The Advisor's Professional Library


January 1, 2012

Access person: A supervised person who has access to nonpublic information regarding clients’ purchases or sales of securities and who is involved in making securities recommendations to clients or who has access to such recommendations that are nonpublic. An access person may also be a supervised person who has access to nonpublic information regarding the portfolio holdings of affiliated mutual funds.

Accredited investor: Accredited investors are eligible to participate in certain private and limited offerings, which are exempt from the registration requirements imposed by the Securities Act of 1933.

Advertisement: A notice, circular, letter or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, which offers (1) any analysis, report, or publication concerning securities, or which is to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security, or which security to buy or sell, or (3) any other investment advisory service with regard to securities.

Agency cross transaction: A transaction in which an RIA, including an IAR, acts as a broker-dealer for both the advisory client and a person on the other side of the transaction.

Annual updating amendment: RIAs must update their Form ADVs each year by filing annual updating amendments within ninety days after the end of their fiscal years.

Associated person: Any partner, officer, or director of an RIA (or any person performing similar functions), or any person directly or indirectly controlling or controlled by such RIA, including any employee of such RIA, except for persons associated with an RIA whose functions are clerical or ministerial.

Best execution: Executing securities transactions for clients, so that the client’s total cost or net proceeds in each transaction is the most favorable under the circumstances. Price is not the only element of best execution.

Block trading: The practice of combining multiple orders for shares of the same securities purchased for advisory accounts being managed.

Blue Sky Laws: State statutes, rules, and regulations governing the sale of securities and mutual funds implemented to safeguard investors from being enticed into fraudulent or unscrupulous deals.

Books and Records Rule: The Books and Records Rule sets forth the types of books and records that must be created and retained by RIAs. SEC-registered advisors are subject to Rule 204-2. Most state-registered advisors must adhere to a similar rule.

Brochure: A written disclosure statement that RIAs must provide to clients and prospective clients.

Brochure Rule: Rule 204-3 under the Investment Advisers Act that requires advisors to provide clients with Part 2 of Form ADV or a written document containing the same information.

Brochure Supplement: Otherwise known as Part 2B of Form ADV, this document is a written disclosure statement containing information about certain supervised persons of an RIA that must be provided to clients and prospective clients. The firm’s brochure describes the RIA. Brochure supplements describe the qualifications of the person or persons providing advice.

Broker: Any person engaged in the business of effecting transactions in securities for the account of others.

Bunching: Aggregating orders on behalf of two or more accounts. An RIA may bunch or aggregate orders to achieve best execution, so no client is systematically helped or harmed by the bunching. RIAs must implement procedures and procedures designed to ensure that the trades are allocated so that all clients are treated fairly and equitably.

Cherry picking: An unethical practice where an advisor picks and chooses which performance statistics to include in an advertisement. The term also refers to a situation where an advisor allocates trades to favored clients after seeing which way the market moves.

Chief Compliance Officer (CCO): Rule 206(4)-7 requires that each SEC registered firm appoint a CCO. Certain state-registered investment advisors must also appoint a qualified individual as CCO.

Code of Ethics Rule: Rule 204A-1 mandates that each SEC registered advisor must adopt a code of ethics. Some states also require RIAs to implement a code of ethics.

Compliance Program Rule: Rule 206(4)-7 under the Investment Advisers Act requires federally registered advisory firms to implement policies and procedures and to conduct an annual audit of them to determine if they are thorough and effective.

Contingent fee: An advisory fee that will be waived or refunded, in whole or in part, if a client’s account does not meet a specified level of performance. The theory is that performance fees and contingent fees give advisors an incentive to speculate or take extraordinary risks to meet the agreed-upon level.

Control: Control means the power, directly or indirectly, to direct the management or policies of a person, whether through ownership of securities, by contract, or otherwise. A firm’s officers, partners, or directors exercising executive responsibility (or persons having similar status or functions) are presumed to control an RIA.

Cross trade: A transaction between two accounts managed by the same RIA. An RIA can execute a cross trade on an agency or principal basis.

