NASAA Series 63Communication with Customers and ProspectsMedium
An investment adviser (IA) firm uses a digital platform to provide automated investment advice. The platform's algorithm sometimes recommends securities in which the IA firm's principals hold significant personal positions. Under the Uniform Securities Act, what is the IA firm's primary obligation regarding these recommendations?
- ATo avoid recommending any securities in which firm principals have a personal stake.
- BTo obtain client consent for such recommendations only if the principal's position exceeds 5%.
- CTo ensure the algorithm prioritizes client interests over the firm's or principals' interests.
- DTo disclose the potential conflict of interest to clients before or at the time of the recommendation.
Show answer & explanationAnswer & explanation
Correct answer: D. To disclose the potential conflict of interest to clients before or at the time of the recommendation.
When an IA firm or its principals have a personal interest in a recommended security, it creates a conflict of interest. The Uniform Securities Act requires the IA to disclose this conflict to the client, either verbally or in writing, before or at the time of the recommendation, to allow the client to make an informed decision.
Why the other options are wrong
- A. While avoiding such recommendations is one way to manage conflict, disclosure is the minimum legal requirement if they choose to recommend.
- B. There is no specific de minimis threshold like 5% for disclosing conflicts of interest; any material conflict must be disclosed.
- C. While prioritizing client interests is good practice, disclosure is the specific legal requirement for conflicts of interest.
Disclosure of Conflicts of Interest (IA)
Investment advisers must disclose all material conflicts of interest to clients, particularly when the adviser or its principals have a personal stake in securities being recommended.
- Disclosure must occur before or at the time of the recommendation.
- The purpose is to allow clients to make informed decisions.
- This applies to both human and automated advice platforms.
Memory trick: Show Your Hand Before You Advise.