NASAA Series 65, Uniform Investment Adviser Law Examination flashcards

A contraction is a phase of the business cycle where the economy is in decline, marked by falling GDP, increasing unemployment, and reduced business and consumer activity.

• Follows a peak and precedes a trough
• Characterized by negative economic growth
• Often associated with recessions

Memory trick: Every Peak Creates Troughs, Then Expands.

Stagflation is an economic condition characterized by slow economic growth, high unemployment, and rising prices (inflation).

• Combines stagnation and inflation.
• Challenging for policymakers to address due to conflicting objectives.
• Historically observed in the 1970s due to oil shocks.

Memory trick: Stagflation is when the economy's 'stag' (slow) and prices 'flate' (inflate).

Fat tails, or leptokurtosis, describe a statistical distribution where extreme outcomes occur more frequently than predicted by a normal distribution.

• Implies higher probability of large gains or losses.
• Increases risk for investors and makes modeling difficult.
• Commonly observed in financial market returns.

Memory trick: Fat tails mean 'F'requent 'A'nd 'T'remendous events.

A valuation ratio that measures a company's current share price relative to its per-share earnings.

• Formula: Market Price Per Share / Earnings Per Share (EPS).
• Indicates how much investors are willing to pay for each dollar of earnings.
• Higher P/E often implies higher growth expectations.

Memory trick: How much is this company worth, relative to its performance?

Owner's equity represents the owner's residual claim on the assets of a business after deducting liabilities. It is also known as shareholders' equity or stockholders' equity.

• Calculated as Assets - Liabilities
• Represents the net worth of a company
• Includes capital contributions and retained earnings

Memory trick: Assets Less Liabilities Equals Equity Always.

Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services.

• Sales Revenue - Cost of Goods Sold (COGS)
• Appears on the income statement
• Represents profitability before operating expenses

Memory trick: Revenue Minus Cost Equals Gross Gain.

The idea that an initial change in spending (e.g., government spending, investment) leads to a proportionally larger change in aggregate demand and national income.

• Driven by the marginal propensity to consume (MPC).
• Spending Multiplier = 1 / (1 - MPC).
• A higher MPC leads to a larger multiplier effect.

Memory trick: A ripple in the pond becomes a wave in the economy.

The interest rate an investor receives after accounting for inflation.

• Measures the true return on an investment in terms of purchasing power.
• Approximated by: Nominal Interest Rate - Inflation Rate.
• Crucial for evaluating the actual profitability of investments.

Memory trick: Nominal is what you see, Real is what you get after inflation's bite.

The cumulative amount of net income a company has retained over time, after paying dividends.

• Calculated as: Beginning Retained Earnings + Net Income - Dividends.
• Important component of owner's equity on the balance sheet.
• Represents profits reinvested in the business.

Memory trick: It's the profit piggy bank: add new profits, subtract what's paid out.

Accounts Payable (AP) are amounts owed by a business to its suppliers for goods or services received but not yet paid for.

• Represent short-term liabilities.
• Found on the balance sheet.
• An increase can indicate delayed payments or increased purchasing on credit.

Memory trick: The Balance Sheet 'Balances' Assets, Liabilities, and Equity.

A peak is the highest point of economic expansion, marking the end of growth and the beginning of a contraction.

• Characterized by maximum employment and output.
• High consumer and business confidence.
• Inflationary pressures may start to build.

Memory trick: Every cycle has a 'T'rough, an 'E'xpansion, a 'P'eak, and a 'C'ontraction.

When interest rates rise, the market value of existing bonds falls, and when interest rates fall, the market value of existing bonds rises.

• Driven by the yield differential between old and new bonds.
• Longer maturity and lower coupon bonds are more sensitive.
• Fundamental concept in fixed-income investing.

Memory trick: Interest rates and bond prices are like a seesaw: one goes up, the other goes down.

The return on an investment after adjusting for the effects of inflation, reflecting the actual increase in purchasing power.

• Calculated as Nominal Return - Inflation Rate (approximation).
• Provides a more accurate picture of investment success.
• Essential for long-term financial planning.

Memory trick: Nominal is the headline, Real is the true story after inflation.

Actions by a central bank to increase the money supply and stimulate economic growth.

• Aims to lower interest rates.
• Encourages borrowing and spending.
• Can lead to inflation if overdone.

Memory trick: The Fed pulls levers to warm or cool the economy.

The Quick Ratio measures a company's ability to meet its short-term obligations with its most liquid assets, excluding inventory. It is a more conservative liquidity measure than the current ratio.

• Formula: (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
• Excludes inventory
• Indicates immediate liquidity

Memory trick: Quick Cash for Quick Bills.