Custody: Holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.

Customer Identification Rule: Section 326 of the USA PATRIOT Act authorized the Treasury Department to create regulations establishing the minimum customer identification standards for financial institutions in order to prevent money laundering. Currently, there is no anti-money laundering rule for RIAs. Nevertheless, depending upon the nature of an advisory practice, examiners may expect to see policies and procedures designed to prevent money laundering.

Deficiency letter: A letter indicating that a securities regulator has found problems during its examination and normally requires corrective action by the RIA.

Desk audit: Examiners review books and records in their own offices and do not visit the advisory firm.

Directed brokerage: The client and not the RIA directs transactions to a particular broker.

Discretionary account: An RIA has been granted authority to make decisions about which assets to buy or sell on a client’s behalf. Without this authority, an investment advisor would be required to call each client to receive authority to effectuate the transaction. The RIA receives a limited power of attorney that specifies the discretionary powers.

Due diligence: The level of investigation expected of a prudent RIA to evaluate whether an investment or business arrangement is advisable.

Examination for cause: An examination prompted by a complaint, a tip, or that is prompted by the results of a prior exam.

Exit interview: The discussion between the RIA and securities examiners on the last day of an on-site visit during which the advisor is told what happens next. The examination team’s findings will usually be delivered weeks or months later in a deficiency letter.

FinCEN: The Financial Crimes Enforcement Network – Since its creation in 1990, FinCEN has been a network to bring people and information together to fight money laundering. It is part of the U.S. Department of the Treasury.

FINRA: Formerly known as the National Association of Securities Dealers. FINRA is a self-regulatory organization (SRO) of broker-dealers and other investment firms that implements rules and regulations.

Forensic tests: Compliance tests that analyze information over time in order to detect unusual patterns, such as overtrading of securities or misappropriation of investment opportunities.

Form ADV: Part 1 of the Form ADV contains registration information. Part 2A of the Form ADV is the information that must be provided to clients as required by the Brochure Rule, found in Rule 204-3 under the Investment Advisers Act. Part 2B is the brochure supplement that must be prepared for certain IARs.

Form U4: The Form U4 is the Uniform Application for Securities Industry Registration or Transfer.

Front running: The unethical practice of trading securities before clients, based on knowledge of forthcoming events. For example, front running occurs when an RIA buys or sells securities, knowing that its client will be making a large trade soon thereafter.

Fulcrum fee: A term used to describe performance fees.

Hedge clause: Contractual language that seeks to limit or avoid an advisor’s legal liability;

Home state: When a firm is state-registered, the RIA’s home state is where the RIA maintains its principal office and place of business.

Insider trading: An illegal practice that occurs when a person trades a security while in possession of material nonpublic information in violation of a duty to withhold the information or refrain from trading.

Interactive website: A website in which computer software-based models or applications provide investment advice to clients based on personal information provided by each client through the website.

Investment Adviser Registration Depository (IARD): An electronic filing system that facilitates registration of RIAs, regulatory review, and the public disclosure information of advisory firms.

Investment Advisor Representative (IAR): Any person who, for 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.

Investment Advisers Act of 1940: The primary law regulating RIAs.

Investment Company Act of 1940: The law that regulates the organization of companies (including mutual funds) that engage primarily in investing, reinvesting, and trading in securities; whose own securities are offered to the investing public.

Investment Policy Statement (IPS): A financial road map for an advisor and the client. It defines the client’s investment objectives and describes how the RIA will attempt to help a client to reach his or her objectives. The IPS takes many forms, including a detailed financial plan, a thorough memorandum of understanding, or a comprehensive letter containing recommendations.

Limited compliance examination: A term used to describe an off-site examination conducted by the SEC.

Management persons: Anyone with the power to exercise, directly or indirectly, a controlling influence over an RIA’s management or policies, or to determine the general investment advice given to clients.

Materiality standard: Whether there is a substantial likelihood that a reasonable client or investor would consider the information to be important.

