Section 4.4Laws, Regulations, and Guidelines

Prohibited Practices, Civil Liabilities & Sanctions

Details prohibited fiduciary conduct—borrowing, churning, front-running, scalping—and contrasts federal vs. state criminal and civil sanctions.

Key Exam Takeaways

Borrowing from or lending to clients is prohibited unless the client or firm is a financial institution in the business of lending.
Performance-based fees are banned under Section 205 unless the client is a Qualified Client ($1.1M AUM or $2.2M Net Worth).
Criminal Penalties: Federal IAA of 1940 = $10,000 fine / 5 years prison; State USA of 1956 = $5,000 fine / 3 years prison.

Common Exam Traps

State Administrators can issue cease-and-desist orders and revoke registrations, but CANNOT sentence anyone to prison.
State civil liability statute of limitations is the EARLIER of 2 years from discovery or 3 years from the transaction (2/3 Rule).

Investment advisers owe clients an undivided fiduciary duty of loyalty and care. NASAA Statement of Policy on Dishonest and Unethical Business Practices prohibits borrowing money or securities from clients, lending to clients, excessive trading (churning), front-running pending client block orders, and scalping (trading personal shares ahead of client recommendations).

Advisory contracts cannot contain exculpatory 'hedge clauses' that purport to waive client legal rights. Performance fees are prohibited unless the client meets the Qualified Client standard ($1.1M AUM or $2.2M net worth). Any assignment of an advisory contract requires affirmative client consent.

Statutory enforcement carries both civil and criminal liabilities. Under state law, civil liability allows recovery of consideration paid, legal interest, court costs, and attorney fees, minus income received. Criminal sanctions for willful fraud reach up to $10,000 fine and 5 years imprisonment federally, and $5,000 fine and 3 years imprisonment under state law.

🎯 Knowledge Checkpoint

Knowledge Checkpoint • Section 4.4

A federal court prosecutes an investment adviser for willful criminal fraud under the Investment Advisers Act of 1940. Simultaneously, a state court prosecutes an adviser under the Uniform Securities Act of 1956. What are the maximum criminal penalties that may be imposed upon conviction under federal law versus state law?