Series 65: Laws and Ethics

Series 65 Laws and Ethics questions help you isolate one part of the NASAA outline before returning to a mixed practice test. The questions below are original Securities Prep practice items aligned to this topic and are not copied from any exam sponsor.

Topic snapshot

Sample questions

Question 1

Jordan runs a small financial-education website.

• Jordan sells a “Model Portfolio Service” for $25 per month. Each subscriber completes a risk questionnaire, and Jordan emails the subscriber a portfolio of specific ETFs to buy and hold. There are 80 subscribers this month.
• Jordan also hosts a live “Investing 101” webinar for $50. The webinar covers diversification and time horizon and does not mention any specific securities. There are 40 attendees this month.

How much of Jordan’s revenue this month is compensation for providing advice about securities (i.e., investment adviser activity)?

• A. $1,000
• B. $0
• C. $2,000
• D. $4,000

Best answer: C

Explanation: The personalized ETF model portfolio is advice about securities for compensation: \(80 \times \$25 = \$2,000\).

Investment adviser activity generally involves being in the business of giving advice about securities for compensation. The model portfolio service provides specific ETF recommendations to subscribers based on their questionnaire responses, so that revenue counts. The webinar is general education without specific securities, so it is not counted as securities advice compensation in this question.

An investment adviser is generally a person who, for compensation and as part of a business, provides advice about securities (such as recommending specific securities) or issues reports/analyses about securities. General financial education (e.g., explaining diversification or time horizon without naming securities) is typically not treated as securities advice.

Here, only the “Model Portfolio Service” involves recommending specific ETFs, and it is provided for a monthly fee:

• Securities-advice revenue: \(80 \text{ subscribers} \times \$25 = \$2,000\)
• Webinar revenue is excluded because it is general education and does not discuss specific securities.

A common trap is adding the educational webinar fee even though it is not advice about specific securities.

• The option totaling both services improperly treats general education as securities advice.
• The smaller dollar amount reflects a multiplication error on the subscription revenue.
• The zero-revenue choice ignores that subscribers pay for specific ETF recommendations.

Question 2

A state-registered investment adviser’s operations team flags an onboarding file for a new client. The client’s electronic signature audit trail shows the IAR logged in from the IAR’s own device and signed the client’s advisory agreement and money-movement authorization. When questioned, the IAR admits doing it “to speed things up” and confirms the authorization was used to move client funds.

As the IAR’s supervisor, what is the best next step?

• A. Escalate to CCO/legal and promptly notify the Administrator
• B. Terminate the IAR after year-end to avoid publicity
• C. Send updated Form ADV and continue monitoring the IAR
• D. Reverse the transfer and document the file; take no further action

Best answer: A

Explanation: Suspected willful fraud should be treated as a potentially criminal matter and escalated for immediate regulatory reporting.

Using a client’s credentials and signing for the client to move funds is fraudulent conduct and, if willful, can expose the individual (and potentially the firm) to criminal penalties. The appropriate workflow response is immediate escalation to compliance/legal and prompt notification to the state securities Administrator so the matter can be addressed through enforcement channels.

Willful violations of securities laws and fraudulent acts (such as forging client authorizations or misappropriating client funds) are not just compliance issues—they can result in criminal prosecution. In an advisory firm, the supervisor’s role is to immediately escalate suspected fraud to the CCO/legal function to stop further harm, preserve evidence, and ensure required notifications are made. The state securities Administrator has enforcement authority and can pursue remedies and, for willful violations, refer the matter for criminal action through the appropriate prosecuting authorities. Key takeaway: when facts indicate willful fraud, the next step is escalation and regulatory notification, not quiet remediation or delayed discipline.

• Quietly reversing the transfer and moving on fails to address suspected fraud and potential criminal exposure.
• Delaying termination to manage publicity prioritizes optics over client protection and regulatory obligations.
• Delivering updated disclosure documents does not remediate forged authorization or suspected misappropriation.

Question 3

A state-registered investment adviser updates its Form ADV Part 2A brochure to reflect a new fee schedule. The firm emails the updated brochure PDF to all existing clients using its normal business email system.

Which recordkeeping approach is most consistent with core investment adviser books-and-records expectations?

• A. Retain a copy of the amended brochure and the distribution email
• B. Keep only a list of recipients; the brochure content need not be retained
• C. Rely on the email vendor’s archive; keep no internal copies
• D. Keep only the most current brochure version; delete prior versions

Best answer: A

Explanation: Advisers are expected to keep copies of required disclosures and business communications used to deliver them.