When evaluating multiple projects where only one can be chosen (mutually exclusive), select the project with the highest positive Net Present Value.

• NPV measures the present value of expected cash inflows minus the present value of expected cash outflows.
• A positive NPV indicates the project is expected to add value.
• For mutually exclusive projects, the highest positive NPV maximizes shareholder wealth.

Memory trick: How to pick the best investment path for profit.

Contractionary monetary policy is used by central banks to slow down economic growth, typically to combat inflation, by decreasing the money supply and increasing interest rates.

• Aims to reduce inflation
• Involves decreasing money supply
• Increases interest rates

Memory trick: Rates Up, Money Down, Economy Cools.

Opportunity cost is the value of the next best alternative that was not taken when a decision was made.

• A fundamental concept in economics.
• Applies to all decision-making, not just financial.
• Represents a trade-off.

Memory trick: Opportunity Cost is the 'O'ther 'C'hoice you 'G'ave up.

Investment advisers using an affiliated broker-dealer for client trades must fully disclose the affiliation and any compensation received (e.g., commissions) to clients, as this constitutes a material conflict of interest.

• Fiduciary duty requires disclosure of all material conflicts.
• Affiliation creates an incentive to direct trades to the affiliated entity.
• Disclosure must be clear and timely, typically in Form ADV Part 2.
• Failure to disclose is a prohibited practice.

Memory trick: Conflicts are okay if they're disclosed, like a warning sign on a winding road.

When a client insists on an unsuitable, unsolicited trade against an IAR's advice, the IAR fulfills their fiduciary duty by providing suitable advice, documenting the client's override, and then executing the client's directive.

• Fiduciary duty requires acting in client's best interest.
• Client has final authority over their account decisions.
• Documentation of advice and client's override is paramount.
• The IAR ensures informed consent for the client's decision.

Memory trick: Advise, Document, Obey: The IAR's duty when clients choose their own way.

A class of ownership in a corporation that has a higher claim on assets and earnings than common stock, typically pays fixed dividends, but usually carries no voting rights.

• Fixed dividend payments (not guaranteed, but prioritized).
• No voting rights (generally).
• Priority claim on assets in liquidation over common stockholders.
• Less volatile than common stock, more sensitive to interest rates.

Memory trick: Preferred Stock: The 'preferred' child – gets paid first, but no say.

The essential filings and disclosures an investment adviser must submit to a state Administrator to legally operate, including Form ADV parts, financial statements, and sometimes surety bonds.

• Includes Form ADV Parts 1 and 2.
• Balance sheet required if custody or substantial prepayments.
• Surety bond or minimum net worth for custody/discretion.
• Professional liability insurance is not a universal mandate.

Memory trick: FORM a BOND with your BALANCE to START!

U.S. Treasury bonds designed to protect investors from inflation by adjusting the principal value of the bond based on changes in the Consumer Price Index (CPI).

• Principal value adjusts with inflation (CPI).
• Interest payments are paid on the adjusted principal, so they also increase with inflation.
• Issued by the U.S. Treasury, considered very low credit risk.
• Provide a real rate of return.

Memory trick: TIPS: Treasury Inflation Protection, Smart choice for rising prices.

Soft dollar arrangements involve an investment adviser directing client brokerage transactions to a broker-dealer in exchange for research and brokerage services that benefit the client. Section 28(e) provides a safe harbor for IAs to pay higher commissions for these services if they are reasonable and benefit clients.

• Part of the Securities Exchange Act of 1934, but applies to IAs.
• Allows payment for 'brokerage and research services' with client commissions.
• Must benefit client accounts, not the IA's overhead or personal expenses.
• Requires disclosure to clients.

Memory trick: Soft Dollar Safe Harbor: Research, Not Rent; Analysis, Not Ads!

A type of permanent life insurance that combines a death benefit with a savings component, allowing the policyholder to invest in various sub-accounts and adjust premiums and death benefits.

• Offers flexible premiums and death benefits.
• Investment choices are made by the policyholder within sub-accounts.
• Cash value grows on a tax-deferred basis.
• Subject to market risk based on sub-account performance.

Memory trick: VUL: Versatile, Unlimited, Life-long investments.

The duty of loyalty requires an IAR to always act in the client's best interest and avoid conflicts of interest. 'Cherry-picking,' where an IAR allocates profitable trades to their own account and unprofitable trades to client accounts, is a direct violation of this duty.

• Core fiduciary principle.
• Requires placing client interests above personal interests.
• Prohibits self-dealing and undisclosed conflicts.
• Cherry-picking is a severe breach of this duty.

