Click here to go back to the Welcome Page




SEC Adopts Form ADV-T and Final Rules to Implement Investment Advisers Supervision Coordination Act

                                              June 5, 1997

The Securities and Exchange Commission (the "SEC") recently announced the adoption of seven new final rules, nine rule amendments, and amendments to Form ADV designed to implement the provisions of the Investment Advisers Supervision Coordination Act (the "Coordination Act"), which will become effective on July 8, 1997. The Coordination Act significantly altered the manner in which investment advisers will be regulated. Under the Coordination Act, an investment adviser will be prohibited from registering with the SEC under the Investment Advisers Act of 1940 (the "Advisers Act"), or from maintaining its registration, unless the investment adviser:

  • has more than $25 million (or such higher amount as may be established by the SEC) in client assets under management, or
  • advises registered investment companies, or
  • is not regulated or required to be regulated by the state in which it maintains its principal office, or
  • is exempted from the prohibition by the SEC.

All investment advisers who are not prohibited from registering with the SEC must be registered with the SEC unless they fit within a previously available registration exemption such as the "Federal de Minimis Exemption" described below. Because the Coordination Act precludes the states from requiring state registration of SEC-registered investment advisers, in most respects dual federal-state regulation of investment advisers will end on July 8, 1997.

Among other things, the new rules and rule amendments, which also become effective on July 8, 1997:

  • create the process by which investment advisers currently registered with the SEC will determine their post-July 8, 1997 status as SEC-registered or state-registered investment advisers (those registered investment advisers who fail to satisfy the eligibility criteria for SEC registration will be required to withdraw their currently effective registrations);
  • provide for annual status reporting to the SEC;
  • clarify how investment advisers should count clients for purposes of both the new "National de Minimis Exemption" from state regulation and the existing Federal de Minimis Exemption from SEC registration.

In order to simplify our explanation of the new rules, this Advisory is organized into the following sections and subsections:

  • Determining SEC or State Registration Status

    - Assets Under Management

    - Absence of State Regulation

    - Form ADV-T

  • Implications For SEC-Registered Investment Advisers

    - Changes to Form ADV

    - State Licensing of Investment Adviser Representatives

    - Other State Laws Affecting SEC-Registered Investment Advisers

  • Implications For Advisers Ineligible For SEC Registration

    - National de Minimis Exemption

    - Primacy of Law of State of Principal Place of Business

    - Applicability of the Advisers Act to State-Registered Investment Advisers

    - Certain Anti-Fraud Rules No Longer Applicable to State-Registered Advisers

DETERMINING SEC OR STATE REGISTRATION STATUS

As noted above, an investment adviser will be prohibited from registering 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 or required to be regulated" by the state in which it maintains its principal office, or (iv) is exempted from the prohibition by the SEC.agencies; (iii) pension consultants rendering advice to employee, government and church benefit plans with respect to at least $50 million of their assets of all kinds (i.e., assets are not limited to securities portfolios); and (iv) certain investment advisers who are affiliated with, and share the same principal office and place of business as, an SEC-registered investment adviser. An investment adviser subject to one of these exemptions is required to be SEC-registered. These exemptions do not become effective until July 21, 1997. Any investment adviser that advises a registered investment company, irrespective of the size of the company or the nature of the adviser's other business, will continue to be required to register with the SEC. The same is true for advisers that perform contractual sub-advisory services to a registered investment company.

Investment advisers that do not advise a registered investment company are free to rely on existing exemptions from SEC registration such as the exemption for investment advisers who have had fourteen (14) or fewer clients during the preceding twelve (12) month period and do not hold themselves out generally to the public as investment advisers (the "Federal de Minimis Exemption"). Investment advisers who satisfy the requirements for the Federal de Minimis Exemption remain free not to register with the SEC, even if the amount of assets under their management would otherwise require them to register. Investment advisers who rely on the Federal de Minimis Exemption will, however, be subject to applicable state registration requirements.

Assets Under Management

The Coordination Act defines the term "assets under management" to include only:

"securities portfolios" for which an investment adviser provides "continuous and regular supervisory or management services."

