Series 66

License Exam Manual Addendum

12th Edition
At press time, this edition contains the most complete and accurate information currently available.
Owing to the nature of qualification examinations, however, information may have been added recently
to the actual test that does not appear in this edition. Please contact the publisher to verify that you
have the most current edition.

This publication is designed to provide accurate and authoritative information in regard to the subject
matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal,
accounting, or other professional services. If legal advice or other expert assistance is required, the
services of a competent professional should be sought.

SERIES 66 LICENSE EXAM MANUAL, 12TH EDITION ADDENDUM

©2023 Kaplan North America, LLC

The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever
without written permission from the publisher.

If you find imperfections or incorrect information in this product, please visit www.kaplanfinancial.com
and submit an errata report.

Published in May 2023 by Kaplan Financial Education.

CONTENTS
Introduction to the Addendum v

UNIT 1
Lesson 1.2: Special Types of Equity Securities 1
LO 1.d Describe how incentive stock options differ from nonqualified stock options. 1
LO 1.e Contrast restricted stock and nonrestricted stock. 2
Knowledge Check 1.2 3
Lesson 1.3: Foreign Equity Securities 4
LO 1.f Identify the unique features of American depositary receipts (ADRs) and the
risks of investing in foreign securities. 4
Knowledge Check 1.3 6

UNIT 2
Lesson 2.3 Money Markets and Bank Accounts 9
LO 2.f Identify the special characteristics of money market instruments and the
risks and benefits of adding them to a client's portfolio. 9
Knowledge Check 2.3 12

UNIT 3
Lesson 3.4: Other Pooled Investments 14
LO 3.h Identify the unique features of real estate investment trusts (REITs). 14

UNIT 5
Lesson 5.3: Other Alternative Investments 14
LO 5.d Compare viaticals and life settlement policies. 14
LO 5.e Contrast passive and active real estate investing. 14
LO 5.h Describe digital assets. 14

UNIT 8
Lesson 8.1: What Are Securities and Who Issues Them? 16
LO 8.b Identify those who issue securities. 16

UNIT 9
Lesson 9.4: Financial and Recordkeeping Requirements for Investment Advisers 16
LO 9.g Recall the investment adviser books and recordkeeping requirements under
state and federal law. 16

UNIT10
Lesson 10.2: Registration and Post-Registration Requirements of Investment
Adviser Representatives 16
LO 10.c Describe the investment adviser representative registration process,
required post-registration filings, and business activities. 16

iii
iv Contents

UNIT 13
Lesson 13.1: Disclosures 18
LO 13.b Recognize the general disclosure requirements. 18

UNIT 14
Lesson 14.8: Business Continuity and Succession 19
LO 14.m Recall what constitutes an adequate business continuity plan. 19
Knowledge Check 14.8 20

UNIT 16
Lesson 16.1: Who Are Clients? 22
LO 16.a Recognize the different types of clients securities professionals serve, the different
ownership categories, and the legal documentation required to open these accounts. 22
Lesson 16.4: Estate Planning 22
LO 16.f Identify estate-planning options. 22

UNIT 17
Lesson 17.2: Investment Objectives and Constraints 23
LO 17.c Distinguish between investment objectives and investment constraints. 23

UNIT 23
Lesson 23.3: Brokers and Dealers and Their Costs 24
LO 23.d Identify the difference between functioning as a broker and acting as a dealer. 24
LO 23.e Describe the costs of trading securities. 25
Knowledge Check 23.3 25
Lesson 23.4: Types of Orders 27
LO 23.g Describe high frequency trading (HFT) and dark pools. 27
INTRODUCTION TO THE ADDENDUM
In February of 2023, NASAA announced changes to the Series 63, 65, and 66 exams that
will be effective for any exam administered on or after June 12, 2023. These changes include
topics that will no longer be tested on the Series 66, as well as content that is new to the Series
66 and will now be testable.

NASAA provided a new content outline that includes the new testable topics and does not
include the removed topics. This addendum was created to accompany your Series 66 License
Exam Manual to provide the newly testable content and note the content that should be
omitted.

Any lessons or learning objectives that are not impacted by NASAA changes are not addressed
here. Your LEM addresses those lessons and learning objectives that remain unchanged. This
addendum does include the new or updated lessons and learning objectives.

Pay close attention to any instructions in bold, red letters. Those instructions will tell you
either to disregard text that is no longer testable or tell you where the new content should be
added. Any text without bold, red instructions can be added as a new part of your text in the
expected place (e.g., Lesson 1.2 immediately follows all the content from Lesson 1.1 in your
License Exam Manual).

v
 Addendum 1

LESSON 1.2: SPECIAL TYPES OF EQUITY SECURITIES

The Series 66 deals mostly with securities purchased by investors. There are instances in
which stock in a corporation is purchased from the company by its employees who have been
granted stock options.

LO 1.d Describe how incentive stock options differ from nonqualified

stock options.

Employee stock options offer employees the right to purchase a specified number of shares
of the common stock of their employer at a stated price over a stated time period. Unlike
qualified retirement plans, there are no nondiscrimination requirements for these plans. For
publicly traded stock, the strike price (also called the grant or exercise price) is usually the
market price of the stock at the time the option is granted. In most cases, there is a minimum
time the employee must remain employed by the company to be able to use the option (the
vesting period). The hope of the employee is that the market price of the employer’s stock
will increase in value. Then, the employee will be able to purchase the stock by exercising the
option at the lower strike price and then sell the stock at the current market price. There are
two principal kinds of stock option programs, each with its own rules and tax consequences:
nonqualified stock options (NSOs or NQSOs) and incentive stock options (ISOs). Don’t
confuse these with publicly traded puts and calls available to investors not employed by the
company; these stock options are available only to employees of the issuing company. Most
states require that the stock option plan be approved by the board of directors.

Nonqualified Stock Options (NSOs)

Nonqualified stock options are the more common of the two varieties of employee stock
options. NSOs are basically treated as a form of compensation. When NSOs are exercised,
the difference between the current market price at the time of exercise and the strike price,
referred to as the bargain element, is reported as wages on the tax returns of the employer
and the employee. Therefore, instead of being taxed as capital gains, the employee is taxed for
ordinary income on the bargain element while the company receives a tax deduction as salary
expense for that same amount.