Minor rule violation: A violation of a self-regulatory organization rule that has been designated as “minor.” A rule may be designated as “minor” if the sanction imposed consists of a fine of $2,500 or less.

National Securities Markets Improvement Act (NSMIA): Legislation that divides regulatory responsibility of RIAs between the states and the federal government.

North American Securities Administrators Association (NASAA): An association of state securities regulators. This organization helps to draft model laws and rules that may be implemented by state legislatures.

Notice filing: SEC-registered investment advisors may be required to provide state securities regulators with copies of documents filed with the Commission.

Other-than-annual amendment: RIAs must file an other-than-annual amendment within thirty days if certain information on their Form ADV becomes inaccurate.

Performance fees: Fees charged by an RIA that are based upon the client’s account reaching a specified level of return. Performance fees are an agreed-upon share of capital gains or capital appreciation of a client’s account paid to the RIA if certain benchmarks are exceeded. Performance fees must be fully disclosed and are not permitted unless the requirements of Rule 205-3 are met. State-registered advisors may be subject to different restrictions.

Principal office and place of business: An RIA’s executive office from which the firm’s officers, partners, or managers direct, control, and coordinate the activities of the firm.

Qualified clients: A natural person or a company with at least $1 million under management of the RIA immediately after entering into the contract; A natural person or a company that the RIA believes has a net worth of more than $2 million or is a qualified purchaser as defined by section 2(a)(51)(A) of the Investment Company Act of 1940; or a natural person who immediately prior to entering into the contract is an executive officer, director, trustee, general partner, or person serving in a similar capacity, of the adviser; or a natural person who is an employee of the adviser, other that someone performing only clerical, secretarial or administrative functions, who participates in the investment activities of the adviser and has done so for at least 12 months. An employee also qualifies if that person performed the same or similar functions for another firm for at least twelve months.

Registered Investment Advisor (RIA): An investment advisor that is registered with either the SEC or one state or many states.

Regulation S-P: The privacy rules promulgated under section 504 of the Gramm-Leach-Bliley Act. Section 504 of the Act required the SEC and other federal agencies to adopt rules implementing notice requirements and restrictions on a financial institution’s ability to disclose nonpublic personal information about consumers. Under the Act, a financial institution must provide its customers with a notice of its privacy policies and practices and must not disclose nonpublic personal information about a consumer to nonaffiliated third parties, unless the institution provides certain information to the consumer and the consumer has not elected to opt out of the disclosure.

Related person: Any advisory affiliate and any person under common control with an RIA.

Routine examinations: An examination by securities regulators that occurs according to the SEC or state securities regulators’ schedules.

Rule 204-2: The Books and Records Rule sets forth the types of books and records that must be created and retained by RIAs.

Rule 204-3: The Brochure Rule requires an RIA to furnish each advisory client and prospective client with a written disclosure document.

Rule 204A-1: Rule 204A-1 requires that SEC registered RIAs adopt a code of ethics and that access persons file transaction reports.

Rule 205-3: This rule sets forth the parameters on charging performance fees to qualified clients.

Rule 206(3)-2: Rule 206(3)-2 governs cross trades, which are transactions between two accounts managed by the same RIA. An RIA can execute a cross trade on an agency or principal basis.

Rule 206(4)-1: Rule 206(4)-1 restricts certain types of advertisements by RIAs.

Rule 206(4)-2: RIAs with custody of clients’ funds or securities must maintain those assets with a broker-dealer, bank, or some other qualified custodian.

Rule 206(4)-3: This rule governs cash payments to solicitors. Rule 206(4)-3 sets forth the conditions that must be satisfied before cash referral fees are paid to individuals and companies that recommend prospective clients to a registered RIA.

Rule 206(4)-4: Pursuant to this rule, RIAs must disclose material disciplinary and financial events.

206(4)-5: Known better as the Pay-to-Play Rule, RIAs may not receive compensation for providing advisory services to state and local government clients for two years if the firm or covered associates made contributions to individuals and entities involved in awarding those contracts.