The new rules define these terms and describe the appropriate method of valuing client accounts as follows:

Securities Portfolio: A "securities portfolio" is any account a majority of whose value consists of securities (including cash and cash equivalents, such as demand deposits). The full value of a securities portfolio (including the part comprised of non-securities assets) that is subject to "continuous and regular supervisory or management services" will constitute assets under management. Securities portfolios of clients for whom an investment adviser provides investment advisory services without compensation must be included. Securities valuations should be determined in a manner consistent with the methods employed by the investment adviser in client reports and in calculating advisory fees. Valuations will be required annually (see "IMPLICATIONS FOR SEC-REGISTERED INVESTMENT ADVISERS-Changes to Form ADV" below).

Continuous and Regular Supervisory or Management Services: An investment adviser will be deemed to be providing "continuous and regular supervisory or management services" with respect to accounts for which the investment adviser has investment discretion and for which the investment adviser provides ongoing management services. Most discretionary accounts will satisfy this test, including accounts which the investment adviser manages without compensation. If only a portion of a securities portfolio receives continuous and regular supervisory or management services, though, only that portion may be included as part of the investment adviser's assets under management. Some non-discretionary accounts might qualify, but only if the investment adviser maintains an on-going responsibility to make recommendations to the account holder and is responsible for the execution of recommended trades that are accepted by the client. The greater the amount of day-to-day responsibility an adviser has with respect to non-discretionary accounts, the greater the likelihood that continuous and regular supervisory or management services are being provided.

Because the assets under management of some investment advisers might fluctuate above and below $25 million, causing needless SEC and state registrations and withdrawals, the SEC has exercised its discretion to raise the threshold for mandatory SEC registration to $30,000,000. Nevertheless, withdrawal from SEC registration will not be required unless assets under management dip below $25 million. Although the new rules will permit investment advisers to register with the SEC with assets under management of only $25 million, investment advisers will have a $5 million cushion available to use in determining their SEC or state registration status.

Absence of State Regulation

Investment advisers that are not "regulated or required to be regulated" by the state in which they have their "principal office and place of business" must register with the SEC, even if they do not have $25 million in assets under management. The SEC interprets the term "regulated or required to be regulated" to refer to the mere existence of a state investment adviser statute. Consequently, an investment adviser will be deemed "regulated or required to be regulated" even if it is exempt from state registration under the applicable statute and the SEC will retain regulatory responsibility with respect to a small advisory firm only if:

the investment adviser's principal office and place of business is in a state that has not enacted an investment adviser statute (currently, Colorado, Iowa, Ohio and Wyoming) or

the investment adviser is a foreign investment adviser doing business in the United States.

In light of the changes implemented by the Coordination Act, some commentators expect that the states without investment adviser statutes will consider adopting them now.

State registration requirements vary significantly among states that do regulate investment advisers and depend on the location, nature and number of an investment adviser's clients. As a result, the SEC has knowingly left open a regulatory "gap" in which investment advisers in some states will be left unregulated. While California, for example, requires that an investment adviser with an office in the state register even if he has only one client, investment advisers do not typically have to register in New York until they have 40 clients in the state (although voluntary registration is permitted). It is believed that there are 600 investment advisers in New York eligible to rely on its de minimis registration exemption. As a result, some investment advisers in states such as New York will be completely free of governmental registration requirements unless state laws change.

Form ADV-T

The SEC is in the process of mailing new Form ADV-T to every existing SEC-registered investment adviser. The form will be used to determine who remains an SEC-registered investment adviser and who will be registered with the states. Every SEC-registered investment adviser will have to file Form ADV-T with the SEC by July 8, 1997. Each investment adviser must indicate on the form whether it remains eligible for SEC registration. Calculations of assets under management must be made as of a date no more than ninety (90) days before filing Form ADV-T.

If Form ADV-T indicates that the investment adviser is not eligible for SEC registration, Form ADV-T will serve as the investment adviser's request for withdrawal from registration as of July 8, 1997 (i.e., no Form ADV-W will be needed). If the form indicates that the investment adviser qualifies to be SEC-registered, it may withdraw all of its state registrations on or after July 8. It currently appears that some states will accept Form ADV-T instead of Form ADV-W for this purpose, but it will be necessary to check with the regulatory authorities in each state before filing any forms.

The SEC's database of information from Forms ADV-T will be shared with the states. It is anticipated that two-thirds of the 23,500 SEC-registered investment advisers will be required to withdraw their SEC registrations and be regulated by state securities regulators.

