Quiz Questions:
Q1. An investment adviser recommends that a client purchase shares of a mutual fund that pays the adviser a 0.25% annual 12b-1 fee. The adviser does not disclose this arrangement to the client. This conduct:
A) Is permitted because 12b-1 fees are a standard industry practice B) Is permitted if the fund's prospectus discloses the 12b-1 fee C) Violates the fiduciary duty because the adviser failed to disclose a material conflict of interest D) Is acceptable if the fund is otherwise suitable for the client
Answer: C — An investment adviser who receives a 12b-1 fee from a mutual fund company has a financial incentive to recommend that fund over alternatives. This is a material conflict of interest that must be affirmatively disclosed to the client. The fact that the fund's prospectus mentions the 12b-1 fee is not sufficient — the adviser must personally disclose the conflict. Receiving undisclosed compensation in connection with client transactions violates the Advisers Act's anti-fraud provisions.
---
Q2. An investment adviser with $800 million in AUM wants to charge a performance fee to a new client. The client has $800,000 invested with the adviser and a net worth of $1.5 million (excluding the value of their primary home). Is a performance fee permitted?
A) Yes, because the adviser manages more than $100 million in AUM B) Yes, because performance fees are unrestricted for SEC-registered advisers C) No, because the client does not meet the "qualified client" standard D) No, because performance fees are categorically prohibited under the Investment Advisers Act
Answer: C — Performance fees are only permitted for "qualified clients" — individuals with at least $2.2 million net worth or $1.1 million in AUM with the adviser. This client has $1.5M net worth (below the $2.2M threshold) and only $800K invested with the adviser (below the $1.1M threshold). The adviser's total AUM is irrelevant to whether a specific client qualifies.
---