Memory trick: Conflicts of Interest: Loyalty's Rule, No Self-Serving Fool!

Investment advisers and their representatives have a responsibility to protect sensitive client information from unauthorized access, use, or disclosure through robust cybersecurity measures, including encryption and secure storage.

• Mandated by regulatory bodies (SEC, state Administrators).
• Applies to all personally identifiable information (PII).
• Requires secure transmission, storage, and access controls.
• Includes employee training and incident response plans.

Memory trick: Client Data: Encrypt, Protect, Never Neglect!

A debt security issued by a corporation to raise capital, promising to pay interest over a specified period and repay the principal at maturity.

• Issuer is legally obligated to pay interest and principal.
• Provides a fixed income stream.
• Generally less volatile than stocks.
• Subject to interest rate risk and credit risk.

Memory trick: Bonds are binding: legal payment obligation, stable income.

A type of private equity fund that provides capital to early-stage, high-growth potential companies in exchange for an equity stake, characterized by high risk, illiquidity, and a long investment horizon.

• Invests in early-stage, high-growth companies.
• High risk, high potential return.
• Illiquid, long investment horizon.

Memory trick: Venture Capital is where 'Ventures' for growth get their 'Capital'.

Investment advisers must amend their Form ADV promptly whenever there are material changes to their business operations, services, or other information previously filed.

• Annual amendment is required within 90 days of fiscal year-end.
• Other-than-annual amendments are required promptly for material changes.
• Material changes include changes in business model, disciplinary events, or custody status.
• Both Part 1 (regulatory information) and Part 2 (client brochure) may need updates.

Memory trick: ADV amendments: Annually, or when a material change makes it a 'prompt' concern.

Short-term debt securities that are highly liquid and considered very safe, typically used by investors for capital preservation and immediate cash needs.

• High liquidity.
• Low risk (capital preservation).
• Short maturity periods (typically less than one year).

Memory trick: Money markets are like a 'money-safe' for your short-term cash.

A contract with an insurance company that guarantees a fixed periodic payment for a specified period, often for the life of the annuitant, in exchange for a premium payment.

• Provides guaranteed income.
• Protects against longevity risk.
• Typically offers conservative returns.

Memory trick: Annuities are your 'Annuity-tee' against outliving your money.

A contract that offers tax-deferred growth potential, professional management through investment sub-accounts, and a death benefit payout.

• Tax-deferred growth
• Investment sub-accounts (similar to mutual funds)
• Death benefit option
• Subject to market risk

Memory trick: Tax-deferred growth, managed investments, and a death benefit: think VA!

When an investment adviser (IA) outsources compliance functions, the IA firm retains ultimate responsibility for ensuring full compliance with all securities laws and regulations. The duty cannot be fully delegated away.

• IA remains ultimately responsible for compliance.
• Delegation does not absolve fiduciary duty.
• IA must oversee and monitor the outsourced function.
• Compliance is a core, non-delegable duty of the IA.

Memory trick: Outsource the task, but OWN the ultimate RISK!

When a client insists on executing trades that an IAR deems unsuitable for their risk profile; the IAR must advise against, document, and then proceed with the client's directive unless ethically or legally prohibited.

• IAR has fiduciary duty to advise.
• Client can override IAR's advice.
• Documentation of advice and client's decision is crucial.
• Waivers of liability are generally unenforceable.

Memory trick: Advise, Document, Proceed (or not).

Under state and federal rules, an investment adviser that has custody of client funds or securities must generally place them with a 'qualified custodian' (e.g., bank, broker-dealer) and ensure clients receive statements directly from this custodian.

• Custody is broadly defined (e.g., direct control, legal ownership, power to withdraw).
• Qualified custodians provide independent oversight.
• Clients must receive direct statements from the custodian.
• Annual surprise audits may be required if the IA itself maintains custody.

Memory trick: Custody's Core: Qualified Custodian, Direct Statements, No IA's Own Safe!

Investment advisers are strictly prohibited from advertising that their registration with a state Administrator or the SEC implies any level of skill, endorsement, or approval of their services by the regulator.

• Registration is a licensing requirement, not an endorsement.
• Prohibited under both federal (SEC) and state (USA) rules.
• Aims to prevent misleading clients about regulatory oversight.
• Must clearly state that registration does not imply skill or approval.

Memory trick: No Approval, No Guarantees, No Misleading!

Investment advisers and their representatives are strictly prohibited from guaranteeing specific returns on investments or promising to protect clients from losses.

• Violates fiduciary duty and anti-fraud provisions.
• Investors must understand that all investments carry risk.
• IARs must provide realistic expectations and disclose risks.
• Applies to all types of investments and services.

