Passing the Series 65 and 66 exams

Series 65 or Series 66 Tutoring?

2012-01-09T10:32:00.003-06:00

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Occupying Wall Street

2011-10-07T06:33:00.005-05:00

So once again folks want to add more regulations on the cartoon-like villain named "Wall Street." These folks obviously have never waded through, say, the Securities Exchange Act of 1934 and the rules "promulgated thereunder," or the dense, barely readable FINRA/NASD manual. If they had, they might see how futile it seems to add MORE regulations to an already highly regulated industry. The SEC, FINRA, and the state regulators have plenty of tools at their disposal. They can go after violators in administrative actions or civil court, maybe even refer cases to criminal prosecutors. And, believe it or not, the compliance officers at broker-dealers and investment advisers are pretty good at catching mischief internally.
Making fat bonuses and accepting bailout money--neither one is a crime. If Uncle Sam is handing out cash, take it, I say. These financial firms provide a huge benefit to the economy by raising capital for government entities and corporations and are behind every single 401K and IRA account in America. Rather than bash Wall Street, educate yourself on this fascinating part of our amazing economic machine.

Updates

2011-08-09T19:16:00.003-05:00

A few things have changed due to Dodd Frank. Some items could be testable. You can get a free update at www.passthe65.com/updates or www.passthe66.com/updates. The main changes have to do with the ADV Part 2, which will be in narrative vs. check-box format, and will have a supplement on the IARs overseeing/involved with a client's account. Also, AUM is now $100m for SEC (federal covered) eligibility.

Trouble with FINRA

2011-06-29T12:42:00.004-05:00

If you click the title of this post, first of all, remember to hit the back arrow; otherwise, you're gone. Secondly, know that this is all public information. The New Jersey Bureau of Securities--what the test calls the Administrator--operates in a very public fashion. If you get in trouble, they publish your name, address, and registration number. And they tell the world what you did and why that was, like, not allowed. For example, the respondent whom we find first on the list, under "Aaron, Shawn E." got in trouble with FINRA (formerly NASD) for, apparently, threatening and intimidating an issuer of common stock, telling them they'd better listen up, or he could drive down the market price of their stock based on his large holdings. Well, like a lot of guys, he overstated the size of his holdings, but that's not what got him in trouble with NASD. It was the whole threatening/extortion thing that really ticked them off. Notice how NASD (now FINRA) suspended him for two years--meaning he might be able to get back in after requalifying by exam and probably finding a firm willing to do heightened supervision for a while, assuming anyone wants to hire him. Also notice that NASD/FINRA notify the state Administrator when somebody gets in trouble with them. And, that the state has a whole separate hearing to determine if the license should be--in this case--revoked.

Registration and Trouble with FINRA

2011-06-29T12:24:00.005-05:00

Can I get registered as an IAR or RIA if I have gotten in trouble with FINRA in the past?

I get that question a lot. At http://passthe7.blogspot.com, we're up to about 350 questions and comments from people who either have arrests and criminal charges or previous trouble with FINRA, a bank regulator, or an insurance commissioner, etc. As always, the answer is: depends. A felony charge has to be disclosed on Form U4 and U5, but it generally takes a conviction to get your license denied or revoked by the state securities Administrator. A misdemeanor conviction will get you in trouble if it's "investment-related." That means that a misdemeanor conviction for shoplifting would be "investment-related" because theft is relevant to ANY position in the financial services industry. On the other hand, if you pled guilty to misdemeanor DUI, that would not be disclosed on Form U4 or Form U5. It's a misdemeanor, and it's not a crime that involves money or deception.
We're talking about criminal disclosure here. There is also a section on Form U4 for regulatory disclosure. If you had been a securities agent 7 years ago and got suspended by FINRA (NASD at that point) for churning and unauthorized transactions, that has to be disclosed when registering as an IAR with your state securities Administrator. Forget to disclose it, and the state will have a hearing to officially deny you a license. Game-over kind of thing. Remember that IARs and RIAs don't register with FINRA; FINRA is for the brokerage side of the business only. IARs always register with the states; RIAs are either state-registered or federally registered. To register as an RIA, the firm uses Form ADV. For some reason, this form only asks about problems in the previous 10 years. But when the IAR associates with the firm, they submit a U4, and this form asks if the applicant has EVER been convicted of/pled guilty or no contest to/charged with any felony or any misdemeanor relevant to the industry. Ever. I know of a few agents who answered "no" to those uncomfortable questions, but when the IL Securities Dept found out they were lying, they revoked their licenses. Game over. Never lie on a form filed with any securities regulator, especially if there's a chance you'll get caught.
There's always a chance you'll get caught, too. A darned good chance, in fact. And, when you go through the Administrative hearing and end up getting your license revoked, the Administrator will be happy to publish the whole thing, complete with your name, address, and registration number.
To see what we mean, let's visit the "Administrator" for New Jersey at: http://www.njsecurities.gov/bosdisc.htm

indexed annuities

2011-05-24T16:00:00.003-05:00

Indexed annuities are insurance products with a minimum rate of return guaranteed to the investor by the insurance company. If the index--usually the S&P 500--has a great year, the investor gets a higher return than the promised minimum rate. But, he doesn't get the full upside on the S&P 500. And, there may be a maximum that the contract can go up in one year, period. These investment/insurance products usually impose a surrender period during which the contract owner would lose a % if he/she took a withdrawal. So they are only suitable for people with no need of liquidity on the money they plan to put into the contract.

Where do I take my Series 65 or 66 Exam?

2011-05-16T07:58:00.004-05:00

Customers and prospects frequently ask, "Where do I take my actual Series 65 or Series 66 exam?" That's because while NASAA's website contains all kinds of information, they are not a well-known bunch of folks, and their website is just slightly more user-friendly than software developed in Redmond, Washington. In order to find information for your exams, you'd have to go to www.nasaa.org . . . then figure out that all the menus are only triggered as "mouse-overs." So, if you lay your pointer on "industry and regulatory resources" and then manage to click the little "exams" link, you'll then be at least half-way finished with your quest for knowledge. If you click on Exam FAQs, you will find the answer to the question above as well as several other important questions. For example, click on Where are the exams given? and you will see that: FINRA is NASAA's contractor for administering the Series 63, 65, and 66. As with other FINRA-administered exams, they are given at Sylvan Prometric Centers." NASAA then points you to the FINRA website, but I'll go ahead and tell you where you can find the "sylvan prometric centers" online, at www.prometric.com

Now, you want to actually SCHEDULE an exam? Better leave that nightmare of a process for a separate blog post. Seriously.

If they have a place of business in the state

2011-04-13T18:34:00.003-05:00

The Series 65/66 exam asks LOTS of questions on what I call "registration of persons." Does this broker-dealer or that adviser have to register in the state if it deals exclusively with institutional investors? That sort of thing. The exam is typically obsessed with these questions . . . which, to me, seems odd, since every single person taking the test obviously has to register and knows he has to register. Whatever. Let's keep it simple. If the "person," which means agent, broker-dealer, investment adviser, and investment adviser representative, has a place of business in the state, he/they have to register in that state. What does it mean to have a "place of business" in a state? More than you'd probably think. Most candidates assume that we're talking about an "office." And, we are, but that's just one example of a place of business. If the agent or adviser meets with people at a diner in New Jersey, THAT is their place of business. More surprising, simply "holding yourself out as an adviser" in a state means you have a place of business in that state. If you're soliciting clients in Minnesota, you're "holding yourself out as an adviser" in that state and need to register. After you get your 6th client? No, as soon as your start soliciting. Remember, if they have a place of business in the state, they register in the state. Except when they don't--the only exception here is the federal covered adviser. For everybody else, if they have a place of business in the state, they register with the state. For the federal covered adviser things are different. They might have a place of business in Nevada but since they're the adviser to a mutual fund company, they are federal covered. They register with the SEC and provide copies (notice filings) to Nevada. There, nice and simple, just the way the regulators like it.