Investment advisers are expected to maintain books and records that document what they disclosed and how they communicated with clients. When a brochure is amended and delivered electronically, the adviser should retain the updated disclosure document and the related business communication used to transmit it. This supports supervision, auditability, and the ability to evidence what clients received.

A core books-and-records principle for advisers is being able to evidence key disclosures and client-facing communications. When an adviser amends a disclosure document like the Form ADV Part 2A brochure and sends it to clients, the firm should keep (1) the version of the brochure that was provided and (2) the business communication associated with its delivery (such as the email and attachment).

This is not about remembering a specific retention period; it’s about maintaining an auditable record of what was communicated to clients in the course of providing advisory services. Keeping only a recipient list (without the content) or deleting older versions undermines the ability to demonstrate what was actually disclosed at the time.

• Keeping only the current version defeats the purpose of documenting what was disclosed at the time.
• Depending solely on a third-party archive without adviser access/control can fail basic recordkeeping expectations.
• A recipient list alone does not evidence the disclosure content that was delivered.

Question 4

A state securities Administrator is reviewing a complaint and requests the broker-dealer’s order record below.

Exhibit: Order ticket (excerpt)

Broker-dealer: Skyline Securities, Inc.
Client: Maria R.
Rep: Jordan Lee
Action: BUY
Security: ABC Corp common stock
Quantity: 200
Order entered: 10:14 a.m.

Based only on the exhibit and Uniform Securities Act concepts, the best interpretation is that Jordan Lee is acting as:

• A. An agent of the issuer of ABC Corp
• B. A clerical employee excluded from the agent definition
• C. An agent of the broker-dealer
• D. An investment adviser representative

Best answer: C

Explanation: Entering a client’s stock order for a broker-dealer is effecting (or attempting to effect) a securities transaction, a typical agent activity.

An agent is an individual who represents a broker-dealer in effecting or attempting to effect securities transactions. The exhibit shows Jordan Lee listed as the representative on an order ticket for a client’s purchase of a stock. That activity is a core example of acting as a broker-dealer agent.

Under the Uniform Securities Act, an agent is generally an individual who represents a broker-dealer in effecting or attempting to effect purchases or sales of securities. Typical agent activities include soliciting orders, taking orders, and entering/executing transactions for clients.

Here, the exhibit is an order ticket showing a client stock purchase with “Rep: Jordan Lee,” which indicates Jordan is the individual handling the transaction for the broker-dealer. That is consistent with agent activity, not merely performing clerical/back-office functions.

The key distinction is that agents participate in the securities transaction process (solicitation or order handling), whereas clerical staff do not.

• The option claiming investment adviser representative status isn’t supported because the exhibit shows broker-dealer order handling, not advisory representation.
• The clerical-employee exclusion doesn’t fit because the exhibit indicates order entry/transaction handling, not ministerial recordkeeping.
• The issuer-agent classification would require representing ABC Corp in distributing its securities; the exhibit instead shows representing a broker-dealer for a client order.

Question 5

An investment adviser representative (IAR) is accused by the state Administrator of making material misstatements to several retail clients about a strategy’s risks. The Administrator offers to resolve the matter through an administrative consent order that would include a cease-and-desist, a fine, and a suspension.

For the clients who want to be made financially whole, what is the primary limitation of relying on this administrative action?

• A. It can sanction the IAR but generally does not award clients money damages
• B. It automatically provides treble damages to harmed clients
• C. It can impose imprisonment for the IAR
• D. It requires proof beyond a reasonable doubt

Best answer: A

Explanation: Administrative remedies are primarily regulatory (e.g., suspend/revoke/censure/fine), while clients typically must pursue civil remedies to recover monetary damages.

Administrative remedies are designed to protect the public by regulating industry participants through actions like censure, suspension, revocation, and fines. Client “make-whole” relief is typically pursued through civil litigation (e.g., damages or rescission), while imprisonment is a criminal remedy. Therefore, the key tradeoff is that an administrative case may punish or restrict the IAR without directly compensating clients.

The core distinction is the purpose and outcome of each remedy type. An Administrator’s administrative proceeding is a regulatory tool aimed at stopping misconduct and protecting investors by restricting the firm/person and imposing sanctions.

At a high level:

• Administrative remedies commonly include censure, cease-and-desist orders, fines, and suspension or revocation of registration.
• Civil remedies are used by harmed parties (or sometimes regulators in court) to seek monetary recovery such as damages or rescission.
• Criminal remedies are pursued by criminal authorities and can result in fines and imprisonment, with a higher burden of proof.

Key takeaway: administrative actions can penalize and bar, but client compensation is generally a civil remedy issue.

