Ethics on the Series 65 Exam
The Series 65 heavily tests your understanding of prohibited practices and ethical conduct for investment adviser representatives (IARs).
- 30% of the exam covers laws, regulations, and ethical guidelines
- 8-12 questions specifically on ethics and prohibited conduct
- Must distinguish unethical vs. Fraudulent behavior
As an investment adviser representative (IAR), you are held to a fiduciary standard, meaning you must always act in your clientsâ best interests. The Series 65 exam tests whether you understand what conduct is prohibited and the consequences of violations.
This content falls under Section IV of the exam: Laws, Regulations, and Guidelines, Including Prohibition on Unethical Business Practices. Understanding these rules is not just about passing the exam. Violations can result in civil penalties, loss of registration, and even criminal prosecution.
Unethical vs. Fraudulent Practices
The Series 65 exam makes an important distinction between unethical and fraudulent business practices. Understanding this distinction is critical because it affects the severity of penalties and regulatory response.
- Generally unintentional or negligent conduct
- Violate professional standards
- Result in administrative sanctions
- May lead to fines, censure, or suspension
- Typically not criminal offenses
- Intentional deception or manipulation
- Violate securities laws
- Result in severe penalties
- Subject to criminal prosecution
- May include imprisonment
Unethical examples: Failing to disclose conflicts, inadequate record-keeping, unsuitable (suitability) recommendations
Fraudulent examples: Insider trading, misappropriation of funds, Ponzi schemes, market manipulation
When an exam question asks whether conduct is âunethicalâ or âfraudulent,â look for intent. Fraudulent conduct involves deliberate deception or knowing violation of the law. Unethical conduct may be harmful but lacks the intentional, criminal element.
Distinguishing between unethical and fraudulent conduct is just one of many ethics scenarios tested on the Series 65. Our flashcard strategies guide explains how to use FSRS-powered spaced repetition to memorize prohibited practices. Not just the definitions, but the subtle distinctions the exam tests, like intent, disclosure requirements, and severity of violations.
Prohibited Trading Practices
Several trading practices are explicitly prohibited because they harm clients or undermine market integrity. These are frequently tested on the Series 65 exam.
Churning (Excessive Trading)
Churning occurs when an adviser excessively trades a clientâs account primarily to generate commissions rather than to benefit the client. This is a direct violation of fiduciary duty.
- High portfolio turnover ratio inconsistent with investment objectives - Trading activity that does not align with stated goals (e.g., aggressive trading in a âconservativeâ account) - Cost-to-equity ratio showing excessive commission charges - In-and-out trading of the same securities
Front-Running
Front-running occurs when an adviser or representative trades in their personal account ahead of executing a known client order, seeking to profit from the anticipated price movement caused by the clientâs order.
- Adviser receives large buy order from client
- Before executing client order, adviser buys same security personally
- Client order drives up price
- Adviser sells at higher price for personal profit
Insider Trading
Insider trading involves buying or selling securities based on material, nonpublic information (MNPI). It is illegal regardless of how the information was obtained.
Material Information
Information that a reasonable investor would consider important in making an investment decision. Examples: earnings announcements, merger plans, major contract wins or losses.
Nonpublic Information
Information that has not been broadly disseminated to the public. Once information is publicly available (press release, SEC filing), it is no longer nonpublic.
You do not have to trade yourself to violate insider trading laws. âTippingâ (sharing MNPI with others who then trade) is equally prohibited. Both the tipper and tippee can face liability.
Market Manipulation
Market manipulation involves artificial interference with market prices. Common forms include:
- Wash trading: Buying and selling the same security to create appearance of activity
- Matched orders: Coordinating with another party to buy and sell at predetermined prices
- Painting the tape: Executing trades to create false impression of trading activity
- Pump and dump: Spreading false positive information to inflate price, then selling
Master Prohibited Trading Scenarios
Ethics questions present real-world scenarios. CertFuel's adaptive practice tracks whether you can distinguish churning from front-running, identify when MNPI rules apply, and spot custody violations. Our Smart Study algorithm prioritizes the ethics scenarios you're getting wrong.
Access Free BetaUnderstanding churning, front-running, insider trading, and market manipulation is essential, but many candidates still miss ethics questions due to common traps. Our common mistakes guide identifies all top exam failure patterns, including the specific ethics confusions that trip up even well-prepared candidates who know the prohibited practices but misapply them in scenario questions.
Other Prohibited Practices
Beyond trading violations, the Series 65 tests several other prohibited practices that investment advisers and IARs must avoid.
Selling Away
Selling away occurs when a representative conducts securities transactions outside of their employing firm without disclosing the transaction and obtaining written approval from the firm.
- Bypasses firm supervision and compliance procedures - May involve unsuitable or fraudulent investments - Leaves clients without firm protections and recourse - Often involves private placements or outside business activities
Borrowing From or Lending to Clients
Investment advisers and IARs are generally prohibited from borrowing money from or lending money to clients.
| Scenario | Permitted? | Reasoning |
|---|---|---|
| Borrowing from a bank client | Yes | Client is in the business of lending money |
| Borrowing from an individual client | No | Creates conflict of interest |
| Lending to any client | No | Creates debtor/creditor relationship |
| Borrowing from family member client | Varies | Some jurisdictions allow with disclosure |
Commingling Client Funds
Advisers must never mix client funds with their own personal or business funds. Client assets must be maintained separately in accounts titled in the clientâs name or a custodial account.
Excessive Markups and Markdowns
When acting as a principal (dealer), an adviser must not charge excessive markups on securities sold to clients or markdowns on securities purchased from clients. What constitutes âexcessiveâ depends on factors like security type, market conditions, and trade size.
