Rules Implementing Amendments to the Investment Advisers Act of 1940
Federal RegisterMay 22, 1997
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SUMMARY: The Commission is adopting new rules and rule amendments under
the Investment Advisers Act of 1940 (``Advisers Act'') to implement
provisions of the Investment Advisers Supervision Coordination Act
(``Coordination Act'') that reallocate regulatory responsibilities for
investment advisers between the Commission and the states. The rules
establish the process by which certain advisers will withdraw from
Commission registration, exempt certain advisers from the prohibition
on Commission registration, and define certain terms. The Commission
also is amending several rules under the Advisers Act to reflect the
changes made by the Coordination Act. The rules and rule amendments are
intended to clarify provisions of the Coordination Act and assist
investment advisers in ascertaining their regulatory status.
EFFECTIVE DATES: July 8, 1997, except for Sec. 275.203A-2, which will
become effective on July 21, 1997. See section iii of this Release.
FOR FURTHER INFORMATION CONTACT: Catherine M. Saadeh, Staff Attorney,
or Cynthia G. Pugh, Staff Attorney, at (202) 942-0691, Task Force on
Investment Adviser Regulation, Division of Investment Management, Stop
10-2, Securities and Exchange Commission, 450 Fifth Street, NW.,
Washington, DC 20549. The Commission has placed a list of frequently
asked questions and answers about Form ADV-T and the changes in the
regulation of investment advisers on the Commission's Internet web
site. This list is located at http://www.sec.gov/rules/othern/
advfaq.htm. The Commission staff will update these questions and
answers from time to time. The Commission urges interested persons with
access to the World Wide Web to review these questions and answers
before contacting Commission staff.
SUPPLEMENTARY INFORMATION: The Commission is adopting new rules 203A-1,
203A-2, 203A-3, 203A-4, 203A-5, 222-1, and 222-2 (17 CFR 275.203A-1,
275.203A-2, 275.203A-3, 275.203A-4, 275.203A-5, 275.222-1, and 275.222-
2), and amendments to rules 203(b)(3)-1, 204-1, 204-2, 205-3, 206(3)-2,
206(4)-1, 206(4)-2, 206(4)-3, and 206(4)-4 (17 CFR 275.203(b)(3)-1,
275.204-1, 275.204-2, 275.205-3, 275.206(3)-2, 275.206(4)-1,
275.206(4)-2, 275.206(4)-3, and 275.206(4)-4), and Form ADV (17 CFR
279.1) under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1) (the
``Advisers Act'' or the ``Act''). The Commission is rescinding Form
ADV-S (17 CFR 279.3) under the Advisers Act.
Table of Contents
Executive Summary
I. Background
II. Discussion
A. Form ADV-T
B. Assets Under Management
1. Securities Portfolios
2. Continuous and Regular Supervisory or Management Services
3. Safe Harbor for State-Registered Investment Advisers
4. Valuation and Reporting of Securities Portfolios
C. Transitions Between State and Commission Registration
1. Transition from Commission to State Registration
a. Annual Reporting of Continued Eligibility
b. 90-Day Grace Period
c. Cancellation of Commission Registration
2. Transition from State to Commission Registration
a. The $5 Million ``Window''
b. Registration with the Commission
D. Exemptions from Prohibition on Registration with the Commission
1. Nationally Recognized Statistical Rating Organizations
2. Pension Consultants
3. Certain Affiliated Investment Advisers
4. Investment Advisers With Reasonable Expectation of
Eligibility
5. Advisers to ERISA Plans
E. Investment Advisers Not Regulated or Required to be Regulated by
States
1. ``Regulated or Required to be Regulated''
2. ``Principal Office and Place of Business''
F. Persons Who Act on Behalf of Investment Advisers
1. ``Investment Adviser Representative''
a. Retail Clients
b. Accommodation Clients
c. Supervised Persons Providing Indirect or Impersonal Advice
d. Dually Registered Investment Adviser Representatives
e. Solicitors
2. ``Place of Business''
G. National De Minimis Standard
H. Scope of State Authority Over Commission-Registered Investment
Advisers
1. Preemption of State Regulatory Authority
2. Preservation of State Anti-Fraud Authority
I. Other Amendments to Advisers Act Rules
1. Amendments to Form ADV; Elimination of Form ADV-S
2. Rule 204-2--Books and Records
3. Rule 205-3--Performance Fee Arrangements
4. Rule 206(3)-2--Agency Cross Transactions
5. Rules 206(4)-1, 206(4)-2, and 206(4)-4--Anti-Fraud Rules
III. Effective Dates
IV. Paperwork Reduction Act
V. Cost/Benefit Analysis
VI. Summary of Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Rules and Forms
Appendix A: Form ADV-T
Appendix B: Schedule I to Form ADV
Executive Summary
The Commission is adopting rules and rule amendments to implement
certain provisions of the Investment Advisers Supervision Coordination
Act. The Coordination Act amended the Advisers Act to, among other
things, reallocate the responsibilities for regulating investment
advisers (``investment advisers'' or ``advisers'') between the
Commission and the securities regulatory authorities of the states.