Effective Tax Rate

2011-04-13T17:11:00.003-05:00

Just learned something by looking at the tax returns I'm about to file in a few days: effective tax rate. As we've seen earlier, we use a progressive income tax system, which means that as your income gets bigger (progresses), so does the rate of tax. Maybe on the first $50,000, you pay 15%, then 20% up to $100,000, then 25% up to $150,000. Therefore, if you earned $150,000 of taxable income, what is the "effective rate" that you paid? What you do is figure out the total tax paid and divide that into/compare it to the $150,000 of taxable income. So, how would this work out? You paid 15% on the first $50,000 ($7,500) You paid 20% on the next $50,000 ($10,000) You paid 25% on the next $50,000 ($12,500) In total, you paid $30,000 on $150,000, which is an "effective tax rate" of . . . 20%. The 65/66 exam ask all kinds of far-flung taxation questions, so, just in case, know what the "effective tax rate" means. And, as always, keep moving.

What if I put money in the Wisconsin prepaid tuition plan?

2011-03-14T11:12:00.008-05:00

Prepaid tuition plans are defined benefit plans. Parents putting money into their state's prepaid tuition plan are trusting their state government to honor their obligation to provide tuition credits that will actually cover the cost of education when it comes time to send Junior off to college.

Hmm. What if you put money into the Wisconsin plan? They've already shown a willingness to change the terms of the deal long after the money has already been contributed and folks are now depending on the payout. At least they stopped taking new money back in 2002, back when Colorado became the first state to come clean and tell people who'd contributed to the plan, "Well, what we actually meant by 'future tuition credits' was . . . "

It's possible the exam could bring up the fact that a prepaid tuition plan is an obligation of a state government to pay out a promised benefit to people crazy enough to trust it with their money. If I lived in a state with a lousy bond rating from Moody's/S&P/Fitch, and that state had already shown a willingness to renege on benefits to its employees, I'm thinkin I'd want the 529 Savings Plan instead, in which I pick little mutual funds and control the outcome to some extent. Just things to consider before taking the exam--not that you can remember every little thing that I blog about. But, if you can remember some or most of it, I'm convinced you'll have an edge at the testing center.

Capital Gains on a House

2011-02-09T17:56:00.003-06:00

A capital gain can be realized on stocks, bonds, mutual funds, and even real estate. The rules for capital gains on a primary residence are considered testable, so remember the following:

If over the previous 5 years you:

owned the property for at least 2 years (the period does not have to be continuous)

used the property as your primary residence at least 2 years (does not have to be continuous)

during the 2-year period ending on the date of sale, you didn't exclude cap gains on a primary residence

you can exclude up to 250K of cap gains on the sale of the house. For married-filing-jointly, 500K of cap gains can be excluded.

So Everything is Subject to Anti-Fraud Provisions?

2011-01-20T08:31:00.004-06:00

No.
Every SECURITY is subject to the Uniform Securities Act's anti-fraud provisions. Some securities are exempt, and some are sold thru exempt transactions. Those securities don't have to be registered. But they are still securities, so if they are sold deceptively, the anti-fraud provisions apply. The folks who put out bogus offering documents, misstating important facts and leaving out important negative information, can be prosecuted and/or sued.
But--and the test is exactly this tricky and mean--if the investment is NOT A SECURITY, it is not subject to anything under the Uniform Securities Act. Therefore, the test could ask you whether a fixed annuity or whole life insurance would be subject to the anti-fraud provisions. The answer?
No.
Why?They're not securities. But a Treasury bond, a municipal bond, or a church bond--though they don't have to be registered--are all securities. Therefore, they are still subject to the Uniform Securities Act's anti-fraud provisions.
And then the securities that are not exempt (non-exempt securities) are not only subject to the anti-fraud provisions, but also they have to either be registered with the Administrator or sold through an exempt transaction.
That way the regulators can keep things the way they like them--nice and simple.

What in the world is a church bond?

2011-01-17T15:49:00.003-06:00

When you're reading the Uniform Securities Act, it's easy to look at the information as if somebody just made it all up. In the live classes, people sometimes stop me and ask something like, "Whoah, hold on, Bob--a church bond? What the heck is a church bond?" Here goes. Religious organizations frequently raise money by selling debt securities to investors. I have an offering circular on my desk for a $240 million offer of various debt securities by a Lutheran organization that funds various missions. The offering is for the "mission investment fund," and on the front page of the offering circular we see that these securities have not been registered with the SEC in reliance on an exemption under the Securities Act of 1933 . . . but that this does not imply that any regulator has approved (or disapproved) of the securities, and any statement to the contrary is a criminal offense.
What does that mean? It means these debt securities do not have to be registered, period. But to raise $240 million, the organization has to disclose to investors all kinds of financial information. If any of that information is deceptive, this offer of securities is still subject to anti-fraud regulations, meaning the organization could face criminal prosecution and civil lawsuits. If the offering circular overstates the amount of money taken in through collections or bequests, that's a mistatement of a material fact. If the document leaves out some bad news that might have made investors think twice, thats' an ommission of material fact. So the offer of these securities is definitely subject to anti-fraud statues. It's just not subject to registration.

Series 65 Exam

2011-01-16T11:09:00.004-06:00

The Series 65 Exam is not known for changing drastically year-by-year. When something major is changed, NASAA announces it with plenty of lead time. For example, in 2010 they warned everyone early on that the outline was being changed and--worse--the passing score was being bumped up from 68.5% to 72%. This year, we don't see any announcements from NASAA about the Series 65 exam or the Series 66 exam. But, the industry itself is implementing some changes that will start showing up on the exams by the middle of this summer. We won't worry about them much now, but in a few months, the following will be considered testable:

federal covered advisers will need $100 million in AUM
form ADV Part 2 is changing formats to a narrative (vs. checkbox) form
form ADV Part 2 will have a Part A and Part B
ADV Part 2B is for disclosure related to IARs working with customer accounts

Series 65 Sample Question

2011-01-15T20:55:00.003-06:00

Best way to prepare for the Series 65/66 exam is to take and analyze practice questions. Notice how I said "take AND analyze." Too many candidates focus on trying to get a particular score on practice questions. It's much more important to learn from the practice questions. In fact, you should probably keep a notebook just for taking notes on what you can learn from working through practice questions. Like this one:

An annuitant chooses the settlement option known as "life with 10-year period certain." The annuitant dies 13 years later; therefore,
A. the annuity stopped paying after 10 years
B. the annuity stops paying when the man dies
C. the annuity pays the beneficiary another three years
D. the beneficiary receives the cost basis only

EXPLANATION: "life with 10-year period certain" means that either the annuitant or the beneficiary will receive at least 10 years of payments . . . and, if the annuitant lives longer than 10 years, the annuity will pay until he, you know, dies.

ANSWER: B

Real-World Low-Level Felonies

2011-01-15T17:29:00.012-06:00

A willful violation of securities law is just what it sounds like--you violated the law and can't reasonably claim there was no way for you to know it was, like, a bad idea. For example, let's say you owned a bar and grill and wanted to raise money to build an addition to the restaurant. If the local bank shuts you down, you might start asking customers if they want to invest $5,000 each in exchange for 2% of the profits. You might not call the investments "stock," but the regulators would consider them to be investment contracts, which are securities. If you didn't register them, they can refer you to a criminal prosecutor (Attorney General, District Attorney, State's Attorney, etc.) who might want to charge you with some low-level felonies for selling unregistered securities through unregistered agents. Would they go that far? They might. Maybe some of your investors complain to the regulators that you didn't disclose the following material information:

your restaurant was on the verge of bankruptcy
the addition could only be built if granted a zoning variance
you intended to use some of the $ for a new Cadillac Escalade
your restaurant has never made a profit

Oopsie. Now, we're talking about multiple counts of felony charges like "securities fraud" or "omissions and misstatements," etc. on top of the unregistered securities and selling thru unregistered agents. The Uniform Securities Act's little "3 years/$5,000" criminal penalties are just for the little pretend Uniform Securities Act. The lowest-level felony in Alabama, for example, a "Class C felony," carries a sentence of anywhere between 1 and 10 years and a $15,000 fine! In IL, a Class 4 felony carries a sentence between 1 and 3 years, and/or a $25,000 fine. Wow. So, if a smarmy businessman takes people's money under false pretenses, the Administrator is not the problem. The problem would really be the possible criminal liability and also the civil liability to investors who end up suing him.

