CHAPTER 6: Portfolio Management Strategies, Styles and Techniques !

ntroduction
Once you have obtained information about your client's goals and financial situation, you can start making investment recommendations. This process begins with choosing an appropriate asset allocation.

Portfolio Management Strategies, Styles and Techniques Asset Allocation and Strategic "s# Tactical Asset Allocation
In simple terms, asset allocation refers to the balance between growthoriented and income-oriented investments in a portfolio. This allows the investor to take advantage of the risk/reward tradeoff and benefit from both growth and income. ere are the basic steps to asset allocation! ". #hoosing which asset classes to include $stocks, bonds, money market, real estate, precious metals, etc.% &. 'electing the ideal percentage $the target% to allocate to each asset class (. Identifying an acceptable range within that target ). *iversifying within each asset class +inimi,ing risk while ma-imi,ing return is any investor's prime goal, and the right mi- of securities is key. 'ee the article Achieving Optimal Asset Allocation for more on optimi,ing your asset allocation strategy. Of course, the appropriate mi- for a particular client depends upon many of the factors discussed in the .naly,ing /our #lient's 0rofile section, including risk tolerance, time hori,on and financial goals. 1or e-ample, an I. with a client who owns commercial real estate properties or a number of rental homes would probably not recommend 23ITs or other real estate securities in the portfolio. .sset allocation is e-plained in detail later in this section. Risk Tolerance The client's risk tolerance is the single most important factor in choosing an asset allocation. +ost I.s will create a risk tolerance 4uestionnaire $or use one provided with their financial planning software% to make sure

they have an accurate measure of risk. .t times, there may be a distinct difference between the risk tolerance of a client and his/her spouse, so care must be taken to get agreement on how to proceed. In addition, risk tolerance may change over time, so it is important to revisit the topic periodically. Time Horizon #learly, the time hori,on for each of the client's goals will affect the asset allocation mi-. Take the e-ample of a client with a very aggressive risk tolerance. The recommended allocation to stocks will be much higher for the client's retirement portfolio than for the money being set aside for the college fund of the client's "(-year-old child. Strategic vs. Tactical Asset Allocation

'trategic asset allocation calls for setting target allocations and then periodicallyrebalancing the portfolio back to those targets as investment returns skew the original asset allocation percentages. The concept is akin to a 5buy and hold5 strategy, rather than an active trading approach. Of course, the strategic assetallocation targets may change over time as the client's goals and needs change andas the time hori,on for ma6or events such as retirement and college funding grow shorter.

Tactical asset allocation allows for a range of percentages in each asset class $suchas 'tocks 7 )8-98:%. These are minimum and ma-imum acceptable percentages that permit the I. to take advantage of market conditions within these parameters. Thus, a minor form of market timing is possible, since the I. can move to the higher end of the range when stocks are e-pected to do better and to the lower end when the economic outlook is bleak.
Look Out! On the test, strategic asset allocation may be linked with a "passive" investment style (see the Portfolio Styles section below), while tactical asset allocation is linked with an "active" investment style.

;earn more about tactical and strategic asset allocation, as well as insured, dynamic, integrated and constant-weighted asset allocation strategies within the article! Asset Allocation Strategies.

Portfolio Management Strategies, Styles and Techniques $i"ersification

Once the target asset allocation percentages have been defined, the ne-t step is to diversify. 1or e-ample, within the bond or fi-ed-income class, investment options include corporate bonds, government bonds, municipal bonds, and so on. 1urther choices within the corporate bond category alone include short-term v. long-term, investment-grade v. high-yield $or 6unk% bonds, convertible, etc. The range of options for stocks or stock funds is even wider. The information on the following page refers to both individual stocks and mutual funds!

+arket capitali,ation - +arket cap simply refers to the value of all of a company's outstanding common shares times the current market price. 'tocks are classified based on si,e as follows!
o o o o

Large-cap stocks $5 billion or more Mid-cap stocks $1 billion - $5 billion Small-cap stocks less t an $1 billion Micro-cap stocks less t an $5! million

*iversifying across stocks with different market capitali,ations is recommended. Typically, a larger allocation is made to large-cap stocks and smaller percentages to small-cap or mid-cap stocks.

"ro#t

vs. val$e - 'tocks also differ by style. Typically, stocks

$and mutual funds% are categori,ed as either growth or value oriented. <oth styles have advocates who believe one is likely to outperform the other for different reasons.
o

=rowth stocks are those whose earnings have been higher than average in the past and are e-pected to continue at a

higher than average rate in the future. They typically pay low or no dividends and often trade at high 0/3 ratios. They tend to do well when the overall market is rising. >alue stocks tend to trade at a lower price relative to their fundamentals $i.e. dividends, earnings, sales, etc.% and are thus considered undervalued by a value investor. #ommon characteristics of such stocks include a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio. >alue stocks tend to outperform growth stocks during a falling market.

.s in other conte-ts, diversification helps to reduce risk in a portfolio. 'ince different types of stocks have different characteristics, their rates of return will differ throughout the economic cycle. 1or e-ample, if a portfolio is composed of 98: stocks, and a large-cap stock fund is the only investment, it may perform better during a downturn in the market than a small-cap fund, but the small-cap may outperform the large-cap during a market rally.
Exam Tips and Tricks Consider these sample exam questions about asset allocation:

1. Strategic asset allocation re%ers to t e selection o%& a. specific securities to purchase. b. variation allowed within an asset allocation range. c. asset classes to invest in. d. target asset allocation for each selected asset class. The correct answer is "d", since "b" refers to tactical asset allocation. '. A val$e manager #o$ld consider all o% t e %ollo#ing in c oosing a stock ()*(+T& a. price/book value ratio. b. stock price growth rate. c. market share. d. price/earnings ratio. The correct answer is "b": value stocks are evaluated based on the company s financials, including balance sheet ratios and market share. The growth rate of the stock is a factor that growth investors would use

to evaluate a stock.