IMPLICATIONS FOR SEC-REGISTERED INVESTMENT ADVISERS

In addition to creating a process by which investment advisers will determine their status as SEC-registered or state-registered investment advisers, the SEC revised several rules that affect those investment advisers who will continue to be SEC-registered, including several changes to Form ADV.

Changes to Form ADV

Schedule I: Form ADV-T will only be filed once, this July. New Schedule I to Form ADV has been adopted for use by new applicants after July 8, 1997 and as an annual report of the information upon which eligibility for SEC registration is based, such as an investment adviser's assets under management. Schedule I will allow the SEC to determine at the time of a new registration application, and on an annual basis thereafter, whether an investment adviser is eligible to be registered with the SEC.

Schedule I must be filed within 90 days after the end of each SEC-registered investment adviser's fiscal year. An investment adviser that reports that it is no longer eligible for SEC registration must withdraw its registration within the 90-day period following the date on which the Schedule I is required to be filed. The grace period is intended to provide investment advisers with sufficient time to comply with the registration requirements of multiple states, particularly where employees may have to pass qualification examinations. Thus, under the new rules an investment adviser whose assets under management fall below $25 million will not be required to report the change or withdraw its SEC registration until after the end of its fiscal year. In essence, temporary fluctuations below $25 million that are restored before year end will have no effect at all. This annual reporting mechanism will reduce the frequency with which investment advisers are required to change regulators as a result of changes in the amount of their assets under management (although an investment adviser may voluntarily withdraw from SEC registration as soon as it is no longer eligible to maintain its SEC registration). Unlike Form ADV-T, however, Schedule I will not operate to withdraw an investment adviser's SEC registration. Investment advisers required to withdraw after July 8, 1997 will have to do so by filing Form ADV-W.

Items 18 and 19: SEC-registered investment advisers will be required to report separately the amounts of their discretionary and non-discretionary assets under management in these items of Part I of Form ADV in the same manner as in Schedule I.

Form ADV-S: With the adoption of Schedule I, Form ADV-S has been rescinded.

State Licensing of Investment Adviser Representatives

Although the Coordination Act preempts state law with respect to SEC-registered investment advisers and their "supervised persons," it allows the states to license, register or qualify an "investment adviser representative" who has a "place of business" in that state, even if the investment adviser itself is SEC-registered. Of the two elements required to be present before a state may subject an investment adviser representative to its regulatory authority, the "place of business" element is likely to be the one on which most questions will turn.

Investment Adviser Representative: The new rules limit the definition an "investment adviser representative" to a "supervised person" more than ten percent (10%) of whose current clients are natural persons. A supervised person is defined as any "partner, officer, director..., or employee of an investment adviser, or other person who provides investment advice on behalf of the investment adviser and is subject to the supervision and control of the investment adviser." Even the sole principal of an advisory firm is subject to the supervision and control of the advisory firm and is, therefore, a supervised person. Natural persons who have at least $500,000 under management with the investment adviser representative's firm, or who the firm reasonably believes have a net worth in excess of $1 million (together with assets held jointly with a spouse) are not counted towards the ten percent threshold.

Accordingly, the definition of investment adviser representative does not include:

  • persons who provide investment advice solely to institutions,
  • persons who provide solely "impersonal" advice, such as preparing an investment
  • newsletter or market timing advice, and
  • persons who are not involved on a regular basis in meeting with, soliciting or communicating with clients.

Non-residents of the United States need not be counted. According to the SEC, its definition of investment adviser representative supersedes any conflicting state law. State regulators have objected to the SEC's position and may raise legal challenges to its enforcement.

While limiting the scope of the term "investment adviser representative," the definition does require advisory firms to consider each person to whom the firm provides advisory services to be a client not only of the firm, but also of any individual supervised person who has substantial responsibilities with respect to the client's account or who, on a regular basis, meets with or communicates advice to the client. If more than one supervised person provides advice to a client, the client should be attributed to each such supervised person.

Place of Business: The new rules only permit states to regulate investment adviser representatives who have a place of business in the state. The new rules define an investment adviser representative's place of business to be an office at which the investment adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates to clients and any other location that is held out to the general public as a location at which such services are performed (whether or not on a regular basis). Places of business from which services are "regularly" provided should be easy to identify. Whether a location from which services are provided only sporadically is a "place of business" will depend on whether the location is being "held out" to the public.