Estimating Probabilities

2011-01-15T11:03:00.003-06:00

Believe it or not, a question as wacky as the following can and allegedly does show up on the Series 65/66 exams:

You have flipped a coin 100 times now. It has come up tails 68 times. If you flip the coin again, the probability of its landing "tails" is

A. 32%

B. 69%

C. 68.5%

D. 50%

EXPLANATION: I was tutoring a man who lives a few blocks from the Las Vegas strip. Man, did he have a hard time answering this question. "Well," he pushed back, "who's flipping the coin?" "What KIND of coin are we talking about here?" "Which casino is he in?"

Eventually, he--like you--figured out that if there are two outcomes, the probability is always 50%, period. End of story.

Also, note that if a coin turns up 7 out of 10 times heads, that is nowhere as freaky as a coin that comes up heads 650 times out of 1,000. The law of large numbers says that as the number of flips increases, the outcome should get closer to 50%. Why is this on the test? Financial planners talk about this stuff to help themselves understand why investing clients are so horrible at estimating and understanding risk.

ANSWER: d

Do You Need a Private Tutor?

2010-12-29T14:19:00.003-06:00

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.

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

Series 65 Question

2010-12-08T10:50:00.004-06:00

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.

ANSWER: a

Investment Risks

2010-11-30T09:46:00.003-06:00

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.

ANSWER: d

Nobody Ever Makes any $ in Stocks, Right?

2010-11-24T12:05:00.003-06:00

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!

Exemptions for Persons

2010-11-23T11:38:00.002-06:00

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?

2010-11-23T11:05:00.004-06:00

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.

Practice Question, investment risks

2010-10-22T09:50:00.004-05:00

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.

ANSWER: c

Cease & Desist

2010-09-28T09:38:00.004-05:00

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.

Exempt Securities in the Real World

2010-09-25T16:10:00.004-05:00

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:
www.bigfilespassthetest.com/securities.
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.

Real-World Fundamental Analysis

2010-09-14T20:25:00.004-05:00

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.

Almost famous

2010-09-09T17:14:00.006-05:00

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 www.facebook.com/helpmepass 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.
Thoughts?

Tough Options Question

2010-08-24T17:00:00.003-05:00

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.

ANSWER: b

Another blurb on FEINs

2010-08-05T23:33:00.004-05:00

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.

FEINs

2010-08-04T21:04:00.002-05:00

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.

Partnerships

2010-08-04T20:16:00.005-05:00

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 . . .

b

Get Your Head in the Game

2010-07-22T14:13:00.005-05:00

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.

RMDs

2010-07-20T09:29:00.002-05:00

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.

ANSWER: b

Durable Power of Attorney

2010-07-12T12:07:00.004-05:00

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

2010-07-12T11:52:00.003-05:00

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.

ANSWER: b

Custody Issues for Advisers as Trustees

2010-07-08T14:17:00.002-05:00

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.

Custody Issues

2010-07-07T13:37:00.006-05:00

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 http://www.nasaa.org/content/Files/IACustodyRules.pdf. 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.

Variable Annuities

2010-07-05T08:32:00.003-05:00

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

ANSWER: b

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.

Fiduciaries

2010-06-19T12:14:00.003-05:00

PRACTICE QUESTION:

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

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".

ANSWER: b

Settlor Functions practice question

2010-06-06T07:45:00.008-05:00

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.

ANSWER: b

Settlor Functions

2010-05-27T14:52:00.005-05:00

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

2010-05-27T10:20:00.016-05:00

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.

Practice question on the 2nd prong

2010-05-13T15:23:00.005-05:00

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.

ANSWER: b

2nd Prong, Compensation

2010-05-13T15:11:00.007-05:00

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

2010-05-13T14:55:00.003-05:00

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."

ANSWER: c

So, Bob, Whadaya Think a' Goldman Sachs?

2010-05-11T12:52:00.009-05:00

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

http://sec.gov/litigation/complaints/2010/comp21489.pdf

1st Prong SEC IA 1092

2010-05-06T14:18:00.011-05:00

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.

Roth IRA question

2010-04-30T13:34:00.003-05:00

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 . . .

b

What the heck is a mutual fund anyway?

2010-04-21T10:31:00.003-05:00

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.

Administrative enforcement actions

2010-04-13T07:29:00.003-05:00

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.

ANSWER: d

Stops, Limits, and Other Things Students Hate

2010-03-31T11:32:00.003-05:00

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.

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

2010-03-17T09:05:00.019-05:00

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.

Fun with Form ADV Part 2

2010-03-11T12:39:00.007-06:00

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

ANSWER: b

You can view an actual ADV Part 2 at www.passthe65.com/extra

The WRONG way to approach test questions

2010-03-03T12:27:00.002-06:00

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

2010-03-03T10:05:00.003-06:00

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 www.passthe66.com/exams.htm. 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:

http://www.nasaa.org/content/Files/Dishonest_Practices_of_BD_or_Agent.83.pdf

http://www.nasaa.org/content/Files/Interpretive_Order.pdf

http://www.nasaa.org/content/Files/Dishonest_Practices.pdf

http://www.nasaa.org/content/Files/IAUnethical091105.pdf

http://www.nasaa.org/content/Files/IACustodyRules.pdf

http://www.nasaa.org/content/Files/NASAA%20Minimum%20Financial%20Requirements%20for%20Investment%20Advisers.pdf

http://www.nasaa.org/content/Files/Sales_of_Securities_at_Financial_Institutions.pdf

OMG!

2010-02-25T16:17:00.008-06:00

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

2010-02-24T13:52:00.004-06:00

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?

2010-02-18T18:05:00.019-06:00

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

2010-02-14T11:54:00.002-06:00

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

2010-02-09T17:17:00.003-06:00

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

2010-02-05T16:29:00.003-06:00

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?

2010-02-04T16:33:00.003-06:00

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

2010-02-01T17:43:00.004-06:00

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

Blogging for dollars

2010-01-30T08:19:00.002-06:00

Everyone taking the Series 66 is also already a Series 7-licensed stockbroker or will soon become one, assuming there are no felony convictions in the recent past or any misdemeanors involving fraud or other "money crimes" to report on Form U-4. Therefore, FINRA rules shape your daily business life. They are also part of the Series 65 exam, so those candidates have to know about them, even if they never get a Series 6 or 7 and become subject to FINRA's awesome powers to ruin careers or protect investors, depending on your perspective.

