer selling Treasury notes to customers does have to be registered. The only time we care about whether the security is exempt is when the individual represents the issuer of that security and does not get special compensation to sell it. If the CFO of a company wants to essentially get a loan by selling commercial paper to an institution, she does not have to register. Or, even if the CFO wanted to sell an ownership stake in the company to institutions only, that would not meet the definition of an agent. But, again, if you represent a broker-dealer in selling securities, you have to be registered.

If a security is non-exempt, it still might escape registration if it's sold through an exempt transaction. This is the one case where an "unregistered, non-exempt security" can be offered and sold without getting in trouble. But, if you're an agent of a broker-dealer taking indications of interest for this offering, YOU have to be registered. You don't work for the issuing corporation, right?Again, if you work for a broker-dealer selling securities, you have to be registered. The security might or might not have to be.

So, if the test asked if an agent of a broker-dealer would have to register just to sell municipal securities to institutional investors, the answer would be . . . absolutely. Why? Because he's an agent of a broker-dealer. In the rare case where somebody works for the issuer of an exempt security or represents the ISSUER in an exempt transaction--getting no special compensation for the sales--that person escapes registration.

Friday, October 22, 2010

Practice Question, investment risks

The Series 65/66 exams don't like to give you a lot of questions that prove only that you've memorized something. You'd never know that from attending many of the live classes across the country, but, I assure you--it's true. NASAA doesn't like a lot of memorization. For example, you don't get to simply memorize "ADR = foreign stock, domestic market." You have to tell them how an American holding an ADR would be affected if the US dollar depreciates relative to the foreign currency. Similarly, you can't just memorize that zero-coupon bonds have "high duration" or a lot of interest rate risk. You have to know that much in order to think outside the box and apply that knowledge on a fun question like this:

If an investor purchases a 10-year US Government zero coupon bond that he plans to hold to maturity, the most important investment risk is

A. market risk

B. interest rate risk

C. purchasing power risk

D. reinvestment risk

EXPLANATION: zero coupon bonds have no reinvestment risk because there is no cash flow coming in every six months to reinvest at varying rates. Eliminate that choice. Market risk is always a problem because investors can definitely panic like a herd of buffalo--but the question says he's going to hold the thing until maturity. What does he really care about the market price if he isn't going to sell? Doesn't that also eliminate "interest rate risk," which sends the market price down when rates rise, but, again, he has no plans to sell? Yes. I think. I mean, at least I have some pretty solid reasons to eliminate those two answer choices. Can I eliminate "purchasing power risk"? No--he's locked into a fixed rate of return over 10 years. Who know where inflation will be?
That's the type of thinking you'll have to do on the exam. You won't know for sure if you're on the right path. Your job is to see if you can eliminate answer choices until you get down to the one you can't eliminate. That one is the right answer.


Tuesday, September 28, 2010

Cease & Desist

When an agent or an investment adviser violates securities law, the Administrator can issue an order to suspend or revoke the license. Before issuing the final order, the respondent has to receive prior notice, an opportunity for a hearing, and the writing findings of fact and conclusions of law that he and his attorneys need to explain somehow to the regulators in a more positive light. On the other hand, if somebody is out there offering securities in his company that are not registered, he has no license that can be suspended or revoked. In this case, the Administrator will issue a "cease & desist" order, with or without prior notice and a hearing. A "cease & desist" order is an official warning from the state securities Administrator to cut it out, or else. If the respondent ignores the Administrator's authority, the test calls that "contumacy." The Administrator can then ask the courts to issue a restraining order/injunction, and if the respondent blows that off, he's looking at "contempt of court," punishable by fines and even jail time. If you click the title of this blog post, you'll see a real-world cease & desist order issued in Arkansas to two gentlemen going around promising 120% annual interest from people who perhaps should have known better. As you can imagine, nobody got his money back from this program. Take a look for yourself--many testable points are illustrated in this Administrative order.

Saturday, September 25, 2010

Exempt Securities in the Real World

I taught a live Series 65 class this past week for the accounting firm who does tax work for my S-corp. It was amazing how quickly this group of five CPAs can absorb new, complex information, but we definitely hit the wall when we covered the Uniform Securities Act's provisions for securities. One of the CPAs said at the end of that section, "That seems to be the most vague of all the information we've covered."
Amen, brother. Regulators like things nice and vague when it comes to "securities." They like vague phrases like "investment contract" or "anything commonly known as a security" because it allows them to fit just about anything under that category if they want to regulate it. So, step one is this: does the investment meet the definition of a "security"? If so, it is subject to anti-fraud rules, whether it has to be registered or not (exempt). That means that a fixed annuity or a whole life insurance policy is not even subject to anti-fraud regulations. Why not? Neither one is a "security." Then, there are securities that are excused from registration requirements. They're still securities, so anti-fraud rules still apply. These securities just don't have to be registered. They are excused/exempted from the registration requirements. For example bank stock does not have to be registered with securities regulators. Neither do church bonds. A church bond is sold with an offering circular rather than a prospectus. But, that doesn't imply that the investment is somehow safer than other debt securities, and the offering circular will announce that at the very beginning. To see how this stuff works in the real world, please check out an offering circular for a "church bond" or series of "mission investments," really, at:
You'll notice that the investments are being sold by employees, who receive no special compensation for sales (not agents). You'll notice that the expenses incurred to sell the investments are about $1 million per year. You'll notice all the disclosure that is provided . . . because even though the securities aren't registered, they are subject to anti-fraud rules. Investors have to be informed of all the risks involved; otherwise, they could sue if they lose money. Spend some time with this document, and I'm confident you will begin to understand "exempt securities" and securities registration issues in general much, much better. Enjoy.

Tuesday, September 14, 2010

Real-World Fundamental Analysis

I was just reading the current issue of TIME and on page "Global 14" there is an article that brought up several testable points. The article discusses a new technology called "hydraulic hybrid" that is used to build fuel-efficient, "green" garbage and recycling trucks. They run about 20% higher than the typical $200,000 for these monster trucks, and they're produced by Eaton, Parker Hannifin, and Peterbilt. There are 70,000 garbage and recylcing trucks currently driving around this nation, and they'll all have to be replaced eventually. Notice how the facts so far have been about sales and the size of a potential market--that's fundamental analysis. Given this information, a great fundamental analyst like Warren Buffett could take an envelope and a pencil and answer some basic questions on each of those three firms like:
  • How many trucks will need to be replaced each year for the next 10 years?
  • How big is the company's market share projected to be?
  • What is their profit-per-unit-sold?
  • How much will profits on these vehicles impact the company's overall net income/bottom line?
  • Does the company have a competitive advantage?
  • Who are the officers and directors, and what have they done in the past?

Notice how some of these questions are answered with numbers and some are qualitative. No matter how quantitative we get, it's all based on projection and speculation. Out of 70,000 vehicles that need to be replaced, we first have to guess how many of those customers will pay the higher price for the hydraulic hybrid. We could be way off there. Then, we have to guess what % of the projected market will go to the firm we're analyzing. At this point, we could be so far off that every calculation about the revenues, costs, and profits will become exponentially inaccurate. Maybe that's why the efficient market theorists have such a following? Not only do we have to get these calculations and assumptions right, but we have to do a "discounted cash flow" model to figure the "net present value." And, we'd have to somehow marry that sort of braniac calculation with the guesswork involved with deciding if a particular senior management team is trustworthy and/or more likely to succeed in this new market space than any other. So many places it could go wrong. Not to mention that this new technology exists largely through government subsidies, and so the fundamental analyst has to try to figure out if those subsidies will keep coming and, if so, will they increase or decrease? If they dry up, which company would most likely survive without them? So, we have regulatory risk (subsidies might dry up) and risk of obsolescence (the technology) also threatening to make a mockery of our sophisticated calculations. No wonder there are technical analysts who leave all this fundamental hand-wringing to others. Just tell them the stock symbol, and they'll pull up the data on its market behavior. What's the 52-week high and low price of the stock? What's the 200-day moving average for its closing price? Where's the support and resistance? What's the volume? Technical analysts study market data, your exam might say.