EXAMPLE
An employee exercises an NSO at $52 per share when the current fair value of the
stock is $66.50. The bargain element is $14.50 per share (the difference between the
exercise price of $52 and the fair value of $66.50). If the exercise was for 100 shares, this
employee will report $1,450 as ordinary income for the year.

TAKE NOTE
Because the spread between the market price and the strike price is considered salary,
it is subject to payroll taxes for the employer as well as income tax for the employee.
2 Addendum

Incentive Stock Options (ISOs)

Unlike NSOs, there are generally no tax consequences to the employer with an ISO, but,
if done properly, they can be more advantageous than NSOs to the employee. While the
employee’s profits from NSOs are taxed as ordinary income, if stock purchased through
exercise of an ISO is held at least two years after the date of the grant and one year after
the date of exercise, any profits are reported as long-term capital gains. If these time limits
are surpassed, the ISO is taxed like an NSO. There is one other time stipulation: there is a
maximum 10-year limit for exercise.

But there is a catch. When an ISO is exercised, the difference between the market value at the
time of purchase and the strike price is a preference item used in calculating the alternative
minimum tax (AMT).

Incentive Stock Options (ISOs)

No income recognized when option is granted
No tax due when option is exercised
Tax is due when stock is sold
Gain is capital (long term) if held at least one year and sold at least two
years after grant
Otherwise—ordinary income
Difference between option price and the FMV on date of exercise is an
add back for AMT purposes

EXAMPLE
Julie’s employer granted her an incentive stock option (ISO) on January 1, 2022, with
an exercise (strike) price of $25 per share. Julie exercised the option on January 1,
2023, when the market price of the stock was $40 per share. Because this is an ISO and
the stock has not yet been sold, there is no salary income or capital gains taxation.
Julie sells the stock two years later for $60 per share. Now that the sale has been
recognized and Julie has followed the required holding periods, the $35-per-share
profit is taxed as a long-term capital gain.

LO 1.e Contrast restricted stock and nonrestricted stock.

One of the characteristics of stock is that it is freely transferable. That is, once purchased, it
may be sold (or gifted) at any time to anyone. There are some exceptions to this general rule.
The two exceptions that are testable deal with the sale of stock that is restricted, and stock
owned by control persons.

There is an exemption from registration for securities sold as part of a private placement (the
limited offering exemption). In general, retail investors cannot sell these securities until they
have held them for a certain period. They are restricted from immediate resale and, therefore,
are referred to as restricted securities. The length of that restriction is generally six months.
There are volume restrictions as well that apply to affiliates of the issuer. You probably will
not be tested on volume restrictions; just know that restricted stock has a time limit for all
investors and may also have a volume limit for affiliates on the amount that may be resold.

The other exemption is control stock. Control stock is stock held by a control person.
What makes it control stock is who owns it, not how it was acquired. For purposes of this
discussion, a control person is a corporate director, an officer, a large stockholder, or an
 Addendum 3

immediate family member of any of the preceding residing in the same home. Control
persons are often referred to as affiliates because of their unique status within the issuer. In
general, purchases and sales of control stock must be reported to the SEC. Control stock
always has volume limits (but those numbers are not tested).

TAKE NOTE
For testing purposes, assume that ownership of 10% or more of the voting stock is
considered control stock.

The mechanism for reporting the sale of control stock as well as the sale of restricted stock is found
in SEC Rule 144 of the Securities Act of 1933. SEC Rule 144 was created so that certain resales of
already existing securities could be made without having to file a complete registration statement
with the SEC. The investment of time and money involved in filing such a registration is usually so
prohibitive as to make it uneconomical for the individual seller. In almost all cases, those who wish
to sell control stock or restricted stock must do so by filing a Form 144.

PRACTICE QUESTION
An investor owns 15% of the stock of a publicly traded company. This investor’s
spouse owns 5% of the stock of the same company. If the spouse wishes to sell the
shares representing that 5% ownership, which of the following statements are true?
I. Both the investor and the spouse are control persons.
II. The investor is a control person, while the spouse is not.
III. The spouse must file a Form 144.
IV. The investor must file a Form 144.
A. I and III
B. I and IV
C. II and III
D. II and IV
Answer: A. The investor’s 15% ownership is evidence of control status. Rule 144
includes in the definition of control person “Any relative or spouse of such person, or
any relative of such spouse, any one of whom has the same home as such person.”
Unless otherwise stated, the assumption on the exam is that spouses reside together,
making both control persons. All sales of control stock (unless an exemption applies)
must be accompanied by a Rule 144 filing on Form 144 by the selling party. Although
both are control persons, the spouse is the only one selling and, therefore, is the one
required to file.

KNOWLEDGE CHECK 1.2

1. Four years ago, Susan was granted enough nonqualified stock options (NQSOs)
to purchase 500 shares of her employer’s stock at $20 per share. Assuming Susan
exercises all of her options when the fair market value of the stock is $30 per share
and her ordinary income tax rate at the time is 28%, how much income tax will be
due?
A. $280
B. $1,400
C. $5,600
D. $8,400
4 Addendum

2. Which of the following statements about restricted stock is correct?

A. It must be held a minimum of one year before resale.
B. Sales must be accompanied by Form R.
C. Volume limits generally apply to sales by control (affiliated) persons.
D. The restrictions apply only to those defined as control persons.

LESSON 1.3: FOREIGN EQUITY SECURITIES

LO 1.f Identify the unique features of American depositary receipts
(ADRs) and the risks of investing in foreign securities.

American Depositary Receipts (ADRs)

American Depositary Receipts (ADRs), also known as American depositary shares (ADSs),
facilitate the trading of foreign stocks in U.S. markets because everything is done in English
and in U.S. dollars. ADRs are bought and sold (traded) in U.S. dollars, and dividends are
paid out in U.S. dollars.

An ADR is a negotiable security that represents a receipt for shares of stock in a non-U.S.
corporation. ADRs are bought and sold in the U.S. securities markets like any domestic stock.

