OMG!

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."

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.

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: http://www.youtube.com/watch?v=sjEAxxrgPVA

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

A. I, III
B. III, IV
C. I, II, III
D. IV

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

The Administrator

The Series 65 and Series 66 are obsessed with the Uniform Securities Act. You will see tons of questions about securities registration and registration/exemptions for agents, advisers, etc. You will also see challenging questions about what the Administrator can and can't do, or what he would or would not do given various made-up little scenarios. For example, the following question should look pretty similar to something you'll see on your exam:

Under the Uniform Securities Act, the Administrator may bring an action in a court of law to force an agent to
A. resign from the firm
B. retake his exam
C. return money to a client
D. none of the choices listed

EXPLANATION: the true bad boys in the business often blow off Administrative orders, which are outside the realm of criminal complaints. For example, Chrisopher Maltasanti might not become overly concerned about the New Jersey Bureau of Securities' little "cease and desist order," even if he would probably quake in his boots over an arrest warrant from the FBI. So, if somebody is thumbing his nose at the Administrator, the Administrator can bring an action in court to request that the judge help to get the person's attention. The judge, if persuaded that it's necessary and in the public interest, can then issue a court order designed to convince the person breaking the rules to comply with the Administrator's cease & desist order. The Uniform Securities Act says [verbatim] "upon a proper showing by the [Administrator] the court may enter an order of rescission, restitution or disgorgement directed to any person who has engaged in any act constituting a violation of any provision of this act, or any rule or order hereunder." The "rescission, restitution or disgorgement" tells us that the answer is "C." To illustrate how this might play out, let's say that an unregistered adviser engages in some self-dealing in which he charges clients "management fees" in order to put them into "securities" of various deadbeat companies he owns, and no disclosure is provided that he owns the companies or how much debt they've accumulated with no hope of profits, and all clients lose big money. Happens all the time, believe it or not. And when it happens, the Administrator could file a civil action asking the court to issue an order that forces the shady guy to give back his advisory fees and give the clients their original money plus interest. The fact that the guy will NEVER be granted a securities registration of ANY kind is a foregone conclusion, by the way.

Investment adviser advertising

If you have the Pass the 65 ExamCram Online Test Prep, you may be pleasantly surprised at the testing center when you see questions very similar to what you've studied. Notice how I say "very similar," which is not the same thing as "exactly the same." Yesterday I saw questions using a few terms I've never heard of, and I am simply not able to recall all four answer choices to 140 questions, many of them so long one has to scroll just to read them. And, I only saw 140 questions out of an unknown number in the test bank. I would think there are at least 5,000 questions in that test bank, but I have no way of knowing that. I do know that I've taken the 65 four times over the past 10 years or so, and I only see one or two verbatim repeats across all those trips to the testing center. Then again, I know the style the test questions come in, I know the outline, and I know how to stretch the imagination to anticipate the weird questions that could show up based on what I've seen and on what customers report through the messy process of feedback. So, it's an art form, not a science, but I really think you'll be amazed by two things at the testing center when you take your Series 65 or 66 exam:
1) many of the questions will seem very familiar and
2) many of them won't.
That's why you have to be a good test-taker. You have to use test-taking skills to minimize the mistakes that people often make on questions they really sorta' know, and to maximize the number of right answers you get on questions you really sorta' don't.

Let's enjoy a fun practice question that should look fairly similar to the stuff NASAA throws at you on the Series 65 or 66 exam:

Nancy Needlemeyer taught finance classes at a large university for 11 years and this year started a financial planning business set up as a single-member LLC. Nancy's Series 65 exam requirement is waived upon request by the Administrator, and she files Form ADV with the state promptly and makes payment through IARD. Which of the following may Nancy indicate on her advertising pieces?
A. Stated fees are non-negotiable
B. I have been certified by the Administrator to offer financial planning services in the state
C. I have 11 years in the financial services industry
D. All choices listed

EXPLANATION: if advisory fees are negotiable, that has to be disclosed, and the same is true if the fees are non-negotiable. Regulators don't certify--they accept registrations. She was not in the financial services industry--she was a college professor/instructor/what have you.


ANSWER: a

What's so hard about the Series 65?

I can only take the Series 65 about once every 2 years, so as time goes on it gets easier to start believing the claims that some customers try to sell me about how they "saw all kinds of questions they'd never seen before" and how "crazy all the test questions were." However, I just got back from the testing center myself and while there was a handful of surprise questions, I was amazed at how closely the Pass the 65 ExamCram Online Test Prep questions track the real deal. No, I did not get a 100% because NASAA can ask anything they want about the US Tax Code, and even my CPA would not have known the answers to a couple taxation questions that I saw. I'm sure I also made a few simple mistakes, just as I do when taking my own questions (I only get a 96% or 98% on my own GoNoGo exams--seriously). But question after question, I was amazed and relieved to see simple points about investment adviser registration, securities features, investment risks, Roth IRA's, etc. In fact, I'm not sure how anyone could study the full package, especially with the ExamCram Online Test Prep, and not pass that test. The only explanations for a failing grade that make any sense at this point are: 1) lack of study time, 2) massive text anxiety, or 3) a wicked combination thereof.

If you don't already have it, get the Pass the 65 ExamCram Online Test Prep and take one or both GoNoGo exams at www.passthe65.com under "Am I ready to take my exam?"

Or through publications or writings

Here's a good practice question on registration issues for investment advisers:

Diane Davis receives detailed financial information from 19 individuals residing in four states and emails financial plans to them based on the data supplied to her by email. If she charges just $189 per year for this service
A. she does not meet the definition of "investment adviser" due to the amount of compensation
B. she must register with the SEC
C. she meets the definition of "investment adviser"
D. she does not meet the definition of investment adviser because she does not meet with any clients in any of the four states

EXPLANATION: she receives compensation to provide financial plans based on specific situations. Whether she meets face-to-face or advises people "through publications or writings" is not what's relevant. The relevant point is that she gives advice specific to each client and receives compensation for doing so. Don't confuse what Diane is doing with somebody else who might be writing a newsletter on investing that goes out to paid subscribers. Diane is not writing articles--she is advising clients without having to shower or put on make-up. That's all. Also, Diane would have to be in 30+ states to claim federal eligibility. She has no assets under continuous, supervisory management, so she can't reach the $25 million threshold.



ANSWER: C