Investment Adviser

The SEC is reviewing the registration application of Bracewell Ridge Advisers. One of the firm's officers was convicted of a felony involving the purchase or sale of a security. Under the Investment Advisers Act, that conviction is a statutory ground for denying, suspending or revoking the firm's registration if the conviction occurred:

1. A.Within three years preceding the filing of the application.Incorrect. Three years is not the Advisers Act period for a disqualifying conviction.
2. B.Within five years preceding the filing of the application.Incorrect. Five years is not the statutory lookback under the Advisers Act for these convictions.
3. C.At any time in the past, with no time limitation at all.Incorrect. The statute expressly limits the lookback rather than reaching back indefinitely.
4. D.Within ten years preceding the filing of the application.Correct. The Advisers Act uses a ten-year lookback for enumerated felony and misdemeanor convictions, and it applies to associated persons as well as to the firm.

Why: The Advisers Act uses a ten-year lookback. A conviction of an enumerated felony or misdemeanor - including offenses involving the purchase or sale of a security, fraud, embezzlement, bribery and similar conduct - is a statutory disqualification if it occurred within ten years preceding the filing of the application. The disqualification reaches convictions of the firm and of persons associated with it, and it is one of the grounds on which the Commission may institute proceedings after notice and opportunity for hearing.

Halverlea Advisory is a state-registered investment adviser that has deliberately structured itself to avoid custody: it uses an unaffiliated qualified custodian, has no authority to withdraw client assets, and never asks clients to send it anything. On Monday morning a client, without being asked, posts Halverlea a cheque for $40,000 made payable to her custodian, together with a note asking the adviser to see that it is invested. Under the NASAA model custody rule, what must Halverlea do to avoid being deemed to have custody?

1. A.Nothing, because the cheque is payable to the qualified custodian rather than to Halverlea.The payee line does not control. The adviser is in possession of a client asset and must act to negate custody.
2. B.Forward the cheque to the qualified custodian within three business days of receiving it.Forwarding is not the prescribed cure under the model rule. The asset must go back to the sender.
3. C.Return the cheque to the client within three business days of receiving it.Correct. Returning inadvertently received funds or securities to the sender within three business days prevents the adviser from being deemed to have custody.
4. D.Deposit the cheque in a separate account maintained solely for inadvertently received client funds.Depositing the cheque anywhere places the adviser in control of client assets, which is precisely what having custody means.

Why: An adviser that inadvertently receives client funds or securities is not automatically treated as having custody, provided it acts quickly. The model rule gives the firm a short window: it must return the funds or securities TO THE SENDER WITHIN THREE BUSINESS DAYS of receiving them. Forwarding the cheque onward to the custodian is not the prescribed cure, and neither is holding it while seeking instructions, because both leave the adviser in possession of client assets. The rule's logic is that custody is about possession and control, so the only reliable way to negate an inadvertent receipt is to put the asset straight back where it came from, promptly, and to document that you did.

Larkfield Data is conducting a Rule 506(c) offering and advertising it openly. A prospective buyer returns a signed questionnaire ticking the box that says he is an accredited investor. The placement agent holds no other information about him. May the issuer sell to him on that basis?

1. A.Yes. A signed representation of accredited status is what Rule 506(c) asks of a natural person.Wrong. That is the reasonable-belief standard available under Rule 506(b), not the verification standard Rule 506(c) imposes.
2. B.No. Rule 506(c) requires reasonable steps to verify, which a self-certification alone is not.Correct. Verification is the condition attached to permitting general solicitation, and a ticked box does not meet it.
3. C.Yes, provided the issuer also delivers the Rule 502(b) information package before the sale.Wrong. That package is owed to non-accredited purchasers in a Rule 506(b) offering and has nothing to do with verification.
4. D.No. An offering that is generally solicited may be sold only to entities, never to natural persons.Wrong. Rule 506(c) draws no line between natural persons and entities; the line it draws is accredited or not.

Why: Rule 506(c) is the trade-off branch of Rule 506: the issuer may advertise the offering to the world, but every purchaser must actually be an accredited investor and the issuer must take reasonable steps to verify it. A ticked box is a representation, not verification. The rule's own non-exclusive methods run to things like reviewing income or asset documentation, or obtaining written confirmation from a registered broker-dealer, registered investment adviser, licensed attorney or certified public accountant. In a Rule 506(b) offering the same questionnaire could support the reasonable belief the rule allows, because no general solicitation has taken place.

Marguerite Auden-Fell writes a widely read weekly column of specific buy and sell recommendations on individual regional bank stocks. She distributes it free by e-mail to about 4,000 subscribers, refuses all advertising, takes no donations, sells nothing, and has no business relationship of any kind with any subscriber, issuer or broker-dealer. She unmistakably holds herself out as being in the business of advising on securities. Under the Uniform Securities Act, is Marguerite an investment adviser?

1. A.No, because she receives no compensation, and compensation is a required element of the definition.Correct. Advice, regular business AND compensation are cumulative requirements. She fails the third, so she is outside the definition.
2. B.Yes, because she gives specific securities recommendations as part of a regular business and holds herself out as doing so.These are only the first two elements. The definition also requires compensation, which is entirely absent here.
3. C.Yes, because distributing recommendations to 4,000 people is by itself holding oneself out as an investment adviser.Holding out goes to the business prong, which she does satisfy. It cannot substitute for the missing compensation element.
4. D.No, because advice delivered in writing rather than in person is never investment advice under the Act.The medium is irrelevant. Written advice is fully capable of being investment advice; the reason she escapes the definition is the absence of compensation.

Why: The definition of investment adviser has three cumulative elements: the person (1) advises others as to the value of securities or the advisability of investing in, purchasing or selling securities, (2) does so as part of a regular business, and (3) receives COMPENSATION for doing so. Marguerite plainly satisfies the first two. She fails the third: she receives no compensation, direct or indirect, in any form. Because all three prongs must be met, she is not an investment adviser. The compensation prong is broad when it is present, reaching indirect compensation such as commissions or fees paid by third parties, but here there is simply nothing.