Portfolio Management Strategies, Styles and Techniques Portfolio Styles: Acti"e "s# Passi"e
There are two basic approaches to investment management!

.ctive asset management is based on a belief that a specific style of management or analysis can produce returns that beat the market. It seeks to take advantage of inefficiencies in the market and is typically accompanied by higher than average costs $for analysts and managers who must spend time to seek out these inefficiencies%.

0assive asset management is based on the concept that markets are efficient, that market returns cannot be surpassed regularly over time, and that low cost investments held for the long term will provide the best returns.

1or those who favor an active management approach, stock selection is typically based on one of two styles!

Top-down - +anagers who use this approach start by looking at the market as a whole, then determine which industries and sectors are likely to do well given the current economic cycle. Once these choices are made, they then select specific stocks based on which companies are likely to do best within a particular industry.

<ottom-up - This approach ignores market conditions and e-pected trends. Instead, companies are evaluated based on the strength of their financial statements, product pipeline, or some other criteria. The idea is that strong companies are likely to do well no matter what market or economic conditions prevail.

0assive management concepts to know include the following!

3fficient market theory - This theory is based on the idea that information that affects the markets $such as changes to company management, 1ed interest rate announcements, etc.% is instantly

available and processed by all investors. .s a result, this information is always taken into account in market prices. Those who believe in this theory believe there is no way to consistently beat market averages.

Inde-ing - One way to take advantage of the efficient market theory is to use inde- funds $or to create a portfolio that mimics a particular inde-%. 'ince inde- funds tend to have lower than average transaction costs and e-pense ratios, they can provide an edge over actively managed funds which tend to have higher costs.
Exam Tips and Tricks Consider these sample exam questions:

1. T e e%%icient market t eor, states t at& a. future market prices are determined by the discounted value of future dividends. b. technical analysis tools cannot be used to beat the market, since current prices already reflect all available information about previous price patterns. c. current market prices already reflect all available information. d. market prices are determined by supply and demand. The correct answer is "c" ! "b" is incorrect because the efficient market theory is not concerned with technical analysis. '. +assive asset management involves& a. using inde- funds as the investments for each asset class. b. choosing the stocks or mutual funds to be purchased for each asset class. c. buying securities for each asset class and holding them until the funds are needed. d. buying securities for each asset class and selling them when they reach their price targets. The correct answer is "a" ! while inde" funds are not a re#uirement of passive management, they are a fre#uently used tool. "$" is incorrect because passive management does not preclude making portfolio changes. %or e"ample, periodic rebalancing is performed, and changes can be made in response to changes in the client s risk tolerance,

financial situation, goals, and so forth.

CHAPTER %: &oundation for Regulatory !ssues !ntroduction

-l$e Sk, La#s 3ach state has its own securities regulations, which are known as <lue 'ky ;aws. The ?'.clarifies who has 6urisdiction if a securities violation occurs, while also specifying the powers of each state's .dministrator. 'tate regulations are designed to protect investors against securities fraud by re4uiring sellers of new issues to register their offerings and provide financial details. This allows investors to base their 6udgments on trustworthy data.
Look Out! The main objective of Blue Sky Laws is to protect investors from fraudulent activity.

.ni%orm Sec$rities Act /.SA0 The ?niform 'ecurities .ct $?'.% is not an actual set of laws. It is, however, documented guidance for each state to use as a template when forming securities related legislation. @e have included the entire updated ?'. within .ppendi- #, at the end of this guide.
Look Out! It is important to know that the USA is not actual legislation, but rather "model" legislation, meaning it is merely a "template" that each state uses in drafting its own legislation.

.ny resemblance the ?'. may have to <lue 'ky ;aws comes from the massive amount of securities related fraud that was widespread in the first half of the &8th century. 'tock promoters would often con individual investors into purchasing investments that had no reasonable basis, and with the lack of any uniformity between states, it was very difficult to prosecute the shysters - assuming they were ever caught. Thus,

the ?nited 'tates saw the emergence of <lue 'ky ;aws and, later, the ?niform 'ecurities .ct.
Look Out! The primary purpose of the USA is to regulate securities professionals and the sale of securities.

Exam Tips and Tricks Because most states simply mirror the model legislation of the USA, you will be tested on the USA itself, not on individual state regulations. The bullet points below outline the origins of the USA.

'tate securities law varied widely from state to state in the first half of the &8th century, despite the passage of the 'ecurities .ct of "A(( and the 'ecurities 3-change .ct of "A().

To unify $streamline% state security laws, the Bational #onference of #ommissioners on ?niform 'tate ;aws $B##?';% drafted the ?'. in "A9C. The B##?'; was a national organi,ation of legal professionals devoted to creating legal congruency from state to state.

The ?'. provides criminal and civil penalties for violations - that is, for fraudulent acts done to deceive investors.

On its website, the B##?'; states! 5The state uniform law commissioners come together as the Bational #onference for one purpose - to study and review the law of the states to determine which areas of law should be uniform.5 Bow that you know how and why the ?'. came to be, let's take a closer look at the nuts and bolts of the legislative template. Deep the following items in the back of your mind as you work through this section of the study guide - they are what the B##?'; wants you to know.

