Which of the following fact patterns would MOST strongly support a regulatory finding that an investment adviser representative churned a client's advisory account?

The representative exercised de facto control over trading in the account and generated a volume of transactions excessive in light of the client's investment objectives, financial resources, and risk profile

An IAR recommends a highly leveraged, complex inverse exchange-traded note as a core, long-term buy-and-hold holding for a 78-year-old retired client whose stated primary objective is capital preservation and modest income. The IAR did not analyze how the product's daily-reset mechanics would perform over a multi-year holding period. This most clearly reflects:

A reasonable-basis suitability violation, since the IAR lacked adequate grounds to believe the recommendation was appropriate for this client's objectives and the product's actual characteristics

A long-standing advisory client, out of the blue, asks the IAR to help wire a large sum to an overseas account the client has never used before, is evasive about the purpose of the transfer, and pressures the IAR to process it same-day. From an anti-money-laundering standpoint, the IAR's most appropriate response is to:

Recognize this as a red flag warranting additional due diligence and escalation per the firm's AML policies before proceeding

An IAR notices that an elderly client, previously very engaged and detail-oriented, has recently begun authorizing unusually large, rapid disbursements to a new acquaintance the client mentions only vaguely, and seems confused when asked routine questions about the transactions. Under provisions modeled on NASAA's protection of vulnerable adults, the firm may:

Place a temporary hold on the disbursement while notifying a trusted contact person and, as appropriate, the relevant state agency (e.g., Adult Protective Services) and securities Administrator

Under the qualified-client exemption that permits an investment adviser to charge a client a performance-based fee, which of the following describes the applicable eligibility threshold?

At least $1.1 million under management with the adviser, or a net worth of more than $2.2 million (subject to applicable exclusions)

An investment adviser representative frequently and excessively trades securities in a client's discretionary account, generating substantial commissions for the representative's affiliated broker-dealer, without regard to the client's stated investment objectives. This practice is best described as:

Churning, a prohibited practice and a breach of fiduciary duty.

An RIA advertises a backtested strategy as "our actual realized 15-year performance," but the account was never run with client money. Which is the central defect?

Misrepresenting hypothetical/backtested results as actual live performance is materially misleading.

Series 65 Prohibited Practices Practice Questions

Official outline: NASAA Series 65 Test Specifications (June 2023)
Questions on this page: 8
Updated: Nov 3, 2026

