Advances to Partners, Officers

As I’ve written, I’m not sure why investors would allow their investment adviser to also maintain custody of the account assets. I mean, if the investments are doing poorly, what’s to stop the adviser from making up his own numbers, or—worse—making withdrawals out of dividend and interest income that the client never finds out about?

But, some advisers do have custody. If so, the firm has to maintain a minimum net worth. NASAA says in one of their model rules that the minimum net worth for such an adviser is $35,000. They then define “net worth” in frightful legalese. Let’s imagine what a test question might look like on the Series 65/66 exam:

Hickory Stick Advisory Partners are deemed to have custody of client assets. When filing their balance sheet, the firm should include in its assets which of the following items?
A. prepaid expenses
B. loans to a senior partner
C. loans to a silent partner
D. marketable securities

EXPLANATION: the NASAA model rule on minimum financial requirements for advisers specifically tells advisers not to include prepaid expenses or loans to partners—if the firm is a partnership—or to officers or stockholders—if the firm is a corporation. Seems like a good idea to me. If the advisory business is doing poorly, what are the chances that the partners are doing well enough to repay the loan they took out? Talk about some shaky assets. Marketable securities have a value—they are an asset.
ANSWER: D

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