As I found out here at Google's "blogspot," setting up a blog is amazingly easy these days. You just give it a name, choose a template and start posting whatever it is you want to say. I'm not sure why so many blogs degenerate into rants and personal assaults on people the blogger has never and will never meet, but bashing the president of the United States is within the blogger's 1st Amendment rights. Recommending that readers purchase securities or stop by the branch office for an IRA checkup is a whole nuther thing entirely. FINRA has a notice to members (10-06) that everyone should read. Turns out, if you're an agent for, say, Morgan Stanley, Morgan Stanley has to worry about all kinds of things connected to your blog, facebook, etc. First, your static blog posts that mention anything about your firm's business or securities in general is likely considered "advertising" by FINRA, and advertising is subject to pre-approval and record retention by the firm. If you're recommending securities, FINRA's suitability rules apply. Is the variable annuity you're pushing suitable to all followers of your blog? If not, that could be a problem, especially if they buy what you're recommending and end up losing money. Facebook allows you to put up static posts, but also allows you to chat in real-time. While "extemporaneous" commentary on a website or during any public appearance does not--and cannot--be pre-approved, it does have to be monitored by compliance, a group not generally known for their sense of humor.
So, before you launch a blog or post a stock recommendation on your Facebook wall, please read the FINRA notice 10-06, and please proceed carefully, letting your compliance officers know exactly what you're up to online.

Can anyone pass the new Series 65?

2010-01-28T14:22:00.003-06:00

In case you're wondering if anyone can pass the "new Series 65" with the new concepts added and the higher passing score, please take a look at an email I just got from a rather elated customer:

Thank you thank you thank you!! Passed the 65 with a 79 the first time. Oops. Must have studied too hard. Great author, great study materials equal great results! Yeehaa!

That score of 79 tells me a few things. First, the customer was not ready to stand up and teach a class on any aspect of the Series 65. Second, the test was REALLY HARD to study for and pass. And, three, he made it happen, anyway. In other words, when somebody gets a 92% on the Series 65, I can't take much credit for that--that person is a braniac. When someone gets a 79%, I know that they performed at a higher level than they thought possible and put in a huge amount of work. So, if you don't plan on getting a 92% on your natural abilities, I suggest you do as this customer did and work your tail off.

What about the new Roth IRA rules?

2010-01-25T11:14:00.001-06:00

Many Series 65 and 66 candidates have been sending emails asking if the exam will be testing the new Roth IRA rules for 2010. The most accurate answer is this: nobody knows. Why not? Because nobody ever knows what the Series 65/66 is going to ask. There are companies out there who will give you a definitive answer here, and there are companies like Pass the Test who prefer to tell you the truth--nobody knows. If the test does ask a question requiring you to know the peculiar situation concerning Roth IRAs in 2010, this is what you would need to know:

Income limits still apply and prevent "high-income" people from making a contribution
The only change is that "high-income" people can do a Roth conversion by paying tax on all the money in their Traditional IRA account and making it a Roth account

That's all that's happening this year--if you want to convert a Traditional IRA to a Roth IRA, you can do that this year regardless of your income level. If you want to add new money to your Roth IRA, you will be prevented from doing so if you reach a certain income level that is one set of numbers for single filers and another for married couples filing jointly. What are those numbers? Your firm has them somewhere, and we do not think those numbers are testable. But, again, nobody really knows for sure what is "testable" and what isn't. That's just the sort of folks we deal with when taking the Series 65/66 exam. They do whatever it takes to flunk about 1/3 of all test takers on any given day. Don't let the wisenheimers put you into that bottom 1/3.

Books and Records

2010-01-21T14:09:00.003-06:00

One of the reasons I'll probably never open an advisory business is that I hate record-keeping. If you read the NASAA's "Recordkeeping Requirements For Investment Advisers Model Rule 203(a)-2" you will see that advisers have to keep better records than surgeons and nuclear waste disposal companies combined. I'm lucky if I remember to print out my monthly account statements for the IRA, SIMPLE, etc.

Since recordkeeping is an important topic, we should expect one or two questions similar to the following:

An investment adviser’s duty to maintain books and records is accurately described by which of the following?
A. only advisers with custody or discretion are required to keep books and records subject to inspection by the Administrator
B. electronic records are allowed only if hard copies are also maintained on site
C. an adviser must retain records for five years from the end of the fiscal year during which the last entry was made on record
D. an adviser with offices in more than one state must meet the books and records requirements of each state

EXPLANATION: all advisers have to keep records, so A is eliminated. Electronic records are okay as long as the adviser can "reasonably ensure that any reproduction of a non-electronic original record on electronic storage media is complete, true, and legible when retrieved" and that the records are "reasonably safeguarded from loss, alteration, or destruction" and the adviser "limits access to the records to properly authorized personnel and the [Administrator] (including its examiners and other representatives)." So, B is eliminated. And, D is eliminated because the adviser only has to meet the books and records requirements set by the Administrator of their "principal place of business."

ANSWER: c

Fair Market Value

2010-01-20T10:44:00.003-06:00

The Series 65/66 exams are constantly reaching for more details than their exam outline would imply. Luckily, we have customers taking the exams who report some of the test writers' little tricks. How would you answer the following practice question?

If you inherit appreciated property, your tax basis is
A. fair market value on the date of death
B. fair market value 6 months after the date of death
C. neither choice listed
D. either choice listed

EXPLANATION: if you inherit, for example, 1,000 shares of MSFT that Grandma purchased for $10 each, you can take the fair market value as of the date of her death or six months later--which is when most estates close out. If the stock is worth $50 on her date of death, you can take that stepped-up value as your cost basis. Or, if the stock is worth $55 six months later, you can take that as your stepped-up cost basis. Also remember that any gains are considered long-term, regardless of your holding period.

ANSWER: D

BID-ASK

2010-01-14T10:01:00.004-06:00

Many exam candidates struggle to understand the terms involved with trading securities. This is only possible if the candidate has never entered his or her own orders online. I, on the other hand, knew exactly how to explain bid-ask, stop, limit, etc. for the first Series 7 class that I ever taught for the big company in this industry. That's because I had entered all types of market, limit, and stop orders for both stocks and bonds through my TD Ameritrade accounts. But, if you haven't done that, you'll probably need some extra help. So, here goes.
There are broker-dealers out there who act as "market makers" and step in between buyers and sellers of stock. You and I don't want to find buyers and sellers, so we go through a dealer/market maker. Let's say Goldman makes a market in MSFT. They publish:

BID: $25 ASK: $25.10

Just like at Sotheby's sellers always sell to a bidder--so we can get that $25 bid right now if we want to sell our MSFT. Buyers always have to pay the ASKing price--so we can buy MSFT for $25.10. That little 10cent per share is Goldman's "spread," and they make money by running as many transactions as possible in which they pay somebody a lower price and immediately sell to someone else at a slightly higher price.

It's a two-sided "coin," in which the test can haze you. Do market-makers buy at the BID, or do customers sell at the BID price? Yes--that's what happens. Customers can sell to the market maker, who will buy at the BID price.

Do market-makers sell at the ASK price, or do customers buy at the ASK price?
Exactly right.

A limit order is used if you don't like the BID-ASK prices. You don't want to pay $25.10? Put in a buy-limit order at $24. If the ask price drops to $24 or lower, you buy the stock. If it doesn't drop, you don't. You want to sell but get more than that $25 bid? Place a sell-limit order at $26. If the bid rises to $26 or higher, you'll sell. If it doesn't rise, you won't.

Completion of a securities transaction

2010-01-12T13:47:00.003-06:00

I was reading a financial planning textbook the past couple of weeks in order to enter the twisted minds of those who write Series 65/66 questions, and I ran into a concept that makes a very likely exam question:

When does the SEC consider that a securities transaction has been "completed"?

A. when the prospectus has been received

B. when a registered representative completes the order ticket and submits it to the wire room

C. when the customer gives oral authorization for the terms of the order

D. upon settlement

EXPLANATION: a securities transaction has been "completed" when it settles/clears, at which point payment has been made, and the securities have been delivered. An investment adviser, for example, must disclose that it intends to act in a 'principal' capacity on a customer transaction and get the customer's consent no later than completion of the transaction, which is settlement. Settlement is usually T + 3 business days.

