Study guide
This chapter carries a 30 percent weighting, about 39 scored questions, and is built on the Uniform Securities Act, NASAA model rules, and the Investment Advisers Act of 1940. It defines who must register and where, what the state Administrator can do, and the fiduciary and ethical standards whose violation ends careers.
Who Is an Investment Adviser? Definitions, Coverage, and Registration
An investment adviser is any person who, for compensation, is in the business of advising others about securities. All three prongs (advice about securities, as a business, for compensation) must be present. Excluded from the definition: banks and savings institutions; lawyers, accountants, teachers, and engineers whose advice is solely incidental to their profession; broker-dealers whose advice is incidental and who receive no special compensation for it; publishers of bona fide, general-circulation publications; and federal covered advisers, who are excluded from the state definition. Dodd-Frank drew the federal-state line by assets under management: advisers below $100 million generally register with their states; between $100 and $110 million they may choose SEC registration; at $110 million SEC registration is mandatory; and an SEC-registered adviser need not switch back to the states until it falls below $90 million. Advisers to registered investment companies register with the SEC regardless of size. Federal covered advisers do not register with states, but states may require notice filings and fees, and state antifraud authority always applies. State registration exemptions cover advisers with no place of business in the state whose clients are only institutions or other professionals, and the de minimis standard: five or fewer non-institutional clients in twelve months. Exempt reporting advisers (venture capital and private fund advisers under $150 million) file reports without full registration. Registration is made on Form ADV: Part 1 for regulators, the Part 2A plain-English brochure describing services, fees, conflicts, and discipline, and Part 2B supplements on personnel. Registration becomes effective at noon on the thirtieth day. Advisers keep books and records five years, the first two in the principal office, and must supervise their representatives, whose NASAA continuing education requirement is 12 credits per year: six in Products and Practice, six in Ethics and Professional Responsibility.
Investment Adviser Representatives, Broker-Dealers, and Agents
An investment adviser representative (IAR) is any individual associated with an adviser who makes recommendations, manages accounts, determines advice to be given, solicits or negotiates for advisory services, or supervises anyone who does. Purely clerical and administrative staff are excluded. IARs of state-registered advisers register in states where they have a place of business or clients beyond the de minimis level; IARs of federal covered advisers register only where they maintain a place of business. When an IAR of a state-registered adviser starts or leaves, the adviser notifies the Administrator; for a federal covered adviser, the IAR gives the notice. Registration is not portable: it terminates when the person leaves the firm and is effective only while employed by a registered firm. A broker-dealer is a person in the business of effecting securities transactions for others or its own account. Excluded from the state definition: agents, issuers, banks and trust companies, and out-of-state firms with no place of business in the state whose only in-state contacts are institutions or existing customers passing through temporarily (the snowbird provision). An agent is an individual representing a broker-dealer or an issuer in effecting securities transactions. Individuals representing issuers are excluded from the agent definition when the transaction is exempt or involves certain exempt securities such as U.S. government and municipal issues, and clerical staff are excluded. Agents and IARs must be registered before doing any business, firms may not employ unregistered persons in registered capacities, and an agent working for two unaffiliated broker-dealers needs each registration properly in place. Watch reportable events: registrants must update their uniform forms (U4, ADV) promptly for disciplinary disclosures, and IAR registration also carries the annual continuing education obligation.
Securities, Issuers, and the Registration of Securities
A security is defined broadly, and the Howey test supplies the catch-all: an investment of money in a common enterprise with an expectation of profit derived from the efforts of others. Stocks, bonds, notes, investment contracts, options, limited partnership interests, and variable annuities and variable life insurance are securities. Fixed annuities, traditional whole life insurance, commodity futures themselves, currency, and collectibles are not. Under the Uniform Securities Act, securities offered in a state must be registered, federal covered, or exempt. Registration by coordination pairs a federal 1933 Act filing with state filings that become effective simultaneously with the federal registration, the common route for interstate offerings. Registration by qualification is a state-only process for purely local offerings and becomes effective only when the Administrator so orders. Registration by filing or notification is available to certain seasoned issuers. Federal covered securities, such as exchange-listed stocks and registered investment company shares, are not registered at the state level, though notice filings and fees may be required. Exempt securities carry an exemption attached to the instrument itself: U.S. government and municipal securities, bank and savings institution securities, insurance company securities, public utility issues, nonprofit securities, and short-term commercial paper. Exempt transactions depend on how the trade happens: isolated non-issuer transactions, unsolicited brokerage orders, transactions with institutions, underwriters, or fiduciaries such as executors and trustees in bankruptcy, and private placements, which under the model act allow offers to no more than ten non-institutional persons in twelve months with no commissions for soliciting them and purchase for investment intent. Issuers are entities that issue or propose to issue securities. The antifraud provisions apply to every offer and sale, exempt or not.