Generally, the Coordination Act provides for Commission regulation of
advisers with $25 million or more of assets under management, and state
regulation of advisers with less than $25 million of assets under
management. The rules and rule amendments:
Establish the process by which advisers that are currently
registered with the Commission determine their status as Commission-or
state-registered advisers after July 8, 1997, the effective date of the
Coordination Act;
Amend Form ADV to require advisers to report annually to
the Commission information relevant to their status as Commission-
registered advisers;
Relieve advisers of the burden of frequently having to
register and then de-register with the Commission as a result of
changes in the amount of their assets under management;
Provide certain exemptions from the prohibition on
registration with the Commission;
Define certain terms used in the Coordination Act,
including ``investment adviser representative,'' ``principal office and
place of business,'' and ``place of business''; and
Clarify how advisers should count clients for purposes of
both the new national de minimis exemption from state regulation and
the federal de minimis exemption from Commission registration.
[[Page 28113]]
I. Background
On October 11, 1996, President Clinton signed into law the National
Securities Markets Improvement Act of 1996 (``1996 Act'').1
Title III of the 1996 Act, the Coordination Act, makes several
amendments to the Advisers Act. The most significant of these
amendments reallocates federal and state responsibilities for the
regulation of the approximately 23,350 investment advisers currently
registered with the Commission.2 These amendments will
become effective on July 8, 1997.3
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\1\ Pub. L. No. 104-290, 110 Stat. 3416 (1996) (codified in
scattered sections of the United States Code).
\2\ Other amendments made by the 1996 Act to the Advisers Act
include revisions to (i) section 205 (15 U.S.C. 80b-5) to create
additional exceptions to the Advisers Act's limitations on
performance fee arrangements, (ii) section 222 (15 U.S.C. 80b-18a)
to impose certain uniformity requirements on state investment
adviser laws (see infra section II. G of this Release), (iii)
section 203(e) (15 U.S.C. 80b-3(e)) to permit the Commission to deny
or revoke the registration of any person convicted of any felony (or
of any adviser associated with such a person), and (iv) section
203(b) (15 U.S.C. 80b-3(b)) to exempt from registration certain
advisers to church employee pension plans. See sections 210, 304,
305(a), and 508(d) of the 1996 Act.
\3\ See section 308(a) of the Coordination Act. The effective
date of the Coordination Act was originally April 9, 1997. On March
31, 1997, President Clinton signed into law Pub. L. 105-8, which
extended the effective date of the Coordination Act to July 8, 1997.
See 111 Stat. 15 (1997).
