Laws, Regulations, and Guidelines, Including Prohibition on Unethical Business Practices
Domain 4: Laws, Regulations, and Guidelines, Including Prohibition on Unethical Business Practices
This domain tests the Investment Advisers Act of 1940, state adviser rules, fiduciary duty, disclosure, custody, advertising, recordkeeping, and ethical conduct. The representative must know what triggers registration and what conduct is prohibited.
Core rules and concepts
- Fiduciary duty: Advisers owe a duty of care and a duty of loyalty. Loyalty requires putting client interests first, disclosing conflicts, and obtaining informed consent; care requires reasonable inquiry and monitoring.
- Form ADV: Part 1 is filed with regulators; Part 2A is the client brochure; Part 2B covers supervised persons. Brochure delivery and annual updating rules apply.
- Custody: Rule 206(4)-2 requires a qualified custodian and account statements; surprise examinations apply in some cases. Fee deduction from client accounts can create custody.
- Advertising: Rule 206(4)-1 prohibits untrue or misleading statements, unsubstantiated claims, and cherry-picked performance. Testimonials and endorsements are permitted only with required disclosures.
- Ethics: Prohibited practices include front-running, insider trading, unauthorized trading, commingling, and making false statements to regulators.
Worked example
An IAR learns that a client plans to sell a large position. Before the client trades, the IAR buys the same security for a personal account. This is front-running: the representative used material, non-public client information for personal benefit. The IAR must pre-clear personal trades under the firm's code of ethics, disclose the conflict, and avoid trading ahead of clients.
Traps
Treating disclosure as a substitute for consent; assuming oral permission is enough for custody; using testimonials without disclosures; ignoring state rules that are stricter than federal rules.