ANSWER: D

Default risk on US Treasury Securities

2010-01-08T13:53:00.008-06:00

If you get a test question asking about whether the US Treasury issues bills, notes, bonds, or STRIPS that present default risk to investors, how would you answer it? Apparently, it depends on how much Glenn Beck, Sean Hannity, and Rush Limbaugh you've been listening to. During the Friday Free Broadcast today, I tried to present a likely test question asking which investment risks an investor bears when buying a Treasury note. The answer--the one the exam wants you to pick--does not include "default risk." One of the attendees began to write that "just because they've never defaulted doesn't mean they can't default." Good point, but the answer is still: no default risk on a US Treasury Note.

Why? Because there IS no default risk on a US Treasury Note. About 220 years ago, the United States of America was formed, and one of the foundations of this new nation was that the federal government would assume all of the 13 states' debts that had been racked up during the 8-year revolutionary war that the legislatures never actually bothered to pay for. Alexander Hamilton insisted that the new central government had to show European trading partners that the credit of the new US Government was solid. After 220 years or so, without ever defaulting on its obligations, the US Treasury has earned the right to claim that their securities have no default risk. This isn't Russia, which in 1994 defaulted on its government bonds. This is a country that has paid its obligations for over two centuries. If you tell your clients that US Treasury securities aren't safe, that they are somehow subject to default risk, you could end up in arbitration or civil court when your clients avoid T-notes in order to buy your mutual funds, stocks, bonds, etc. In fact, if your client took your Glenn Beck-style anti-federal-government advice and avoided perfectly safe, secure Treasuries only to lose even 10% on what you recommended, his attorney would have a field day with you. He could say, "So, you're convinced that the US Treasury is not fiscally sound? Do you have any cash in your wallet? Could I see it for a second? Do you mind if I light this $300 on fire? Oh, you do? So, apparently, the US Treasury is strong enough to back up your money, just not your clients' money, is that right, sir?"

Maybe you saw that one coming and wisely left your currency at home. All the client's attorney has to do now is pull up a bunch of historical outcomes for mutual funds, stocks, and bonds. He would have ample examples of massive investment losses on bonds, stocks, and variable annuities. But for over 2 centuries, Uncle Sam has returned every dollar it ever borrowed from an investor. And you told the client that Uncle Sam was too risky; go ahead and buy this variable annuity instead.

This isn't just hypothetical. A customer who bought the Pass the 65 book has never been able to get registered because he went around showing senior citizens PowerPoint slides with titles such as, "Why your money isn't safe in the bank." I guess he also doesn't trust the US Government, even though its FDIC program has never failed bank customers. The regulators in Massachusetts decided it was a fradulent, misleading sales tactic--which it was. Just like the guy still up on NASAA's website who got caught on Dateline trying to scare people out of their bank accounts because "the FDIC's credit rating is F-minus."

Anyway, if you want to enjoy conspiratorial radio and TV ranters as a diversion, please do so. But be careful how much of that hysteria you bring to a test question and--more important--be very careful how much you bring to the table with your prospects and clients.

Figure it out, people!

2010-01-05T10:15:00.005-06:00

Far too many license exam candidates labor under a misconception about the exams; they think they are supposed to know the answer as soon as they read the question. Unfortunately, for most questions, your job is to FIGURE IT OUT. For example, take a look at the following:

Parents often use zero coupon bonds such as Treasury STRIPS to fund future educational needs. Which of the following is an inaccurate statement of such investments?
A. they lock in a rate of return for the life of the bonds
B. taxation is deferred until maturity
C. their market price volatility is higher compared to interest-paying debt securities
D. they require lower capital commitments

Maybe you already know the answer, but your approach should be to take each choice and try to eliminate it--the choice you can't eliminate must be your answer. Also, it helps to remember that you're eliminating the three TRUE statements in this one. Right? Ok, so do zero coupon bonds lock in a rate of return for the life of the bond? Don't try to picture an imaginary flash card here--ask yourself how zero coupons work. Why are they called "zero coupon" bonds in the first place? Because they make exactly zero coupon payments--therefore, the investor does not reinvest coupon payments at varying rates along the way (reinvestment risk), so I guess the return is "locked in for the life of the bonds." See how much thought it can take to eliminate just one answer choice? Good--two more need to be eliminated, and then we're done. Taxation is deferred until maturity--is that true? Many people have memorized this, but even if so, don't choose this answer yet. Not until you eliminate the other two. Put this one on hold--it looks good, but maybe one of the other choices looks even gooder. What about the "market price volatility," does that make sense? Well, if you remember all that we've said about "duration" and how zero coupons have high "durations," you know it's true. If you don't remember it, figure it out--why would their price be volatile? Probably because there's no cash flow being paid to make the investor feel better about holding the thing. That's true, so we eliminate it, and we sit 50-50 at this point. Either B or D is going to be our answer--getting tired and frustrated? Suck it up, people--you have over 100 questions to answer whether taking the Series 65 or 66. Okay, Choice D says that zero coupon bonds somehow "require lower capital commitments." And here is where we separate those who will pass the first time and those who might pass on their second or third attempt. The candidates who get frustrated now and start preparing their snarky email to Kaplan, STC, or Pass the Test, want to start squirming like a little kid all dressed up for a 3-hour church service on a hot Sunday in August--no fair! I don't remember ever seeing that before! Is this test testing my knowledge or my ability to take a test?
Yes, and yes--the clock is ticking; what is your answer?
Take a deep breath and t-h-i-n-k about it. Why would the zero coupon require a lower capital commitment? Well, how are they purchased? At a deep discount to the par value--aha! If you can buy $100,000 par value of STRIPS for just $50,000 or $60,000, I'd say that represents a "lower capital commitment," whether I've ever thought of it that way or not. Choice D is eliminated, along with Choice A and Choice C. What's the right answer?
I just told you. It's not A, C, or D.

If I seem to be getting a little edgier, it's because 2010 represents a whole new reality, what with the 72% required passing score for the Series 65 and the even scarier 75% passing score for the Series 66. I can't afford to be nice at every turn this year. My job is to scare exam candidates sufficiently to take this stuff seriously and start thinking through exam questions as opposed to expecting to have them memorized as you used to do in high school and blow-off college courses.

Frankly, the harsh, cold January weather here in Chicago is making my job a little easier.

Tax Forms

2009-12-30T10:27:00.004-06:00

Even though NASAA claims that their Series 65 and 66 exams are not based on memorization, their exams sure do churn out their share of mindless memorization questions. Like this one:

A limited partnership uses which of the following forms when reporting taxable income?
A. 1040
B. 1120
C. 1065
D. 1031

EXPLANATION: the 1040 is used by individuals and sole proprietors. A 1031 tax-free exchange can be done on real estate investments, and the 1120 is used by corporations. Form 1065 is used by partnerships.

ANSWER: C

Sideways

2009-12-29T11:43:00.007-06:00

Have you ever seen a college basketball game in which the opposing fans try to haze the free-throw shooter by waving colorful distractions and shouting at him?

Ever noticed how it has zero effect on a good free-throw shooter?

The Series 65 and 66 exam also like to haze the people shooting free-throws at the testing center. They know that the answer is sitting right there in front of you like an open hoop, so they have to distract you from choosing it. One trick is to overwhelm you with verbiage. Another is to present common formulae backwards. Still another is to use weird jargon that you weren't expecting. Like this possible exam question:

Joey Investor is long 1,000 shares of ORCL common stock. It is now June, and Joey feels that the market for ORCL is headed sideways over the next several weeks. Therefore, he should

A. sell 10 ORCL Jul calls

B. buy 10 ORCL Jul puts

C. sell 10 ORCL Jul puts

D. buy 10 ORCL Jul calls

EXPLANATION: Always sell options if the market is supposed to go "sideways" or "remain unchanged." That way, you get the premium now, and then the option expires. Don't sell puts if you own stock--if the stock goes to zero, you lose 100% on the stock, then you have the OBLIGATION TO BUY the stock for the strike price . . . even though it's worthless. Sell covered calls in this situation. Joey owns 1,000 shares, so he can cover 10 call options.