Fundamental analysts, on the other hand, study companies--their operations, their projected revenues and profits. And, I'm sure some of them pretend they buy stocks based on the "discounted cash flow model" when, really, they just have a feeling about this Google, Facebook, or Groupon company everybody's talking about.

Thursday, September 9, 2010

Almost famous

Pass the 65 and Pass the 66 are getting just big enough now to have clients who are celebrities. If you've visited the fan page at you might have noticed that one of our Series 7 clients sent in a photo of his smiling face with passing score in hand outside the testing center. He happens to be Whip Hubley, with film credits including Top Gun and St. Elmo's Fire.
This morning while reading the Sun-Times, I saw a full-page ad for Macy's with a familiar looking photograph at the center. Under the photo, the name Vicki Gunvalson really caught my eye. Hey, I know her, I realized. She's studying for the 65. Turns out, she's also a reality TV star on The Real Housewives of Orange County. She's in Chicago tomorrow night to autograph copies of her new book and help Macy's sell some high-end apparel.
Not only do I know Vicki through emails, but here in Chicago her sister, Lisa, has been coming in for Series 65 tutoring recently. Today she managed to pass her Series 65 on her third attempt, with a 76%. That's going to put the pressure on her famous sister, I'm thinking. I wonder if it's possible that this little back story could somehow find its way into the reality show. Maybe I go on the show and provide some private tutoring for Vicki's Series 65. Take her to the point of tears like some psychotic personal trainer--I think that's what sells on reality TV, right? Other people's pain. And, boy, I can't think of a bigger source of pain than the Series 65. Maybe it's nutty, but I think it would make for some good reality TV.

Tuesday, August 24, 2010

Tough Options Question

Some of the options questions on the Series 65/66 exam can be quite alarming. Like this one:

An investor owns a portfolio of large-cap, blue chip stocks, all of them in the Dow Jones Industrial Average. He fears a downturn and wants to protect his holdings without selling off the stocks. To best protect the portfolio, he should
A. purchase a narrow-based index put
B. purchase a broad-based index put
C. sell a narrow-based index call
D. sell a broad-based index call

EXPLANATION: they key is to know that "the Dow" is a broad-based index of stocks from many different industries. That eliminates the "narrow-based index" choices. Narrow-based indexes focus on a particular sector, i.e. the pharmaceutical or telecommunications index. Now, if the question says the investor wants to generate some income, recommend that he sell an option. When the question says or implies that he just wants to protect a position, have him buy something. He's afraid the index could drop, so he buys a put on the index.


Thursday, August 5, 2010

Another blurb on FEINs

So, based on the last post, a test-taker like yourself might conclude that sole proprietors don't receive FEINs. That's certainly what the folks who write test questions are hoping--they love assumptions that people bring to the testing center. They exploit them again and again. Do sole proprietors receive FEINs?
Not automatically, the way a corporation or an estate would.
But if you look closely at the questions the IRS asks in the previous post, you begin to see that it could easily include sole proprietors. A word like "excise" is easy to just skim over because it's boring and, let's face it, so is most of the Series 65/66 material. But a trucker would have to pay "excise" taxes and, therefore, need an FEIN. And a restaurant could be owned by a sole proprietor, but if he has 20 waitresses and 10 cocktail servers, he's going to either admit he has "employees" now or wait for the revenue collectors to issue a ruling plus penalties and interest. He needs an FEIN. So, as always, don't make assumptions. Think through your answer choices clearly--is this always the case? Are there exceptions to this general rule? Did anybody ever actually say that, or did I just sort of assume that?
That's what the test demands of you--an ability to think clearly, from many angles, using creative problem solving and solid reasoning.

Wednesday, August 4, 2010


A federal employer identification number (FEIN) would probably be easier to understand if it were only issued to, you know, employers. But as you've probably noticed, things are never what they seem to be in connection to finance, taxation, and other testable points. An estate also receives an FEIN, which I learned when serving as executor several years ago. A trust receives an FEIN. Estates and trusts are legal entities/legal persons. Like corporations and partnerships, they receive FEINs from the IRS. If you go to the IRS website and type in "fein," you find a helpful table that determines if somebody needs to apply for an FEIN. If the answer to ANY of the following questions is "yes," then the person needs to get a federal employer identification number:
Do you have employees?
Do you operate your business as a corporation or partnership?
Do you have a Keogh plan?
Are you involved with: trusts, estates, REMICs, non-profit organizations, farmers' cooperatives, plan administrators

Is this informatoin testable?
Sure. If NASAA says that "taxation issues" are testable, they only give a couple of examples as to which items we should focus on. Everything is, apparently, testable. And, since business entities are a testable item, we have to assume that you might need to remember what an "FEIN" is and that trusts and estates have them, as do corporations and partnerships.


The Series 65/66 exams definitely consider limited and general partnerships to be fair game, as they indicate on their exam outlines. How would you navigate a question like this one . . .

Which of the following is an accurate statement of the business structures known as "general partnerships" and/or "limited partnerships"?
A. only limited partnerships allow for direct flow-through of income and expenses
B. both ownership structures leave at least some owners with unlimited liability
C. general partnerships are no longer enforceable effective January 1, 2011

D. general partnerships relieve the owners of personal liability

EXPLANATION: a general partnership is really just a sole proprietorship with more than one owner. These folks want to go into business together, so they form a general partnership. It does provide for flow-through of income and expenses, but it also leaves all general partners personally liable for debts and lawsuits of and against the business. To form a limited partnership, you have to have at least one general partner (GP), and GPs always have unlimited liability. Don't read a choice like Choice C and automatically assume you forgot to study something. The Exam occasionally makes stuff up to see if you'll fall for it when a much better answer was available. Don't do that. Instead choose answer . . .


Thursday, July 22, 2010

Get Your Head in the Game

I'm going to tread a thin and dangerous line here. On the one hand, I don't want to offend any of our customers, but on the other hand, I want to help all customers pass their exams. Here's the issue: WAY too many Series 65 and 66 candidates are trying to pass their exams without making a full commitment to the process. They don't like or understand the process and, therefore, want to pay as little attention to it as possible. How else to explain all the emails we get over the absolutely simple Pass the 65/66 ExamCram Online Test Prep? "I never got my username and password!!!" we see at least twice a week. "I never got my CDs for the ExamCram stuff!!!" we see just about as often.
Okay, first, we've plastered all kinds of warnings that there ARE no CDs, that you choose YOUR OWN USERNAME and PASSWORD, and that if you don't see the automatic email, check your spam folder. Still, some customers swear they were "never told" about any of this.
Poppycock. They never opened their eyes is what happened. Guess how many times the computer servers have failed to send out the automatic email with the installation link?
Zero. They're computer servers; they do exactly as their told, no more and no less.
We have made the ordering process as simple as possible, and setting up the ExamCram Online Test Prep is as easy as paying attention, choosing your own username and password, and voila--you're ready to go.
So, if the process is so easy, how come some customers are still confused?
Because their head is not in the game. They're, apparently, still in the feeling-sorry-for-myself phase of the process and, therefore, pay as little attention as possible. That's exactly what the regulators are hoping. Like an oversized defensive line, the regulators are hoping you try to break through the line going half-speed. That way they can crush you and get one or two more rounds of testing fees out of you.
Is it fair that you have to take the Series 65/66? Don't know; don't care. You either want to pass the test and, therefore, put maximum effort into it. Or, you need to look at a career change. It's bad enough that we see every single day orders from people who, allegedly live in Chicago, Idaho, Dallas, Tennessee, and Anchorage, Alabama. Uhm . . . you will be entering all kinds of important information on your clients into computer systems once you get licensed. If you can't get your own state and credit card number on the order right . . . well, again, your head is not in the game.
We don't offer support groups or personal therapy. If you don't think you should have to take the test, don't. But if you want to pass it, we have provided everything you need. Unfortunately, all we can do is provide the material. We can't open it, activate it, or study it for you.
Are you interested in passing the test, for real? Good. Let's get our heads in the game, then, before we step onto the playing field.

