Series 65 Investment Adviser Ethics: Fiduciary Duty, Form ADV, and What You Must Disclose

The investment adviser ethics rules tested on the Series 65 are not abstract. They are a specific set of legal obligations rooted in the Investment Advisers Act of 1940 and NASAA's model rules. The exam tests whether you know what advisers must disclose, what they cannot do, and what triggers their fiduciary duty.

This post covers the major ethics and disclosure rules you need for the exam.

Fiduciary Duty

Investment advisers owe a fiduciary duty to their clients. This is the highest standard of care in the law — it requires the adviser to put the client's interests ahead of their own at all times.

The fiduciary duty has two components:

Duty of loyalty: The adviser must not place their own interests or a third party's interests ahead of the client's. Conflicts of interest must be disclosed, not just avoided.

Duty of care: The adviser must provide advice that is suitable for the specific client based on a reasonable investigation of the client's financial situation, investment objectives, and risk tolerance.

This fiduciary standard is higher than the suitability standard that applies to broker-dealers. Suitability requires that a recommendation be appropriate for a customer. Fiduciary duty requires that the adviser act in the client's best interest, which means disclosing conflicts even when the recommendation is technically suitable.

Form ADV and the Brochure Rule

Every registered investment adviser must file Form ADV with regulators and deliver Part 2 to clients as a disclosure brochure. The exam tests the timing and content requirements in detail.

Part 1A contains the adviser's business information: name, legal form, office locations, affiliates, past disciplinary history, and custody arrangements. Officers, directors, and partners who provide advisory services are automatically registered as IARs and disclosed here.

Part 2A is the brochure delivered to clients. It must be written in plain English and include:

• The advisory services offered and fees charged
• Types of clients served and minimum account sizes
• Investment strategies and methods of analysis
• Risk disclosures
• Disciplinary history (last 10 years of material events)
• Outside business activities and affiliations
• Code of ethics and personal trading policies

Delivery timing for state-registered advisers:

• The brochure must be delivered at least 48 hours before signing an advisory contract, OR
• On the day of signing if the client has a 5-day right to cancel the contract without penalty

Annual delivery: A state-registered adviser must send an updated brochure (or a summary of material changes with an offer to provide the full brochure) within 120 days of the adviser's fiscal year end.

Exceptions: Advisers who charge less than $500 per year in fees, advisers to investment companies registered under the 1940 Act, and advisers providing only impersonal advice are exempt from the brochure rule.

Withdrawal from SEC Registration: Form ADV-W

An adviser withdrawing from SEC registration files Form ADV-W. The withdrawal becomes effective 60 days after filing.

Performance-Based Fees

Performance-based fees — where the adviser's compensation rises with positive portfolio performance — are generally prohibited under NASAA rules because they create an incentive for the adviser to take excessive risk.

They are permitted only for qualifying clients:

• Clients with at least $1 million in assets under the adviser's management, OR
• Clients with a net worth of at least $2.1 million (excluding the value of the primary residence)

Performance fees must be based on net gains and losses over a specified time period measured against a specific benchmark. An adviser cannot charge a fee based only on gains — losses must also factor into the calculation.

Custody of Client Assets

An adviser with custody of client funds or securities must:

• Segregate client assets from the adviser's own assets
• Hold client funds and securities with a qualified custodian (a bank with FDIC insurance or an SEC-registered broker-dealer)
• Notify clients of the name and address of the custodian
• Send clients quarterly statements of their account holdings and transactions
• Undergo an annual surprise examination by an independent CPA (and file Form ADV-E with regulators)

An adviser does not have custody simply by receiving a client check made payable to a third party — as long as the check is forwarded to the payee within 3 business days and the adviser keeps records of it.

Prohibited Practices for Investment Advisers

The exam tests a specific list of prohibited practices. Know these:

Churning: Excessive trading in a client's account to generate fees or commissions.

Unauthorized transactions: Placing trades without the client's permission. An oral authorization is valid for up to 10 business days for a new IA or for a temporary arrangement.

Borrowing from clients: An adviser may not borrow money or securities from clients unless the client is a financial institution engaged in the business of lending money.

Lending to clients: Similarly prohibited without disclosure and client consent.

Sharing in client profits and losses: An adviser may share in an account's gains or losses only if the adviser has a financial interest in the account (i.e., they own part of it) or shares losses proportionally. This rule mirrors the broker-dealer rule for agents.

Agency cross transactions without disclosure: An adviser acting as a broker-dealer to cross one client's order against another client's order must disclose the conflict and obtain written consent from both clients. An annual statement of all such transactions must be provided.

Testimonials: Investment advisers are prohibited from using testimonials in their advertising. This is one of the most commonly tested distinctions — broker-dealers and their agents CAN use testimonials, but IAs cannot.

Using past performance without full disclosure: If an adviser references past recommendations or past performance, all recommendations for the relevant period must be disclosed — not just the winners.

Insider trading: An adviser in possession of material non-public information must not trade on it or recommend trading based on it.

Soft Dollars

An adviser may receive research and other services (soft dollar compensation) from broker-dealers in exchange for directing client trades to that broker-dealer. This is permitted only if:

• The research or service is used to benefit clients (not the adviser personally)
• The adviser discloses the arrangement

Permissible soft dollar items include: research reports, analytical software, financial data services, seminars, and market data.

Impermissible soft dollar items include: office rent, hardware, travel expenses, and anything primarily benefiting the adviser rather than clients.

Mastering these rules gives you a reliable framework for every ethics question on the Series 65. The exam will vary the fact pattern, but the underlying obligations are always the same: disclose conflicts, act in the client's best interest, and know the specific rules for fees, custody, and communications.