Suitability

Perrin Halstow, an agent at Corvale Securities, recommends the Merrowgate Income Fund to a retail client. Corvale receives ongoing revenue sharing payments from the fund distributor for placing the fund on its recommended list, and Halstow personally receives a higher payout on that fund family than on others. He mentions neither arrangement. Under the Uniform Securities Act, his conduct is:

1. A.lawful, because the fund was a suitable recommendation for this clientSuitability does not excuse concealing a material conflict of interest.
2. B.lawful, because the payments are made to the firm rather than to the client accountWhere the money goes is what creates the conflict. It does not remove the duty to disclose.
3. C.unlawful, because a material conflict of interest in how the firm and the agent are paid must be disclosed to the clientCorrect. Compensation arrangements that bias a recommendation are material facts that must be disclosed.
4. D.unlawful only if the client actually loses money in the fundThe omission is complete at the time of the recommendation and does not depend on performance.

Why: An agent must disclose material facts a reasonable investor would want to know in deciding whether to follow a recommendation, and that includes conflicts of interest arising from how the firm and the agent are paid. Revenue sharing from a fund distributor and a differential payout both give the agent a financial reason to prefer one fund over another. Concealing them is an omission of a material fact in connection with the offer or sale of a security.

An adviser recommends a tax-deferred variable annuity inside an IRA for a client with no need for extra deferral. This:

1. A.Raises a suitability concernCorrect - redundant tax deferral, extra cost.
2. B.Doubles the tax benefitTax deferral does not stack. The IRA already shelters growth from current taxation, so the annuity's deferral feature adds nothing while the client still pays the annuity's insurance and contract costs.
3. C.Is required for IRAsAn IRA is an account type that can hold a wide range of investments, and no rule directs that an annuity be among them. Treating one permissible product as mandatory reverses the relationship between the account and its contents.
4. D.Is always idealAn annuity inside an IRA is not automatically improper, since features such as guaranteed lifetime income can justify it for the right client. But the stem specifies the client has no need for additional deferral, which removes the main rationale and leaves the added cost unexplained.

Why: An IRA is already tax-deferred, so wrapping a VA inside it for its deferral raises a suitability concern.

Before making a recommendation to a retail customer, FINRA Rule 2111 requires a representative to use reasonable diligence to obtain the customer's investment profile. Which item is NOT one of the profile elements the rule enumerates?

1. A.The customer's credit score.Correct. Creditworthiness is not among the enumerated investment profile elements.
2. B.The customer's tax status.Tax status is expressly listed in the rule.
3. C.The customer's investment time horizon.Time horizon is expressly listed in the rule.
4. D.The customer's liquidity needs and risk tolerance.Both liquidity needs and risk tolerance are expressly listed in the rule.

Why: Rule 2111 lists the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer discloses. Creditworthiness is not part of the profile; a credit score speaks to a customer's ability to repay borrowings, not to the suitability of a securities recommendation.

Two customers each tell their representative they are comfortable with sharp market swings. Cassian, 38, has a secure salary, a full emergency fund and no withdrawals planned for twenty years. Wendell, 66, is retired and must draw 40,000 dollars a year from the same portfolio to live on. The representative should recognise that the two men differ mainly in their:

1. A.Investment objectives, since one seeks growth and the other seeks income.The stem gives no difference in objectives. The difference described is the ability to absorb loss.
2. B.Risk capacity, since Wendell must draw on the portfolio and cannot afford to sell into a decline.Correct. Both report the same tolerance, but Wendell's need to withdraw sharply reduces his capacity to bear loss.
3. C.Risk tolerance, since an older customer is by definition less willing to accept volatility.Age does not determine willingness, and both customers state the same tolerance. Capacity is what differs.
4. D.Liquidity of their holdings, since both would hold the same funds.The funds are equally liquid. The difference is the demand each customer places on the portfolio.

Why: Risk tolerance is the customer's willingness to accept volatility, which both men report as high. Risk capacity is the customer's financial ABILITY to absorb losses without damaging their plan, and it depends on time horizon, income security and the need to draw on the assets. Wendell must sell into any decline to fund his living costs, so his capacity is far lower than Cassian's even though their tolerance is the same.