SEC SEEKS TO POSTPONE NEW RULES REGULATING INVESTMENT ADVISERS; COMMENTERS OBJECT TO SEVERAL NEW RULES

Effective Date May Be Postponed

March 10, 1997

    The Securities and Exchange Commission recently asked Congress to postpone for 90 days, the effective date of those parts of the National Securities Markets Improvement Act of 1996, (the "Improvement Act") that govern the regulation of investment advisers. If Congress acts, the effective date will be postponed from April 9 to July 8, 1997. In explaining its request, the SEC expressed concern that even though it expects to be able to complete its rulemaking by April 9, the current timetable "is likely not to afford investment advisers sufficient time to examine the new rules "and may not allow regulated advisers enough time to consult with counsel as to their continuing regulatory status or to properly complete and submit the required forms. According to the SEC, an additional 90 days would allow investment advisers enough time to comply with the new rules and avoid disrupting state regulatory efforts.
    
    As noted below, several aspects of the SEC's proposed rules are controversial. This, too may be prompting the SEC to seek a delay.

Certain Proposed Rules Trigger Objections

    In a Hedge Fund & Investment Managers Advisory dated January 23, 1997, we reported on the SEC's rule proposals to implement those provisions of the Improvement Act that alter the manner in which investment advisers will be regulated. Under the Improvement Act, an investment adviser need not register with the SEC unless it (i) has more than $25 million (or such higher amount as may be established by the SEC) in client "assets under management," or (ii) advises registered investment companies, or (iii) is not regulated by the state in which it maintains its principal office, in any of which cases such advisers must register exclusively with the SEC. All other advisers will be regulated only by the states. Supervised persons will be regulated exclusively by the SEC, except that a state may license, register or qualify an "investment adviser representative" who has a "place of business" within the state. Thus, in most respects, dual federal-state regulation of investment advisers will cease, in most cases, on April 9, 1997 (or, as noted, above on July 8).



The Securities Industry Association (SIA) has asked the SEC to include cash and cash equivalents as securities in determining whether an account qualifies as a "securities portfolio." The proposed rules define the term "assets under management" by reference to the "securities portfolios" for which an adviser provides "continuous and regular supervisory or management services." A "securities portfolio" would be a portfolio in which at least 50 percent of the total value of the account, exclusive of cash and cash equivalents, consists of securities. To determine the total amount of assets under management, the adviser must then include the entire value of each qualifying portfolio, adding back in amounts for cash and non-securities positions. The proposed initial exclusion of cash and cash equivalents may, especially during the employment of defensive strategies, significantly impact whether the SEC or state regulators will have primary jurisdiction over certain investment advisers. "Since cash and cash equivalents are a legitimate defense strategy and asset category in asset allocation models, they should be treated as securities as long as the account contains any other securities or has a history of owning securities," said the SIA. The SIA also advocated an alternative to the "assets under management" criteria - such as revenues derived from advisory services - to permit certain other types of large advisers to quality for SEC registration.

The Government Finance Officers Association (GFOA), on the other hand, urged that "the portfolio should in fact be predominantly securities. In order to ensure that this is the case, a substantially higher threshold should be set if cash and cash equivalents are to be included." Similarly, the North American Securities Administrators Association (NASAA) advocated that a portfolio, exclusive of cash and cash equivalents, should have to contain at least 80 percent securities to be considered a securities portfolio. NASAA and GFOA both advocated also that real estate, commodities and collectibles should be excluded when calculating "assets under management" and recommended that the SEC define "cash equivalents."

NASAA also advised the SEC that it believes that the SEC lacks the power to define the term "investment adviser representative" and that the states, as the primary regulators of adviser representatives, have this authority. GFOA also expressed doubts that the SEC has this authority. The Improvement Act limits a state's authority to register and regulate investment adviser representatives of SEC-registered investment advisers to those investment adviser representatives who have a "place of business" within the state. The SEC proposals define an investment adviser representative to be a supervised person covered by the Investment Advisers Act of 1940, as amended (the "Advisers Act"), if a substantial portion of his or her business is providing advice to clients who are natural persons. A "substantial portion" would mean that natural persons represented more than 10 percent of the supervised person's clients or were the holders of more than 10 percent of the supervised person's assets under management.

NASAA also objected to the SEC's proposed definition of "place of business" as being underinclusive. However, the SIA and the Investment Council Association of America (ICAA) have both advised the SEC that the proposal is "overly broad." The proposed rules define "place of business of an investment adviser representative" as --


"a place or office from which the investment adviser representative regularly provides advisory services or otherwise solicits, meets with, or communicates to clients, unless the investment adviser representative does not regularly provide advisory services or otherwise solicit, meet with, or communicate to clients at any place or office, in which case the place of business of such investment adviser representative will be the residence of each client." 

NASAA objects to the inclusion of the word "regularly" as confusing, and believes that the definition should include the place from which an adviser provides services via the Internet. Conversely, SIA and ICAA take the position that the proposed definition should require an established physical location in a state from which the representative regularly conducts business and, consequently, that representatives who have offices should be regulated only by those states in which those offices are located.

NASAA also requested that SEC to correct its statement that states may not "indirectly regulate activities of Commission-registered advisers by enforcing state requirements that define `dishonest' or `unethical' business practices unless the prohibited practices would be fraudulent absent the requirements" because states are expressly permitted by the Improvement Act to "investigate and bring enforcement action with respect to `fraud or deceit.'" GFOA also urged the SEC to withdraw the statement. ICAA strongly supported the SEC statement.

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Whether or not the SEC is successful in postponing the implementation of the new rules or decides to supplement or revise the proposed rules before adopting them, investment advisers should begin preparing to calculate their "assets under management" in anticipation of the existing April 9, 1997 filing deadline for new Form ADV-T. As previously reported, Form ADV-T is the form from which the SEC will (i) determine whether an adviser may continue to be registered with the SEC or will be subject to exclusive state regulation and (ii) if the adviser no longer qualifies for SEC registration, serve as the document that withdraws an adviser's registration under the Adviser's Act.) Calculations of "assets under management" would have to be made within 10 business days before filing Form ADV-T.

To take action on any of the information contained in this report, you should seek professional advice.