Holding out would, for example, include publishing information in a professional directory or a telephone listing, or distributing advertisements, business cards, stationery, or similar communications that identify the location as one at which the investment adviser representative is or will be available to meet or communicate with clients. Under the new definition, the location need not be a permanent one. Temporary offices as well as other locations at which services may be provided, such as a hotel or an auditorium, can constitute a "place of business". Frequency of use will not be a determinative consideration. The key element is whether the investment adviser representative has let it generally be known that he or she will conduct advisory business at a particular location. Direct communications to existing clients should not constitute holding out.

Thus, under the new rules, investment adviser representatives who do not advertise or otherwise hold out to the public the locations at which they will meet with or communicate with clients will generally be entirely free of state regulation. Conversely, if an investment adviser representative has a "place of business" in more than one state, each of those states can require the representative to register.

Other State Laws Affecting SEC-Registered Investment Advisers

Solicitors: State laws regulating solicitors who work exclusively for SEC-registered investment advisers are generally preempted unless the solicitor is an investment adviser representative. Accordingly, whether a solicitor for an SEC-registered investment adviser is subject to state qualification requirements depends on whether the solicitor is a partner, officer, director, or employee of an investment adviser or another person subject to the investment adviser's supervision and control who provides investment advice (which may include recommending the adviser's services) to natural persons. The rules are silent as to how much supervision and control will trigger state jurisdiction.

Anti-Fraud Enforcement: All states remain authorized to investigate and bring enforcement actions against SEC-registered investment advisers and associated persons under their anti-fraud laws.

Notice Filing and Fee Requirements: States also retain the authority to receive copies of documents filed with the SEC for notice purposes, to require consents to service of process, and to impose fees on investment advisers. The states are precluded from raising the fees that were in effect at the time the Coordination Act was enacted (October 11, 1996).

IMPLICATIONS FOR ADVISERS INELIGIBLE FOR SEC REGISTRATION

National de Minimis Exemption

As noted above, states may not require the registration of an investment adviser who is registered with the SEC. Generally, a state is free to regulate any investment adviser who is not SEC-registered and either has a place of business in the state or has clients who are residents of the state. States may not, however, require the registration of an investment adviser who does not have a place of business in the state and who has had fewer than six (6) clients who are residents of the state during the preceding twelve (12) month period (the "National de Minimis Exemption").

The new rules treat as a single "client" for this purpose:

a natural person and

  • (i) any relative, spouse or relative of the spouse of that person sharing the same principal residence, and
  • (ii) that person's minor children (whether or not they share the same principal residence), and
  • (iii) all accounts of which such persons are the sole primary beneficiaries, and
  • (iv) all trusts of which such persons are the sole primary beneficiaries,
  • a corporation, general partnership, trust, or other legal entity (other than a limited partnership or a trust included in (iv) above) that receives investment advice based on its own investment objectives, rather than the objectives of its individual owners, and
  • a limited partnership that would be treated as one client under Rule 203(b)(3)-1.

Rule 203(b)(3)-1 is the existing safe harbor rule defining when a limited partnership may be treated as a single client for purposes of determining whether an investment adviser may rely on the Federal de Minimis Exemption from SEC registration.

Any person for whom an investment adviser provides investment advisory services without compensation is not deemed to be a client for purposes of either the National de Minimis Exemption from state registration or the Federal de Minimis Exemption from SEC registration. Nevertheless, as noted above, if the assets of such an account are held in a securities portfolio with respect to which the investment adviser provides continuous and regular supervisory or management services, those assets must be included in the determination of the investment adviser's assets under management.

As adopted, the rule provides a safe harbor. It is not intended to specify the exclusive method for determining who may be treated as a single client for purposes of the de Minimis Exemptions. If a client relationship involving multiple persons does not come within the rule, the question of whether it may appropriately be treated as a single client will have to be determined on the basis of the facts and circumstances involved.

Primacy of Law of State of Principal Place of Business

In order to achieve uniformity of regulation, no state may impose requirements greater than those mandated by the state in which the investment adviser maintains its principal place of business with respect to:

  • minimum net capital,
  • bonding or
  • maintenance of books and records.

These uniformity limitations apply, however, only if the adviser is registered or licensed in the state in which it maintains its principal place of business, and is in compliance with the requirements of that state.