An ADR may represent the underlying shares on a one-for-one basis or may represent a
fraction of a share or multiple shares. For example, for one company, an ADR may represent
several shares of the underlying security, while for another company, an ADR may represent a
fraction of the underlying security. The use of a ratio (or participation rate) allows ADRs to be
priced at an amount more typical of U.S. market share prices.

EXAMPLE
If one U.S. dollar (USD) is worth about 5.5 Brazilian reals (BRs), a Brazilian corporation’s
ADRs might be structured on a ratio of 1:5. That is, each ADR is equivalent to owning
five shares of the underlying stock. Therefore, if the ADR was trading at $10, the
investor would be paying approximately 55 BRs for five shares of the Brazilian stock.
The math is not tested; only tested is the concept that ratios other than 1:1 exist with
some ADRs.

Rights of ADR Owners

Most of the rights that common stockholders normally hold, such as the right to receive
dividends, also apply to ADR owners. In some but not all cases, there are also voting rights.
For the purposes of the exam, ADRs never have preemptive rights.

Risks of ADRs
In addition to the normal risks associated with stock ownership, ADR investors are also
subject to currency risk. Currency risk is the possibility that an investment denominated in
one currency (such as the Mexican peso) could decline if the value of that currency declines in
its exchange rate with the U.S. dollar. Because ADRs represent shares of stock in companies
located in foreign countries, currency exchange rates are an important consideration.
 Addendum 5

TAKE NOTE
Banks collect the dividend payments, convert them into U.S. funds for U.S. owners,
and withhold any required foreign tax payments. Owners of ADRs can claim a U.S. tax
credit for these withholdings.

TEST TOPIC ALERT

The exam will want you to know that ADRs are issued by domestic branches of U.S.
banks and that, even though they are traded in U.S. dollars, they still bear currency
risk.

Investing in Foreign Markets

Although foreign securities offer investors the potential for substantial gains, they bear a
variety of risks that are not present with domestic investments. There are two broad market
classifications of foreign markets: emerging and developed.

Emerging Markets
Emerging markets are markets in lesser developed countries. They are generally associated
with:
„ low levels of income, as measured by the country’s gross domestic product (GDP);
„ low levels of equity capitalization;
„ questionable market liquidity;
„ potential restrictions on currency conversion;
„ high volatility;
„ prospects for economic growth and development;
„ stabilizing political and social institutions;
„ high taxes and commission costs for foreign investors;
„ restrictions on foreign ownership and on foreign currency conversion; and
„ lower regulatory standards resulting in a lack of transparency.
Despite primitive market infrastructures, many emerging markets have rapid growth rates
that make their securities attractive to foreign investors whose local markets experience more
modest growth.

TAKE NOTE
Frontier markets are to emerging markets as emerging markets are to developed ones.
The risks of frontier markets are extremely high.

Developed Markets
Developed markets are those associated with countries that have highly developed economies
with stable political and social institutions. These are characterized by:
„ large levels of equity capitalization;
„ low commission rates;
6 Addendum

„ few, if any, currency conversion restrictions;

„ highly liquid markets with many brokerage institutions and market makers;
„ many large capitalization securities; and
„ well-defined regulatory schemes leading to transparency similar to that enjoyed by those
investing in U.S. securities.

In summary, why would you include foreign securities in a client’s portfolio?

„ Foreign securities expand the potential investment universe leading to greater
diversification.
„ Foreign securities sometimes outperform domestic ones.
„ Foreign securities are usually not highly correlated with domestic ones, and, as a result,
the overall risk of the portfolio is reduced.

Risks of Investing in Foreign Markets

By investing in foreign market, whether emerging or developed, the investor faces the
following risks not present in normal, domestic investing:
„ Country risk
„ Exchange controls
„ Currency risk
„ Withholding taxes and fees

Country Risk
Country risk is a composite of all the risks of investing in a particular country. These may
include political risks, such as revolutions or military coups, and structural risks, such as
confiscatory policies toward profits, capital gains, and dividends. Economic policies, interest
rates, and inflation are also elements of the risk of investing in emerging countries.

Exchange Controls
Foreign investors can also be subject to restrictions on currency conversion or movement.

Withholding, Fees, and Taxes

Some foreign countries may withhold a portion of dividends and capital gains for taxes.
Some also impose heavy fees and taxes on securities that the investor must bear in addition to
generally higher brokerage commissions.

KNOWLEDGE CHECK 1.3

1. ADRs are used to facilitate
A. foreign trading of domestic securities.
B. foreign trading of U.S. government securities.
C. domestic trading of U.S. government securities.
D. domestic trading of foreign securities.
 Addendum 7

2. Which two of the following risks would be of greatest concern to the holder of an
ADR?
I. Currency
II. Liquidity
III. Market
IV. Purchasing power
A. I and II
B. I and III
C. II and IV
D. III and IV
KNOWLEDGE CHECK ANSWERS
Knowledge Check 1.2 Knowledge Check 1.3

1. B The exercise cost of the NQSO is $10,000 1. D Because everything is in U.S. dollars and
(500 shares × $20 per share). She will have to in English, ADRs make trading in foreign
pay ordinary income taxes of $1,400 on the securities much easier for those who live in the
bargain element: ($30 FMV − $20 exercise U.S.
price) × 500 shares × 28%. In addition, that LO 1.f
$10,000 will also be subject to the same taxes
as her regular salary, e.g., Social Security tax. 2. B ADRs represent ownership in a foreign
LO 1.d security so there is always going to be currency
risk (I). These ADRs trade in the market and
2. C All purchasers of restricted stock generally have market risk (III). Because most ADRs are
have a holding period requirement of six traded on the exchanges, there is little liquidity
months, not one year. When reselling risk and, because they represent equity, they
that stock, the sale must be accompanied are usually a good hedge against inflation.
by Form 144. Once the six months are LO 1.f
over, nonaffiliated persons have no further
restrictions, while control (affiliates) generally
have a volume limit.
LO 1.e

8
 Addendum 9

LESSON 2.3 MONEY MARKETS AND BANK ACCOUNTS

LO 2.f Identify the special characteristics of money market
instruments and the risks and benefits of adding them to a client's
portfolio.