&oundation for Regulatory !ssues 'SA Regulation and The Administrator

.SA Reg$lation 1 at does t e .SA reg$late2 The sale of securities .gents, broker-dealers and other persons Issuers 2egistration Transactions T e 3ational Sec$rities Markets 4mprovement Act /3SM4A0 /ou probably will not see a 4uestion regarding the B'+I. on the test, but it is still a good idea to know what it is, 6ust in case. The B'+I. was passed by #ongress in "AAC in an effort to lessen instances of repetition between state and federal securities laws. It is important to recogni,e the B'+I., because it has a profound effect on the ?'.. #ongress enacted the B'+I. in an effort to unify federal and state securities laws, giving rise to 5federal covered securities and transactions5. In short, the .ct prohibits states from regulating securities that are already registered with the '3# $that is, registered on a federal level%. T e Administrator 3ach state has an enforcement agency, $the .dministrator%, that strives to regulate the securities business within its 6urisdiction. The whole purpose of the 'eries CC e-am is to ensure you know which activities are compliant and which are fraudulent in the .dministrator's eyes. Therefore, you should be prepared to see the term 5.dministrator5 repeatedly in your readings.

CHAPTER (: Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es !ntroduction

S(* Registered 4nvestment Advisors

1 o m$st register as a %ederal covered investment advisor2 The Investment .dvisers .ct of "A)8 $a link to the entire .ct can be found in .ppendi- <% was enacted to protect the public by re4uiring those who provide investment advice for compensation to register as advisors with the 'ecurities and 3-change #ommission $'3#%. The provisions of the .ct set out both re4uired and prohibited behaviors for advisors who meet the following definition! An investment advisor /4A0 is an individ$al or entit, # o& 5for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.5 ;et's translate that definition into plain 3nglish and break it down to three main components! "iving advice abo$t sec$rities o This includes references to securities in general, not 6ust specific investment recommendations - for e-ample, even advising a client to invest a set percentage in 5stocks5 is considered advice about securities. -eing in t e b$siness o% giving t at advice o This refers to presenting yourself as an investment advisor. -eing compensated %or t at advice o This includes receiving compensation of any kind, including fees, commissions, or a combination of the two - and the compensation does not have to be received directly from the client.
Exam Tips and Tricks Many questions on the exam hinge on these components of the must be present to require registration as an investment advisor. For example, you might find a question where a professional such as an accountant or an attorney provides advice about asset allocation, but does not charge a separate fee for this service. In that case, he/she is not being compensated for the advice and so is not required to register.

Look Out! As a rule of thumb, if a person gives specific advice related to investments - for a client\'s specific condition or portfolio - he/she is an investment advisor.

(5cl$sions .t first glance, it seems that virtually all financial planners, stockbrokers, money managers, pension consultants, etc. would be covered under this definition. owever, anumber of e-clusions may apply!

<anks, or bank holding companies 0rofessionals such as lawyers, accountants, teachers, etc. whose advice is incidental to their profession and who receive no special compensation for making recommendations 0ublishers of bona-fide newspapers, maga,ines or financial publications of a general and regular circulation =overnment securities advisors <roker-dealers and their registered representatives whose advisory services are incidental to the securities business and who receive no special compensation for making recommendations

This last e-ception may seem illogical, since stockbrokers seem to be the ma6or dispensers of investment advice. owever, their 6ob function is investment salesE therefore, the investment advice they give is considered incidental to that role. In addition, the 'ecurities 3-change .ct of "A() regulates broker-dealers and their representatives. 6t ers # o are e5empt %rom registration&

I.s whose clients are all residents of the state of the I.'s principal office and who do not provide advice on e-change-traded securities

I.s whose only clients are insurance companies I.s who 4ualify for the private advisor e-emption $less than "9 clients, do not hold themselves out to the public as investment advisors, and do not advise registered investment companies%

Exam Tips and Tricks You can expect at least one question on the "out of state" clients. One of the options may be "IAs whose only clients are banks", but remember it is IAs whose only clients are insurance companies that are exempt, not those with other institutional clients.

Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es SEC !n"estment Ad"isor Releases !A %%* + ,*-.
4A 77! was issued in "AF" to clarify the definition of investment advisors. It provided guidance on the following matters!

1 at is a 8sec$rit,82 - ;ife insurance and fi-ed securities are not securities, so those who give advice solely on these financial instruments are not re4uired to register as I.s.

1 at is 8advice82 - The guidelines here are very broad - simply recommending that a client buy 5stocks5 instead of insurance is considered advice.

1 o is 8in t e b$siness8 o% giving advice abo$t sec$rities2 The standard re4uires only that you 5hold yourself out5 as a financial planner or investment advisor $e.g. by advertising, making business cards, etc.%, even if you have no clients yet.

1 at is 8compensation8 %or giving advice abo$t sec$rities2 #ompensation includes fees, commissions, assigning a liability of the advisor to the client, or re4uiring the purchase of another product.

4A 1!9' was issued in "AFG in response to increased activity in financial planning and investment advice. It essentially reaffirmed the definition of an I. as stated in I. GG8, but refined some of the definitions!

0ension consultants and advisors to athletes and entertainers are considered providers of investment advice.

1irms that recommend investment advisors may have to register

themselves.

.n I. does not have to give advice as his/her principle business activity - simply doing so on occasion is enough to re4uire registration.

If a registered representative of a broker-dealer sets up a separate business entity to provide financial planning or investment advice for a fee, he/she may not rely on the broker-dealer e-emption from registration $this is known as a statutory investment advisor%.

#ompensation does not have to be monetary to fall under the definition - receipt of products, services or discounts is also considered compensation.

Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es State Registered !n"estment Ad"isors
'ome I.s must register with the state rather than with the '3# $see the section below%. If you register through your state, you are regulated by the ?niform 'ecurities .ct $?'.% instead of the Investment .dvisers .ct of "A)8. ?nder the ?'., you must register as an investment advisor if you provide any of the following services for compensation!