Tuesday, July 20, 2010


The exam loves to ask surprising and tricky questions about IRAs and other retirement accounts. How would you answer something like this one?

Your Aunt Betty will celebrate her 70th birthday on July 11th, 2011. Therefore, you would remind her that she must take her first distribution from her Traditional IRA no later than

A. April 1, 2012

B. April 1, 2013

C. December 31, 2012

D. April 15th, 2012

EXPLANATION: investors benefit by letting their money grow tax-deferred as long as possible in the Traditional IRA. But, the IRS insists on being paid eventually. The longest we can wait to start taking money out is April 1st following our "70 1/2th birthday." This investor was not 70 1/2 in 2011 . . . not until 2012. So, she has until April 1st 2013 to take her first withdrawal. She'll have to make two withdrawals that year, but she can wait that long without being penalized for failing to take her required minimum distribution. BTW, you would only be 70 1/2 in 2011 if your birthday occurred by June 30th.


Monday, July 12, 2010

Durable Power of Attorney

When people finally face their biggest fears and respond by doing some estate planning, chances are they will want to express their wishes now as to what happens should they become incapacitated. A "living will" is a document that allows an individual to express her wishes concerning life-sustaining procedures. Does she want all possible measures to be taken while she's in a coma or terminally ill, or does she want them to "pull the plug" if her quality of life is virtually non-existent? That's all that a living will does. If an individual wants to take it a step further, she can appoint someone to act as "attorney in fact" or "agent" on her behalf should she become incapacitated. She can achieve this by establishing a durable health care power of attorney. The durable health care power of attorney grants the agent or "attorney in fact" for the individual the power to make health care decisions for the individual if the individual is unable to do so after an accident or illness.

There are also general powers of attorney that appoint an agent/attorney in fact to oversee your financial matters should you be incapacitated or, perhaps, traveling overseas and unable to manage your own financial dealings. This type of power of attorney can also be made "durable." The individual, with the help of her lawyers, can draft a durable power of attorney so that it is clear when the power "kicks in." Maybe it's when a named physician determines that the individual is truly incapacitated. Or, maybe it's when two separate physicians come to that conclusion.

Whether it's a durable health care or a durable general power of attorney, the test may ask if it remains in force after the individual dies. The answer: no. The power survives the incapacitation of the individual (also called the "principal"), but not his/her death.

European Style

How would you answer the following question?

A European-style option is considered a "derivative" because
A. the option may be exercised prior to expiration of the contract
B. the value of the contract is contingent on the value of some other thing
C. the option may be exercised only at expiration of the contract
D. the option contract is created and traded on a non-US exchange

EXPLANATION: you do need to know that a European-style option can be exercised only at expiration. If you know that, you can eliminate Choice A, which describes "American-style" options. The option contract can trade on a US Exchange, so you can eliminate Choice D. Is Choice C true? Not within the context of this question. Yes, European-style options may be exercised only at expiration, but that is not what makes them "derivatives." Believe it or not, what makes them derivatives is the fact that they derive their value based on some other thing, i.e. a stock, or an index.


Thursday, July 8, 2010

Custody Issues for Advisers as Trustees

Since we've been having such a rip-roaring good time discussing custody issues, let's keep bringing up points made in NASAA's page-turner of a model rule. Often the trustee of a trust is an investment adviser and not just the trust department of a bank & trust company. Investment advisers like to get paid, and it's convenient to be paid directly by the custodian of the securities account. If the adviser can appropriate/receive his fees from the custodian, the adviser does have custody. But, the adviser can avoid the higher financial requirements and the CPA surprise audit if they follow certain safeguards. To avoid those requirements, the adviser must indicate on Form ADV that it does or may have custody. The adviser needs the written authorization of the grantor (if he's still alive) or the attorneys for the trust (if it's a testamentary trust, established upon death of the grantor), the co-trustee (other than the adviser or its employees or owners), or a beneficiary of the trust. The adviser needs to send a billing statement showing the asset values and the method used to compute the fee. And, the custodian has to agree to send at least quarterly to the attorneys/grantor/co-trustee/benefiary a statement of all disbursements from the account of the trust, including the amount of investment management fees paid to the investment adviser and the amount of trustees' fees paid to the trustee.
If all of these safeguards are taken, the adviser acting as trustee can receive advisory fees directly from the qualified custodian. The adviser would have custody but would have the minimum financial net worth/bonding requirement waived.

Wednesday, July 7, 2010

Custody Issues

Let's cover potential exam concepts concerning custody issues since you almost certainly will get one or two questions on this stuff. First, you should probably read NASAA's model rule on custody requirements for Investment Advisers at Second, you need to understand the background here: most advisers don't want to be deemed to have custody of client assets. If they are deemed to have possession of client securities and/or cash--or the ability to appropriate securities and/or cash--advisers are generally subject to higher net worth requirements ($35,000 minimum) and the annual surprise CPA audit. So, a wise adviser usually avoids being deemed to have custody. For example, if the client sends the adviser a 3rd- party check, that check needs to be forwarded to the payee within 24 hours. If not, the adviser had custody of client assets. If the adviser receives client securities in the mail, the adviser needs to return them to the sender in 3 days to avoid being deemed to have custody of those securities. In both cases, if the adviser keeps records as to what happened, the adviser will not be deemed to have had custody and will not need to notify the Administrator by updating Form ADV. Advisers who manage client portfolios typically have the discretion to trade the account, with the account held by a custodial broker-dealer such as Charles Schwab, TD Ameritrade, or Fidelity. So far, such an adviser would not be deemed to have custody of client assets; however, the adviser will likely want to get paid by the custodian quarterly. If the adviser can obtain his advisory fee from the client's account, he does have the ability to appropriate client assets and is considered to have custody. Does he have to maintain the higher financial requirements and the CPA audit? Not if he follows certain safeguards. The Adviser needs to indicate on Form ADV that they intend to follow the safeguards, and if they do, in fact, follow them, the net worth/bonding and the CPA audit requirements are waived. Here are the safeguards:
  • written authorization from the client to deduct advisory fees from the account held with the qualified custodian
  • Each time a fee is directly deducted from a client account, the investment adviser must send the qualified custodian an invoice of the amount of the fee to be deducted from the client’s account and send the client an invoice itemizing the fee. Itemization includes the formula used to calculate the fee, the amount of assets under management the fee is based on, and the time period covered by the fee.

So, the adviser does have custody if he can obtain his advisory fee directly from the custodian. But, he can avoid the usual hassles related to custody by following certain safeguards. What's the big deal about custody? Well, Bernie Madoff would not have made off with people's money if they would not have let him have custody of those assets. Since their "adviser" was able to send account statements, with no independent oversight, he was able to show clients any numbers he thought they'd believe, even after all the money was gone. If the custodian is independent of the adviser, there is no reason to doubt the veracity of the account balances. When the adviser can show you whatever numbers he thinks you'll believe he can A) overcharge your account or B) mislead you into thinking that you actually have an account when, in fact, all the money was drained years ago.