One important asset is cash. We don’t mean greenbacks buried in the backyard; instead we’re
referring to places to keep funds that are in the bank or in securities that are considered to be
the same as cash. When it comes to cash equivalents, the exam will include money market
instruments with a maturity of up to one year.

Money Markets
The money market may be defined as the market for buying and selling short-term loanable
funds in the form of securities and loans. It is called the money market because that is what is
traded there: money, not cash. The buyer of a money market instrument is the lender of the
money; the seller of a money market instrument is the entity borrowing the money.

Although there are many different kinds of money market instruments, they share several
common factors. For example, they all have a maturity date of one year or less. In fact, most
money market instruments mature in less than six months. Another factor that many money
market instruments share is that they are issued at a discount. They do not regularly pay
interest because unlike other debt securities which generally pay interest semiannually. Most
money market instruments have a maturity of six months or less and the administrative costs
of paying out interest would be very high. Therefore, the solution is to issue the security at a
discount with the investor being paid back par at maturity. Money market instruments are
safe. Although some are not quite as safe as others (e.g., commercial paper is not as safe as a
Treasury bill), they are all considered to be low-risk securities.

Treasury Securities
Because there is so much Treasury debt outstanding, the level of activity in Treasury bills
and other short-term government issues is by far the highest and most carefully watched.
Governments with short terms also refer to U.S. Treasury notes or U.S. Treasury bonds that
are in their last year before maturity because, at that time, they would trade like any other
security with one year or less to maturity.

Negotiable Certificates of Deposit (CDs)

Negotiable CDs are unsecured time deposits (no asset of the bank is pledged as collateral),
and the money is being loaned to the bank for a specified period of time. A negotiable CD
allows the initial investor, or any subsequent owner of the CD, to sell the CD in the open
market prior to the maturity date. The bank that issues the CD redeems the CD at face value
plus interest on the maturity date. CDs are the only money market instrument that pays
periodic interest, usually semiannually. To be considered a negotiable CD, a CD must have
a face value of $100,000 or more, with $1 million or more being most common. Although
maturities can run as long as 10 years, it is those with a maturity of one year or less that are
considered money market instruments.
10 Addendum

TAKE NOTE
In the industry (and sometimes on the exam), negotiable CDs are referred to as jumbo
CDs. Although covered by FDIC insurance, these are not the CDs that you purchase at
your local bank branch.

TEST TOPIC ALERT

Negotiable CDs do not have a prepayment penalty.
FDIC insurance applies up to $250,000.
Jumbo CDs pay interest semiannually.
They are the money market instrument that is always issued at par, not a discount.

Commercial Paper
Another money market instrument is commercial paper. This is short-term unsecured paper
issued by corporations (especially finance companies) primarily to raise working capital to be
used for current rather than long-term needs. Commercial paper is exempt from registration
on both the federal and state levels as long as the maximum maturity is 270 days.

While negotiable CDs are interest bearing and issued at face amount, commercial paper
is generally issued at a discount; instead of receiving interest, the investor receives the face
amount at maturity.

PRACTICE QUESTION
A company realizes money from the sale of surplus equipment. It would like to invest
this money but will need it in 4–6 months and must take that into consideration
when selecting an investment. You would recommend
A. preferred stock.
B. Treasury bills.
C. AAA-rated bonds with long-term maturities.
D. common stock.
Answer: B. For this client, the appropriate investment is a money market instrument,
and nothing is safer than a T-bill.

In summation, why would you place money market securities in a client’s portfolio?
„ Highly liquid
„ Very safe
„ The best place to store money that will be needed soon
By investing in money market securities, the client would be incurring the following risks:
„ Because of their many advantages, the rate of return is quite low, so these are not suitable
for long-term investors
„ Due to short-term maturities, principal is potentially being reinvested at a different rate
each time the instrument matures (fluctuating income)
 Addendum 11

Bank Accounts
When referring to cash as part of one’s asset allocation, in addition to cash equivalents in the
form of money market instruments, one might keep cash in the bank. The term insured will
frequently be used in reference to bank accounts on the exam because, at least up to the legal
limits, the funds involved are insured by the FDIC. There are several ways this may be done.

Demand Deposit
Demand deposit is the legal term for a checking account. It is the favorite repository for funds
that will be needed in the very near term.

TEST TOPIC ALERT

What we normally refer to as cash in the bank is, in banking terms, known as a
demand deposit. To bankers, the term demand deposit refers to a type of account
(usually just shown by the initials DDA) held at banks and financial institutions from
which funds may be withdrawn at any time by the customer. Historically, the term
referred only to checking accounts, but it now commonly includes savings accounts
and money market accounts (not money market mutual funds because those are not
banking products).
Demand deposit accounts are considered short-term funds (readily available) and provide safe
but low returns.

Certificates of Deposit (CDs) (Time Deposit)

In the money market material a few pages ago, we introduced you to the jumbo (negotiable)
CD. The CD we’re considering here is nonnegotiable: you can’t sell it to anyone, you can
only redeem it at the bank. Certificates of deposit are available at your bank and are typically
available with a minimum deposit of as little as $500 and have maturities of anywhere from
three months to five years. In most cases, withdrawal prior to the maturity date will result in a
penalty. Here are some key facts to remember for the exam:
„ If capital preservation is the goal with no risk, the answer is an insured bank CD.
„ Insured bank CDs have no interest rate risk (they don’t fluctuate in value as interest rates
change).

Even with the potential early withdrawal penalty, these are considered liquid assets, but
certainly not as liquid as a DDA.

There are risks, however:

„ As fixed-income investments, they bear purchasing power (inflation) risk.
„ Yields tend to be quite low, so they should not be a major portion of a long-term
investment.
12 Addendum

PRACTICE QUESTION
One would expect to have checkbook access to a
A. CMO.
B. DDA.
C. GNMA.
D. SOFR.
Answer: B. DDA stands for demand deposit account, most often a checking account
at a bank.