The Administrator: Powers, Remedies, and Liabilities
The state Administrator has jurisdiction when an offer or sale originates in, is directed into, or is accepted in the state. Powers include making rules and orders in the public interest, investigating within or outside the state, subpoenaing witnesses and records, inspecting registrants, and requiring the filing of advertising. The Administrator may issue a cease-and-desist order, and may do so summarily, without a prior hearing, to stop a violation in progress. Denying, suspending, or revoking a registration is more demanding: the order must be in the public interest AND based on a specific statutory cause, such as willful violations, felony convictions or securities-related misdemeanors within ten years, insolvency, or failure to supervise, and it requires notice, an opportunity for a hearing, and written findings. The Administrator cannot imprison anyone; criminal matters are referred to prosecutors. Nonpunitive events are different: a withdrawal of registration becomes effective 30 days after filing if no proceedings are pending, and the Administrator keeps jurisdiction over a former registrant for one year. Civil liability gives buyers of securities sold illegally or by material misstatement the right of rescission: recovery of the price paid plus interest, minus any income received, plus costs and reasonable attorney fees; advisory clients have parallel remedies for advice sold in violation of the act. A seller who discovers its own violation may extend a rescission offer, and a buyer who fails to accept within 30 days loses the right to sue. The civil statute of limitations is the earlier of three years after the sale or two years after discovery of the violation. Criminal penalties under the model act reach $5,000 in fines and three years imprisonment per violation, with a five-year statute of limitations, and no prison sentence may be imposed on a person who proves no knowledge of the rule or order violated. Administrator orders may be appealed to court within 60 days, and filing an appeal does not automatically stay the order.
Fiduciary Duty, Compensation, Custody, and Prohibited Practices
Advisers are fiduciaries owing duties of care and loyalty: act in the client's best interest and fully disclose every material conflict. Communications must never mislead: stating that registration means the Administrator or SEC has approved or endorsed anyone is unlawful, and guaranteeing performance or promising to cover losses is prohibited. Advisory contracts (in writing for state-registered advisers) must describe services, term, fees and refund policy, and any discretion granted, may not be assigned without client consent, and require notice of partnership membership changes. Performance-based fees are prohibited except for qualified clients, defined as of June 29, 2026, as clients with at least $1.4 million under management with the adviser or more than $2.7 million net worth. All compensation, including fees, commissions, and soft dollars, must be disclosed; the Section 28(e) safe harbor covers research and brokerage services paid with client commissions, but rent, travel, marketing, and hardware fall outside it. Advertising, social media, email, and websites face the same anti-fraud standards; the SEC marketing rule permits testimonials and endorsements only with disclosure and oversight, and states may be stricter. Custody means holding client funds or securities or having authority to obtain them; it requires a qualified custodian, notices, account statements, and surprise verification, and under NASAA model rules a state-registered adviser with custody maintains a $35,000 minimum net worth ($10,000 if it has only discretion) or bonding. Forwarding a mistakenly received third-party check within three business days avoids custody. Discretion requires prior written authorization, though NASAA permits oral discretionary authority for the first ten business days; time-and-price instructions are not discretion. Prohibited practices include churning, unauthorized trading, borrowing from or lending to clients, sharing in account profits, insider trading, selling away, market manipulation, front running, pay-to-play political contributions (a two-year compensation timeout; de minimis $350 per candidate the person can vote for, $150 otherwise), exploiting vulnerable adults (advisers may delay suspicious disbursements roughly 15 business days and must report), breaching confidentiality, and anti-money laundering failures (customer identification, suspicious activity reports, currency transaction reports above $10,000). Firms also need cybersecurity and privacy safeguards and a business continuity and succession plan.
Key terms
- Investment adviser
- — A person who, for compensation, is in the business of advising others about securities, with all three elements required.
- Federal covered adviser
- — An adviser registered with the SEC (generally $110 million or more in AUM or advising registered funds) and therefore excluded from state registration.
- Investment adviser representative (IAR)
- — An individual at an advisory firm who gives advice, manages accounts, solicits advisory business, or supervises those who do.
- Broker-dealer
- — A person in the business of effecting securities transactions for the accounts of others or its own account.
- Agent
- — An individual who represents a broker-dealer or an issuer in effecting securities transactions.
- Howey test
- — The Supreme Court test defining an investment contract as money invested in a common enterprise with profits expected from others' efforts.
- Exempt transaction
- — A trade excused from registration because of how it occurs, such as an unsolicited order, institutional trade, or private placement.
- Administrator
- — The state official empowered to register, investigate, and discipline securities professionals and enforce the state securities act.
- Cease-and-desist order
- — An Administrator's order to stop a practice, which may be issued summarily without a prior hearing.
- Rescission
- — The civil remedy of undoing a sale, returning the price paid plus interest, minus income received, plus costs and attorney fees.
- Custody
- — Holding client funds or securities, or having the authority to obtain them, which triggers custodian, net worth, and verification requirements.
- Churning
- — Excessive trading in a client's account to generate compensation rather than serve the client's objectives.
Exam tips
- Exempt security versus exempt transaction: a security exemption travels with the instrument itself, while a transaction exemption must be established for each individual trade, and the antifraud provisions apply to both, always.
- Any answer choice containing 'guaranteed,' 'approved by the Administrator,' or an implication that registration equals endorsement is a violation. Eliminate it on sight.
- A cease-and-desist order can be issued summarily without a hearing, but denying, suspending, or revoking a registration requires notice, an opportunity for a hearing, written findings, and both public interest and a specific statutory cause.
- Drill the numbers: $110 million mandatory SEC registration, $100 million option, $90 million exit buffer; five or fewer non-institutional clients for the de minimis exemption; noon of the 30th day for effectiveness; three years or two from discovery for civil suits; $5,000 and three years for criminal penalties; qualified client at $1.4 million AUM or $2.7 million net worth as of mid-2026.
- Custody and discretion traps: deducting fees, a general power of attorney, or holding a third-party check beyond three business days creates custody; time-and-price instructions are not discretion; and oral discretionary authority is valid only for the first ten business days for a state-registered adviser.