Monday, July 5, 2010

Variable Annuities

The exam will likely ask you 3 or more questions on variable annuities. How would you answer something like this:

Which of the following statements is/are true of non-qualified variable annuities?
I. the annuitant's return of principal is guaranteed
II. the annuitant's net deposits into the account equal her cost basis
III. the annuitant is subject to penalties on withdrawals prior to age 59 1/2
IV. the annuitant is subject to penalties if withdrawals do not commence by age 70 1/2

A. I
C. I, IV

EXPLANATION: choice "I" is true only during the accumulation phase due to the death benefit, but the statement falls apart during the annuity phase and, therefore, has to be eliminated. The variable annuity does not promise a return of principal, which is one of the risks disclosed in the prospectus and sales literature. If the annuitant dies during the accumulation period, the beneficiaries receive at least what he put in, but when the contract is annuitized, there is no guarantee on what will be received. So, eliminate choices A and C. Now, you get II and III for free because they are both in the remaining two choices. The only difference between B and D is that one contains choice "IV" and one doesn't. So, do withdrawals have to begin at age 70 1/2? Even though the 10% early withdrawal penalty is there, the annuitant does not have to start taking money out at age 70 1/2. . . not on a non-qualified variable annuity. Choice D is eliminated, leaving you with . . .


Also remember that a qualified variable annuity would be subject to lifetime maximum contributions and would force the annuitant to begin withdrawals at age 70 1/2. So, as always, read each test question very carefully.

Saturday, June 19, 2010



Which of the following are considered to be acting in a fiduciary capacity?
I. securities agent recommending an aggressive growth stock
II. investment adviser representative
III. executor of an estate
IV. CEO, when deciding on matching levels for a 401(k) plan

A. I, II

EXPLANATION: the securities agent is not a fiduciary, unless he's been granted discretion over the account. The CEO is performing a "settlor function" when deciding on matching levels--making a business decision, in other words. The executor of the estate is a fiduciary, so the answer had to contain "III".


Sunday, June 6, 2010

Settlor Functions practice question

If the test asks about "settlor functions," maybe it would throw something like this at you:

An employee participant of a 401(k) plan is 61 years old. A family member, who is an attorney with a specialization in financial matters, tells her that if her company had provided a higher matching contribution she "would be a lot better off financially" now. Therefore, under ERISA, the CEO and other fiduciaries of the plan
A. can be sued up to the amount that the company could have contributed with a higher matching incentive in place
B. can not be sued for breach of fiduciary duty
C. can be sued up to the amount that the company could have contributed with a higher matching incentive plus the expected return on that amount over the holding period
D. can only be sued for breach of fiduciary duty while performing settlor functions

EXPLANATION: as we said in the previous post, the CEO's decision on how the company will match employees' contributions, or whether they will match them at all, are examples of "settlor functions" in which the fiduciaries to the plan are NOT acting as fiduciaries. Instead, they are making business decisions. So, A and C can be eliminated, and so can D. Remember, the CEO is not a fiduciary based on his title of CEO. He's a fiduciary to the plan participants and their beneficiaries only when functioning in that capacity. His or her decision to start or stop a 401(k) plan would be a "settlor function" based on how it affects the business. If, on the other hand, the 401(k) plan offered to employees does not provide enough information on the funds or the participants' balances, or doesn't allow them to alter their investment choices at least quarterly, then the CEO could be breaching his or her fiduciary duty.


Thursday, May 27, 2010

Settlor Functions

Apparently, the term "settlor functions" has been known to appear on the Series 65/66 exams, so let's take a brief look at this concept. As you know, ERISA says that pension funds and 401(k) plans are run by "fiduciaries" such as the CEO, investment advisers managing the assets, members of the board who oversee the plan, etc. But, the CEO is a fiduciary only when he's managing the plan or directing the investment advisers, for example. He's not a fiduciary to the plan participants and beneficiaries just because he's the CEO. It's the function, not the title, that makes him a fiduciary. So, when a plan fiduciary is actually just making "business decisions," called "settlor functions" by ERISA, he/she is not performing fiduciary functions. I'm looking at a letter from the Department of Labor, in which the Assistant Secretary of the Department explains that "in light of the voluntary nature of the private pension system governed by ERISA, the Department has concluded that there is a class of discretionary activities which relate to the formation, rather than the management, of plans. These so-called 'settlor functions' include decisions relating to the establishment, termination and design of plans and are not fiduciary activities . . . "

So, the decision to start or terminate a retirement plan is considered a business decision (settlor function), not a fiduciary matter. The exam might expect you to know that the following decisions are considered "settlor functions" and not fiduciary activities:

--Choosing the type of plan or options in the plan

--Amending the plan

--Requiring employee contributions/changing contribution levels

--Terminating a plan

I'll have to think up some practice questions for future posts. With any luck the exams won't go very deep into this topic. I'm still struggling to understand why investment adviser representatives actually need to know anything about this topic. As if relevance actually played a role in placing a question on the Series 65/66.

3rd Prong - business standard

Ok, we've looked at the question of whether somebody is providing investment advice, and whether that somebody receives compensation as a result of it. What, then, do the regulators mean when they ask, "Is the person in the business of providing investment advice?" ? In SEC Release IA-1092, the regulators state that, "Under section 202(a)(11), an investment adviser is one who, for compensation, (1) engages in the business of advising others as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or, alternatively, (2) issues or promulgates reports or analyses concerning securities as part of a regular business. Each of these two alternatives in the statutory definition of investment adviser contains a business test -- one involves 'engaging in the business' of advising others while the other involves issuing reports about securities as 'part of a regular business.' While the business standards established under Section 202(a)(11) are phrased somewhat differently, it is the staff's opinion that they should be interpreted in the same manner." As the release then states, "The giving of advice need not constitute the principal business activity or any particular portion of the business activities of a person in order for the person to be an investment adviser under Section 202(a)(11). The giving of advice need only be done on such a basis that it constitutes a business activity occurring with some regularity. The frequency of the activity is a factor, but is not determinative." Okay, what the heck does that mean? It means that there is really no objective standard whatsoever used to determine if someone is "in the business of providing investment advice." There is no guidance based on the percentage of income the advisory services comprise of a professional's total compensation, and there is no guidance based on the frequency with which the advice is provided. As that famous judge said about pornography, he can't define it, but he knows it when he sees it. Great. Let's see what the SEC has to say next: The staff considers a person to be "in the business" of providing advice if the person: (i) holds himself out as an investment adviser or as one who provides investment advice, (ii) receives any separate or additional compensation that represents a clearly definable charge for providing advice about securities, regardless of whether the compensation is separate from or included within any overall compensation, or receives transactionbased compensation if the client implements the investment advice, or (iii) on anything other than rare, isolated and non-periodic instances, provides specific investment advice. The SEC then writes, "For the purposes of (iii) above, "specific investment advice" includes a recommendation, analysis or report about specific securities or specific categories of securities (e.g., industrial development bonds, mutual funds, or medical technology stocks). It includes a recommendation that a client allocate certain percentages of his assets to life insurance, high yielding bonds, and mutual funds or particular types of mutual funds such as growth stock funds or money market funds. However, specific investment advice does not include advice limited to a general recommendation to allocate assets in securities, life insurance, and tangible assets." In other words, good luck trying to push the edge of that envelope. As if you're going to build a career telling people that they really oughta, you know, invest in securities, life insurance, and tangible assets, but, unfortunately, that's all you can really tell them. You can't tell them which types of securities to invest in, let alone which companies they might want to invest in. Good luck getting anybody to pay your bill for that "advice," right? Also, did you notice that if you merely "hold [yourself] out as an investment adviser or as one who provides investment advice," guess what--you're an investment adviser. In other words, if you pass out business cards announcing that you are available to provide investment advice, or if you put up a billboard trying to pull in new clients, you are definitely "holding yourself out as an investment adviser." Then again, if you do NOT hold yourself out as an investment adviser and privately advise not more than 15 clients, the SEC won't make your register. The states, however, can do what they want in that case--you have an office somewhere, maybe that state will require you to register. What do you want, a clear answer? Sorry, you're dealing with the regulators here, who like everything to remain at least as clear as mud.
What if somebody is a financial planner who avoids giving specific advice on securities? The SEC explains that, "In applying the foregoing tests, the staff may consider other financial services activities offered to clients. For example, if a financial planner structures his planning so as to give only generic, non-specific investment advice as a financial planner, but then gives specific securities advice in his capacity as a registered representative of a dealer or as agent of an insurance company, the person would not be able to assert that he was not 'in the business' of giving investment advice." So, the way I read all this mumbo jumbo is that if you provide specific investment advice for compensation, and you do it more than once in a VERY great while, you are in the business of providing investment advice and will almost certainly have to register, either with the SEC or the state regulators.