Sharing in Client Profits and Losses
Advisers generally cannot share in client profits or losses except:
- With written client consent
- In proportion to their capital contribution
- Or under performance-based fee arrangements (if qualified client requirements are met)
Third-Party Research Disclosure
When providing third-party analysis or research reports to clients, advisers must disclose that the material was created by a third party. Without disclosure, clients may incorrectly assume the adviser created the research.
Custody Rules
âCustodyâ means holding client funds or securities or having the authority to obtain possession of them. Because custody creates opportunities for misappropriation, advisers with custody face heightened requirements.
When Does an Adviser Have Custody?
- Adviser holds client funds or securities directly
- Adviser has authority to withdraw funds from client accounts
- Adviser can write checks from client accounts
- Adviser has access to client login credentials
- Adviser acts as trustee for a client trust
- Adviser only has trading authority (discretion)
- Adviser deducts pre-agreed fees with proper safeguards
- First-party wire transfers only (client to client)
- Client maintains direct control of assets
Requirements for Advisers With Custody
Investment advisers with custody of client assets must comply with these requirements:
Qualified Custodian
Maintain client assets with a qualified custodian (bank, broker-dealer, or futures commission merchant)
Quarterly Statements
Ensure clients receive account statements directly from the custodian at least quarterly
Surprise Examination
Undergo an annual surprise examination by an independent public accountant
Deducting advisory fees directly from client accounts is generally considered a form of custody. However, the surprise examination requirement may be waived if the client receives prior notice, fees follow a written agreement, and invoices are sent to the custodian.
The four custody requirements. Qualified custodian, quarterly statements, surprise examination, and Form ADV disclosure. Are frequently tested and easily confused. Our flashcard strategies guide provides techniques for memorizing these requirements using FSRS algorithms, ensuring you can instantly recall all four components and their specific conditions on exam day.
Advertising Restrictions
The SECâs Marketing Rule (Rule 206(4)-1 under the Investment Advisers Act) governs how investment advisers can advertise their services. Understanding these rules is tested on the Series 65.
General Prohibitions
An advertisement cannot:
- Include untrue statements of material fact
- Include information that is materially misleading
- Discuss potential benefits without fair treatment of material risks
- Include performance results the adviser cannot substantiate
- Make claims about SEC review or approval (the SEC does not approve advisers)
Performance Advertising Rules
When advertising performance, advisers must follow specific requirements:
| Performance Type | Requirements |
|---|---|
| Gross Performance | Must be accompanied by net performance with at least equal prominence |
| Net Performance | Must reflect deduction of all fees and expenses |
| Hypothetical Performance | Must adopt policies ensuring relevance to intended audience; cannot be shown in mass marketing |
| Past Specific Recommendations | Must include all recommendations for the prior year or use objective criteria for selection |
Testimonials and Endorsements
The Marketing Rule now permits testimonials and endorsements (previously prohibited), but with requirements:
- Must disclose whether the person is a client
- Must disclose if compensation was provided
- Must disclose material conflicts of interest
- Compensated promoters generally must be registered or exempt
Advisers cannot state or imply that the SEC or any state regulator has approved them or their qualifications. Registration only means you have filed required documents. It is not an endorsement.
Series 65 Exam Tips: Ethics
Ethics questions often present scenarios and ask you to identify the prohibited conduct or appropriate response. Here is what to focus on:
High-Priority Topics
Unethical vs. Fraudulent
Know the distinction and be able to categorize specific conduct
Churning Indicators
High turnover, trading inconsistent with objectives, excessive commissions
Front-Running Definition
Trading ahead of known client orders for personal benefit
Insider Trading
Material + Nonpublic = Prohibited (both trading and tipping)
Custody Requirements
Qualified custodian, quarterly statements, surprise exam, Form ADV
Common Exam Traps
- Borrowing exception: Can borrow from clients in the lending business (banks), not individual clients
- Selling away: The issue is conducting business outside the firm without disclosure, not the investment itself
- MNPI scope: Insider trading rules apply to everyone, not just âinsidersâ
- Discretion vs. Custody: Trading authority (discretionary account) alone does not create custody
- Testimonials: Now permitted under Marketing Rule with proper disclosures (changed in 2021)
Scenario Analysis Strategy
When facing ethics scenarios on the exam:
Identify the Conduct
Identify the specific conduct in the scenario
Check Client Interests
Ask: Does this prioritize adviser interests over client interests?
Verify Disclosure
Consider: Was there proper disclosure?
Classify the Violation
Determine: Is the conduct unethical or fraudulent?
Investment advisers are fiduciaries. If an answer choice prioritizes the adviserâs interests over the clientâs, it is almost certainly the wrong answer. The fiduciary standard means always putting clients first.
Ethics questions require scenario-based thinking and pattern recognition that develops through consistent practice. Our study schedule guide shows how to incorporate ethics scenarios into your daily study routine, ensuring you can recognize prohibited conduct quickly without spending disproportionate time on a section that represents 8-12 questions.
Ethics represents a significant portion of the Series 65 exam. Master the distinction between unethical and fraudulent conduct, memorize the custody requirements, and always remember that fiduciary duty means putting clients first. For comprehensive exam preparation including ethics practice questions, explore our study guides or learn about other exam topics you should master.
Ace the Ethics Section
Section IV covers 30% of your exam, with 8-12 questions on ethics alone. CertFuel's FSRS spaced repetition helps you memorize custody requirements, advertising prohibitions, and distinctions between unethical and fraudulent conduct. Retain more in less time.
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