KNOWLEDGE CHECK 2.3

1. Which of the following statements about jumbo CDs is not correct?
A. Negotiable CDs do not have a prepayment penalty.
B. FDIC insurance applies up to $250,000.
C. They are secured by pledged assets of the issuing bank.
D. Jumbo CDs pay interest semiannually.
2. Which of the following have no interest rate risk?
A. Negotiable CDs
B. Commercial paper
C. U.S. Treasury bonds
D. Time deposits at your local bank
KNOWLEDGE CHECK ANSWERS
1. C The jumbo (negotiable) CDs traded in the
money market are unsecured debt of the issuer.
LO 2.f

2. D Time deposits, either in the form of a savings

account or a certificate of deposit, have no
interest rate risk. Because these do not trade in
the market, the value is not subject to changes
in market interest rates.
LO 2.f

13
14 Addendum

LESSON 3.4: OTHER POOLED INVESTMENTS

LO 3.h Identify the unique features of real estate investment trusts
(REITs).

Add this sentence to the TAKE NOTE preceding Knowledge Check 3.4:

Obviously, the suitability conditions change when the REIT is nonliquid.

LESSON 5.3: OTHER ALTERNATIVE INVESTMENTS

LO 5.d Compare viaticals and life settlement policies.

This learning objective is no longer tested on the Series 66.

LO 5.e Contrast passive and active real estate investing.

This learning objective is no longer tested on the Series 66.

LO 5.h Describe digital assets.

This learning objective is out of order (presented before LO 5.f ) because it is new content
tested in the Series 66.

Digital assets are assets that can be electronically created, stored, and transferred. This
alternative asset class includes cryptocurrencies, tokens, and digital collectibles. A digital asset
relies on distributed ledger technology (DLT). A blockchain is a digital ledger that records
information sequentially within blocks. Consensus protocols determine how blocks are
chained together.

A cryptocurrency is a digital currency issued privately with no backing from a central bank.
Cryptocurrency uses digital ledger technology called blockchain. Bitcoin is the first and most
widely known cryptocurrency. Alternate cryptocurrencies (i.e., altcoins) are based on Bitcoin
technology. The most well-known altcoin is Ether, which is built on the Ethereum network.
As of July 2022, Bitcoin and Ethereum represented about 80% of the value of all digital
currencies.

There are two types of digital assets that are most likely to be tested: cryptocurrency and
nonfungible tokens (NFTs). By using this digital medium of exchange, parties can execute
near-real-time transactions without the need for an intermediary. Cryptocurrencies commonly
limit how many currency units can be issued. For example, Bitcoin is limited to 21 million
coins.

When physical assets like real estate change hands, considerable work (like a title search) is
required to verify ownership. Tokenization uses DLT to streamline this process by digitally
tracking the historical record of ownership. An NFT is an example of tokenization in which
a digital asset is linked to a certificate of authenticity. The key difference between NFTs and
fungible tokens is that each NFT represents a distinct object. For example, digital artwork
 Addendum 15

is a common application for NFTs. Investing in nonfungible tokens (NFTs) involves buying
and holding unique digital representations of a specific item. Unlike cryptocurrencies, which
are fungible (interchangeable with each other just like cash), each NFT is one of a kind and
has its own unique value. Some of these have sold for tens of millions of dollars. These NFTs
can represent a variety of digital items, including artwork, music, and virtual real estate. As
with other digital assets, the prices can be highly volatile, and securities professionals must be
cautious when making recommendations to their customers.

Investing in digital assets is the act of buying and holding digital assets with the intention to
generate a profit over time. Digital assets are digital representations of value that are stored
and transferred using cryptography and that makes them secure and tamper-proof.

Investing in digital assets can be a high-risk, high-reward endeavor. The value of digital assets
has tended to be highly volatile, often in a way that is totally unrelated to the stock market or
the economy.

As a securities professional, you need to conduct thorough research and due diligence before
recommending digital assets to your clients. There is still uncertainty in the regulatory arena
about if these are securities or not, and the transparency of digital assets leaves much to be
desired.

Historically, cryptocurrency returns have demonstrated low correlations with traditional asset
class returns. Therefore, cryptocurrencies have the potential to provide portfolio diversification
benefits. In general, cryptocurrency prices are influenced by the unique aspects of this asset
class, including market adoption, risk appetite, technological innovation, network impacts,
speculation, and regulation.

Two categories of altcoins are stablecoins and meme coins. Stablecoins offer stable digital
currency values by linking to another asset (e.g., the U.S. dollar). Meme coins are launched
for entertainment purposes and have the potential to generate quick profits.

Tokenization uses blockchain technology to digitally track the historical record of asset
ownership:
„ A nonfungible token (NFT) links a unique digital asset to a certificate of authenticity.
„ A security token digitally tracks ownership rights in publicly traded securities.
The key differences in investment features between digital assets and other asset classes are as
follows:
„ Inherent value differences. Most digital assets are not backed by underlying assets or
cash flows, as is the case with traditional financial instruments. Digital assets do not have
expected earnings, so they have no fundamental value.
„ Transaction validation differences. Traditional financial assets are typically recorded on
private ledgers maintained by central intermediaries. In contrast, digital assets are typically
recorded on decentralized digital ledgers.
„ Medium of exchange differences. Traditional financial assets are traded and priced in
globally accepted fiat currencies. In contrast, digital assets are used as an alternative to fiat
currencies and are mainly used for online transactions.
„ Regulatory differences. Most jurisdictions have clear and established rules that govern
traditional financial instruments. However, digital assets currently lack these well-
developed standards.
16 Addendum

LESSON 8.1: WHAT ARE SECURITIES AND WHO ISSUES THEM?

LO 8.b Identify those who issue securities.

SPACs
In recent years, there has been much attention focused on public offerings where the funds
are not used for the usual purposes: operating expenses or expanding the business. The exam
will want you to know about these special purpose acquisition companies (SPACs), which are
sometimes called blank-check companies SPACs are companies without business operations
that raise money through IPOs in order to have their shares publicly traded for the sole
purpose of seeking out a business or combination of businesses to acquire or merge with.
When a business is located, they will present proposals to their shareholders for approval.
SPACs carry their own unique risks.