ANSWER: A

What if you don't know what "sideways" and/or "long" mean?

You could be in trouble. That's why I just posted this question.

An options question

2009-12-29T10:47:00.005-06:00

Sammy Bonami buys a MSFT May 55 call @3. When MSFT rises to $62 a share, Sammy sells 100 shares short, then covers the short position by exercising the call option. What is the result of Sammy's trading activity?
A. gain of $7 per share
B. gain of $4 per share
C. loss of $10 per share
D. loss of $3 per share

EXPLANATION: this is exactly how a trader would exercise a call. In order to take advantage of the temporary market price of $62, Sammy needs to sell the stock short now. At this point he can "cover his short position" by exercising his right to buy the stock for $55 a share. He doesn't keep the full $7 a share difference, since he paid $3 a share for the right to buy the stock at $55. He keeps $4 per share.
Some test-takers would report that they have "never seen anything like this before," but, in fact, they have learned the fundamentals that would allow them to figure it out with strategy and patience. Our Pass the 65 book covers options in more detail than it probably should, and--no matter what we cover in the book--the exam wants to see if you can apply the fundamentals in a very unexpected, challenging way. You have to figure this sort of question out. Ask yourself, "what does a call buyer get to do?" He gets to buy at the strike price--okay, so have him pay the strike price and the premium. You see that he "sells" the stock for $62 a share, so that has to offset the $58 per share that he paid. Are you 100% confident with your answer? Heck no--luckily, you only need a 68.5% to pass before 1/1/10, and a 72% to pass thereafter.

ANSWER: B

Be preapred to figure things out at the testing center--no matter what you've studied, the test questions will force you to apply the concepts in unexpected, seemingly impossible ways. You don't get to spit back the little flash cards you've memorized on the Series 65 or 66. You have to use logic and test-taking skills to apply the fundamentals in a very challenging, often confusing environment.

Lucky you.

Types of Trusts

2009-12-17T10:18:00.005-06:00

Here is a question very similar to what many of you will see on the Series 65 or Series 66:

What type of trust requires the trustee to distribute to beneficiaries immediately?

A. Simple

B. Complex

C. Irrevocable

D. Revocable

EXPLANATION: a simple trust distributes "DNI" (distributable net income) to the beneficiaries, while a complex trust can retain some of the income to build up the "corpus" or principal. The choices "irrevocable" and "revocable" have more to do with estate taxes and tax liabilities during the lifetime of the grantor.

ANSWER: a

Series 65 - Likely Test Question

2009-12-07T13:04:00.002-06:00

A customer who recently passed his Series 65 exam reports that he saw a question similar to the following:

There is a federally covered advisor with an office in state A, who has clients in state A. He also has 3 non-institutional clients in state B and 3 non-institutional clients in state C. He has 3 more clients in state X and wants to have custody of the clients' accounts in state X. In which states does he have to register?

A. A only
B. A, B, C and X
C. A and X only
D. None, because he is federally registered

My explanation:
The answer is D because this is a federal covered adviser. They notice file in State A, where they have an office. They do NOT need to notice file in State B, State C, or State X because they aren't soliciting new business there (holding out as advisers) and have no more than 5 non-institutional clients. Even if they had more than 5 non-institutional clients in those states, they would not register there; they would only notice file there. Custody has nothing to do with this question. As a federal covered adviser, they'll meet the SEC's net capital requirements under IA Act of 1940. The only authority the states have over SEC-registered advisers is anti-fraud and notice filing authority.

Another happy Series 65 customer

2009-12-07T11:28:00.003-06:00

When customers pass their Series 65 or 66 exams, few think to email me and let me know the good news. Still, I have hundreds of thank-you emails from ecstatic test-takers who skipped their way out of the exam center. This is one I received today, and I think you'll find some good stuff that you can apply yourself. Looking at his GoNoGo results, I asked if he had taken the Series 65 yet. He replied:

Yes, sorry did not get back to you. I have to look up the cert sheet, but I scored around 85.

Interesting observation on the test. They are getting very good at writing the questions with language and phrasing that is enough different, and fairly obscure, as to really make you have to re-read the question many times. I am sure nerves have something to do with it, but it seems they are going to great lengths to make sure no one who studied material like yours or Kaplan easily recognizes questions verbatim.

Also of note, there were less retirement vehicle questions than I expected, and more trust formation questions, which is a subject I never really remembered any questions on as I studied. Those were pure guesses for me. All in all, I seemed to “check for review” about 35-40% of the test because of the wording of so many of the questions. In the end I did not change a lot of my answers unless it was obvious I was overlooking the right answer. It just seems the test writers are getting better at making the questions and answer choices a little harder to decipher. Definitely not as easy to immediately remove 2 of the 4 choices as it used to be.

Alls well that ends well. I will gladly recommend your materials to others.

Thanks,

MPK

PS. People should not underestimate the power of an experimental question. I know we cannot “tell” which is and is not, but some of the questions will be so confusing, and I recall one that I am sure had 4 wrong answers, and one that had four right answers. Well, when you are in a game time frame of mind and extremely nervous about passing, these definitely can knock you off your game and change your focus. Remind your clients, as I am sure you do, not let any one question mess with your head — because it may be a mind bending experimental one. If you still haven’t answered in 2 minutes, click and move.

Am I ready to pass the exam?

2009-12-02T09:08:00.003-06:00

The best part of my chosen career is the satisfaction I get helping others to pass their securities license exams. Checking my InBox last night, I found this uplifting email from a Series 65 customer:

Whoo, Hoo, I passed the 65 today with an 85%. Your training materials and test questions are awesome. They provided all I needed to learn (along with the official website readings).

Your practice test questions are right on.

This student had already taken the GoNoGo exams that you'll find at http://www.passthe65.com/. Her scores were 86% and 90%, for an average score of 88%. As usual, the score on the actual Series 65 was a bit lower, but only by 3 points. At this point, the majority of GoNoGo exam scores are + or - 6 points from the actual score on the Series 65. This is not a guarantee, but it does imply that anyone scoring in the high 70's has a high chance of passing the exam at the testing center. I encourage you to take one or both "GoNoGo exams" just before scheduling your test. If you don't like the results, send me an email at walker@passthe65.com to set up some private, online tutoring.

Remember--you want to get the 65 off your plate before the end of 2009, when the passing score jumps from 68.5% to 72%.

Higher Passing Scores Required on the 65 and 66 exams!

2009-11-24T09:42:00.002-06:00

HEADS UP:

IF YOU NEED TO PASS THE SERIES 65 OR 66 EXAM, THE TIME TO DO IT IS BY DECEMBER 31, 2009.

Starting January 1st, the passing score for the Series 65 is going up from 68.5% to 72%. Even worse, the passing score for the Series 66 is going up from 71 to 75%.

My company, Pass the Test, is helping people get the exams done this year with coupon codes. For any product at www.passthe66.com use coupon code: 66now.

