Study guide
This chapter covers NASAA outline Section IV, Laws, Regulations, and Guidelines Including Prohibition on Unethical Business Practices, consistently the single largest section of the Series 65 exam (often around 25-30% of scored items). It covers the Uniform Securities Act and Investment Advisers Act of 1940 framework for registering advisers and their representatives, the definitions and exclusions from 'investment adviser,' custody rules, the SEC Marketing Rule, and the NASAA model rule on unethical business practices, along with the Administrator's enforcement powers.
Definition of Investment Adviser and Key Exclusions
Both the Uniform Securities Act and the federal Investment Advisers Act of 1940 define an investment adviser using a three-part test: a person who (1) for compensation, (2) is in the business of, (3) providing advice about securities. Several categories are excluded entirely from this definition, meaning they are never considered investment advisers regardless of compensation: banks and bank holding companies, lawyers, accountants, teachers, and engineers whose investment advice is solely incidental to their profession (the 'LATE' exclusion), broker-dealers whose advice is incidental to their brokerage business and who receive no special compensation for it, and publishers of bona fide publications of general and regular circulation. The publisher exclusion, grounded in Lowe v. SEC, requires that the publication be impersonal (not tailored to any individual's specific situation), available to the general public, and published on a regular schedule not timed to specific market events; a publisher meeting this test is excluded from the definition entirely, which is different from being exempt from registration while still meeting the definition. This distinction between exclusion (never an adviser) and exemption (an adviser who is relieved of a specific requirement, such as registration) is tested repeatedly and candidates often conflate the two.
Registration of Investment Advisers: State vs. SEC
Under Section 203A of the Investment Advisers Act (as amended by the National Securities Markets Improvement Act and Dodd-Frank), advisers are divided between state-registered advisers and federal covered advisers (SEC-registered), based primarily on regulatory assets under management (AUM). An adviser with less than $100 million in regulatory AUM generally must register at the state level; an adviser with regulatory AUM between $100 million and $110 million falls into a buffer zone and may elect either state or SEC registration; once regulatory AUM reaches $110 million, SEC registration becomes mandatory, and a currently SEC-registered adviser generally may not withdraw to state registration until its AUM falls below $90 million. This asymmetric buffer prevents an adviser from repeatedly switching regulators as assets fluctuate near the threshold. Certain advisers must register with the SEC regardless of AUM (e.g., advisers to registered investment companies), and certain very small advisers may be exempt from registration altogether. A federal covered adviser is not registered at the state level but generally must make notice filings and pay fees in states where it has clients; dual registration (state and SEC simultaneously) is not part of this framework.
Registration of Investment Adviser Representatives
An investment adviser representative (IAR) of a state-registered adviser generally must register in any state where they conduct business with clients, subject to de minimis exceptions for a small number of retail clients. For an IAR of a federal covered adviser, however, state registration authority is narrower: a state may require registration of such an IAR only if the IAR has a place of business in that state, regardless of how many clients the IAR serves remotely in other states or how those clients were contacted (phone, video, or otherwise). This means an IAR working entirely from an office in State X, serving clients who reside in State Y with no office presence there, registers only in State X. The firm's own regulatory status (federal covered) does not exempt its individual representatives from state registration where they do maintain a place of business -- only the SEC does not register individuals; individual representatives always register at the state level. Registration for both advisers and representatives generally involves filing Form ADV (or the IAR equivalent), passing applicable examinations (such as the Series 65 or an approved alternative), and paying required fees, and registrations must be kept current through periodic updating amendments.
Custody, Recordkeeping, and the Marketing Rule
An adviser has custody whenever it holds client funds or securities, has authority to withdraw them, or has any arrangement (such as being granted a power of attorney) giving it access to client assets; custody triggers significant obligations including use of a qualified custodian, prompt notice to clients, account statements (at least quarterly), and typically a surprise examination by an independent accountant. An adviser that inadvertently receives client funds or securities (for example, a client mistakenly mails stock certificates to the adviser's office) avoids being deemed to have custody only if it returns them to the sender within three business days of receipt; retaining them longer triggers the full custody framework. The SEC's Marketing Rule (Rule 206(4)-1) governs adviser advertisements, including testimonials (statements by current clients) and endorsements (statements by non-clients, such as paid social media promoters); compensated testimonials and endorsements are now permitted, replacing the prior blanket prohibition, subject to conditions including clear disclosure of compensation and conflicts, a written agreement once compensation exceeds a de minimis threshold over a trailing 12 months, and a reasonable belief that the promoter is not a disqualified 'ineligible person.' Recordkeeping requirements under the Advisers Act and corresponding state rules require advisers to retain books and records (client agreements, correspondence, trade records, advertising) for specified periods and to make them available for regulatory examination.