The terms blind pool SPAC and blank check SPAC are often used interchangeably, but there is
a subtle difference between them. While the blind-pool company will usually provide at least
some indication of what general industry the funds will be invested in, blank-check offerings
do not identify any proposed investment intent.

LESSON 9.4: FINANCIAL AND RECORDKEEPING REQUIREMENTS FOR

INVESTMENT ADVISERS

LO 9.g Recall the investment adviser books and recordkeeping

requirements under state and federal law.

Add to the list of recordkeeping requirements

„ All investment advisers must keep complete and accurate records relating to the
continuing education requirements of their investment adviser representatives.
This topic will be covered in depth in Unit 10.

LESSON 10.2: REGISTRATION AND POST-REGISTRATION

REQUIREMENTS OF INVESTMENT ADVISER REPRESENTATIVES

LO 10.c Describe the investment adviser representative registration

process, required post-registration filings, and business activities.

Add the following text at the end of LO 10.c.

 Addendum 17

Investment Adviser Representative Continuing Education

(IAR CE)
The newly-implemented and adopted Continuing Education Model Rule for Investment
Adviser Representatives has multiple implications and effects for professionals throughout the
financial services industry. Let’s cover the most likely items to be tested.

What is IAR CE?

IAR CE is an annual continuing education requirement for IARs governed by the NASAA
Model Rule on Continuing Education that was adopted in 2020 and implemented by states
and jurisdictions that began in 2022.

Why was the IAR CE Model Rule adopted?

NASAA’s membership, with strong industry support, adopted the IAR CE Model Rule to
address the lack of a continuing education requirement for IARs in contrast to other financial
services professionals. These types of professionals are often required to maintain or expand
their level of knowledge and competence after initial qualification, which is what the IAR CE
Model Rule will now accomplish for IARs.

Who is the IAR CE for?

Any IAR who is registered in a state or jurisdiction that has adopted the NASAA IAR CE
Model Rule will be subject to its new CE requirements.

FINRA and IAR CE

For dual registrants (IARs who are also registered agents of BD firms), completion of
the FINRA CE Regulatory Element may be applied to meet the Products and Practices
component of the IAR CE requirement. NASAA will accept the FINRA Regulatory Element
taken in the previous year as an equivalent of the six credits for Products and Practices for the
current year.

FINRA CE Firm Element training may also be applied to meet the IAR CE requirement if
the training is approved by NASAA. Professional designation CE courses (CFP®, ChFC®,
CFA®, PFS, CIC) are also eligible for IAR CE credit as long as they are approved by NASAA.

Currently, 11 states have passed legislation to adopt the Model Rule. Because this is
approximately 20% of the NASAA U.S based members (54 in all), we don’t expect a great
deal of specificity from exam questions.

IAR CE Requirements
IARs are required to complete 12 hours of CE credit per year to maintain their IAR
registration. This total includes six hours covering products and practices and six hours
covering ethics and professional responsibility. An IAR taking more than 12 credit hours per
year is not allowed to carry forward those excess credits into the following year.
18 Addendum

Approved IAR CE Course Providers and Costs

IARs are required to take NASAA-approved CE courses from approved course providers.
Any vendor, firm, individual, or state may provide CE as long as the provider and course
are approved. The list of approved course providers—including Kaplan—can be found on
the NASAA website. NASAA has implemented a course reporting fee of $3 per credit hour.
Therefore, in addition to any training costs, an IAR can expect to pay up to $36 per year to
meet their CE requirement.

LESSON 13.1: DISCLOSURES

LO 13.b Recognize the general disclosure requirements.

Under the heading “Regulation Best Interest,” remove the final paragraph and replace
with the following:

Regulation Best Interest (Reg BI) is focused primarily on broker-dealer recommendations.

Any broker-dealer or agent, when recommending a securities transaction or investment
strategy to a retail customer, must act in the best interest of that customer at the time the
recommendation is made. Under no circumstances may the broker-dealer or agent place any
financial or other interest ahead of the retail customer.

While broker-dealers and their agents have always had a suitability requirement, Reg BI goes
a step further. Reg BI has a standard of care obligation. For retail customers, the metric is
the best interest of the customer rather than simply a suitability standard. For example, a
particular mutual fund might be suitable, but because it is proprietary to the broker-dealer,
the expenses might be higher or the commissions to the agent might be greater than a similar
fund available elsewhere. Recommending the proprietary fund, in this case, would not hold
up to Reg BI’s standard of care.

Any broker-dealer or agent making a recommendation must exercise reasonable diligence,

care, skill, and prudence, and they must
„ acknowledge the potential risks, rewards, and costs associated with a recommendation;
„ act in the best interest of a particular customer based on that retail customer’s personalized
investment profile;
„ believe that a series of recommendations is in the customer’s best interest when viewed
„ in isolation and is not excessive and unsuitable for the customer when taken together as a
whole; and
„ identify conflicts of interest and disclose and mitigate or eliminate them.
 Addendum 19

LESSON 14.8: BUSINESS CONTINUITY AND SUCCESSION

LO 14.m Recall what constitutes an adequate business continuity
plan.

Business Continuity and Succession Plans

In 2015, NASAA released a Model Rule dealing with business continuity plans for state-
registered investment advisers. The rule requires that every investment adviser establish,
implement, and maintain written procedures relating to a business continuity and succession
plan (BCP). The plan should be based upon the facts and circumstances of the investment
adviser’s business model, including the size of the firm, the types of services provided, and
the number of locations of the investment adviser. The plan shall provide for at least the
following:
1. The protection, backup, and recovery of books and records
2. Alternate means of communication with customers, key personnel, employees, vendors,
service providers (including third-party custodians), and regulators, including, but
not limited to, providing notice of a significant business interruption or the death or
unavailability of key personnel or other disruptions or cessation of business activities
3. Office relocation in the event of temporary or permanent loss of a principal place of
business
4. Assignment of duties to qualified responsible persons in the event of the death or
unavailability of key personnel
5. Otherwise minimizing service disruptions and client harm that could result from a
sudden significant business interruption

Purpose of a Business Continuity Plan

The most common purpose of a BCP is to have processes and procedures in place to ensure
that critical business functions can continue during and after a disaster or other significant
business interruption. BCPs outline actions advisers should take if utility outages, catastrophic
natural disasters, national emergencies, acts of terrorism, or other types of disturbances disrupt
day-to-day business operations. Advisers’ BCPs should reflect comprehensive approaches to
reduce and manage risks associated with disasters, significant business interruptions, and
work stoppages. All BCPs should include succession plans. Advisers have a fiduciary duty to
act in the best interest of their clients, and it is in the best interest of clients for advisers to
adopt a succession plan with procedures to ensure continuity of services and the day-to-day
operations of the business, or to smoothly wind down advisers’ businesses in the event of
death, disability, or incapacity. Without proper planning, the unexpected loss of executives,
key personnel, or owners can be disastrous to the business and to clients.