For any product at www.passthe65.com use coupon code: november

FINRA fines firms over lack of email supervision

2009-11-20T08:23:00.006-06:00

I'm at the FINRA website this Friday morning looking for recent disciplinary actions against member firms and/or their agents. Today's firm in the time-out chair is a well-known broker-dealer with lots of branch offices and affiliate broker-dealers. Unfortunately, they did not have an adequate system in place, according to FINRA, to monitor their agents' emails or their outside business activities, or their private securities transacations. Many financial service salespeople are hard-charging entrepreneurial types who think they can do whatever they want to do to make a buck. In fact, they can't. Once you sign on with a broker-dealer, you have to notify them of any outside employment, and you can not offer securities outside their knowledge and supervision, especially if you might get caught. Remember that even though the Series 65/66 exam is for investment advisers and IARs, it still asks plenty of questions about broker-dealers and their agents. Go ahead and see the notice of disciplinary action at:
http://www.finra.org/Newsroom/NewsReleases/2009/P120393

Securities Registration

2009-11-12T18:58:00.001-06:00

Jimmy Jones is a go-getting business owner who recently sold "units of participation" in his plastic injection molding company, totalling $290,000, to 24 investors in State A and 15 investors in State B. Jimmy did not register the units based on his belief that they were not securities. The company has now filed for bankruptcy protection and is in receivorship. The "units of participation" have no secondary market and are deemed to be worthless. Therefore
A. investors may not pursue civil suits unless filed within 3 years of the securities offering
B. whichever state represents the majority of capital invested has sole jurisdiction in this matter
C. State A, where the majority of investors reside, has jurisdiction in this matter
D. the SEC has no authority over this matter unless the securities were registered under the Securities Act of 1933

EXPLANATION: both states could claim jurisdiction and pursue separate legal actions. The SEC could definitely get involved, since this is inter-state commerce. Investors have the right to sue as long as they file within 2 years of discovery/3 years of the cause of action. Chances are, Old Jimmy never bothered to register the "units of participation" and never disclosed any risk to investors . . . or, he presented bogus financial statements, etc. If so, they will have grounds to sue. Unfortunately, Old Jimmy appears to have no money at this time.

ANSWER: A

Are you an adviser or not?

2009-11-07T08:28:00.006-06:00

There is a subtle difference between the following two questions:

Is the firm an investment adviser?
Does the investment adviser have to register?

The first question is talking about an "exclusion," while the second is talking about an "exemption." In other words, some entities simply don't meet the definition of "investment adviser." An accounting firm that encourages clients to make IRA contributions is not an investment adviser. Neither is a bank or savings & loan. Whatever the Investment Advisers Act of 1940 or various state securities laws have to say about investment advisers, it does not apply to the accountants in our example, a bank, or an S & L. Why not?

They are not investment advisers.

On the other hand, an adviser in Rhode Island might have a couple of financial planning clients move to Massachusetts--if so, the Rhode Island investment adviser is excused/exempt from registration requirements in Massachusetts. As long as he isn't soliciting new business in Massachusetts, and as long as he has no more than 5 of these clients there, he is exempt from registration requirements.

But he is an investment adviser. And that's important to note because if you're not an investment adviser, then the Investment Advisers Act of 1940 has nothing to say to you. But, if you are an investment adviser who simply doesn't have to register--exempt--then, some parts of the Investment Advisers Act of 1940 still apply to you. At the risk of going overboard, let's look at the difference. Section 205 of the Act requires the contract between advisers and clients to contain at least 3 main items. But, it clearly doesn't apply to advisers who are exempt from registration requirements:

No investment adviser, unless exempt from registration pursuant to section 203(b), shall make use of the mails or any means or instrumentality of interstate commerce, directly or indirectly, to enter into, extend, or renew any investment advisory contract, or in any way to perform any investment advisory contract entered into, extended, or renewed on or after the effective date of this title, if such contract--
provides for compensation to the investment adviser on the basis of a share of capital gains upon or capital appreciation of the funds or any portion of the funds of the client;
fails to provide, in substance, that no assignment of such contract shall be made by the investment adviser without the consent of the other party to the contract; or
fails to provide, in substance, that the investment adviser, if a partnership, will notify the other party to the contract of any change in the membership of such partnership within a reasonable time after such change.

On the other hand Section 206, the anti-fraud statute, applies to anyone who meets the definition of investment adviser, even those who are exempt from registration requirements:

It shall be unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly--
to employ any device, scheme, or artifice to defraud any client or prospective client;
to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client;
acting as principal for his own account, knowingly to sell any security to or purchase any security from a client, or acting as broker for a person other than such client, knowingly to effect any sale or purchase of any security for the account of such client, without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction.

So, if you're not an investment adviser, even Section 206's anti-fraud statute is outside of your world. But, while an adviser with an exemption would not have to comply with Section 205's requirement for client contracts, they're still an investment adviser, so they're still stubject to Section 206's anti-fraud statute. They don't have to comply with most of the Act of 1940, but if they're an investment adviser, they had better not do anything deceptive or misleading, even if they are excused from registration.

On the test and in the real world, it is difficult to know for sure if you meet the definition of "investment adviser." The State of Ohio has an excellent flow chart that helps people decide this crucial question. Take a look at it--very helpful stuff:

http://www.com.ohio.gov/secu/docs/Investment%20Adviser%20Flowchart.pdf

Insider Trading, For Real

2009-11-06T08:09:00.001-06:00

It's Friday morning and, as usual, I'm at the FINRA website looking up recent disciplinary actions. Today I find a well-known broker-dealer being fined for insufficient anti-money laundering policies. $600,000 is the fine, but I also know how much it costs to shoot advertisements involving helicopters, let alone running those ads in prime time, so I think their pocketbook will survive.On the other hand, the individual referenced in the link I'll post below is done. Game over. Forced early retirement. As you'll see, when a broker-dealer is called in for investment banking work, they end up knowing information no one else has, information that can move the price of the company's stock up or down with near certainty. So, investment bankers are fiduciaries who have to keep the information confidential. Don't spread the news, and--for crying out loud--don't try to buy shares of the company's stock so you can dump it when the news becomes public. Tempting, sure. But it's a criminal violation. It leaves you open to all kinds of civil suits. And--as you'll see--it tends to end a registered representative's career permanently.
See what I'm talking about here:http://www.finra.org/Newsroom/NewsReleases/2009/P120328

Economics Practice Question

2009-11-04T11:52:00.005-06:00

On the Series 65 exam, you should expect to see at least three or four questions concerning economic indicators. Like this one:

Which of the following is/are generally associated with the economic phase known as "expansion"
A. falling CPI
B. falling interest rates
C. falling unemployment
D. all choices listed

EXPLANATION: during an expansion, everybody’s working, so unemployment is falling, decreasing, dropping, or whatever the exam wants to call it. The CPI and interest rates tend to rise during an expansion. In other words, stockholders tend to do better in an expansion while bond holders tend to do worse . . . and during a contraction, bondholders tend to do better, since falling interest rates raise the market price of their bonds, and since their fixed income stream has greater purchasing power if the CPI begins to drop (deflation).

ANSWER: C

Agency Cross Transactions

2009-11-01T07:20:00.005-06:00

One of my Series 65 customers just asked me to explain "agency cross transactions," which are potentially "conflicts of interest" for investment advisers. I repsonded this way:

Hi, Kevin
If I'm your adviser, I'm supposed to be buying and selling securities only because it benefits you. If my advisory firm has an affiliated broker-dealer, and I start buying securities for your account or selling them from your account to our brokerage customers and pocketing commissions, that would be a major violation unless the "agency cross transactions" were disclosed to you. The fact that we get commissions when managing your portfolio could be making our buying and selling activities less than objective. So, we disclose the agency cross transactions to our advisory clients and once a year send itemized lists of all the agency cross transactions that we did while managing those accounts. We can never advise both sides of a transaction any more than a divorce attorney can represent both the husband and the wife in a divorce case. Here is the actual rule:
http://www.law.uc.edu/CCL/InvAdvRls/rule206(3)-2.html

On a related note, the affiliated broker-dealer can act as a "principal" on a transaction and instead of getting a commission, the firm charges a markup-markdown. That also requires disclosure and client consent because the firm benefits suddenly beyond just the advisory fees being charged. Remember that whenever an adviser gets compensated beyond the advisory fee, this needs to be disclosed to the advisory client. If I put you into a mutual fund and receive 12b-1 fees or sales charges (with my Series 6 or 7 license) that definitely needs to be disclosed. Is my advice totally objective? If not, I must disclose anything that could make it less than objective.