Rule 206(4)-6: The Proxy Voting Rule helps to ensure that SEC registered investment advisors act in the best interests of their clients when exercising proxy voting authority.

Rule 206(4)-7: Otherwise known at the Compliance Program Rule, Rule 206(4)-7 requires SEC-registered advisors to appoint a Chief Compliance Officer (CCO). They must also develop compliance policies and procedures and test their adequacy annually.

Rule 222-2: Generally, an SEC registered advisor is not required to register or notice file in a particular state if it has five or fewer clients during the past twelve months.

Securities Act of 1933: Otherwise known as the “truth in securities” law. The statute requires that investors receive financial and other significant information concerning securities being offered for public sale. It also prohibits deceit, misrepresentations, and other fraud in the sale of securities.

Securities Exchange Act of 1934: The statute that created the SEC. The law empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies, as well as self-regulatory organizations (“SROs”) such as FINRA.

Selling away: A situation where an IAR/registered representative solicits an investor to purchase securities not held or offered by the firm, which is a violation of securities laws. Quite often, these violations occur in conjunction with private placements and exotic investments.

Series 65: The examination that IARs are usually required to minimum pass, which is administered by FINRA.

Soft dollars: A term used to describe an agreement by which an RIA with discretion receives research or other services from a broker-dealer in addition to the execution of transactions. The broker-dealer provides this research in exchange for brokerage commissions from transactions made on behalf of discretionary clients’ accounts. These research services may be produced in house or obtained from a third party.

Solicitor: A solicitor is any person who, directly or indirectly, solicits clients for, or refers clients to, an RIA. Brokers, bankers, accountants, and attorneys often act as solicitors.

Sub-advisor: Although the term is often interchanged with third-party advisor, the sub-advisory relationship is an agreement between the sub-advisor and the RIA. In contrast, the third-party advisory relationship is between the third-party advisor and the client. The RIA usually recommends the third-party advisor and monitors that entity’s performance.

Suitability standard: Investments recommended must be suitable for clients in view of their risk tolerance, investment objectives, and financial situation. Historically, brokerage firms owe a duty to clients to use due diligence to ensure that the investments they recommend are suitable for customers who rely upon their advice. RIAs also owe a duty to only recommend suitable investments as part of fiduciary obligations.

Supervised person: Any partner, officer, director (or person occupying a similar status or performing similar functions), or employee of the RIA, as well as any other person who provides investment advice on behalf of the firm and is subject to its supervision or control.

Sweeps: Wide-scale examinations to learn more about industry practices.

Testimonials: A statement relating to a client’s experience with, or endorsement of, an RIA. Testimonials are prohibited by Rule 206(4)-1. The prohibition applies to both explicit and implied testimonials.

Third-party advisor: Although the term is often used interchangeably with sub-advisor, the third-party advisory relationship is the relationship between the third-party advisor and the client. The RIA usually recommends the third-party advisor and monitors that entity’s performance.

Trading blotter: A purchase and sales journal that lists transactions in securities and other financial instruments for current and former clients, proprietary and/or trading accounts, and access persons.

Trading error: An error in the placement, execution, or settlement of a client’s trade. It is not a trading error if the mistake is detected and corrected before the trade settles.

Wrap fee brochure: The written disclosure statement that sponsors of wrap fee programs must provide to each of their wrap fee program clients.

Wrap program: A program under which investment advisory and brokerage execution services are provided for one wrapped fee that is not based on the transactions in a client’s account.

Les Abromovitz

Les Abromovitz

Les Abromovitz is the author of The Investment Advisor’s Compliance Guide, published by The National Underwriter Company/ALM Media.

An attorney and member of the Pennsylvania bar, Les has handled hundreds of consulting and publishing projects for National Compliance Services,, a leading compliance and regulatory services firm. He has conducted a number of seminars and training sessions dealing with compliance subjects. Les is also the author of several white papers that analyze compliance issues impacting Registered Investment Advisors (RIAs)‎.

To contact Mr. Abromovitz, email or call 561-330-7645 Ext. 213‎.