3ngaging in the business of advising others, either directly or indirectly $such as via a newsletter%, as to the value of securities or the advisability of investing in securities O2

Issuing analyses or reports on a regular basis as part of a business O2 0roviding investment advisory services to others in a financial planning practice

(5cl$sions %rom t is de%inition incl$de t e %ollo#ing&

<anks, savings and loans, trusts 0rofessionals such as lawyers and accountants whose advice is incidental to their professional practice <roker-dealers whose advice is incidental to the conduct of their

business and who receive no special compensation for these services 0ublishers, employees or columnists of bona-fide newspapers, news maga,ines, business or financial periodicals, and owners and employees of cable, radio or T> networks where the content is BOT based on the specific investment situation of each client 1ederal covered advisors Investment advisor representatives .ny other person that is e-cluded by the Investment .dvisers .ct of "A)8 from the definition of investment advisorE or .ny other person e-cluded by the .dministrator

Bote that the definitions and e-clusions for state covered advisors and federal coveredadvisors are similar but not identical.
Look Out! The acid test for a publication (and you could easily see a question regarding Internet publications on the exam) is whether the publisher gives advice on the specificsituations of clients. If a publication does not advise clients of stock-specific information and is a "bona-fide" publication (for example, the Wall Street Journal Online), it is not an investment advisor.

Stop! Refer to Appendix C for the Uniform Securities Act.

Registration Re:$irements .n I. must register in every state where he or she does business with clients, whether or not he or she actually maintains a place of business in the state. The only e-emption is for advisors with no place of business in a state who! only deal with professional investors

O2 have five or fewer clients in that state.

Look Out! Notice that this USA definition for IAs, who must register if they have out of state clients, is very different from the one under the

Investment Advisers Act of 1940, (mentioned in the earlier section). On the exam, make sure you determine whether a question is about an IA who is state registered or federally registered.

Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es Registration /ith the SEC or /ith the State0
The Bational 'ecurities +arkets Improvement .ct of "AAC $B'+I.%, referenced in the 1oundation for 2egulatory Issues section, divides registration and oversight responsibilities between state and federal securities regulators.

The value of client assets under management is one key indicator of whether you must register with the '3# instead of with your individual state.

5.ssets under management5 means securities portfolios for which an investment advisor provides continuous and regular supervisory or management services. ?nder the B'+I., the '3# generally registers investment advisor firms with over H&9 million in assets under management, while the states register investment advisor firms with under H&9 million in assets under management. If assets under management e4ual H(8 million or more, an I. must register with the '3#. Those with client assets under management between H&9 and H(8 million may register with the '3# or their individual state. Those with a lesser amount of client funds must register with their state instead.

There are certain situations that re4uire I.s with less than H&9 million to register with the '3# instead of their state! I.s whose only clients are other registered investment companies I.s whose state does not regulate investment advisors 0ension consultants who provide advice to employer retirement

plans with assets of at least H98 million Bewly formed I.s who reasonably believe they will become eligible for federal registration within "&8 days

In addition, there are several categories of investment advisors who are re4uired to register with the '3# instead of the individual 'tate! Bationally 2ecogni,ed 'tatistical 2ating Organi,ations $B2'2Os% #onsultants who advise pension plans with assets over H98 million .ny advisor that believes it may be re4uired to register with the

'3# within "&8 days of initial state registration Investment advisors counseling registered investment companies

0lease note that all I.s, even those not re4uired to register, are sub6ect to the anti-fraud provisions of both the ?'. and the Investment .dvisers .ct of "A)8.

Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es Additional !nformation

If a broker-dealer both effects transactions and offers investment advice for special compensation, then he or she must register as an investment advisor as well.

*e +inimus! The Bational 'ecurities +arkets Improvement .ct of "AAC mandates that an investment advisor that has fewer than siclients in a state $in a "&-month period%, and has no physical address in the state where the clients are located, is not re4uired to register as an investment advisor in the state in which the clients reside. The ?'. also states that an investment advisor is prohibited 5from employing an individual who is prohibited from such employment or association by the administrator5. >iolation of this provision does not result in strict liability. To be liable, the investment advisor must have known or should have known of the administrator's order to the individual suspended or barred. .n investment advisor may conduct business with institutional clients in different states than where it is registered, if! o the investment advisor has no physical address in that state, but is registered in another state.

the client the investment advisor is providing advice to is an institutional client $i.e. bank, another investment advisor, benefit plans with assets greater than H" million, and/or government%.
Exam Tips and Tricks The De Minimus exemption could easily show up on the exam, so remember: for registration exemption, an investment advisor must have fewer than six clients in 12 months and mustnot have a physical address in the state.

Exam Tips and Tricks Exam questions will often refer to definitions or regulations for either the USA or the Investment Advisers Act of 1940. Most of the requirements are similar, but make sure you read the question carefully, since there may be differences. Here are examples of each type of question:

1. 1 ic o% t e %ollo#ing are de%ined as 84nvestment Advisors8 $nder t e.SA2 4. "eneral circ$lation ne#spaper #it an 4nvesting col$mn 44. +$blis er o% an investment ne#sletter t at o%%ers speci%ic advice %or clients in certain circ$mstances 444. 4ndivid$al # o c arges a %ee %or giving clients advice abo$t sec$rities 4;. La#,er # o advises a pension client abo$t investments at no c arge a. I I I> b. III I I> c. I I III d. II I III '. 1 ic o% t e %ollo#ing are de%ined as %ederal covered investment advisors2 4. 44. An engineer # o provides investment advice %or a %ee to '! o% is colleag$es A stockbroker # o gives a %ree %inancial plan to er clients

444. 4;. a. b. c. d.