Succession Issues
Planning for an unexpected succession situation is an important part of a BCP. While there
are some succession issues that apply to every adviser (e.g., every adviser needs a designated
regulatory contact person), each adviser must also tailor its succession plan to the adviser’s
needs. An adviser’s business entity structure will affect the types of items that should be
addressed in the adviser’s succession plan.
20 Addendum

For example, in a sole proprietorship, the client’s legal relationship is with the sole proprietor,
who is often the only investment adviser representative. With the death or permanent
disability of the owner, the sole proprietorship itself may legally terminate as an entity, as
would any powers of attorney, advisory contracts, and other client agreements. The deceased
(or otherwise incapacitated) sole proprietor is likely to be the only regulatory contact and
may be the only person who would be able to access electronic client files or authorize
rebates of prepaid fees. There are many additional issues, such as probate, that are unique to
sole proprietorships and that affect the implementation of a succession plan. Therefore, the
adviser should have a succession plan that will immediately address these issues when an IAR
becomes unavailable. Regardless of who takes over, a person cannot provide advisory services
for compensation unless she is registered with the state’s securities regulator(s) or exempt from
registration.

Advisers should consider the following items when drafting a succession plan to ensure that
the plan adequately accounts for the risks related to the business entity: (1) Are the clients’
investment advisory contracts with an individual or a legal entity? and (2) Does an IAR’s
death or unavailability affect the advisory agreement?

PRACTICE QUESTION
A BCP should be designed to protect the firm’s clients in the event of which of the
following?
I. A natural disaster such as a hurricane or tornado
II. Acts of terrorism
III. Pregnancy of one of the firm’s IARs
IV. Climate change
A. I and II
B. I and IV
C. II and III
D. III and IV
Answer: A. Business continuity plans are designed to provide for the sudden
unexpected events that can disrupt day-to-day business operations.

KNOWLEDGE CHECK 14.8

1. The first step in developing a business continuity plan (BCP) is to identify the risks
that could cause a service interruption. Such risks would include:
A. a natural disaster (such as storms, earthquakes, or flooding).
B. the death or disability of a key employee.
C. a service provider interruption (such as the internet going down).
D. all of these.
2. The death of an investment adviser’s key person would most likely have the greatest
immediate effect when the firm is organized as
A. a C corporation.
B. an LLC.
C. an S corporation.
D. a sole proprietorship.
KNOWLEDGE CHECK ANSWERS
Knowledge Check 14.8

1. D Each of these choices is an event that could

lead to an interruption in an investment
adviser’s ability to provide service to clients.
LO 14.m

2. D Although each of these business structures

could consist of a single key individual,
that would always be the case with a sole
proprietorship.
LO 14.m

21
22 Addendum

LESSON 16.1: WHO ARE CLIENTS?

LO 16.a Recognize the different types of clients securities
professionals serve, the different ownership categories, and the legal
documentation required to open these accounts.

Following the heading “Joint Tenants with Right of Survivorship (JTWROS),” add the
following:

Community Property with Rights of Survivorship (CPWROS)

The community property with rights of survivorship (CPWROS) form of ownership is used
in community property states (there are nine such states) and functions the same as JTWROS.
CPWROS allows married couples to share property, like a home, equally. In a community
property state, legally each one has a 50% interest. When the first dies, the entire home is
then owned by the survivor. Just as with JTWROS, probate is avoided.

LESSON 16.4: ESTATE PLANNING

LO 16.f Identify estate-planning options.

Before the Knowledge Check questions, add the following:

Donor Advised Funds

Generally, a donor advised fund (DAF) is a separately identified fund or account that
is maintained and operated by a 501(c)(3) organization, which is called a sponsoring
organization. Each account is composed of contributions made by individual donors. Once
the donor makes the contribution, the organization has legal control over it. However, the
donor, or the donor's representative, retains advisory privileges with respect to the distribution
of funds and the investment of assets in the account.
For example, if an individual plans to make $100,000 in charitable contributions during
the taxable year, the usual method is to write a check to each organization. This creates a
paperwork burden at income tax time because all of the separate receipts have to be gathered
and totaled.

With a DAF, the $100,000 may be donated at one time or periodically through the year.
The real benefit to the taxpayer is that there is one tax statement at the end of the year. This
approach merits caution. First of all, the DAF cannot make its distributions only to a single
charity. Secondly, if the donor can advise as to which individuals receive grants for travel,
study, or other similar purposes, the IRS can disallow deductions for charitable contributions
to the fund.
 Addendum 23

LESSON 17.2: INVESTMENT OBJECTIVES AND CONSTRAINTS

LO 17.c Distinguish between investment objectives and investment
constraints.

Add this text under the heading “Social Security” before the heading “Death Benefits.”

For those on Medicare, there are graduated premiums based on income. The Medicare
Income-Related Monthly Adjustment Amount (IRMAA) is an amount you may pay in
addition to your Part B or Part D premium if your income is above a certain level. The Social
Security Administration (SSA) sets four income brackets that determine your (or you and
your spouse's) IRMAA. Because these brackets change every year, the numbers will never be
tested, only the concept.

