NASAA Series 65, Uniform Investment Adviser Law ExaminationLaws, Regulations, and Guidelines, including Prohibition on Unethical Business PracticesHard
An investment adviser (IA) firm uses an affiliated broker-dealer to execute client trades. The IA does not disclose this affiliation to clients, nor does it inform clients that it receives a portion of the commissions generated by these trades. Is this practice permissible under current securities regulations?
- ANo, this practice constitutes an undisclosed conflict of interest and is prohibited.
- BNo, unless the client explicitly consents to the use of an affiliated broker-dealer in writing.
- CYes, provided the IA does not mark up the commissions beyond the standard rate.
- DYes, as long as the trades are executed at the best available price for the client.
Show answer & explanationAnswer & explanation
Correct answer: A. No, this practice constitutes an undisclosed conflict of interest and is prohibited.
Using an affiliated broker-dealer and receiving commissions from client trades creates a clear conflict of interest. Under its fiduciary duty, an IA must disclose all material conflicts of interest to clients. Failure to disclose this affiliation and the receipt of commissions is a prohibited practice.
Why the other options are wrong
- B. While written consent is good practice, the primary issue is the *failure to disclose*. Disclosure is paramount, and then consent might be sought.
- C. Even if commissions are standard, the conflict of interest arising from the affiliation and compensation must be disclosed.
- D. Best execution is a separate duty; it does not negate the requirement to disclose conflicts of interest.
IA Conflicts of Interest - Affiliated Broker-Dealer
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.