The Coordination Act did not affect the application of state law to investment adviser representatives of state-registered investment advisers. A state may continue to require these representatives to register even if they do not have a place of business in the state.

Applicability of the Advisers Act to State-Registered Investment Advisers

Several provisions of the Advisers Act will continue to apply to investment advisers that are registered with a state and not with the SEC. Among them are the provisions that:

  • make it unlawful to engage in fraudulent, deceptive or manipulative practices,
  • prohibit performance-based fees in most advisory contracts,
  • prohibit the assignment of an advisory contract without client consent, and
  • require investment advisers to enforce written procedures designed to prevent the misuse of material nonpublic information (i.e., insider trading).

In addition, the new rules extend the following provisions of the Advisers Act to state-registered investment advisers:

Investment Advisers to ERISA Plans: Because the Employee Retirement Income Security Act of 1974 ("ERISA") protects a plan's named fiduciary from liability for the individual decisions of an investment manager appointed by the fiduciary only if the investment manager is a bank, an insurance company or an investment adviser registered under the Advisers Act, the Coordination Act amended ERISA to include state-registered investment advisers as investment managers, but only until October 11, 1998. In response to the concern that small investment advisers would eventually be denied the ability to manage ERISA accounts, SEC Chairman Levitt has written to Congress urging that the "sunset" provision in the Coordination Act be eliminated in order to permit state-registered investment advisers to continue to serve as investment managers to ERISA accounts.

Reporting Eligibility for SEC Registration: State-registered investment advisers whose assets under management grow to $30 million may (but are not required to) postpone their SEC registration until 90 days after the date the investment adviser is required to report $30 million or more of assets under management to its state securities authority. The ability to postpone SEC registration in this manner is dependent upon being registered in a state that requires the filing of Schedule I or a similar report of assets under management at least annually. If no such report is required annually, SEC registration will be required "promptly" upon exceeding the $30 million registration threshold.

Books and Records: The rule revisions change the record keeping requirements of the Advisers Act to make them applicable only to SEC-registered advisers. However, advisers that register with the SEC after July 8, 1997 must preserve any books and records previously required to be maintained under state law for the same periods of time they are required to be maintained under the existing books and records rule, Rule 204-2. The period during which the books and records were maintained under state law will count toward compliance with the SEC's record keeping requirements.

Performance Fee Arrangements: Generally, only investment advisers exempt from SEC-registration under the Advisers Act (as opposed to advisers prohibited from registering by reason of ineligibility) are permitted to enter into advisory contracts in which compensation is based on a share of the realized and unrealized capital gains in client accounts. Because the existing Rule 205-3 exemption that permits registered advisers to enter into performance fee arrangements with high net worth clients applies only to SEC-registered investment advisers, Rule 205-3 is being amended to make the exemption available to all investment advisers.

Agency Cross Transactions: The Advisers Act prohibits all advisers from engaging in agency cross transactions. Existing Rule 206(3)-2 provides a non-exclusive safe harbor from this prohibition, but it applies only to SEC-registered advisers and broker-dealers. The rule is also being amended to make the safe harbor available to all investment advisers.

Certain Anti-Fraud Rules No Longer Applicable to State-Registered Advisers

Four existing rules will no longer be applicable to investment advisers that are not registered (or required to be registered) with the SEC. The four rules, each of which was promulgated under the general rule prohibiting fraudulent, deceptive, or manipulative acts, practices, and courses of business, are the rules that address the following activities:

  • certain abusive advertising practices,
  • an adviser's custody of client funds and securities,
  • solicitation or referral fee arrangements, and
  • required disclosure regarding an adviser's financial condition and disciplinary history.

Each of these rules, other than the solicitation fee rule, currently applies to all advisers, whether they are registered with the SEC or are exempt. Thus, after July 8, 1997, the application of similar rules to state-registered advisers will be exclusively determined by state law.

* * *

Many states are in the process of amending their laws to bring them into conformity with the Coordination Act. State-registered advisers, in particular, need to pay attention to the changes enacted by the states in which they will be required to be registered.

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

For more information, please contact Howard Neuman in the firm's New York office at (212)818-9200.


[Home | Attorneys | Practice Areas | Articles | Contact Us | New Uploads | Site Search | CyBarrister Page | Immigration Law Center | Hedgefund Resource]