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Fundamentals of Investment Regulation

By Adam D. Birch | Categories: Business & Tax Law | Share September 2016

There is often confusion regarding the difference between an “Investment Adviser” and a securities broker.  This is understandable given the fact that many brokerage firms refer to their brokers as “financial advisers.”  To give a simple example, the manager of a mutual fund is required to register as an Investment Adviser who charges a fee to manage the fund’s portfolio.  When that mutual fund manager decides to buy or sell a security for the mutual fund’s portfolio, the trade is placed with a securities broker who charges a commission for executing the transaction.

Investment advisers are subject to federal regulation under the Investment Advisers Act of 1940 (the “Advisers Act”).  However, some investment advisers are not subject to regulation by the Securities and Exchange Commission (“SEC”), leaving them subject to state “blue sky” regulation.  The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), significantly changed the exemptions from registration under the Advisers Act and division of the regulation between the SEC and the states.

The Advisers Act generally requires all investment advisers to register with the SEC or the states unless they are excluded from the definition of “investment adviser” or exempt from registration. Even if an investment adviser is not required to register under the Advisers Act (e.g., because it qualifies under an exemption), it may still be required to register under state law and be subject to certain provisions of the Advisers Act.

Because the rules, regulations and exemptions can be complex, and the correct analysis is very fact specific, any person considering the rendering of investment advice should work with an experienced securities attorney.

Who is an “Investment Adviser”?

“Investment adviser’ means any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and, as part of regular business, issues or promulgates analyses or reports concerning securities.1 The key factor in determining whether a person is an investment adviser is the extent to which the person’s advisory activities constitute being “engaged in the business” of an investment adviser.  The giving of investment advice need not constitute the principal business activity or any particular portion of the business activities of a person for that person to be an investment adviser. The SEC considers a person to be “engaged in the business” of providing investment advice if the person:

  • holds himself or herself out as investment adviser or as one who provides investment advice;
  • receives any separate or additional compensation that represents a clearly definable charge for providing advice about securities; or
  • on anything other than rare, isolated and non-periodic instances, provides specific investment advice.

The definition of investment adviser applies to persons who give investment advice for compensation. The compensation element is satisfied by the receipt of any economic benefit, whether in the form of an advisory fee, some other fee relating to the total services rendered, commissions, expense reimbursement or some combination of the foregoing.  It is not necessary for the person receiving the advice to pay the compensation; only that the adviser receives compensation from some source.2

Federal Registration and Regulation

A person that falls within the definition of investment adviser must register with the SEC, unless it either:

  • Falls within a specific exclusion form the definition of investment adviser in Section 202(a)(l 1) of the Advisers Act, which includes:
    • Banks and bank holding companies;
    • Persons acting in certain professional capacities;
    • Broker-dealers (i.e. securities brokers);
    • Publishers;
    • Government securities advisers;
    • Credit rating agencies;
    • Family offices; and
    • Governments, government agencies and their employees.
  • Is prohibited from registering under the Advisers Act because it manages a limited amount of assets and is regulated by one or more of the states (as discussed below); or
  • Qualifies for an exemption from the Adviser Act’s registration requirement, which includes:
    • Intrastate advisers;
    • Insurance company advisers;
    • Foreign private advisers;
    • Private fund advisers;
    • Venture capital advisers;
    • Commodity trading advisers;
    • Charitable organizations; and
    • Small business investment company advisers.

State Registration and Regulation

In a significant rebalancing of federal (SEC) and state responsibility for the regulation of investment advisers, the National Securities Markets Improvement Act of 1996 (“NSMIA”) generally preempted state regulation of investment advisers that have $25 million or more in assets under management or that advise registered investment companies.3   The Dodd-Frank Act raised this dividing line to $100 million or more assets under management if the adviser is subject to registration and examination as an investment adviser by the state’s relevant agency.

However, states may continue to investigate and bring enforcement actions against SEC- registered investment advisers for fraud or deceit, to require advisers to consent to service of process, to require certain filings and the payment of fees by investment advisers, and to license adviser representatives and solicitors.4

The full interplay of the federal and state registration requirements is beyond the scope of this article but, once again, questions regarding registration requirements should be discussed with experienced counsel.

Advisers Act Regulatory Framework

Registration under the Advisers Act is effected by submitting Form ADV electronically using the Investment Adviser Registration Depository (the “IARD”), an internet-based filing system operated by the financial Industry Regulatory Authority (“FINRA”).  State registration also may be initiated by filing Form ADV using the IARD system, however, the requirements of each individual state is beyond the scope of this article.

Within 45 days after filing of the Form ADV, the SEC must grant registration or institute an administrative proceeding to determine whether registration should be denied.  The SEC may deny registration if the adviser or a related person is subject to a statutory disqualification under Section 203(e) of the Advisers Act including:

  • making a false or misleading statement in its registration application;
  • having been convicted of a felony within the past ten years;
  • having been convicted by a court or found by a US or foreign regulatory agency to have violated a securities-related statute or rule; or
  • having been the subject of a securities-related injunction.

Form ADV

Form ADV is the basic registration form for registration as an investment adviser. It consists of two parts and the information provided is the basis of the SEC’s registration decision.

Part 1A of Form ADV requires an investment adviser to provide information on the adviser including:

  • identifying information;
  • basis of SEC registration eligibility;
  • information on its advisory business including:
    • number of employees;
    • number of and types of clients’
    • compensation arrangements; and
    • amount of regulatory assets under management.
  • other business activities;
  • financial industry affiliations;
  • information on private funds managed;
  • proprietary interests in client transactions;
  • custody arrangements;
  • control persons; and
  • criminal and regulatory disciplinary history of the adviser and its related persons.

Part 1B of Form ADV requires information specific to individual state registrations and is not discussed in detail in this article.

Part 2 contains information, which must be filed with the SEC and provided to an investment adviser’s clients at the beginning of an advisory relationship and annually.

Part 2A of Form ADV (the “Brochure”) requires an adviser to prepare a narrative brochure that includes plain English disclosures of the investment adviser’s business, including its:

  • principal owners, types of advisory services or amount of assets managed on discretionary and non-discretionary basis;
  • fees and compensation, including performance fee arrangements;
  • types of clients;
  • methods of analysis, investment strategies and risk of loss;
  • disciplinary information;
  • other financial industry activities and affiliations;
  • code of ethics, participation or interest in client transactions and personal trading;
  • brokerage practices;
  • review of accounts; client referrals and other compensation;
  • custody arrangements;
  • investment discretion;
  • proxy voting procedures; and
  • financial information.

Part 2B of Form ADV (the “Brochure Supplement”) requires an adviser to provide information about each advisory employee who provides investment advice to its clients, including the employee’s:

  • educational background;
  • business experience;
  • other business activities;
  • disciplinary history;
  • additional compensation arrangements; and
  • supervision.

Failing to properly register and failing to maintain proper reporting and registration can lead to significant penalties and can create significant liability.  Such failure may lead to being banned from the securities industry.  For these reasons, it cannot be stated too strongly that, the advice of experienced counsel is necessary when acting as an investment adviser.

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1 Advisers Act, Section 202(a)(11). 2 Applicability of the Investment Advisers Act to Financial Planners, Pension Consultants, and Other Persons Who Provide Investment Advisory Services as a Component of Other Financial Services, SEC Release No. IA-1092 (Oct. 8, 1987). 3 Advisers Act, Section 203A(a)(1)(A). 4 Advisers Act, Section 203A(b)(2).


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