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
Saturday, June 19, 2010
Sunday, June 6, 2010
Settlor Functions practice question
If the test asks about "settlor functions," maybe it would throw something like this at you:
An employee participant of a 401(k) plan is 61 years old. A family member, who is an attorney with a specialization in financial matters, tells her that if her company had provided a higher matching contribution she "would be a lot better off financially" now. Therefore, under ERISA, the CEO and other fiduciaries of the plan
A. can be sued up to the amount that the company could have contributed with a higher matching incentive in place
B. can not be sued for breach of fiduciary duty
C. can be sued up to the amount that the company could have contributed with a higher matching incentive plus the expected return on that amount over the holding period
D. can only be sued for breach of fiduciary duty while performing settlor functions
EXPLANATION: as we said in the previous post, the CEO's decision on how the company will match employees' contributions, or whether they will match them at all, are examples of "settlor functions" in which the fiduciaries to the plan are NOT acting as fiduciaries. Instead, they are making business decisions. So, A and C can be eliminated, and so can D. Remember, the CEO is not a fiduciary based on his title of CEO. He's a fiduciary to the plan participants and their beneficiaries only when functioning in that capacity. His or her decision to start or stop a 401(k) plan would be a "settlor function" based on how it affects the business. If, on the other hand, the 401(k) plan offered to employees does not provide enough information on the funds or the participants' balances, or doesn't allow them to alter their investment choices at least quarterly, then the CEO could be breaching his or her fiduciary duty.
ANSWER: b
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
Thursday, May 27, 2010
Settlor Functions
Apparently, the term "settlor functions" has been known to appear on the Series 65/66 exams, so let's take a brief look at this concept. As you know, ERISA says that pension funds and 401(k) plans are run by "fiduciaries" such as the CEO, investment advisers managing the assets, members of the board who oversee the plan, etc. But, the CEO is a fiduciary only when he's managing the plan or directing the investment advisers, for example. He's not a fiduciary to the plan participants and beneficiaries just because he's the CEO. It's the function, not the title, that makes him a fiduciary. So, when a plan fiduciary is actually just making "business decisions," called "settlor functions" by ERISA, he/she is not performing fiduciary functions. I'm looking at a letter from the Department of Labor, in which the Assistant Secretary of the Department explains that "in light of the voluntary nature of the private pension system governed by ERISA, the Department has concluded that there is a class of discretionary activities which relate to the formation, rather than the management, of plans. These so-called 'settlor functions' include decisions relating to the establishment, termination and design of plans and are not fiduciary activities . . . "
So, the decision to start or terminate a retirement plan is considered a business decision (settlor function), not a fiduciary matter. The exam might expect you to know that the following decisions are considered "settlor functions" and not fiduciary activities:
--Choosing the type of plan or options in the plan
--Amending the plan
--Requiring employee contributions/changing contribution levels
--Terminating a plan
I'll have to think up some practice questions for future posts. With any luck the exams won't go very deep into this topic. I'm still struggling to understand why investment adviser representatives actually need to know anything about this topic. As if relevance actually played a role in placing a question on the Series 65/66.
So, the decision to start or terminate a retirement plan is considered a business decision (settlor function), not a fiduciary matter. The exam might expect you to know that the following decisions are considered "settlor functions" and not fiduciary activities:
--Choosing the type of plan or options in the plan
--Amending the plan
--Requiring employee contributions/changing contribution levels
--Terminating a plan
I'll have to think up some practice questions for future posts. With any luck the exams won't go very deep into this topic. I'm still struggling to understand why investment adviser representatives actually need to know anything about this topic. As if relevance actually played a role in placing a question on the Series 65/66.