• Imprisonment is a criminal penalty, not an administrative sanction imposed by the Administrator.
• Treble (or other punitive) damages are associated with certain civil claims and are not an automatic feature of administrative orders.
• “Beyond a reasonable doubt” is the criminal standard; administrative actions use a lower evidentiary standard.

Question 6

An IAR is reviewing a new client’s existing holdings to determine which positions are securities under the Uniform Securities Act. Which holding is most likely a security?

• A. A fixed annuity
• B. A variable annuity
• C. Term life insurance
• D. A bank-issued certificate of deposit

Best answer: B

Explanation: A variable annuity’s value fluctuates with underlying investment subaccounts, making it a security.

A variable annuity is generally treated as a security because the purchaser bears investment risk and returns depend on the performance of underlying investment options. In contrast, traditional insurance contracts with guaranteed values and bank CDs are typically non-securities under the Act’s definitions.

Under the Uniform Securities Act, many investment products are securities (for example, stocks, bonds, investment contracts, and variable insurance products). A variable annuity is funded through a separate account with subaccounts that resemble mutual funds, and the contract’s value and payouts vary with market performance; that investment-risk feature is why it is generally regulated as a security.

By contrast, fixed annuities and term life insurance are insurance products with obligations based primarily on the insurer’s guarantees rather than market performance, and a bank certificate of deposit is a banking product rather than a security for purposes of the Act. The key takeaway is to focus on whether the client’s return is primarily investment-performance based versus contractually guaranteed.

• The option describing a fixed annuity is typically an insurance contract with guaranteed terms, not a market-value security.
• The option describing a bank CD is generally excluded from the definition of a security as a banking product.
• The option describing term life insurance is pure insurance protection without an investment component.

Question 7

A state-registered investment adviser wants to run a short social media ad that says: “Our strategy beat the S&P 500 by 6% last year—join now for consistent upside.” The claim is based on a model portfolio’s gross returns before advisory fees, and the adviser has not yet assembled supporting records showing the calculation, benchmark used, or how many client accounts actually followed the model. The marketing team says the post must stay short, but it can include a link to a longer disclosure page. What is the best compliance decision?

• A. Replace the index comparison with a single best-performing client account example to keep the post short
• B. Run the ad as written because model performance is permitted as long as the benchmark is a well-known index
• C. Run the ad as written if it adds “past performance is no guarantee” at the bottom
• D. Run the ad only after substantiating the claim and revising it to be fair and balanced with clear disclosures (including time period, benchmark, fees/expenses, and material limitations) and without implying guaranteed or “consistent” results

Best answer: D

Explanation: Advertising must be substantiated, not misleading, and balanced, so the adviser should document the basis and add concise, prominent disclosures (or a clear link) while removing guarantee-like language.

Investment adviser advertising must be fair and balanced, not misleading, and supported by a reasonable basis (substantiation). Here, the adviser lacks records to support the “beat the S&P 500 by 6%” claim and uses language (“consistent upside”) that can imply a guarantee. The best decision is to substantiate first, then present performance with clear, material disclosures and appropriate limitations (with a linked disclosure page if needed).

The core advertising principle is that an investment adviser may not publish communications that are misleading or that cannot be substantiated. A performance comparison requires a reasonable basis: the adviser should be able to produce records showing how returns were calculated, what benchmark was used, what period is being presented, and whether the results reflect the client experience (including the impact of fees and other material costs/assumptions). The presentation must also be fair and balanced—avoid cherry-picking or implying that favorable results are likely to continue. Phrases like “consistent upside” are problematic because they can suggest a guaranteed outcome or minimized risk. If the medium is space-limited, concise disclosures plus a clear link to fuller, prominent disclosures can help, but the ad still must not be misleading on its face.

• Adding only a generic “past performance” disclaimer does not fix an unsubstantiated or potentially misleading performance comparison.
• Using a famous benchmark does not remove the need to document calculations and disclose material assumptions (including fees and limitations).
• Highlighting a single best-performing client is generally misleading because it is not fair and balanced and can imply typical results.

Question 8

A state securities Administrator is reviewing outreach materials explaining who is excluded from the definition of “investment adviser” under the Uniform Securities Act. Which statement is INCORRECT?

Assume each person is providing the described service in the ordinary course of business.

• A. A bank trust department is excluded
• B. A financial planner charging fees for personalized plans is excluded
• C. A broker-dealer is excluded when advice is incidental
• D. A bona fide financial publisher of general circulation is excluded

Best answer: B

Explanation: Providing personalized investment advice for a fee generally makes the planner an investment adviser, not an excluded person.