Question 1, hard
Which of the following fact patterns would MOST strongly support a regulatory finding that an investment adviser representative churned a client's advisory account?
- A.The account had high turnover, but the client had directed, in writing, an active short-term trading strategy consistent with that turnover
- B.The representative exercised de facto control over trading in the account and generated a volume of transactions excessive in light of the client's investment objectives, financial resources, and risk profile
- C.The account underperformed its benchmark during a broad market downturn despite low turnover
- D.The client paid an asset-based wrap fee rather than per-trade commissions
Show answer and explanationHide answer
Correct answer: B. The representative exercised de facto control over trading in the account and generated a volume of transactions excessive in light of the client's investment objectives, financial resources, and risk profile
Churning requires (1) control over the account by the adviser/representative (whether through discretion or de facto control over a non-discretionary account), and (2) trading that is excessive in size or frequency in light of the client's objectives, financial situation, and resources. Generally undertaken to benefit the representative rather than the client. Choice B captures both required elements. High turnover consistent with the client's own directed strategy (A) is not churning; poor performance alone (C) does not establish churning without excessive/inappropriate trading; and a flat asset-based fee (D) removes much of the transaction-based financial incentive that typically motivates churning, making it a less (not more) supportive fact.
- A. Incorrect. Trading consistent with the client's own written instructions is not churning, even if turnover is high.
- B. Correct. Control plus trading excessive relative to the client's objectives/resources is the textbook definition of churning.
- C. Incorrect. Poor performance during a downturn, without excessive trading, does not by itself establish churning.
- D. Incorrect. An asset-based wrap fee reduces the incentive to over-trade for commissions, making churning less likely to be supported by this fact, not more.
- Source: Exam outline: NASAA Series 65 Test Specifications (June 2023), accessed October 2026
Question 2, hard
An IAR recommends a highly leveraged, complex inverse exchange-traded note as a core, long-term buy-and-hold holding for a 78-year-old retired client whose stated primary objective is capital preservation and modest income. The IAR did not analyze how the product's daily-reset mechanics would perform over a multi-year holding period. This most clearly reflects:
- A.A reasonable-basis suitability violation, since the IAR lacked adequate grounds to believe the recommendation was appropriate for this client's objectives and the product's actual characteristics
- B.A permissible recommendation, since leveraged and inverse products are suitable for any client who seeks growth, including as a long-term core holding
- C.A customer-specific suitability issue, because the product is sound but its risk level does not match the client's profile; the IAR's product analysis is not at issue
- D.No violation, as long as the client signs a risk acknowledgment form and the IAR documents that the product's daily-reset features were disclosed
Show answer and explanationHide answer
Correct answer: A. A reasonable-basis suitability violation, since the IAR lacked adequate grounds to believe the recommendation was appropriate for this client's objectives and the product's actual characteristics
This scenario reflects a reasonable-basis problem. The IAR didn't understand the product's daily-reset/decay mechanics well enough to have a reasonable basis for recommending it as a long-term hold at all. Layered on top of a customer-specific mismatch, since leveraged/inverse products are broadly unsuited to buy-and-hold retirees seeking capital preservation. A best captures the IAR's failure to have adequate grounds for the recommendation in the first place. B mischaracterizes leveraged products as universally suitable for growth-seekers, ignoring their structural unsuitability for long holds; C wrongly denies the clear reasonable-basis failure; D treats a signed disclosure form as a cure, which it is not.
- A. Because the IAR didn't understand or analyze how a daily-reset leveraged inverse product would behave over a multi-year hold. And recommended it as a core holding for a capital-preservation client. The IAR lacked adequate grounds to believe the recommendation was appropriate, which is a reasonable-basis suitability failure.
- B. Leveraged and inverse products are not suitable as long-term core holdings for just any growth seeker, and this client's objective was capital preservation and income.
- C. The IAR failed to analyze the product's daily-reset behavior over a multi-year hold, which is a reasonable-basis problem in addition to any client-specific mismatch.
- D. A signed acknowledgment and documented disclosure do not cure a recommendation made without adequate understanding of the product or fit for the client.
- Source: NASAA Model Rule 502(b) (Prohibited Conduct of Investment Advisers, IARs and Federal Covered Investment Advisers), accessed October 2026
Question 3, medium
A long-standing advisory client, out of the blue, asks the IAR to help wire a large sum to an overseas account the client has never used before, is evasive about the purpose of the transfer, and pressures the IAR to process it same-day. From an anti-money-laundering standpoint, the IAR's most appropriate response is to:
- A.Process the wire immediately since the client has an established, trusted relationship with the firm
- B.Recognize this as a red flag warranting additional due diligence and escalation per the firm's AML policies before proceeding
- C.Ignore it, since AML obligations never apply to advisory relationships