3rd Prong - business standard
Ok, we've looked at the question of whether somebody is providing investment advice, and whether that somebody receives compensation as a result of it. What, then, do the regulators mean when they ask, "Is the person in the business of providing investment advice?" ? In SEC Release IA-1092, the regulators state that, "Under section 202(a)(11), an investment adviser is one who, for compensation, (1) engages in the business of advising others as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or, alternatively, (2) issues or promulgates reports or analyses concerning securities as part of a regular business. Each of these two alternatives in the statutory definition of investment adviser contains a business test -- one involves 'engaging in the business' of advising others while the other involves issuing reports about securities as 'part of a regular business.' While the business standards established under Section 202(a)(11) are phrased somewhat differently, it is the staff's opinion that they should be interpreted in the same manner." As the release then states, "The giving of advice need not constitute the principal business activity or any particular portion of the business activities of a person in order for the person to be an investment adviser under Section 202(a)(11). The giving of advice need only be done on such a basis that it constitutes a business activity occurring with some regularity. The frequency of the activity is a factor, but is not determinative." Okay, what the heck does that mean? It means that there is really no objective standard whatsoever used to determine if someone is "in the business of providing investment advice." There is no guidance based on the percentage of income the advisory services comprise of a professional's total compensation, and there is no guidance based on the frequency with which the advice is provided. As that famous judge said about pornography, he can't define it, but he knows it when he sees it. Great. Let's see what the SEC has to say next: The staff considers a person to be "in the business" of providing advice if the person: (i) holds himself out as an investment adviser or as one who provides investment advice, (ii) receives any separate or additional compensation that represents a clearly definable charge for providing advice about securities, regardless of whether the compensation is separate from or included within any overall compensation, or receives transactionbased compensation if the client implements the investment advice, or (iii) on anything other than rare, isolated and non-periodic instances, provides specific investment advice. The SEC then writes, "For the purposes of (iii) above, "specific investment advice" includes a recommendation, analysis or report about specific securities or specific categories of securities (e.g., industrial development bonds, mutual funds, or medical technology stocks). It includes a recommendation that a client allocate certain percentages of his assets to life insurance, high yielding bonds, and mutual funds or particular types of mutual funds such as growth stock funds or money market funds. However, specific investment advice does not include advice limited to a general recommendation to allocate assets in securities, life insurance, and tangible assets." In other words, good luck trying to push the edge of that envelope. As if you're going to build a career telling people that they really oughta, you know, invest in securities, life insurance, and tangible assets, but, unfortunately, that's all you can really tell them. You can't tell them which types of securities to invest in, let alone which companies they might want to invest in. Good luck getting anybody to pay your bill for that "advice," right? Also, did you notice that if you merely "hold [yourself] out as an investment adviser or as one who provides investment advice," guess what--you're an investment adviser. In other words, if you pass out business cards announcing that you are available to provide investment advice, or if you put up a billboard trying to pull in new clients, you are definitely "holding yourself out as an investment adviser." Then again, if you do NOT hold yourself out as an investment adviser and privately advise not more than 15 clients, the SEC won't make your register. The states, however, can do what they want in that case--you have an office somewhere, maybe that state will require you to register. What do you want, a clear answer? Sorry, you're dealing with the regulators here, who like everything to remain at least as clear as mud.
What if somebody is a financial planner who avoids giving specific advice on securities? The SEC explains that, "In applying the foregoing tests, the staff may consider other financial services activities offered to clients. For example, if a financial planner structures his planning so as to give only generic, non-specific investment advice as a financial planner, but then gives specific securities advice in his capacity as a registered representative of a dealer or as agent of an insurance company, the person would not be able to assert that he was not 'in the business' of giving investment advice." So, the way I read all this mumbo jumbo is that if you provide specific investment advice for compensation, and you do it more than once in a VERY great while, you are in the business of providing investment advice and will almost certainly have to register, either with the SEC or the state regulators.
What if somebody is a financial planner who avoids giving specific advice on securities? The SEC explains that, "In applying the foregoing tests, the staff may consider other financial services activities offered to clients. For example, if a financial planner structures his planning so as to give only generic, non-specific investment advice as a financial planner, but then gives specific securities advice in his capacity as a registered representative of a dealer or as agent of an insurance company, the person would not be able to assert that he was not 'in the business' of giving investment advice." So, the way I read all this mumbo jumbo is that if you provide specific investment advice for compensation, and you do it more than once in a VERY great while, you are in the business of providing investment advice and will almost certainly have to register, either with the SEC or the state regulators.
Thursday, May 13, 2010
Practice question on the 2nd prong
Let's try to apply what we've been discussing about the "three-pronged approach" to the following practice question:
Which of the following least likely meets the definition of an "investment adviser"?