An investment advisor # ose onl, clients are ins$rance companies An investment advisor # ose onl, clients are la#,ers I I I> III I I> I, II I III I, II, III I I>

&hile there are some common e"clusions between the two definitions 'such as publishers of general investing information and professionals who give incidental advice(, there are differences in the definitions. )uestion * is very straightforward and the correct answer is "d". )uestion + is more difficult. The first instinct may be to e"clude ,,, - ,., due to the e"clusion of professionals. /owever, there is no e"clusion for providing advice to attorneys, only insurance companies, so the correct answer is "a" ! the engineer who has more than *0 clients does not #ualify for the private advisor e"emption and the investment advisor to attorneys also doesn t #ualify for e"emption.

Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es The &ederal and State Registration Process
<ederal Registration +rocess To register as an I. with the '3#, you are re4uired to file 1orm .*> +art 4 and +art 44.

0art I discloses basic information to regulators, such as contact and background information on the advisor and employees, number of accounts, compensationarrangements, etc.

0art II serves as a disclosure document to clients and potential clients. It can be used to satisfy the 5<rochure 2ule5 discussed in the #lient #ommunications and #ompensation Issues section.

The I. must amend 1orm .*> any time the information within it changes. The form must be resubmitted within A8 days of the end of each fiscal

year. 'ee .ppendi- . for 1orm .*> filing instructions, 0art I and II e-amples, schedules and more from the B.'... Investment .dvisor 2egistration *epository $I.2*% .ll federal covered advisors are now re4uired to register with the '3# and file notice with the states via the Investment .dvisor 2egistration *epository $I.2*%. The I.2* is an electronic filing system for I.s, sponsored by the '3# and the Borth .merican 'ecurities .dministrators .ssociation $B.'..%. This system collects and maintains data for both federally registered I.s and state I.s. 'ee the ,A12 website. State Registration +rocess @hile the Investment .dvisers .ct of "A)8 governs federal registration of I.s, state registration of I.s is regulated under the ?niform 'ecurities .ct. 2egistration of investment advisors and investment advisor representatives is now available using the I.2* system referenced above. *onsent to Service o% +rocess ?nder the ?'., state registered I.s must also file what's known as a 5consent to service of process5, which appoints the 'tate .dministrator as your agent to receive and process any legal complaints. 1inally, while a state may not re4uire I.s to file if they are registered with the '3#, they may re4uire I.s to file with the state any documents filed with the '3#, to file a consent to service of process, and/or to pay state fees.
Look Out! What is a consent to service of process? In essence, the Administrator has been given the power of attorney to receive non-criminalgrievances.

6t er State Re:$irements& . passing score on a competency e-amination for each person acting as an investment advisor or investment advisor representative 0ayment of a fee for processing investment advisor application

#ertain disclosures to the securities agency and/or the public 2egistration of branch offices of the advisor . bond or minimum net capital

4nitial <inancial Re:$irements .t any time, the .dministrator has the power to demand minimum financial re4uirements for any/all investment advisors. 'pecifically, the ?'. states!

.n .dministrator may re4uire an authority bond or insurance $sub6ect to theInvestment .dvisers .ct of "A)8% for an 5investment adviser that has custody of or discretionary authority over funds or securities of a customer or client to obtain insurance or post a bond or other satisfactory form of security ... The administrator may determine the re4uirements of the insurance, bond, or other satisfactory form of security.5

If for any reason an investment advisor fails to meet the imposed re4uirements, it should immediately notify the .dministrator.

S$mmar, o% <inancial Re:$irements .dministrators have the ability to re4uire investment advisors to carry bonds or insurance - if the aforementioned persons/entities have discretionary authori,ation or hold client funds. In short, if the .dministrator thinks a situation is risky to the client, he or she may re4uire bonds to protect against possible e-cessive losses. .pdate If a broker-dealer has any material change in vital information $e.g.

address% at any time, it is to notify the .dministrator immediately. Investment advisors must create and maintain all records $including books, marketing and correspondence% for a minimum of three years.

Rene#al Investment advisors must pay annual dues and are sub6ect to periodic e-amination by the .dministrator. In addition, investment advisors must file annual financial statements.

Exam Tips and Tricks On the exam, you will probably not see a question dealing with financial reporting as it applies to investment advisors and brokerdealers because such requirements can easily differ from state to state. If you do, it is wise to remember that a State cannot require an investment advisor or broker-dealer to reportmore frequently than quarterly and, in most cases, annual reporting is the norm.

Exam Tips and Tricks The Series 66 exam is likely to have a number of questions about the State Registration Process, but most are straightforward. Here is a typical example:

1. A State Administrator can re:$ire all o% t e %ollo#ing o% an investment advisor applicant ()*(+T& a. minimum surety bond coverage. b. minimum competency evidenced by passing an e-amination. c. minimum net capital. d. minimum number of years of investment advisory e-perience. ,n this #uestion, the correct answer is "d", since the 3niform Securities Act does not re#uire a specific number of years of e"perience.

Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es !n"estment Ad"isor Re)resentati"es: $efinition
.n investment advisor $I.% can be either an individual or a company. If you are providing investment advisory services as an employee of an I., you are actually an investment advisor representative $I.2%. =e%inition To paraphrase the ?'., an investment advisor representative is!

an individual employed by or associated with an investment advisor.

an individual employed by or associated with a federal covered investment advisor, who makes any recommendations or otherwise gives investment advice regarding securitiesE manages accounts or portfolios of clientsE determines which recommendation or advice regarding securities should be givenE and/or provides investment advice. anyone who holds herself or himself out as providing investment advice and/or receives compensation for such. anyone who supervises employees who perform any of the foregoing.
Look Out! If a person meets the above criteria for IAR he or she must register with the state.

