NASAA Series 65, Uniform Investment Adviser Law ExaminationLaws, Regulations, and Guidelines, including Prohibition on Unethical Business PracticesHard
An investment adviser (IA) firm is considering using an affiliated broker-dealer to execute client trades. This arrangement could potentially create a conflict of interest. To comply with regulatory requirements, what is the MOST important action the IA must take?
- ADisclose the affiliation and any potential conflict of interest to clients in writing.
- BEnsure the affiliated broker-dealer offers the lowest possible commission rates.
- CGuarantee that the affiliated broker-dealer will always provide best execution for all trades.
- DObtain written consent from each client before executing any trades through the affiliate.
Show answer & explanationAnswer & explanation
Correct answer: A. Disclose the affiliation and any potential conflict of interest to clients in writing.
Under both state and federal securities laws, an IA has a fiduciary duty that requires full and fair disclosure of all material conflicts of interest. Using an affiliated broker-dealer is a clear conflict that must be disclosed so clients can make informed decisions.
Why the other options are wrong
- B. While seeking competitive rates is part of best execution, it doesn't fully address the conflict of interest disclosure requirement.
- C. Guaranteeing best execution is impossible and not the primary action required for disclosing the affiliation itself.
- D. Written consent may be required in some specific situations (e.g., principal trades), but general disclosure of affiliation and conflict is the *most important* action for this scenario.
IA Conflicts of Interest - Affiliated Broker-Dealer
An investment adviser using an affiliated broker-dealer for client trades presents a conflict of interest that must be fully and fairly disclosed to clients in writing, detailing the nature of the relationship and potential for bias.
- Fiduciary duty requires disclosure of all material conflicts.
- Affiliated B/D creates a conflict (e.g., incentive to churn).
- Disclosure must be full, fair, and in writing (e.g., Form ADV Part 2).
- Focus on enabling informed client decision-making.
Memory trick: AFFILIATION requires FULL DISCLOSURE to CLIENTS!