- D.Refuse to ever work with the client again without any further inquiry
Show answer and explanationHide answer
Correct answer: B. Recognize this as a red flag warranting additional due diligence and escalation per the firm's AML policies before proceeding
Red flags for potential money laundering or fraud. Unusual urgency, a new unexplained destination, evasiveness about purpose. Warrant heightened scrutiny and escalation under a firm's AML/suspicious activity policies, regardless of how long-standing the client relationship seems. A wrongly assumes tenure neutralizes red flags; C understates that firms maintain relevant AML-related policies; D overreacts without any investigative step.
- A. Processing the wire simply because of a long relationship ignores the classic AML red flags present (unusual destination, evasiveness, time pressure) and would be an inappropriate response.
- B. The unusual destination, evasiveness about purpose, and pressure for same-day processing are textbook AML red flags that call for additional due diligence and escalation under the firm's AML procedures before acting. The correct answer.
- C. AML obligations do apply to advisory relationships and firms handling client funds; this statement is factually wrong.
- D. Cutting off the client without any inquiry or escalation skips the required due-diligence and reporting steps and is an overreaction, not the appropriate first response.
- Source: 31 U.S.C. § 5318, accessed October 2026
Question 4, medium
An IAR notices that an elderly client, previously very engaged and detail-oriented, has recently begun authorizing unusually large, rapid disbursements to a new acquaintance the client mentions only vaguely, and seems confused when asked routine questions about the transactions. Under provisions modeled on NASAA's protection of vulnerable adults, the firm may:
- A.Do nothing unless a court order is presented, because the firm must execute client disbursement instructions on receipt and has no authority to delay them
- B.Place a temporary hold on the disbursement while notifying a trusted contact person and, as appropriate, the relevant state agency (e.g., Adult Protective Services) and securities Administrator
- C.Liquidate the client's entire account at once and move the proceeds to a firm-controlled account for safekeeping, without notifying the client or any trusted contact
- D.Act when a family member submits a written request, after which it must obtain a court order before placing a hold on the disbursement
Show answer and explanationHide answer
Correct answer: B. Place a temporary hold on the disbursement while notifying a trusted contact person and, as appropriate, the relevant state agency (e.g., Adult Protective Services) and securities Administrator
Model provisions addressing financial exploitation of vulnerable adults permit a qualified individual at the firm to place a temporary hold on a suspicious disbursement, notify a previously designated trusted contact person, and report concerns to the appropriate state agency and/or securities Administrator. Without waiting for a court order. A treats client instructions as absolute even facing exploitation red flags; C is an overreaction unsupported by the rule; D wrongly requires a family request as a precondition.
- A. Firms are not required to wait for a court order and do have authority to delay a disbursement temporarily when there is a reasonable belief of financial exploitation.
- B. Correct. Rules modeled on NASAA's vulnerable adult provisions permit a temporary hold on disbursements, notification of a trusted contact, and reporting to Adult Protective Services and the Administrator when exploitation is suspected.
- C. Liquidating the account and moving the proceeds without notice goes well beyond what is authorized and would itself be an inappropriate unilateral action.
- D. Action is not contingent on a family member's written request or on a court order; the firm may place a temporary hold based on its own reasonable belief of exploitation.
- Source: FINRA Rule 2165, accessed October 2026
Question 5, medium
Under the qualified-client exemption that permits an investment adviser to charge a client a performance-based fee, which of the following describes the applicable eligibility threshold?
- A.At least $750,000 under management with the adviser, or a net worth of more than $1.5 million
- B.At least $1.1 million under management with the adviser, or a net worth of more than $2.2 million (subject to applicable exclusions)
- C.Annual income exceeding $200,000 in each of the two most recent years
- D.Any net worth, provided the performance fee arrangement is disclosed in the advisory contract
Show answer and explanationHide answer
Correct answer: B. At least $1.1 million under management with the adviser, or a net worth of more than $2.2 million (subject to applicable exclusions)
Performance-based fees are generally prohibited under the Act because they can incentivize excessive risk-taking, but the qualified-client exemption permits them for clients meeting an assets-under-management or net-worth threshold. Currently $1.1 million under management with the adviser, or a net worth exceeding $2.2 million. The $750,000/$1.5 million figures in Choice A are outdated/incorrect thresholds, the income test in Choice C describes accredited-investor income criteria (a different exemption entirely), and mere disclosure (Choice D) does not substitute for meeting the actual net worth or AUM test.
- A. These dollar figures don't match the qualified-client thresholds under the performance-fee exemption; the actual amounts are higher than $750,000/$1.5 million.
- B. Correct. The qualified-client thresholds (as adjusted) are at least $1.1 million under management with the adviser, or a net worth exceeding $2.2 million (excluding primary residence and subject to applicable exclusions), permitting performance-based fee arrangements.