Thursday, May 13, 2010

Practice question on the 2nd prong

Let's try to apply what we've been discussing about the "three-pronged approach" to the following practice question:

Which of the following least likely meets the definition of an "investment adviser"?
A. an individual who merely rents a billboard in State A announcing the availability of "total financial planning services"
B. a financial planner limiting her services to budgeting, bill paying, and credit score improvement
C. a newsletter writer who covers mid-cap technology stocks and sends the newsletter to paid subscribers based on market index movements
D. a geological engineer who charges a flat fee to help investors determine promising royalty trusts and limited partnership interests involved with oil & gas exploration

EXPLANATION: the phrase "holding itself out to the public" often messes with people. But, the individual who rents a billboard is doing exactly that--holding herself out to residents of the state as being in the business of providing investment advice. Close enough--she's an adviser. The newsletter writer loses his exclusion by blasting out his so-called "newsletter" based on "market developments." He's only a newsletter writer if he's publishing a newsletter that goes out to a general audience on a regular circulation--if the thing goes out based on market developments, he's an adviser. The engineer would not be an adviser if he's merely telling partnerships whether there is or is not oil/gas underground worth trying to extract, but this guy is telling investors what to invest in, for compensation. He is also an adviser. While "financial planners" usually do meet the definition of "investment adviser," that is only if part of their service involves securities. If, on the other hand, they keep it to non-securities matters, they escape the definition.


2nd Prong, Compensation

Again, if you don't have our Pass the 65 ExamCram Online or Pass the 66 ExamCram Online, I highly recommend getting it. I continue to add new questions to the mix based on feedback from blog readers and customers. I'm confident that you will learn a ton from these products.
In any case, let's look at the next prong in the "three-pronged approach" to defining investment advisers: does the person receive compensation as a result of providing investment advice? Many candidates have a hard time with this one. They think that the compensation has to be in the form of money, but "compensation" includes any form of economic benefit. So, if you get a test question about a finance professional in a rural area who provides total financial planning and investing checkups in exchange for sacks of potatoes or sides of beef, that finance professional is receiving compensation for his advice and would meet the definition of "investment adviser." Also remember that the compensation does not have to be paid by the person receiving the advice. In the previous blogpost we had an insurance agent charging advertisers while providing advice to site visitors--makes no difference who pays him. He's getting compensation indirectly for providing investment advice. Close enough for rock and roll. Or, maybe a test question has somebody giving employees of a large company portfolio allocation advice and charging the company, not the employees. Again--makes no difference who pays him. He's providing investment advice and receiving compensation. He meets the definition of "investment adviser." What if a newsletter writer charges subcribers $300 a year for monthly emailed newsletters discussing large cap value stocks? Is that compensation? Yes. Is the newsletter writer providing investment advice? No. He's just writing a newsletter, just expressing his opinions as guaranteed by the 1st Amendment to the US Constitution.
In other words, you gotta think hard and carefully when dealing with these issues. Look for a practice question on the compensation issue in the next few blog posts.

Practice question on the 1st prong

If you don't have our Pass the 65 ExamCram Online or Pass the 66 ExamCram Online, I highly recommend getting it, even if you already have a full suite of materials. The questions are often challenging, and they provide clear explanations when you hit the "rationale" button.

Either way, let's apply what we discussed in the blog post before last, the one discussing "Does the person provide investment advice?" Here goes:

Which of the following least likely meets the definition of an "investment adviser"?
A. a certified public accountant who includes a 401(k) portfolio allocation service with his tax preparation services at no extra charge
B. an insurance agent who publishes a website in which visitors receive allocation strategies based on data they input; only site advertisers are charged
C. a writer of an Internet newsletter who publishes recommendations on small cap stocks to paid subscribers on the 15th of each month
D. a lawyer who offers total financial planning services to certain clients

EXPLANATION: this is a tough question. You have to find three people who do meet the definition of "investment adviser" and cross them out. The one who does not meet the definition is your answer. Right? Okay, what about the accountant--accountants are not investment advisers, right? Right?
Wrong--nobody ever said that. An accountant is not an investment adviser if he/she is not providing investment advice. But, this CPA is providing specific investment advice. Even though he doesn't itemize the bill with a charge for the advice, the advice is part of the services for which he receives compensation. This accountant is an investment adviser. The insurance agent might not receive compensation from site visitors, but he receives compensation from somebody as a result of providing specific advice. The insurance agent is also an investment adviser. The lawyer is holding himself out as a "total financial planner" to the public. I'd say he's an adviser. However, the newsletter writer gives no investment advice specific to anyone's individual needs. Therefore, he least likely meets the definition of "investment adviser."


Tuesday, May 11, 2010

So, Bob, Whadaya Think a' Goldman Sachs?

Without expressing any opinions on the Goldman Sachs situation, let me see if I can relate it to what you're studying for your exam. This is what the SEC is alleging so far in their civil suit: a sophisticated securities product called a "synthetic CDO" (collateralized debt obligation) based on residential mortgage-backed securities was marketed by Goldman Sachs to their investors. What investors didn't know, allegedly, is that Goldman Sachs allowed a hedge fund to help select the mortgage-backed securities for the portfolio and then bet against the portfolio. The marketing materials made it appear that the hedge fund's interests were aligned with those of the investors, when, in fact, their interests were in conflict with investors. Where's the conflict? If true, the hedge fund was able to structure a portfolio that would likely collapse and profit from that while, meanwhile, the investment bankers are selling the portfolio to investors, as if it's a good investment. Ouch. How many times have you read and tried to understand the phrase "undisclosed conflict of interest"? Well, this is one of those, apparently. Selling securities while concealing important/material facts is a big no-no, as all the big players know-know. Again, I'm not saying that's what happened; I'm just explaining how the SEC's actions relate to "undisclosed conflicts of interest" and "ommissions of material fact in the offer/sale of any security." There will be big, thick books written on this topic. I just wanted to relate the development to what you're studying in a brief blog post. By the way, if you have a few minutes, check out the actual SEC complaint at

Thursday, May 6, 2010

1st Prong SEC IA 1092

The so-called "three prongs" discussed in SEC Release IA-1092 include the following:
Does the person provide investment advice on securities?
Is the person in the business of providing investment advice?

Does the person receive compensation for the advice?

