NASAA Proposes Competency Examination for Investment Adviser Representatives

July 27, 1998

The North American Securities Administrators Association (the “NASAA”), whose members are comprised of the states’ securities regulators, has recently published a Memorandum of Understanding (the “MOU”) on issues affecting investment advisors and investment advisor representatives. The MOU was drafted in response to Title III of the National Securities Markets Improvement Act of 1996 ("NSMIA"), the Investment Advisers Supervision Coordination Act ("Coordination Act"), which created a two-tier system for the registration of investment advisers in the United States by dividing responsibility for registering investment advisers between the states and the United States Securities and Exchange Commission ("SEC").

Overview of the Coordination Act

Under the Coordination Act investment advisers with less than $25 million of assets under management will generally register with the states and those with more than $25 million of assets under management or that advise registered investment companies will register with the SEC. If an investment adviser is registered with the SEC, the states may not require registration, licensing, or qualification of the investment adviser or its supervised persons, except that states may license, register, or otherwise qualify investment adviser representatives who have a place of business located within that state. Additionally, the states retain the authority to investigate and bring enforcement actions in the case of fraud or deceit by SEC registered investment advisers and their associated persons.

If an investment adviser does not qualify for SEC registration, its registration is governed by state laws. State registration authority is limited, however, by a national de minimis standard that prohibits the laws of any state from requiring the registration, licensing, or qualification of an investment adviser if the adviser does not have a place of business located in the state and during the prior 12 months had five or fewer clients that reside in the state. In addition, the Coordination Act permits the states to enforce only those books and records, minimum net capital, or bonding requirements of the state in which the investment adviser maintains its principal place of business.

Proposed Competency Examination

The most controversial proposal in the MOU was the proposal that the NASAA develop an exam to test the subject matter knowledge and competency of state-registered investment adviser representatives. The NASAA has proposed to seek to have state regulators implement and require the passage of an exam as a requirement of being licensed as an investment adviser representative. States currently rely on the Series 65 exam to test investment advisor representatives. The NASAA proposal would revise the Series 65 exam to reflect recent state law changes resulting from the NSMIA and to insure that the exam will mandate a minimum degree of competency for investment advisor representatives.

The NASAA competency exam initiative is being supported by the Institute of Certified Financial Planners but has been criticize by the Investment Company Institute (the “ICI”). The ICI’s main criticism of the proposed exam is that a single “one-size fits all examination” will not adequately assess a person’s competency as an investment advisor representative given the broad definition of an investment advisor representative and the diverse functions which may be performed by an investment advisor representative. Additionally, the ICI does not feel that there is a demonstrated need for such an examination. Despite this criticism, it is expected that the NASAA will continue its initiative on the proposed investment advisor representative examination over the next several months.

Registered Advisers to be Grandfathered

According to Rick Cortese, Vermont’s deputy commissioner of securities, NASAA will grandfather all currently registered investment advisers. Also, in response to the Securities Industry Association (“SIA”), which maintains that all Series 7 licensed advisers should be exempted from the examination, Cortese has stated that a modified examination will be considered for Series 7 license holders.

To discuss other issues relating to hedge funds and their investment managers, contact Howard A. Neuman or Steven B. Katz at (212) 818-9200 .