- C. An income-based test like $200,000 in each of the two most recent years describes accredited investor criteria for certain securities offerings, not the qualified-client thresholds for performance fees.
- D. Simply disclosing the performance-fee arrangement in the contract is not sufficient on its own; the client must actually meet the qualified-client net worth or assets-under-management threshold for the fee arrangement to be permissible.
- Source: Exam outline: NASAA Series 65 Test Specifications (June 2023), accessed October 2026
Question 6, easy
An investment adviser representative recommends a stock to clients, and after client buying pressure pushes the price up, quietly sells shares he personally already owned, without disclosing his position or intent beforehand. This practice is known as:
- A.Scalping
- B.Front-running
- C.Portfolio rebalancing
- D.Dollar-cost averaging
Show answer and explanationHide answer
Correct answer: A. Scalping
Scalping is the undisclosed practice of recommending a security to clients while secretly holding (and intending to sell into the resulting price rise) a personal position in that same security. It is a fraudulent, undisclosed conflict of interest and a prohibited practice for investment advisers. Front-running, by contrast, involves trading ahead of a known, imminent client block order.
- A. Correct. Undisclosed personal profit-taking from one's own recommendation is the definition of scalping.
- B. Incorrect. Front-running specifically involves trading ahead of a known impending client order, not profiting from a general public recommendation.
- C. Incorrect. Rebalancing is a legitimate, routine portfolio management activity, not a prohibited practice.
- D. Incorrect. Dollar-cost averaging is a legitimate periodic investing strategy, unrelated to this fact pattern.
- Source: Exam outline: NASAA Series 65 Test Specifications (June 2023), accessed October 2026
Question 7, medium
An investment adviser representative frequently and excessively trades securities in a client's discretionary account, generating substantial commissions for the representative's affiliated broker-dealer, without regard to the client's stated investment objectives. This practice is best described as:
- A.Churning, a prohibited practice and a breach of fiduciary duty.
- B.Portfolio rebalancing, a routine and permissible activity.
- C.Tax-loss harvesting, a legitimate strategy to reduce a client's tax liability.
- D.Dollar-cost averaging, a disciplined investment technique.
Show answer and explanationHide answer
Correct answer: A. Churning, a prohibited practice and a breach of fiduciary duty.
Churning is excessive trading in a client's account, undertaken primarily to generate commissions or fees for the adviser or its affiliated broker-dealer rather than to serve the client's investment objectives. It is a prohibited practice and a clear breach of the fiduciary duty of loyalty and care, since it prioritizes the adviser's compensation over the client's interests. Legitimate rebalancing, tax-loss harvesting, and dollar-cost averaging are all purposeful strategies tied to the client's objectives, not indiscriminate trading volume for its own sake.
- A. Correct: excessive trading disconnected from client objectives, generating commissions for the adviser's affiliate, is the definition of churning.
- B. Wrong: rebalancing is periodic and tied to restoring a target allocation, not frequent and excessive trading disregarding the client's objectives.
- C. Wrong: tax-loss harvesting is a targeted, objective-driven strategy, not indiscriminate excessive trading.
- D. Wrong: dollar-cost averaging is a disciplined, regular investment schedule, not excessive trading generating commissions without regard to objectives.
- Source: Exam outline: NASAA Series 65 Test Specifications (June 2023), accessed October 2026
Question 8, easy
An RIA advertises a backtested strategy as "our actual realized 15-year performance," but the account was never run with client money. Which is the central defect?
- A.Hypothetical performance may not be studied internally by an adviser, so any backtest must be discarded before it is used for strategy research.
- B.Any strategy analysis must be reviewed and signed by a regulator before it is published in advertising or sent to prospective clients.
- C.The absence of an investment prospectus makes the performance actual, so the label is acceptable if the backtest follows the firm's written model.
- D.Misrepresenting hypothetical/backtested results as actual live performance is materially misleading.
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Correct answer: D. Misrepresenting hypothetical/backtested results as actual live performance is materially misleading.
A backtest is not a real track record. Presenting it as actual performance is materially misleading, and hypothetical performance must be clearly labeled and meet marketing-rule conditions.
- A. Advisers may study and use hypothetical analysis internally; the problem is how it is presented to others.
- B. Regulators do not pre-approve advertising or strategy analysis in this way.
- C. Whether a prospectus exists does not determine whether performance is actual; it comes from real client accounts.
- D. Correct: presenting a simulation as realized performance is misleading.
- Source: SEC Rule 206(4)-1 (investment adviser marketing), accessed October 2026
- Source: Investment Advisers Act Section 206, 15 U.S.C. 80b-6 (prohibited transactions by investment advisers), accessed October 2026

Sources

NASAA Model Rule 502(b) (Prohibited Conduct of Investment Advisers, IARs and Federal Covered Investment Advisers), checked October 2026
31 U.S.C. § 5318, checked October 2026
FINRA Rule 2165, checked October 2026
SEC Rule 206(4)-1 (investment adviser marketing), checked October 2026
Investment Advisers Act Section 206, 15 U.S.C. 80b-6 (prohibited transactions by investment advisers), checked October 2026

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