A. an individual who merely rents a billboard in State A announcing the availability of "total financial planning services"
B. a financial planner limiting her services to budgeting, bill paying, and credit score improvement
C. a newsletter writer who covers mid-cap technology stocks and sends the newsletter to paid subscribers based on market index movements
D. a geological engineer who charges a flat fee to help investors determine promising royalty trusts and limited partnership interests involved with oil & gas exploration
EXPLANATION: the phrase "holding itself out to the public" often messes with people. But, the individual who rents a billboard is doing exactly that--holding herself out to residents of the state as being in the business of providing investment advice. Close enough--she's an adviser. The newsletter writer loses his exclusion by blasting out his so-called "newsletter" based on "market developments." He's only a newsletter writer if he's publishing a newsletter that goes out to a general audience on a regular circulation--if the thing goes out based on market developments, he's an adviser. The engineer would not be an adviser if he's merely telling partnerships whether there is or is not oil/gas underground worth trying to extract, but this guy is telling investors what to invest in, for compensation. He is also an adviser. While "financial planners" usually do meet the definition of "investment adviser," that is only if part of their service involves securities. If, on the other hand, they keep it to non-securities matters, they escape the definition.
ANSWER: b
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
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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.
In any case, let's look at the next prong in the "three-pronged approach" to defining investment advisers: does the person receive compensation as a result of providing investment advice? Many candidates have a hard time with this one. They think that the compensation has to be in the form of money, but "compensation" includes any form of economic benefit. So, if you get a test question about a finance professional in a rural area who provides total financial planning and investing checkups in exchange for sacks of potatoes or sides of beef, that finance professional is receiving compensation for his advice and would meet the definition of "investment adviser." Also remember that the compensation does not have to be paid by the person receiving the advice. In the previous blogpost we had an insurance agent charging advertisers while providing advice to site visitors--makes no difference who pays him. He's getting compensation indirectly for providing investment advice. Close enough for rock and roll. Or, maybe a test question has somebody giving employees of a large company portfolio allocation advice and charging the company, not the employees. Again--makes no difference who pays him. He's providing investment advice and receiving compensation. He meets the definition of "investment adviser." What if a newsletter writer charges subcribers $300 a year for monthly emailed newsletters discussing large cap value stocks? Is that compensation? Yes. Is the newsletter writer providing investment advice? No. He's just writing a newsletter, just expressing his opinions as guaranteed by the 1st Amendment to the US Constitution.
In other words, you gotta think hard and carefully when dealing with these issues. Look for a practice question on the compensation issue in the next few blog posts.
Practice question on the 1st prong
If you don't have our Pass the 65 ExamCram Online or Pass the 66 ExamCram Online, I highly recommend getting it, even if you already have a full suite of materials. The questions are often challenging, and they provide clear explanations when you hit the "rationale" button.
Either way, let's apply what we discussed in the blog post before last, the one discussing "Does the person provide investment advice?" Here goes:
Which of the following least likely meets the definition of an "investment adviser"?
A. a certified public accountant who includes a 401(k) portfolio allocation service with his tax preparation services at no extra charge
B. an insurance agent who publishes a website in which visitors receive allocation strategies based on data they input; only site advertisers are charged
C. a writer of an Internet newsletter who publishes recommendations on small cap stocks to paid subscribers on the 15th of each month
D. a lawyer who offers total financial planning services to certain clients
EXPLANATION: this is a tough question. You have to find three people who do meet the definition of "investment adviser" and cross them out. The one who does not meet the definition is your answer. Right? Okay, what about the accountant--accountants are not investment advisers, right? Right?
Wrong--nobody ever said that. An accountant is not an investment adviser if he/she is not providing investment advice. But, this CPA is providing specific investment advice. Even though he doesn't itemize the bill with a charge for the advice, the advice is part of the services for which he receives compensation. This accountant is an investment adviser. The insurance agent might not receive compensation from site visitors, but he receives compensation from somebody as a result of providing specific advice. The insurance agent is also an investment adviser. The lawyer is holding himself out as a "total financial planner" to the public. I'd say he's an adviser. However, the newsletter writer gives no investment advice specific to anyone's individual needs. Therefore, he least likely meets the definition of "investment adviser."
ANSWER: c
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
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