Let's look at the first prong in this post--does the person provide investment advice? A person is only providing investment advice if the advice involves securities--either their value or the advisability of buying, holding, or selling them. For example, a financial planner that deals only with insurance and budgeting would not meet the definition of "investment adviser." On the other hand, a sports agent who helps his clients determine how much money to invest in the stock market and how much in, say, real estate, or bank products, probably would meet the definition of "investment adviser," even if the advice does not involve specific securities--just the fact that he's telling people how much to invest in the securities markets is close enough for rock 'n' roll. Remember that a person could meet the definition of "investment adviser" whether meeting with people in person, or through emails and websites. So, if a professional provides individualized recommendations or financial plans by email or website only, that professional is an investment adviser. However, if somebody merely writes a newsletter on investing that does not provide any advice based on the needs of individuals, that person is a publisher, not an investment adviser. Doesn't matter how much the subscription costs; this person simply does not meet the definition of "investment adviser." Where this exclusion could be lost, however, is if the so-called "newsletter" is sent out based on "market developments." In other words, if this so-called "newsletter writer" is really just charging people to tell them when to buy or sell based on charts or trading patterns, that person does meet the definition of "investment adviser" and would probably have to register. So, if you get a question about a "newsletter writer," try to determine if this person is expressing his opinions to a general audience and, therefore, not an adviser; or is this person really telling people when to buy or sell securities based on "market developments" and, therefore, functioning as an investment adviser who uses market timing?
A lawyer could be determining the value of an illiquid investment in, say, an oil & gas drilling operation, when doing trust or estate work--does that make him an investment adviser? Probably not--that advice on securities values is "solely incidental" to his profession. But, that doesn't mean that lawyers can't be investment advisers. If they start providing investment advice, then they need to get registered. But, if they only work with securities to the extent required by their legal work, that's a different ballgame. Similarly, if your CPA "advises" you to maximize your IRA account, that's what she's supposed to do to help your tax situation. She's not an investment adviser if she's only doing tax preparation work. However, if the CPA starts providing financial planning services or "portfolio allocation" services, then she would be an invesment adviser and would need to register.
Don't try to memorize a bunch of bullet points here--train your mind to analyze each situation. How is the person functioning in the question? Are they giving specific advice on securities for compensation? If so, they're an adviser. If not, they're probably not an adviser.
We'll keep looking at this "three-pronged approach" over the next several blog posts. Once you begin to understand this material, a lot of other issues should fall into place.

Friday, April 30, 2010

Roth IRA question

Which of the following can a 72-year-old individual earning $20,000 annually not do in a Roth IRA?
A. continue to make non-tax-deductible contributions
B. make tax-deductible contributions to the account
C. elect to take no distributions
D. change the beneficiary

EXPLANATION: sometimes the wording of a test question can make an otherwise simple concept seem difficult. But, if you patiently read the answer choices and eliminate the ones you can eliminate, you usually end up with the advantage. What's tricky here is that true statements must be eliminated. Let's find three true statements, then. I like to start with the short statments like Choice D. Ask yourself, why couldn't somebody change a beneficiary? No reason, so D is eliminated. What about Choice C--can this person delay taking money out of the account? The government isn't going to tax the money coming out of a Roth, so there's no requirement to start taking distributions at age 70 1/2. C is true and, therefore, must be eliminated. Yes, it's tricky to have to eliminate true statements, which is why the exam likes to force you to do exactly that. What about Choice A, could a 72-year-old with earned income still contribute to a Roth? Yes. Not a Traditional IRA, but a Roth, yes. So, Choice A is eliminated.
Leaving us with the right answer . . .


Wednesday, April 21, 2010

What the heck is a mutual fund anyway?

The last post drew a comment from a long-time reader of this blog. Rather than answer the question in the comments section, I thought I would use it for a blog post. Daniel is now in the business and asks me the following question:

How can I define/describe mutual funds to a "normal" person? I know the financial definition of it, but I can't seem to reword it properly.

RESPONSE: I would tell investors first that they could always purchase shares of stock or individual bonds all by themselves without going through a mutual fund. Trouble is, if they only have a few hundred or a few thousand dollars, they will not be diversified that way, and it is very inefficient to purchase less than $100,000 worth of bonds due to the high markups or commissions that brokers charge. Rather than invest a few hundred or thousand dollars into just a couple of stock issues or one bond issue that could easily end up defaulting, most investors prefer to buy shares of a portfolio that is already diversified and run by a team of professional investors. We call these portfolios "mutual funds" because each investor mutually owns his percentage of each security in the portfolio. Now, a few hundred or a few thousand dollars can be invested and provide the investor with immediate diversification--it is safer to own little pieces of, say, 100 different stocks or bonds, versus putting all the money an investor has to invest into just a couple of stocks or bonds. Also, a mutual fund investor can liquidate some shares without losing the diversification he enjoys. If he, on the other hand, owned shares of stock, he would have to decide which issue to sell, and if he liquidated all of his GE, his diversification would be lost. In exchange for the diversification and the professional management mutual fund investors sometimes pay sales charges to buy or sell the shares and always pay expenses (management fees, 12b-1 fees usually, and other expenses). If the expenses are reasonable, it's a fair bet that most investors are better served through mutual funds as opposed to trying to pick stocks and bonds on their own.

In the textbooks I often describe a mutual fund as a big "portfolio pie" that serves up as many slices as investors want to buy. Every investor mutually owns his percentage of the portfolio pie. If the ingredients of the pie go up in value, so does the value of the investor's holding. If the ingredients (stocks and bonds) pay dividends and interest to the portfolio, that also makes the slices owned by the investor much sweeter/more valuable. If investors want to turn their slices of pie into cash, the mutual fund will do so any day the markets are open. There's no guarantee as to what a share will be worth on any given day, but that's always true of the investment world.

Tuesday, April 13, 2010

Administrative enforcement actions

The powers of the securities Administrator tend to generate a few questions on both the Series 65 and 66. Since most candidates struggle with anything connected to the Uniform Securities Act, let's make sure you understand the fundamentals. How would you answer a practice question like the following?

Which of the following Administrative orders is most severe?
A. cease & desist
B. suspension
C. cancellation
D. revocation

EXPLANATION: a good test question writer knows how to mess with the people who dared to come to the exam center without sufficient preparation--let's give these people three choices that sound pretty darned severe. Cease & desist sounds pretty harsh, but it's also an order that can be issued before a hearing has been granted and held and is often just a formal warning from the Administrator to cut it out. A cancellation is definitely final, but it's issued when a registrant dies, leaves the state, goes out of business, or is declared mentally incompetent. Nobody violated the Act necessarily--a cancellation is a "non-punitive order," meaning it does not provide a form of punishment. The "Administrator" in my state is also in charge of driver's licenses. If you're an inveterate lead-foot, you may already sense that a "revocation" is more serious than a "suspension" of your license, right? That's why the answer is the order of "revocation." An order of revocation from the Administrator is like a "bar" order from FINRA. Game over. Find a new career. We've seen what you have to offer, and you won't be offering any securities or investment advice anymore.


Wednesday, March 31, 2010

Stops, Limits, and Other Things Students Hate

A Series 65 customer just sent me a question by email:

Thanks for the tutoring on Saturday!! I am still a little unsure about the whole stop order and stop limit order. When do you want to use these ? Also does one make a bear market worse or a bull market better.. Also with the short sale... Are a lot of these a sign of a bull market...?

The following is my response to her inquiry:
Hi, Nicole

First, separate the sell limit order from the stop order. A sell limit order is placed at a price higher than the current market. Let's say the bid on ABC is $50, but you don't want to sell your ABC for anything less than $52. Place a sell-limit at $52. If the bid rises to $52, your stock is sold. If not, you keep holding. So there's no protection here. If the stock drops, it keeps dropping. You just want to sell it for a specific price or better/higher. The stock has to go up before it can be sold.