Certain persons are excluded from the investment adviser definition, such as banks, broker-dealers whose advice is solely incidental and not specially compensated, and bona fide publishers of general and regular circulation. By contrast, a person who holds out as a financial planner and charges fees for individualized investment plans is typically providing investment advice for compensation and would not fall under those exclusions.

The Uniform Securities Act excludes several categories of persons from the definition of “investment adviser,” meaning they generally do not register as IAs solely because of those roles. Common exclusions include banks, broker-dealers when any advisory services are incidental to brokerage and not specially compensated, and bona fide publishers of general and regular circulation (impersonal commentary to the general public).

A financial planner who charges a fee for personalized financial plans is providing individualized investment advice for compensation. That activity fits the core investment adviser definition and does not match the typical exclusions, so the planner would generally need to register (unless another exemption applies based on facts not given).

• The bank trust department exclusion is a standard carve-out from the IA definition.
• The broker-dealer exclusion applies when advice is incidental and not specially compensated.
• A bona fide publisher with general, regular circulation is excluded because the content is impersonal.
• Fee-based, individualized financial planning is advisory activity that generally triggers IA status.

Question 9

A state-registered investment adviser has a written compliance manual, but it does not review or retain an IAR’s client emails and social-media messages. The IAR regularly sends recommendations and performance claims from a personal account. During an examination, the Administrator finds multiple misleading statements and no evidence of supervisory review.

What is the most likely regulatory outcome for the adviser?

• A. Automatic cancellation of the adviser’s registration upon exam discovery
• B. Administrative action for failure to supervise and keep required records
• C. Client advisory contracts become void without any client right of rescission
• D. No regulatory consequence if the IAR, not the adviser, sent the messages

Best answer: B

Explanation: An adviser must implement effective supervision and recordkeeping, and a paper policy without monitoring communications can lead to sanctions.

Supervision under an adviser’s compliance program requires more than having written policies; the adviser must reasonably implement and enforce them. If an IAR uses unmonitored channels to communicate recommendations and misleading claims, regulators commonly treat it as a failure to supervise and a recordkeeping/compliance breakdown. The Administrator may pursue remedies such as censure, fines, and orders to correct controls.

Investment advisers are expected to supervise their IARs through a compliance program that is actually implemented, not merely documented. Communications with clients and prospects (including electronic messages and social media used for advisory business) are part of the adviser’s books and records and should be subject to retention and supervisory review designed to prevent and detect misleading statements and other violations. When an exam shows the adviser did not capture or review those communications and misleading statements occurred, the durable consequence is an enforcement/disciplinary response for inadequate supervision and recordkeeping controls. The regulator’s focus is the firm’s supervisory system and whether it was reasonably designed and followed, not just who typed the message.

• The idea that registration is automatically canceled assumes a mandatory, self-executing penalty; administrators typically must bring an action and can choose among remedies.
• The claim that contracts become void with no rescission misunderstands remedies; clients commonly have rights when violations occur, and contract validity is not automatically resolved that way.
• Saying there is no consequence because the IAR sent the messages ignores the adviser’s duty to supervise its personnel and business communications.

Question 10

In an anti-money laundering (AML) program, a Customer Identification Program (CIP) is primarily designed to:

• A. Monitor transactions for unusual activity and escalate for possible SAR filing
• B. Determine the customer’s investment objectives and risk tolerance
• C. Approve and document all third-party disbursement requests
• D. Verify a customer’s identity when opening an account

Best answer: D

Explanation: CIP focuses on collecting and verifying identifying information to form a reasonable belief the firm knows the customer’s true identity.

A CIP is the “who is the customer?” part of AML—obtaining identifying information and taking steps to verify it so the firm can form a reasonable belief it knows the customer’s true identity. Suitability/KYC profiling and ongoing transaction monitoring are separate functions. Controls around disbursements may be part of broader supervision, but they are not the core purpose of CIP.

CIP is a foundational AML control focused on identity. At a high level, it requires a firm to collect basic identifying information (such as name, date of birth for individuals, address, and an identification number) and to verify that information using documents and/or non-documentary methods so the firm can form a reasonable belief it knows who the customer is.

KYC/suitability (investment goals and risk tolerance) addresses whether recommendations are appropriate, while AML transaction monitoring looks for patterns or activity that may indicate money laundering and may lead to an internal escalation and, if warranted, a Suspicious Activity Report (SAR). Disbursement approvals can help reduce fraud and laundering risk but are not what “CIP” primarily means.

• The option about investment objectives and risk tolerance describes suitability/KYC profiling, not identity verification.
• The option about monitoring for unusual activity and possible SAR filing describes ongoing AML surveillance, not CIP.
• The option about approving third-party disbursements is a supervisory/fraud-control practice, not the core CIP definition.

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