Look Out! If you are having trouble with the concept of the investment advisor representative, remember this: an IAR\'s relationship to an IA is similar to that of an agent in relation to a broker-dealer. An IAR represents an investment advisor.

Regulation of !n"estment Ad"isors and !n"estment Ad"isor Re)resentati"es !n"estment Ad"isor Re)resentati"es: E1clusions
T e term investment advisor representative =6(S 36T incl$de an individ$al # o&

performs only clerical or ministerial acts. is an agent whose performance of investment advice is solely incidental to the individual acting as an agent and who does not receive special compensation for investment advisory services. is a federal covered investment advisor representative $however, if a federal covered investment advisor has a place of business in a state where a representative conducts business, the representative may be re4uired to register with the .dministrator%. *o not confuse

federal covered with an investment advisor that is re4uired to file on a state level. If you are listed as a partner, officer or director of an I. at the time of initial registration, you do not need to register separately as an I.2. If not, you must register as an I.2 through your state. /our employing firm will supply the necessary information for registration. I. employees who perform any of these functions must register as I.2s! +aking investment recommendations or giving securities advice +anaging client accounts or portfolios 'oliciting or offering investment advisory services 'upervising employees who perform any of the above (5ample 1 If John calls 3-cellent +oney +anagers, Inc. to speak with someone about his portfolio and ends up talking to Dathy Dash, is he talking to the investment advisor representative or to the investment advisorK Ans#er 4ohn is talking to the investment advisor representative '5athy 5ash(, an employee of the investment advisor: 6"cellent 7oney 7anagers, ,nc. (5ample ' <ig <ubba <ob is an investment advisor representative of Damika,e 0ortfolio +anagers, a federal covered investment advisor $meaning it is registered with the '3#%. <ob has clients in #alifornia, Bew /ork, #olorado and .laska. The company's offices are located in =eorgia. In which states must he register with the .dministrator to work as an investment advisor representativeK Ans#er 8one, e"cept 9eorgia if he does any business there. /owever, because 5amika:e ;ortfolio 7anagers is a federal covered investment advisor 'registered with the S6$(, he does not have to register in the state where his firm has no physical address.
Watch out for questions that ask if an office manager who supervises account managers or solicitors has to register as an

IAR. While those who have only clerical duties do not need to register, those who supervise IAR employees must do so.

Watch out for the distinction between an IA and an IAR when you are reading exam questions, since there may be differences in registration requirements. You will likely find a number of questions that refer to both IAs and IARs, such as these two examples:

1. All o% t e %ollo#ing statements regarding individ$als # o transact b$siness in t e state are tr$e ()*(+T& a. investment advisor representatives must register in the state. b. investment advisors must register in the state. c. representatives of federal covered advisors must register in the state. d. federal covered advisors must register in the state. The correct answer is "d", since federal covered advisors are not re#uired to also register with the state. '. T e 8consent to service o% process8 m$st accompan, # ic o% t e %ollo#ing2 4. advisor>s initial registration application 44. 4nvestment advisor representative>s initial registration application 444. 4nvestment advisor representative>s rene#al registration application 4;. 3on-criminal complaint %iled against an investment advisor a. b. c. d. II I III I I I> I I II I, II I III

The correct answer is "c": the consent to service of process is only necessary at the time of initial registration for both investment advisors and investment advisor representatives.

CHAPTER -: Regulation of 2ro3er dealers !ntroduction

=e%inition ere is the definition of a broker-dealer, directly from the ?niform 'ecurities .ct! 5broker-dealer5 means a person engaged in the business of effecting transactions in securities for the account of others or for the person's own account. The term does not include! .. .n agentE <. .n issuerE #. . bank or savings institution if its activities as a broker-dealer are limited to those specified as! i. <anking institution organi,ed under the laws of the ?nited 'tates ii. . savings institution, trust company, credit union, or a depository institutio iii. Those registered under the 'ecurities 3-change .ct of "A(), or not re4uired to register because of such *. .n international banking institutionE or 3. . person e-cluded by rule adopted or order issued under the ?'.. S$mmar, o% =e%inition . broker-dealer is A3? person 6R entity that acts in the business of securities transactions either for its own account, or for others. If the person/entity enacting securities transactions has a physical address $office, or any established place of business% where he/she conducts these activities, then the person/entity is a broker-dealer. If the person in 4uestion only trades principal accounts $the person's own account%, he or she is still a broker-dealer.
Look Out! It is vitally important to know that, for present purposes, the term "person" can mean either an individual or an entity like acorporation, partnership, broker-dealer or investment advisor.

(5cl$sions The term broker-dealer does not include the following!

". Issuers &. 5.n institutional investor5E or another broker-dealer (. 5. nonaffiliated federal covered investment adviser with investments under management in e-cess of H"88,888,8885, with signed discretionary authority ). . 5bona fide5 pre-e-isting customer from another state that only effects transactions with financial institutions, banks, institutional investors or issuers 9. . 5bona fide5 pre-e-isting customer that now resides in the same state as the transaction, but didn't when the initial relationship was established if! o 'ee 1ourth bullet point above. o The customer files an application for registration within )9
o

days of the first transaction, or . person that does not effect another transaction G9

days after the application is filed. C. . person that does not have more than ( customers in "& months, beyond issuers of securities, those defined in the fifth bullet point above, and/or those registered under the 'ecurities 3-change .ct of "A(), or not re4uired to be registered because of such. G. . person that deals $and is recogni,ed as a dealer% in 1ederal and/or 1I*# securities. F. 5Transactions by a #anadian or a foreign broker-dealer with a person from #anada or other foreign 6urisdiction who is resident in a state ... effective only if the administrator adopts a rule or order.5 S$mmar, o% (5cl$sions

<roker-dealers, or persons with no physical address in the state, doing business with another broker-dealer or financial institution that does have a physical address are generally e-cluded from registration.