To protect your downside, place a sell-stop order. If you're holding ABC and the market price is $50, you could protect your downside by placing a sell-stop at, say, $49. If the stock stays above $49, you hold it. If it drops to $49 or lower, it is sold automatically. Notice how your upside is still wide open--you only sell to protect against a loss. That's why the order is also called a "stop loss" order. These can make a bear market worse because if the stock drops a little, a bunch of sell orders go off at the same time on autopilot.

If you turn this order into a sell-stop @49, limit 49, you no longer have protection. Why not? If the stock opens in the morning at $48.50, your order would be activated, but you're saying you won't accept one penny under $49. If the stock keeps dropping, the broker-dealer won't be able to sell it for you . . . not unless or until the stock makes it to $49 or higher.
So, to protect the position, enter just a sell-stop . . . don't add the word "limit." whenever the order has a " limit " price, it can only be executed at that price or better.

On a completely different note, a high level of "short interest" on a stock could be a BULLish indicator. If a big % of a company's stock has been sold short, it will also have to be bought back by the short sellers . . . that buying pressure could--maybe--raise the price of the stock. That's how technical analysts think--has nothing to do with the underlying company; it's based entirely on stock market data.

Wednesday, March 17, 2010

Broker-Dealers and Investment Advisers--Who's Who and What's What?

Remember that a broker-dealer is in the TRANSACTION business. As the Uniform Securities Act states, a broker-dealer is "any person engaged in the business of effecting transactions in securities for the account of others or for his own account." If the firm acts as a broker, they arrange a transaction for the accounts of others. If the firm acts as a dealer, they effect a transaction for their own account in which they buy from or sell to a customer. They work the secondary market, either arranging or participating in trades, and they work the primary market as investment bankers, bringing new issues to market in order to raise capital for government and corporate issuers. On the other hand, an investment adviser is not paid to complete securities transactions. An investment adviser, believe it or not, is compensated for providing advice on securities. This advice could be delivered in person or through reports and analyses. It could involve managing portfolios for a % of the assets, or charging a fee to act as a consultant or financial planner. The big financial services firms work both sides of the business, but they still register the broker-dealer as one entity and the investment adviser as another. For example, at Wells-Fargo, the structure is explained in their Form ADV 2 like this: Wells Capital Management Incorporated (“WellsCap”) is a registered investment adviser and a wholly owned subsidiary of Wells Fargo Bank, N.A. (“Wells Fargo"), which is wholly owned by Wells Fargo & Company, a diversified financial services company. If we go to the broker-dealer's website, we see that: Brokerage is offered through Wells Fargo Investments, LLC (member SIPC), a non-bank affiliate of Wells Fargo & Company. Now we see why the Uniform Securities Act exludes "banks, savings institutions, and trusts" from the definition of both broker-dealer and investment adviser. A bank may be related to a broker-dealer and /or investment adviser because they have the same parent, but they are only siblings. WellsCap is the adviser. Wells Fargo Investments, LLC is a broker-dealer. They are both siblings of Wells Fargo Bank, N.A., and all three have the same parent, known as Wells Fargo & Company. Three kids, all related, yet all distinct entities.
Yesterday, a young man came in for some Series 6 tutoring and was trying to figure out what some of the senior reps at NMFN are doing under "wealth management" and how it differs from what he'll be doing when he passes his Series 6 and 63. His question was prompted by my overview of the same mutual fund prospectuses he'll be handing out very soon to investors. As I explained to him, he will be selling investment securities products called open-end mutual funds to investors. He will be trying to "effect transactions in securities" on behalf of his broker-dealer, NMIS, who has a sales agreement with another broker-dealer called American Funds Distributors. After customers buy these investment products, money will be regularly deducted to cover management fees, which go to the investment adviser known as Capital Research and Management Company. As always, the broker-dealers get paid to effect sales of securities; the adviser gets paid a % of assets to manage the portfolio. The senior reps at NMFN, who get their Series 7 & 66, can work both sides of the business. They can sell mutual funds and annuities as securities agents of a broker-dealer. Or, when they work the wealth management/investment advisory side, they basically bypass the little product known as a "mutual fund" and simply put their clients' assets under management with a team of investment advisers. Average Joe and Joann, with maybe $100,000 to invest, are probably best served buying mutual fund products, in which their registered rep (of a broker-dealer) makes part of the sales charge and the ongoing 12b-1 fees. Big-Time Charlie and Charleene, with maybe $5 million to invest, are often best served by getting their own investment adviser/portfolio manager, who will charge a percentage of assets as opposed to calling them up twice a week to try and sell them something.
So, if the firm is selling securities to customers, they are acting as a broker-dealer. If the firm is managing the client's account for a % of assets, they are acting as an investment adviser. The big financial services firms work both sides of the business, but there are many firms that act only as broker-dealers or as advisers. For example, if I wanted to get directly into the financial services industry, I could easily become an investment adviser. All that would take is filling out Form ADV, paying $400 to the Secretary of State's office, and keeping better records than I've ever kept in my life. To become a broker-dealer, I would have to take a bunch of principal-level exams, become accepted as a member firm of FINRA, and somehow overcome the fact that I have no idea how a broker-dealer is actually run. It's a very unique and peculiar business model that requires all kinds of infrastructure. An "adviser" is really just anyone who can pass the Series 65, afford the licensing fees, and find enough clients willing to pay for the so-called "advisory" services. I could be your adviser without ever executing a trade--just charge you $1,000 a year to send you quarterly reports that tell you specifically what to do with your stocks, bonds, and real estate investments. If I were your broker-dealer, I'd be holding custody of your assets like a bank, and taking commissions every time you placed an online trade or told one of my rep's to buy or sell securities for you.
I was actually trying to keep this more concise. Sorry about that; I would have made it shorter if I'd had more time.

Thursday, March 11, 2010

Fun with Form ADV Part 2

There are several testable points concerning the adviser's disclosure brochure, which is usually just a copy of Form ADV Part 2. Let's look at a possible test question:

Which of the following is/are accurate of Form ADV Part 2?
I. it must be delivered within 48 hours after signing the advisory agreement with a new client
II. it must be delivered to existing clients requesting it in writing within 5 days
III. it must be filed with the Administrator
IV. it must be delivered to all prospects

A. I
C. I, IV

EXPLANATION: if this particular question showed up on the exam, it would be one of the hardest-hitting questions in the batch. Choice I looks good--but it's backwards; the disclosure contained in the brochure must be delivered 48 hours before you sign the agreement with clients, or at the time of signing if they have 5 days to cancel without losing any prepayment. Advisers offer to send the thing to existing clients, and if clients send a written request, advisers must send it within 7--not 5--days. In the old days ADV 2 did not have to be filed with the Administrator, but now it does. Finally, the brochure is not required if the client is a registered investment company or if the advice is considered "impersonal," meaning that it does not purport to be specific to individual clients.