Unethical Practices, Fiduciary Duty, and Performance Fees
The Investment Advisers Act (Section 206) and the NASAA Model Rule on unethical business practices impose a fiduciary duty on advisers requiring them to act in the client's best interest, avoid and disclose conflicts of interest, and refrain from a list of specifically prohibited practices: guaranteeing a client against loss or promising a specific investment result, churning (inducing trading excessive in size or frequency relative to the client's resources and objectives), disclosing a client's identity or holdings without consent absent a legal requirement, and borrowing from or lending to clients except in narrow circumstances (such as when the client is a broker-dealer, an affiliate, or a bank/financial institution in the ordinary business of lending). Performance-based compensation (fees tied to capital gains or appreciation) is generally prohibited under Section 205(a)(1) but is permitted under Rule 205-3 with 'qualified clients' who meet a minimum assets-under-management threshold with that adviser or a minimum net worth threshold (excluding the primary residence); these dollar thresholds are periodically adjusted for inflation by SEC order, so candidates should focus on the structure of the rule (AUM test or net worth test, natural persons vs. qualified purchasers/knowledgeable employees) rather than memorizing a specific dollar figure that may change.
Administrator's Authority and Administrative Remedies
Each state's securities Administrator has broad authority under the Uniform Securities Act to deny, suspend, revoke, condition, or bar a registration, but only when doing so is in the public interest AND a specific statutory ground exists -- the Act enumerates grounds such as willful violations of securities laws, false or misleading statements in a filing, certain criminal convictions (typically securities-related, within a defined lookback period), injunctions related to securities activities, being subject to an unethical-practices finding, or insolvency. Critically, the Act specifically provides that a lack of experience alone is not a sufficient ground to deny registration to an otherwise qualified applicant; the Administrator must point to one of the enumerated grounds, not merely a subjective view that the applicant is inexperienced. The Administrator also has investigative and enforcement powers, including the ability to conduct examinations, issue subpoenas, seek injunctions, and impose administrative penalties, and generally must provide notice and an opportunity for a hearing before a final adverse action (with limited exceptions for emergency summary orders). Administrative actions are distinct from and can run parallel to civil liability (private rights of action for violations) and criminal liability (for willful violations), each with its own standards and remedies under the Act.
Key terms
- Investment adviser (three-part test)
- — A person who, for compensation, is in the business of providing advice about securities; several categories (banks, LATE professionals, certain broker-dealers, bona fide publishers) are excluded entirely.
- Exclusion vs. exemption
- — An excluded person never meets the definition of investment adviser; an exempt person meets the definition but is relieved of a specific requirement, such as registration.
- Federal covered adviser
- — An SEC-registered investment adviser, generally required once regulatory AUM reaches $110 million, exempt from state registration but subject to state notice filings.
- Place of business test
- — The rule that a state may require registration of an IAR of a federal covered adviser only if the IAR maintains a place of business in that state, regardless of client location.
- Custody
- — Holding client funds or securities, or having access/authority over them, triggering qualified custodian, notice, statement, and surprise examination requirements.
- Marketing Rule (Rule 206(4)-1)
- — SEC rule governing adviser advertisements, permitting compensated testimonials and endorsements subject to disclosure, agreement, and disqualification conditions.
- Qualified client
- — A client meeting a minimum AUM-with-the-adviser or net-worth threshold, allowing the adviser to charge performance-based fees under Rule 205-3.
- Churning
- — Inducing trading in a client's account that is excessive in size or frequency relative to the client's resources and objectives; a prohibited unethical practice.
- Public interest plus statutory ground
- — The two-part test an Administrator must satisfy to deny, suspend, or revoke a registration; lack of experience alone never satisfies the statutory-ground requirement.
- Notice filing
- — A filing (with fee) made by a federal covered adviser in states where it has clients, in lieu of full state registration.
Exam tips
- When a question describes a publisher, check for all three Lowe v. SEC factors: impersonal content, general public availability, and a regular schedule not tied to market events -- all three must be present for the exclusion.
- Memorize the AUM registration structure conceptually: under $100M generally state; $100-110M elective buffer; $110M+ mandatory SEC; SEC-registered firms generally can't drop to state until below $90M.
- IAR of a federal covered adviser: registration follows the IAR's place of business, not the client's location or client count -- this is a frequently tested distractor pattern.
- Inadvertent receipt of client securities: return within three business days to avoid custody. Memorize the specific number and action (return to sender, not segregate-and-hold).
- On 'EXCEPT' questions about unethical practices, recall the narrow exceptions to the borrowing/lending prohibition: broker-dealers, affiliates, and banks/financial institutions in the ordinary course of lending.
- For Administrator authority questions, always check for BOTH required elements: public interest AND an enumerated statutory ground. An answer citing only 'public interest' or only 'inexperience' alone is wrong.