These potential conflicts of interest are laid out in ADV Part 2 (disclosure brochure) and are also disclosed on a per-transaction basis to the advisory client.

Private Placements

2009-10-31T11:14:00.003-05:00

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

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

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

Registration of Persons

2009-10-25T08:54:00.004-05:00

The Series 65/66 exam usually asks several questions about registration issues for broker-dealers, investment advisers, and their agents/IARs. It helps to keep a little flow chart in your head, like the ones we published at http://www.passthe66.com/updates/.

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

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

5 out-of-state clients

2009-10-21T21:41:00.004-05:00

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

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

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

So the answer above is A.

Advances to Partners, Officers

2009-10-19T18:25:00.006-05:00

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

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

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

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

http://www.nasaa.org/content/Files/NASAA%20Minimum%20Financial%20Requirements%20for%20Investment%20Advisers.pdf

Money Purchase Plan

2009-10-19T17:59:00.002-05:00

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

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

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

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

If you vehemently disagree with this and can explain why, send me an email walker@passthe65.com.

Out-of-State Adviser with 5 clients

2009-10-14T18:40:00.006-05:00

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

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

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

Thanks for the help!

I RESPONDED:

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

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

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

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

Annuity Payout

2009-10-11T09:04:00.004-05:00

If you're studying for the Series 65, I highly recommend purchasing one or more of the recorded classes at www.passthe65.com/classes.htm. Maybe you already have materials that your firm provided--these recorded classes will make sense of that stuff in a hurry.

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

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

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

ANSWER: C

IRA Contributions

2009-10-07T10:18:00.003-05:00

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

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

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

ANSWER: A

Unregistered, non-exempt securities

2009-10-01T19:30:00.002-05:00

Even a phrase as annoying and opaque as "soliciting sales of unregistered, non-exempt securities" relates to the so-called "real world." Just two days ago a federal court issued an injunction on some people who were, allegedly, trying to issue securities without bothering to get them registered. If you read the announcement at the link at the bottom of this post, you'll see that the SEC is just an army of attorneys--no criminal charges are being discussed here. The SEC is seeking all that they can, which is "permanent injunctions, disgorgement of ill-gotten gains, and civil penalties against all defendants." In other words, they would like to use the permanent injunction as a reason to deny these people any opportunity to work the securities business or offer securities in the future. They want them to give up the money they took (disgorge). And, they want the courts to hand down a stiff monetary penalty against them. You'll notice that specific sections of the Securities Act of 1933 are referenced, and it will do you good to read it all in the native tongue. Enjoy:
http://lawprofessors.typepad.com/securities/2009/09/sec-obtains-preliminary-injunction-in-florida-against-microcap-offering-fraud.html

Misappropriating Money

2009-09-30T17:01:00.003-05:00

Just when I start to think the material related to the Series 65/66 exam is boring, I find a headline such as the following to snap me out of my funk:

SEC Charges Illinois Money Manager with Misappropriating Investor Assets . . .

Of course, you have to love the word "misappropriating" in place of "stealing," but regulators are lawyers, and this is how they communicate. As a resident of big, scary Chicagoland, it is nice to see that some shenanigans take place downstate. As you'll see from the announcement at http://lawprofessors.typepad.com/securities/2009/09/sec-charges-illinois-money-manager-with-misappropriating-investor-assets.html this investment adviser (money manager) apparently made some false claims to investors (fraud) and used investor deposits to enjoy a high-rolling lifestyle (misappropriating/stealing).

Notice how the SEC is doing whatever they can in this case, "seeking injunctive relief, disgorgement, prejudgment interest, civil penalties and the appointment of a receiver." So, they wanted a federal judge to issue an injunction, and this is what they got for the asking: The Honorable Ruben Castillo, U.S. District Court Judge for the Northern District of Illinois, granted the SEC's request for emergency relief, including an order permanently enjoining Huber and Hubadex from committing further violations of the antifraud provisions and an order freezing the assets of Huber, Hubadex and the relief defendants. Huber, Hubadex and the relief defendants agreed to the emergency relief requested by the SEC.

So, at this point, it's a civil matter. But, the US Attorney's office can also pursue these matters in criminal court--I mean millions of dollars are involved.

In any case, read the announcement yourself. If you still think the Series 65/66 material on regulatory issues and business practices is "irrelevant," go ahead and post your comment below.

Natural Persons

2009-09-24T20:48:00.003-05:00

Just got another great question, this one from a customer studying for his Series 63. Don't worry--the Series 63 exists on both the Series 65 and (moreso) on the Series 66 exams. The customer asked:

Can a broker-dealer be a natural person?

I responded:
The question is really asking if a broker-dealer could be set up as a sole proprietor.
The answer is--yes he could. A sole proprietor does business as himself, so he is a natural person--there is no LLC or corporate structure set up as a separate legal entity from himself.
An investment adviser could also be set up as a sole proprietor, which means he/she is a natural person doing business as him or herself. Usually, a broker-dealer or adviser would set up an LLC or corporation. When they do that, they end up with a separate legal entity/person apart from the human beings who run the business.
On the other hand, agents and IARs are always natural persons--they are employees who represent the broker-dealer or the adviser. Period.
Broker-dealers and RIAs can be natural persons, but are usually "legal persons" in the form of a corporation or LLC.

Why the exam would even go into this weird territory . . . no idea. It's NASAA's world. We just try to live in it.

Felony Drug Conviction

2009-09-24T20:30:00.004-05:00

I just received an interesting question from a blog visitor, but he placed it after a blog written in July, and the content is just too important to leave it there, where it might get lost in the shuffle. He wrote:

Interested in acquiring the Series 7 and 66 license to obtain employment. I have a non-financial 1st-degree felony conviction (1996 drug charge), will I be accepted?

I responded:

There is no absolute black-and-white answer here, but it is extremely likely that you will be granted a license. You first have to get hired by a broker-dealer, though, to take the Series 7, and this could be the first roadblock. The firm might not want to hire any convicted felons, period. If you do get hired, you'll complete a Form U-4, and you will have to disclose the 1996 drug conviction and then explain it in detail on a DRP (disclosure reporting page). FINRA generally only uses the things that happened in the past 10 years against you, but you also have to get a salesperson or "securities agent" license from your state regulator. They might view a drug conviction as a red flag, because it represents an illegal financial scheme--they might see it in the same category as counterfeiting. Others might see it as a one-time event, a youthful indiscretion, etc.
If you can't get in as a securities agent, you could actually just take the Series 65 exam, then register your own LLC as an investment adviser through Form ADV. This form only asks about things that happened in the past 10 years, which means you don't even have to disclose the drug conviction from 1996.
With lawyers writing the rules, there is always an angle.

Economic Indicators

2009-09-17T07:06:00.003-05:00

Once again the economy is in the news this morning. New claims for unemployment are expected to rise, as is the number of people who remain on unemployment. That's the bad news. The good news includes the fact that inflation--measured by the CPI--is virtually nonexistent. Also, inventories are low, meaning factories will have to ramp up production soon. And, building permits are expected to rise about 3.5%. As you know, building permits and new claims for unemployment are leading indicators. CPI and unemployment/employment rates are coincident indicators. And, inventory is a lagging indicator.

In the article referenced below, you will see brief mention of both fiscal and monetary policy, even though those terms are not used. You'll see that "the Fed" sees no reason to change the discount or fed funds rate. You'll also see that fiscal policy, in the form of a tax credit, can help increase demand for housing.

I invite you to read the brief article at the link below. See how the "test world" matches up with the "real world" at:
http://news.yahoo.com/s/ap/20090917/ap_on_bi_ge/us_economy