You can view an actual ADV Part 2 at

Wednesday, March 3, 2010

The WRONG way to approach test questions

If you don't have our ExamCram Online Test prep for the Series 65 or 66, get it. Be sure to work the Power Quizzes, too, which is where the newest questions show up first. As you work through practice questions, try to avoid a common tendency that I just noticed again this morning. First, let's look at the practice question my customer is determined to get wrong:

Which of the following investments is exempt from the anti-fraud provisions of the Uniform Securities Act?
A. Treasury note
B. Federal covered security
C. Whole life insurance
D. None of the choices listed

My customer is convinced that "nothing is ever exempt from the anti-fraud provisions of the Uniform Securities Act." And that is almost true. However, if the thing in question is not a security, then it IS exempt from everything contained in the Uniform SECURITIES Act. Is whole life insurance (or a fixed annuity) a "security"? No. So whole life insurance/fixed annuities are exempt from the anti-fraud provisions of the Uniform SECURITIES Act. A T-note and a federal covered security are still securities, so even though they don't have to be registered, the people who sell them are subject to anti-fraud rules. Mislead me when selling IBM or a T-note, and you are subject to anti-fraud rules.
Why didn't my customer just pick "C"? Because he doesn't want to cooperate with the question. Rather than play along, he decided that whole life insurance is not an investment; therefore, the answer is D.
Hmm. If the question says "which of the following investments . . . " you can safely assume that it's not an arguable point whether all choices are investments--they are. Even if you wanted to make the argument, how could you? Where do you find the definition of "an investment" in any of the securities laws you've had to study? Is a fixed annuity an investment? I think so. Is it a security? No. Is a house a security? No. Is it an investment? Many people would say that it is.
But, why are you arguing? There is no one at the testing center with whom you can argue. You have to play along with the questions, or come back and try it again in 30 days.

Took the Series 66 Yesterday

So I took the Series 66 exam yesterday, just for fun. Looked pretty much like the Series 65, only shorter. Bigger focus on the Uniform Securities Act and various NASAA model rules and policy statements. Smaller focus on securities products. As their vague outline indicates, they focus on variable annuities, options, and life insurance under their little "investment vehicle characteristics" section. Expect 5 basic options questions, 5 on variable annuities, and 2 or 3 on insurance. They mentioned "capital needs analysis" twice, which I'm sure will please you insurance folks no end.

The only way I can feel confident that you're prepared is if you get and use the Pass the 66 ExamCram online test prep at If you're on a time crunch, go straight to the "Power Quiz." I will continue to add timely questions to that one, even after you purchase the product.

Also, you will need to be intimately familiar with the following NASAA model rules/policy statements:

Thursday, February 25, 2010


So I held an online Series 65/66 class today, and one of the attendees typed a message through the chat window that nearly sent me falling out of my chair. His question, essentially, was this:

I am currently in the process of registering my firm as an RIA. For the past few years I have been trading the online accounts of several friends, who gave me trading authorization. I don't charge any fees; instead, when my friends take their profits, they cut me a check for my share of those profits. This is okay, right?

My response was a little bit nicer than this, but essentially I wrote:
Uh, no, that's about as far from okay as you can possibly get. Why? First, if you're being compensated to manage your friends' accounts, you are an UNREGISTERED investment adviser. Even if you were registered, you can't share so-called "profits" with your clients based on gains on particular stocks. Why not? Because they aren't profits! If you put your friend into, say, 10 stocks, and one of them goes up 200%, you might think of that as a "profit," but what if the other 9 stocks drop 90%? Your friend is losing money big time. If the math doesn't jump out at you, let's try an example. Your friend has $100,000 in 10 stocks, $10,000 for each. One of those stocks goes up 200%, taking it up to $30,000. He sells and gives you a percentage of that, so he's made a "profit" of less than $20,000. The other $90,000 invested is worth only $9,000, now that those stocks dropped 90%. So, where's this "profit" you guys are talking about? YOU made a profit--your friend has lost in the neighborhood of 70-80% of his investment, depending on how much he shared with you. Hey, some friend you are!
That's why advisers get paid a percentage of assets--the whole account, not a percentage of the rare stock that happened to go up. If an adviser wants to share in capital appreciation, he has to use an index that represents the makeup of the client's portfolio, and if he meets or beats that index, then he can get a performance bonus. But, if you think that selling one stock for a gain is the same thing as a profit, you must believe that the stocks that have dropped 90% or more are just "paper losses." As if all stocks have to come back to your purchase price. The NASDAQ (qqqq) used to be at about 5,000. Now, almost 10 years later, it has not even come back to half that value. We could call it a "paper loss," just like we could call Sara Palin a thinker. Wouldn't make it true.
Even if you were doing performance-based compensation the right way, your friends would need to have at least $750,000 under your management, which I doubt is the case.

So, as Marsellus Wallace tells Butch in Pulp Fiction, this is pretty ******** far from "okay."

Wednesday, February 24, 2010

Scam leads to jail time

Sometimes it's hard to understand what "fraud" is all about when studying for your exam. Remember that fraud always involves an element of deceit or manipulation. If somebody sells you securities under false pretenses, you have been defrauded. For example, if I sell you stock in my company and never tell you that we owe American Express $800,000, use your money to pay them off, and then close down our office, you would be sort of upset, right? Or, if I pretended to be your investment adviser but was really just withdrawing money from your account and covering it up with bogus account statements, you might want to, you know, talk to me?
Just the other day, a gentleman in nearby Oak Brook was sentenced to 4 1/2 years after he sold stock in his company to 6 investors. Unfortunately for the investors, the gentleman's company had already been dissolved by the Illinois Secretary of State's Office when he sold the "stock", and he simply took their money to pay off his own bills and personal expenses.
Nice. If you want to see a press release, Google "Dion H. Welton." And never give your money to someone for any type of investment opportunity without checking things out first.

Thursday, February 18, 2010

Is Fannie Mae a Direct Obligation Now?

Got an email from a Series 7 customer who is attending a live "crash course" this week. Apparently, the instructor allowed an argument to persist over whether Fannie Mae is now a direct obligation of the US Government. I don't argue without doing my homework, so I went straight to FNMA's website and ended up reading key sections of their annual and quarterly reports. It only took a few minutes to verify that FNMA is still just a "GSE," or government sponsored enterprise. The federal government has placed a conservator over them, an agency of the federal government, and that conservator has authority to run the business. The federal government has agreed to provide hundreds of billions of dollars to FNMA, but that's not the same as saying that FNMA is a direct obligation of the US Government. It isn't. The US Treasury has given FNMA billions of dollars in exchange for senior preferred stock that converts to common stock at a set price. FNMA has all kinds of different preferred and common stock issues outstanding, but no dividends can be paid to any other preferred or common stock holder without the Treasury's approval, which means that right now the only dividends that will be paid are the ones paid on the "senior preferred stock" that the Government holds. The following line from the 10q clarifies everything: although our conservator is a US government agency and Treasury owns our senior preferred stock and a warrant to purchase our common stock, the US Government does not guarantee, directly or indirectly, our securities or other obligations.

So, I hope they didn't lose too much time to the "argument." Not sure why the instructor didn't think to look it up over lunch or during the break. And, I know for sure that the 65/66 can ask you to pick only GNMA--not Fannie or Freddie--as a direct obligation of the US Government, so stick with what you've learned.

Kind of interesting though, isn't it, that when the Treasury provides capital to a financial institution, it's typically done by buying senior preferred stock that converts to common stock. This way, if the capital infusion works, the common stock rises, Treasury sells at a profit, and the "taxpayers win." What if the capital infusion isn't enough and the company goes belly up, anyway? Then the taxpayers, you know, don't.

To watch a VIDEO presentation of this topic:

Sunday, February 14, 2010

Practice question on the Roth IRA

Let's see if you're ready for a question based on the changes to the Roth IRA account in 2010:

An individual filing singly and earning $201,500 in 2010 is able to do which of the following?
I. make a non-deductible contribution to a new Roth IRA
II. make a maximum deductible contribution to an existing Roth IRA
III. make a maximum non-deductible contribution to an existing Roth IRA
IV. convert a Traditional IRA account to a Roth IRA after paying taxes on the account balance


EXPLANATION: as I wrote in another post, the only thing that changes for Roth IRAs in 2010 is that an individual who makes what the IRS considers a high income can convert a Traditional IRA to a Roth IRA after paying ordinary income tax rates on the entire balance. Can he also contribute to the Roth? No. And no one ever makes deductible contributions to a Roth IRA. The answer is . . . d