Remove the TAKE NOTE following the “Time Horizon” and replace it with the
following:

Older adults in the United States hold a huge amount of assets. Sadly, where large amounts
of assets can be found, one will also find unscrupulous people looking to acquire those funds
through intimidation, deception, or any undue influence. These people can be family, friends,
guardians, and those with power of attorney. The NASAA Model Act to Protect Vulnerable
Adults from Financial Exploitation dealing with eligible adults applies to a natural person age
65 and older or a natural person age 18 and older who the qualified individual reasonably
believes has a mental or physical impairment that renders the individual unable to protect
his or her own interests. The act mandates reporting to a state securities regulator and state
adult protective services (APS) agency when a qualified individual has a reasonable belief that
financial exploitation of an eligible adult has been attempted or has occurred.

TAKE NOTE
Under the NASAA Model Act to Protect Vulnerable Adults, eligible adults include
those age 65 or older and those adults who would be subject to the provisions of a
state’s adult protective services (APS) statute. Qualified individuals include broker-
dealer agents; investment adviser representatives; those who serve in a supervisory,
compliance, or legal capacity for broker-dealers and investment advisers; and any
independent contractors that may be fulfilling any of those roles.

Delayed Disbursements
The model act provides broker-dealers and investment advisers with the authority to delay
disbursing funds from an eligible adult’s account for up to 15 business days if the broker-
dealer or investment adviser reasonably believes that a disbursement would result in the
financial exploitation of the eligible adult. If the broker-dealer or investment adviser delays
a disbursement, it must notify people authorized to transact business on the account (unless
these individuals are suspected of the financial exploitation), notify the state securities
regulator and the adult protective services agency, and undertake an internal review of the
suspected exploitation. Under the model, the securities regulator or adult protective services
agency may request an extension of the delay for an additional 10 business days for a total of
25 business days.
24 Addendum

TAKE NOTE
FINRA has a similar rule pertaining to vulnerable adults, but there are important
differences. It is possible the exam will ask about these. For example, FINRA does not
require mandatory reporting of suspected financial exploitation to state regulators
or state APS agencies, and FINRA does not incentivize reporting by offering immunity
for disclosing information to government and third-parties. Furthermore, while FINRA
requires retention of records, it does not require the sharing of records with state APS
and law enforcement agencies, which can prove an essential tool for agencies tasked
with preventing exploitation. Finally, the FINRA rule permits temporary holds on all
transactions, not just disbursements, and the holds can be as long as 55 business
days.

LESSON 23.3: BROKERS AND DEALERS AND THEIR COSTS

LO 23.d Identify the difference between functioning as a broker and

acting as a dealer.

Add the following text after the Test Topic Alert:

Carrying Versus Introducing Broker-Dealers

A further distinction among broker-dealers is the nature of their back-office operations.
Broker-dealers are either carrying or introducing.

Carrying (Clearing) Firms

A carrying firm carries customer accounts and accepts funds and securities from customers.
In addition, these firms provide clearing and settlement functions for their own customers
including other broker-dealers operating as introducing firms. As you will see in the following
discussion, the clearing firm acts essentially as the introducing firm’s back office.

A firm carrying customer funds and securities clearly has a line of business that poses more
risk to their customers than firms that do not carry customer funds and requires a greater net
capital. Another difference is that introducing firms are exempt from the Customer Protection
Rule while carrying firms are not.

Introducing Firms (Fully Disclosed Firms)

A firm that operates on a fully disclosed basis is one that introduces its customers to a clearing
firm and is therefore often called an introducing firm. The clearing firm holds funds and
securities of the introducing firm’s customers and performs related functions, such as sending
confirmations and statements for its correspondent firms.

When a customer opens an account with an introducing BD, the clearing or carrying firm
must notify the customer in writing of this arrangement.

All clearing agreements between an introducing firm and its clearing agent must, at a
minimum, specify the responsibilities of each party with respect to:
„ opening, approving, and monitoring of customer accounts;
„ extension of credit;
 Addendum 25

„ maintenance of books and records;

„ receipt and delivery of funds and securities;
„ confirmations and statements; and
„ acceptance of orders and execution of transactions.
In short, an introducing firm outsources many important jobs. By allowing the carrying firm
to perform these critical functions, a fully disclosed introducing firm can focus on its core
activities while its clearing firm may provide its customers with good service, economies of
scale, and expertise in technology.

LO 23.e Describe the costs of trading securities.

Add the following text after the first Practice Question:

Payment for Order Flow

Broker-dealers may agree to preference (direct) all of their orders in a certain stock or stocks
to a particular market maker in a Nasdaq security. In return, the Nasdaq market maker will
rebate, on a cents-per-share basis, a portion of its profit. These agreements must be in writing
and must be disclosed.

The broker-dealer can meet the SEC’s requirements by disclosing the firm’s payment for order
flow policy upon opening a new account, annually after account’s opening, and on every trade
confirmation where payment was received.

As we know, a market maker is a broker-dealer that stands ready to buy or sell a stock at
publicly quoted prices. As a way to attract orders from broker-dealers, some market makers
will pay a broker for routing orders to them. This is called payment for order flow.

KNOWLEDGE CHECK 23.3

1. A customer of an introducing firm, in reviewing her current account statement,
notices an error in the number of shares of XYZ she recently purchased. Under
industry rules, the customer should notify
A. both the introducing firm and the clearing firm.
B. only the introducing firm.
C. only the clearing firm.
D. the Administrator.
2. If applicable, payment for order flow
A. must be disclosed on the confirmation.
B. must be disclosed on the order ticket.
C. must be disclosed on both the order ticket and confirmation.
D. is not a required disclosure.
KNOWLEDGE CHECK ANSWERS
Knowledge Check 23.3

1. A Both firms should be notified. Then, they will

work together to determine where the error
occurred and who bears the liability.
LO 23.d

2. A If applicable, payment for order flow must

be disclosed on confirmations. The SEC also
requires that firms disclose on confirmations
that customers can make a written request to
find out the source and type of payment for
that particular transaction.
LO 23.e

26
 Addendum 27

LESSON 23.4: TYPES OF ORDERS

LO 23.g Describe high frequency trading (HFT) and dark pools.

Remove the information on Dark Pools.