Memory trick: Never guarantee gains, like a broken slot machine, it's a fraud claim.

The risk that a bond issuer will be unable to make its promised interest payments or repay the principal amount at maturity.

• Higher for lower-rated bonds (e.g., 'junk bonds').
• Lower for higher-rated bonds (e.g., government bonds, investment-grade corporates).
• Can lead to partial or total loss of investment.
• Bond ratings (e.g., S&P, Moody's) assess credit risk.

Memory trick: Credit Risk: The company's credit is like its character – low rating means low trust.

A U.S. Treasury bond that is indexed to inflation to protect investors from the erosion of purchasing power.

• Principal value adjusts semi-annually based on the Consumer Price Index (CPI).
• Coupon rate is fixed, but interest payments vary as they are applied to the adjusted principal.
• At maturity, investors receive the greater of the original or adjusted principal.
• Provides a hedge against inflation.

Memory trick: TIPS: Treasury's Inflation Protection Shield.

An Investment Adviser Representative (IAR) who is also licensed to sell insurance products (dual registration) may receive commissions for the sale of those products, provided that the compensation arrangement is fully and clearly disclosed to the client, and the recommendation is suitable.

• Dual registration is permitted.
• Commissions for insurance products are allowed if properly licensed.
• Full and clear disclosure of all compensation is mandatory.
• Fiduciary duty still applies; recommendations must be suitable.

Memory trick: Dual Roles, Dual Pay: Disclose All, Come What May!

Regulations, primarily under the Investment Advisers Act of 1940 and Uniform Securities Act, that mandate investment advisers retain specific business records, including client communications, for a set period (e.g., five years).

• Governed by Investment Advisers Act of 1940 (SEC) and Uniform Securities Act (State).
• Includes client communications, trade records, financial statements.
• Minimum retention period is typically five years.
• Records must be readily accessible for two years.

Memory trick: Keep your ADVISORY records for a FIVE-YEAR FIX!

An options strategy where an investor holds a long position in an asset (e.g., 100 shares of stock) and sells (writes) a call option on that same asset. It generates income (premium) and partially hedges against a moderate price decline, but limits upside gains.

• Involves owning the underlying stock and selling a call option.
• Generates income from the option premium.
• Limits potential upside profit on the stock.
• Provides limited downside protection up to the premium received.

Memory trick: Covered Calls 'C.A.P.I.T.A.L.'ize on holding stock and selling options.

Financial instruments representing a loan made by an investor to a borrower (typically corporate or governmental entity) that must be repaid, usually with interest, by a certain date.

• Provide regular income (interest payments).
• Have a fixed maturity date.
• Value is inversely sensitive to interest rate changes.
• Prioritized over equity in liquidation.

Memory trick: Income, Maturity, Rates – D.E.B.T. delivers!

The unethical and illegal practice of an investment professional using material non-public information about an impending client transaction to trade for their own account ahead of the client.

• Involves trading on advance knowledge of client orders.
• Done for personal gain.
• Breaches fiduciary duty.
• Prohibited under the Uniform Securities Act.

Memory trick: Fiduciaries Follow Rules, Front-Running Fails.

An exemption from state investment adviser registration for firms that have no place of business in that state and fewer than six clients who are residents of that state within any 12-month period.

• Applies to state-registered IAs.
• Requires no place of business in the new state.
• Limits client count to fewer than 6 residents in 12 months.

Memory trick: Don't Minimize Your State Client Count!

Updates or changes made to an investment adviser's registration document (Form ADV) to reflect current and accurate information.

• Annual Updating Amendment (within 90 days of fiscal year-end).
• Prompt Amendments for material changes.
• Material changes include business type, disciplinary actions, ownership.
• Ensures accurate public disclosure.

Memory trick: ADV must always reflect the truth, quickly if things change.

A core aspect of fiduciary duty requiring investment advisers to possess and maintain the necessary knowledge and skills to provide competent and suitable advice to clients.

• Advise only within areas of expertise.
• Must decline advice if lacking competence.
• Prioritizes client's best interest.
• Ensures suitability of recommendations.

Memory trick: Fiduciaries know their limits, and won't cross them.

A municipal bond that is backed by the full faith, credit, and taxing power of the issuing governmental unit.

• Repaid from the general revenues of the issuer, often including property taxes.
• Requires voter approval for issuance.
• Considered less risky than revenue bonds due to broader backing.
• Used to finance public projects that do not generate their own revenue (e.g., schools, roads).

Memory trick: Muni bonds: GO for general taxes, Revenue for specific projects.