0ersons that have less than ( customers $not including issuers and 5bona fide5 e-empt pre-e-isting customers% are generally e-cluded from registration.

Exam Tips and Tricks Series 66 Exam Flash Card - Broker-dealer Go down this list of items when trying to determine if a person/entity is a broker-dealer requiring registration: 1. Is the legal person/entity effecting securities transactions (excluding financial institutions, pensions, trusts) either in agency or principal capacity? If yes, the entity/person must register. 2. Does the person/entity have a physical address in the state in which it is effecting transactions? If yes, the entity/person must register with the Administrator. 3. Is the person/entity located out of state, with no address within the state where the transactions are effected, and is the person/entity conducting business solely with issuers, brokerdealers, federally regulated financial institutions, and/or preexisting customers who are vacationing in the state? If yes, the entity/person in question does not have to register with the Administrator.

Regulation of 2ro3er dealers Registration Requirements

4nitial Registration Initial registration for a broker-dealer is very simple. If a person or an entity falls under the definition of a broker-dealer, he/she/it must register as a broker-dealer. To register, the prospective broker-dealer must file an application with the state. The initial application includes the following! Bame of business .ddress of business Type of business to be conducted Lualifications of partners, directors and officers - including work

history and financial solubility .ny/all negative history, including securities-related misdemeanor convictions, .dministrative orders, and/or any felony convictions including those not related to the securities markets

4nitial <inancial Re:$irements - S$ret, -onds .t any time, the .dministrator has the power to demand minimum financial re4uirements for any/all broker-dealers. 'pecifically, the ?'. states!

5. licensed broker-dealer who is not registered under the 'ecurities 3-change .ct of "A() MmustN maintain minimum net capital and a prescribed ratio between net capital and aggregate indebtedness, which may vary with type or class of broker-dealer.5

5The .dministrator by rule may re4uire a fidelity bond from a broker-dealer who is not registered under the 'ecurities 3-change .ct of "A().5 0araphrased! If a broker-dealer or an investment advisor is not meeting the imposed re4uirements, it should immediately notify the .dministrator.
Exam Tips and Tricks Administrators have the ability to require brokerdealers or investment advisors to carry bonds (Surety or Fidelity) if the broker-dealers or IAs have discretionary authorization or hold client funds. If the Administrator thinks a situation is risky to the client, he or she may require bonds to protect against possible excessive losses. In addition, the Administrator may require a broker-dealer to maintain a minimum amount of net (liquid) capital.

<ees 1iling fees are re4uired by the .dministrator, usually on an annual basis. If an application is re6ected for any reason, the .dministrator retains the right to keep part of the fee. 1ees are transferable, applications are not. . broker-dealer with several subsidiaries that purchases a subsidiary can use the previous company's remaining filing fee, but must file anew application.
Look Out! You might see a question on the test regarding the transferability of annual fees. Remember that fees are transferable and applications are not.

Testing .dministrators can reserve the right to re4uire applicants to take an e-amination - either oral or written.

Exam Tips and Tricks Most likely, questions about broker-dealer regulation under the Uniform Securities Act will include investment advisors as well. For example:

1. T e state Administrator can re:$ire t e %iling o% an application@ t e consent to service o% process@ and a %iling %ee %rom all o% t e %ollo#ing ()*(+T& a. an investment advisor. b. an investment advisor representative. c. a federal covered advisor. d. a broker-dealer registered representative. The correct answer is "c", since the Administrator cannot re#uire an application from a federal covered advisor but does have <urisdiction over broker!dealers and their representatives who do business in the state. .pdate

If a broker-dealer has any material change in vital information $e.g. address% at any time, it is to notify the .dministrator immediately.

2ecords of a broker-dealer must be kept for a minimum of three years.

1inancial reports must be filed annually - and even 4uarterly, in some special cases - with the .dministrator. ?sually, all advertising and promotional material must be filed with the .dministrator, unless e-empt on either a security or transaction basis.

Regulation of 2ro3er dealers Post Registration Requirements

Rene#al The only re4uirement for renewal is for broker-dealers to pay annual fees - provided thereare no proceedings pending $including denial, suspension, revocation or cancellation%.

Termination

2egistration terminates annually on *ecember ("st.

owever, if an

.dministrator deems it necessary, he or she can suspend or revoke registration at any time.

Bon-disciplinary registration can be terminated at any time regardless of whether or not there is/was an infraction of the ?niform 'ecurities .ct. @ithdrawal! .t any time, a person may withdraw from registration $if there are no violation-oriented proceedings in progress% by submitting a re4uest directly to the .dministrator. @ithdrawal is effective (8 days after receipt of withdrawal re4uest. #ancellation! .n .dministrator can cancel registration at any time due to death, mental incompetence or non-activity. It is very important to note that cancellation isnot the same as suspension, revocation or ab6uration $denial%.

A broker-dealer is required to file the following forms with the Administrator: 1. Application 2. Consent to Service of Process On top of these two items, a broker-dealer can be required to take an examination, pay a filing fee, maintain a minimum (liquid) net capital specified by the Administrator, and potentially post a surety bond.

CHAPTER ,*: Regulation of Sales Re)resentati"es 4Agents5 !ntroduction

Look Out It is important to note that the USA refers toagents as "sales representatives". Do not get confused if the two terms are use interchangeably on the exam.

Sales Representatives /Agents0 =e%inition The ?'. specifically defines a sales representative $agent% as!

