CFP - Professional Conduct and Regulation (8% of the exam) - Section A.3

Function, purpose, and general structure of financial institutions

The roles of banks, credit unions, broker-dealers, investment advisers, insurance companies, trust companies and their regulators, and how a client's assets and advice relationships map onto them. Items distinguish which institution or registration governs a given service.

Investment Advisers Act of 1940Securities Exchange Act of 1934

Practice question for this objective

Free sampleProfessional Conduct and Regulationmedium

A CFP professional is forming a new firm. The firm will give continuous investment advice to individual clients for an annual fee based on assets, and it will also execute those clients' securities trades in the secondary market itself and keep the resulting commissions. Which statement best describes the registration structure the firm needs?

AAdviser registration alone covers both activities, because giving advice and executing the resulting trades is a single integrated service once an annual fee is charged for it.
BThe advisory activity is regulated under the Investment Advisers Act of 1940, while executing the trades requires registration as, or association with, a broker-dealer under the Securities Exchange Act of 1934. Correct
CThe Securities Act of 1933 governs both activities, because it regulates every offer and sale of a security to the public, including ordinary trades between investors in the secondary market.
DNeither registration is required, provided the firm discloses its commission schedule in the client agreement and every person giving advice at the firm holds the CFP certification.

Match a firm's advisory and execution functions to the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934 respectively. The federal framework regulates functions, not firm labels. Advising others about securities for compensation as a regular business is the activity captured by the Investment Advisers Act of 1940, which is why the fee-based advice arm registers as an investment adviser. Effecting transactions in securities for the account of others is a different activity, captured by the Securities Exchange Act of 1934, which is why the execution arm needs broker-dealer registration or an association with a registered broker-dealer. A firm doing both performs two regulated functions and therefore carries both, which is the ordinary dually registered structure. Neither client disclosure nor a professional certification substitutes for a registration the statute requires.

Why A is wrong: Tempting because the two activities serve one client relationship and many advisory firms describe execution as part of their service. It is wrong because effecting securities transactions for others is a separate regulated activity that adviser registration does not authorise.

Why B is correct: Correct because the two statutes regulate different functions: advice for compensation about securities falls under the 1940 Act, and effecting securities transactions for the account of others falls under the 1934 Act.

Why C is wrong: Tempting because the Securities Act of 1933 does regulate offers and sales of securities. It is wrong because its subject is the issuance and registration of securities and the disclosure that accompanies it, while the ongoing secondary market and its intermediaries sit under the Securities Exchange Act of 1934.

Why D is wrong: Tempting because disclosure and a professional credential both matter to conduct standards and clients often treat them as sufficient. It is wrong because a certification is not a securities registration, and disclosing compensation does not remove the statutory duty to register.

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Exam traps in Professional Conduct and Regulation

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

Remain registered with her state regulator and notice file in the other two states, because advisers with clients in fewer than fifteen states stay under state authority.
Why it is wrong: Tempting because a fifteen-state test does exist in adviser regulation, but it is the multi-state exemption that lets a smaller adviser register federally, not a ceiling that keeps a 142 million dollar firm at state level. Client count in states does not override the asset thresholds stated in the stem.
The firm should follow the Federal Trade Commission Safeguards Rule and appoint a qualified individual, since that rule reaches firms that give financial advice.
Why it is wrong: Tempting because the Federal Trade Commission rule is a real and detailed safeguards regime with a named qualified individual. It is wrong here because that rule applies to financial institutions that are not subject to another functional regulator, and this adviser is regulated by the Securities and Exchange Commission.
The Investment Advisers Act fiduciary duty, because holding an adviser registration attaches that duty to every recommendation he makes in any capacity, including his brokerage business.
Why it is wrong: Tempting because Tomas does hold an adviser registration and the adviser fiduciary duty is the higher-profile standard. It is wrong because that duty attaches to the advisory relationship, not to the individual, so a recommendation made in a brokerage capacity is not governed by it.

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