Chapter 9 Answers and Explanations

1. D – A professional who stores a client’s stock and bond certificates in his or her firm’s safe. Having physical possession over a client’s securities definitely constitutes custody. If an investment adviser who is not also a broker-dealer receives securities, they must be returned to the sender within three days to avoid it constituting custody. Being able to initiate trades in an account held at another broker-dealer simply constitutes a trading authorization. Passing along a check made out to another firm or investment company would not constitute custody, as long as the investment adviser or investment adviser representative forwards it on to the proper custodian within three business days. Prepaid fees are simply that, prepaid fees.

2. A – It shifts responsibility for determining suitability off of the professional and on to a client. Since the professional has been given the highest level of freedom to buy and sell in a customer’s account without them authorizing each trade, there is even more responsibility than before to determine suitability placed on the adviser. Discretionary authority can be revoked at any time by a customer. Discretionary authority for investment advisers and investment adviser representatives can be initially granted verbally, and must be evidenced by a written agreement within 10 days of the initial discretionary trade.

3. A – Segregated. Assets should be segregated, or separated from a professional’s or firm’s assets. If they are not, it is considered commingling and is unethical. Client assets should only be invested after a professional has determined suitability, which may take a while. Client accounts should be audited at least yearly.

4. C – I, III, and IV. Depositing client funds to a professional’s personal account is commingling and is highly unethical. Likewise, using client assets to pay any expenses (business luncheons, firm expenses, etc.) is m