". 5.n individual, other than a broker-dealer, who represents a broker-dealer in effecting or attempting to effect purchases or sales of securities, or &. Man individual whoN represents an issuer in effecting or attempting to effect purchases or sales of the issuer's securities.5
Look Out! Agent: Any individual who acts for, or represents a broker-dealer in effecting securities transactions. The term also applies to any individual who similarly represents an issuer.

S$mmar, .n agent is a salesperson who represents a broker-dealer or an issuer, either selling orattempting to sell securities to the investing public. .ny time an agent is acting on behalf of another person, he or she generally is known as acting on the behalf of principals. .gents are also known as registered representatives, but they can also be referred to as sales representatives. . brokerage firm cannot be an 5agent5 - as an agent can only be areal person.

Regulation of Sales Re)resentati"es 4Agents5 Sales Re)resentati"es 4Agents5: E1ce)tions

.ssistants such as sales assistants and office personnel are not considered agents so long as their activities do not aid in securities transactions. In other words, as long as a secretary's duties are solely confined to office assistance, he or she is not an agent.

In addition to office personnel, there are several categories of transactions that e-empt personnel from registration. o Transactions of the following securities are e-empt from registration! .ny/all #anadian securities #ommercial paper maturing in nine months or less, and with a value of H98,888 or less

3mployee savings, pensions, profit-sharing or purchase plans ?.'. federal and municipal securities .ny/all employees transacting e-empt issues from institutions such as! banks, financial institutions and/or the government The following transactions are also e-empt from registration!

.ny transaction between the issuer and underwriter Transactions between savings and trust companies Transactions with/between employees of a firm $e.g. general employees, e-ecutives or directors% of an issuer, as long as no commission is transacted. The key to this e-emption is that no commission is charged. 1inally, there are two other types of transactions that are e-empt from registration - both include actual clients! o Transactions with clients 6ust visiting another state, assuming the client is only visiting the other state for a ma-imum of (8 days.

(5ample If broker 'am 'henanigan calls one of his best customers while she is on her ;ear 6et over +ississippi and he effects a transaction to sell some of her stock, does he have to be registered in that stateK Ans#er 8o, because Shenanigan s client was simply visiting 'or, in this case, flying over( the state. o .n agent can effect transactions - only with e"isting customers - in a state if his or her registration is pending $but not approved% for up to C8 days, assuming the following! e or she is registered in another state. The broker-dealer the agent represents is registered in the state. There must not be an in6unction restricting the agent from registration in another state. (5ample Jane decides one day that she's had it with Bew /ork, where she is a

registered agent. #onse4uently, she throws all her stuff into a suitcase and relocates to sunny #alifornia, where she gets a 6ob with the brokerdealer 1lashy #ali, Inc. @ith the consent of her new firm, Jane starts effecting transactions with e-isting customers who also recently moved to the state. 'he operates for the first 9C days, until the .dministrator informs her that her registration is active. <ecause Jane began effecting transactions before she had actually received registration approval from the .dministrator, did she commit any fraudulent activityK Ans#er 8o, assuming her registration was never revoked in another state, she is safe because her new firm, %lashy $ali, ,nc, is registered in $alifornia. /owever, while in the =>!day window, 4ane can only conduct transactions with e"isting customers who have moved into the state? she cannot solicit new business until her registration is active.

Exam Tips and Tricks Series 66 Exam Flash Card - Agent Go down this list of items when trying to determine if a person is an agent requiring registration: 1. If you receive direct compensation from a commission, you must register as an agent. 2. If you represent a broker-dealer that charges commissions or an underwriting fee, you must register as an agent. 3. If you do not charge a commission and are effecting exempt transactions and/or transacting exempt securities, you do not need to register as an agent. 4. However, unless you are representing some sort of government-oriented entity, you usually do need to register. For example, if you represent a firm that doesn\'t charge a commission for the sale of a municipal or federal security, but does receive an underwriting fee, you have to register.

Look Out Regardless of exemptions, if you accept a commission/compensation based on the sale of a security you are an agent, and registration as an agent is required.

Exam Tips and Tricks

Expect to see a question similar to the following on your upcoming Series 66 exam: "If you are office personnel and do not benefit from a commission, are you an agent?" The answer is no. Assistants who simply provide price and/or supporting information are notagents.

Additional in%ormation provided b, t e .SA regarding agents&

;imitation of affiliations! The ?'. 5limits agents to a single employment or affiliation unless a rule or order of the .dministrator authori,es multiple affiliations.5 In short, an agent can only represent one firm, unless he or she gets approval from the .dministrator.

There are no specific minimum financial re4uirements to register as an agent, although the .dministrator reserves the right to re4uire the agent, or broker-dealer, to post a bond. If the agent becomes insolvent $i.e. bankrupt%, registration may be terminated. +ultiple agents may split commissions, as long as they are employed by the same parent broker-dealer. 1urthermore, transactions from a state can only benefit more than one agent if the agents are both registered in that particular state.

Regulation of Sales Re)resentati"es 4Agents5 Registration Requirements

4nitial Registration ". Initial registration for an agent is very simple! if a person or an entity fits the definition of an agent, he/she/it must register as an agent via the broker-dealer. &. In addition, the ?'. mentions that both the agent and the brokerdealer are to notify the .dministrator of new employment. .pdate ". If an agent has any material change in vital information $e.g. address% at any time, both he/she and the broker-dealer must

notify the .dministrator. +ost Registration Re:$irements Rene#al .n agent's broker-dealer usually pays annual renewal fees. Termination ". If an agent's affiliation with a broker-dealer is terminated at any time, either by the agent or by the broker-dealer, both parties are to notify the .dministrator. &. .n agent's registration is active only as long as he or she is affiliated with a broker-dealer.