One of the keys to passing the Series 66 exam is to make sure that you have a complete understanding of how investment recommendations will be tested on the Series 66 Exam. This article which was produced from material contained in our Series 66 textbook and will help you master the material so that you pass the Series 66 exam.
An investment adviser charges a fee for his or her services for advising clients as to the value of securities or for making recommendations as to which securities should be purchased or sold. Unlike a broker dealer, the investment adviser has a contractual relationship with his or her clients and must always adhere to the highest standards of professional conduct.
In addition to the fees charged by an investment adviser, an investment adviser may also:
The above sources of additional revenue must be disclosed to the client in writing prior to the investment adviser executing such transactions.
An agency cross transaction is one in which the investment adviser represents both the purchasing and selling security holder and receives advisory fees and commissions from both parties. If the investment adviser is going to execute an agency cross transaction, they must get the advisory client’s authorization in writing. The authorization may be pulled at any time verbally and the adviser may not have solicited both sides of the trade. Advisers who execute agency cross transactions must send clients an annual report detailing the number of agency cross transactions executed by the adviser and the amount of commission received by the adviser.
An investment adviser must disclose all of the following:
An investment adviser may not:
An investment adviser with custody of customer’s funds must:
TAKE NOTE!
The state securities administrator may or may not allow advisers to have custody of clients’ funds. If custody is allowed, the adviser must notify the state that they have custody and adhere to all requirements relating to custody of client funds.
All investment adviser contracts must be in writing and must contain disclosures of:
TAKE NOTE!
If an investment adviser uses an outside solicitor to refer business, such as an accounting firm, the client must get both the advisory’s brochure and the solicitor disclosure document or solicitor’s brochure.
As the business services offered by various professionals have expanded, so has the definition of who must register as an investment adviser. Sports and entertainment representatives now often advise their clients on how or with whom to invest their earnings. As a result, the representative is considered an investment adviser, even if investment advice is only a small part of the services they perform. Individuals who advise pension funds on the merits of portfolio managers or who act as pension consultants must also register as investment advisers.
A private investment company or 3 C7 hedge funds may charge performance-based compensation to clients, provided that the clients have a minimum of $1,000,000 of assets under the adviser’s management or have a net worth of $2,000,000. Corporations with $25 million in assets and individuals with at least $5 million in investments may also participate.
Advisers who manage accounts for investment companies or accounts with a value greater than $1 million, if those accounts are not for trusts or retirement plans, may charge fulcrum fees. A fulcrum fee provides the adviser with additional compensation for outperforming a broad-based index such as the S & P 500 and less compensation for under performing the index. The amount of the additional compensation received for outperforming the index must be equal to the amount of compensation that would be lost for underperformance. The index used as the basis to determine the adviser’s performance must contain similar securities and risks.
A wrap account is an account that charges one fee for both the advice received as well as the cost of the transaction. All clients who open wrap accounts must be given the wrap account brochure that will provide all of the information that is found on Form ADV part II.
Brokerage firms will oftentimes provide investment advisers with services to assist the investment adviser in their business that go beyond execution and research. These services are provided in exchange for commission business and are known as soft dollars. The services received should normally be research related. However there are instances when the services received are used for other purposes. Investment advisers must ensure that the services received are for the benefit of the client and need to pay careful attention to the disclosure requirements relating to soft dollars. The SEC has divided soft dollar consideration into the following categories:
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