Investment advisers are generally registered with either state securities authorities or the SEC, based primarily on their Assets Under Management (AUM). The threshold for mandatory SEC registration is $110 million AUM.

• Below $100M AUM: State registration (unless specific exemptions apply).
• Between $100M and $110M AUM: Option to register with either state or SEC (mid-sized adviser).
• At or above $110M AUM: Mandatory SEC registration (large adviser).
• A grace period of 90 days applies when crossing thresholds.

Memory trick: AUM's Climb: State Below 100, Mid-Range is a Choice, Over 110 SEC's Voice!

A type of investment fund that holds assets such as stocks, commodities, or bonds, and trades on stock exchanges like regular stocks.

• Trades throughout the day
• Typically passively managed (index tracking)
• Lower expense ratios than actively managed funds
• Can be bought on margin and sold short

Memory trick: ETFs: Exchange-Traded Funds trade like stocks, low fees, track indexes.

A debt security issued by a state or local government or their agencies to finance public projects, with interest typically exempt from federal income tax.

• Interest is federally tax-exempt.
• May be state and local tax-exempt for in-state residents (triple tax-free).
• Generally considered low risk (especially general obligation bonds).
• Provides consistent income.

Memory trick: Munis for money, tax-free at multiple levels!

The asset under management (AUM) level that typically mandates an investment adviser to register with state securities Administrators rather than the SEC.

• AUM less than $100 million.
• Principal place of business in the state.
• No specific federal triggers (e.g., advising investment companies).
• Governed by the Uniform Securities Act.

Memory trick: Small AUM, stay local; Big AUM, go federal.

The SEC's Marketing Rule (Rule 206(4)-1) permits investment advisers to use testimonials in advertising, provided they meet specific disclosure and oversight requirements to prevent them from being misleading.

• Replaced the old advertising rule in 2021.
• Allows testimonials with proper disclosures.
• Must not be misleading, must disclose conflicts, and if compensated, must disclose compensation.

Memory trick: Marketing's New Rule: Testimonials are Fine, Just Disclose and Be Kind!

The prompt, fair, and thorough handling of client complaints by an investment adviser is a direct manifestation of their fiduciary duty to act in the best interests of their clients.

• Fiduciary duty requires acting in client's best interest.
• Complaint resolution builds and maintains client trust.
• Failure to address complaints can breach fiduciary duty.
• Regulatory bodies often require complaint logs and procedures.

Memory trick: Care, Loyalty, and Transparency with Clients!

An investment product that tracks the performance of a single commodity or a basket of commodities, traded on stock exchanges like shares, without requiring direct ownership of the physical commodity.

• Tracks commodity prices.
• Trades on an exchange throughout the day.
• Does not require physical ownership.

Memory trick: ETCs let you 'E-Track Commodities' like stocks.

An investment adviser's online presence (website, email) does not automatically establish a 'place of business' in every state. State registration obligations are triggered by having a physical 'place of business' or by exceeding the de minimis client threshold (usually 5 clients) in a given state.

• Website accessibility alone is not a 'place of business'.
• De minimis exemption applies per state for IAs without a physical office.
• More than 5 clients in a state (without a physical office) typically triggers registration.
• Principal office state always requires registration.

Memory trick: Place of business or too many web clients, state registration is due.

If a client insists on executing an investment that is unsuitable for them, against the IAR's advice, the IAR should execute the trade but must obtain a written acknowledgment from the client that they are overriding the IAR's recommendation and understand the risks.

• IAR's primary duty is suitability and client's best interest.
• Clients have ultimate control over their accounts.
• Documentation of advice and client's override is crucial for IAR protection.
• A 'hold harmless' letter or similar acknowledgment is often used.

Memory trick: Advise, document, then let the client decide, with a written 'override' to abide.

An investment adviser is deemed to have custody if it holds, directly or indirectly, client funds or securities, or has the authority to obtain possession of them.

• Holding client funds/securities.
• Authority to obtain possession (e.g., full power of attorney).
• Exceptions: promptly forwarding checks made out to IA firm.
• Custody triggers strict safeguards.

Memory trick: Custody means Control: Can you touch or take client assets?

An IAR's fiduciary duty requires them to always act in the client's best interest, including ensuring investment recommendations are suitable. This duty cannot be waived by a client, and an IAR must decline to facilitate transactions deemed unsuitable, even if the client insists.

• Fiduciary duty is non-waivable.
• Suitability is a core component of fiduciary duty.
• IARs must decline unsuitable transactions.
• Client insistence or waivers do not override this duty.

Memory trick: Fiduciary's Line: No Waiver Can Make Wrong Right, Uphold Suitability with All Your Might!