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The reallocation of regulatory responsibilities grew out of a
number of Congressional concerns regarding the regulation of investment
advisers. Congress was concerned that the Commission's resources are
inadequate to supervise the activities of the growing number of
investment advisers registered with the Commission, many of which are
small, locally operated, financial planning firms.4 Congress
concluded that if the overlapping regulatory responsibilities of the
Commission and the states were divided by making the states primarily
responsible for smaller advisory firms and the Commission primarily
responsible for larger firms, the regulatory resources of the
Commission and the states could be put to better, more efficient
use.5
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\4\ See S. Rep. No. 293, 104th Cong., 2d Sess. 3-4 (1996)
(hereinafter Senate Report). The number of investment advisers
registered with the Commission increased dramatically from 5,680 in
1980 to approximately 23,350 today. By 1995, the Commission was able
to examine smaller advisers on a routine basis on average only once
every 44 years. See The Securities Investment Promotion Act of 1996:
Hearing on S. 1815 Before the Senate Comm. on Banking, Housing, and
Urban Affairs, 104th Cong., 2d Sess. 36 (1996) (hereinafter Senate
Hearing) (testimony of Arthur Levitt, Chairman, SEC).
\5\ See Senate Report, supra note 4, at 3-4.
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Congress also was concerned with the cost imposed on investment
advisers and their clients by overlapping, and in some cases,
duplicative, regulation.6 In addition to the Commission,
forty-six states regulate the activities of investment advisers under
state investment adviser statutes.7 States generally have
asserted jurisdiction over investment advisers that ``transact
business'' in their state.8 Consequently, many large
advisers operating nationally have been subject to the differing laws
of many states. Industry participants strongly asserted that compliance
with differing state laws has imposed significant regulatory burdens on
these large advisers.9 Congress intended to reduce these
burdens by subjecting large advisers to a single regulatory program
administered by the Commission.10
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\6\ Id. at 2.
\7\ The District of Columbia, Guam, and Puerto Rico also have
enacted statutes regulating investment advisers. See D.C. Code Ann.
sections 2-2631 to -2651 (1994); 22 Guam Code Ann. sections 46201-
46206 (1995); P.R. Laws Ann. tit. 10, sections 861-864 (1976). The
four states that currently do not have investment adviser statutes
are Colorado, Iowa, Ohio, and Wyoming.
\8\ See, e.g., Unif. Sec. Act section 201(c) (1988); Ark. Code
Ann. section 23-42-301(c) (Michie Supp. 1995); Md. Code Ann., Corps
& Ass'ns section 11-401(b) (1993).
\9\ See Senate Hearing, supra note 4, at 153 (Testimony of Mark
D. Tomasko, Executive Vice President, Investment Counsel Association
of America, Inc.) (``In some (advisory) firms, there are one or more
persons whose sole job is to work on State registrations and
requirements.'').
\10\ See Senate Report, supra note 4, at 2.
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The Coordination Act reallocates regulatory responsibilities over
advisers by limiting the application of federal law and preempting
certain state laws. Under new section 203A(a) of the Advisers
Act,11 an investment adviser that is regulated or required
to be regulated as an investment adviser in the state in which it
maintains its principal office and place of business is prohibited from
registering with the Commission unless the adviser (i) has assets under
management of not less than $25 million (or such higher amount as the
Commission may, by rule, deem appropriate), or (ii) is an adviser to an
investment company registered under the Investment Company Act of 1940
(the ``Investment Company Act'').12 The Commission is
authorized to deny registration to any applicant that does not meet the
criteria for Commission registration,13 and is directed to
cancel the registration of any adviser that no longer meets the
criteria for registration.14
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\11\ 15 U.S.C. 80b-3A(a).
\12\ 15 U.S.C. 80a. Any person that is an investment adviser to
an investment company under section 2(a)(20) of the Investment
Company Act (15 U.S.C. 80a-2(a)(20)), including a ``sub-adviser,''
is eligible to register with the Commission, regardless of the
amount of assets under management.
\13\ Section 203(c) of the Advisers Act (15 U.S.C. 80b-3(c)).
\14\ Section 203(h) of the Advisers Act (15 U.S.C. 80b-3(h)).
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On December 20, 1996, the Commission proposed rules and rule
amendments to implement the Coordination Act.15 The proposed
rules would establish the process by which advisers no longer eligible
to register with the Commission would withdraw from Commission
registration, exempt certain advisers from the prohibition on
Commission registration, and define certain terms used in the
Coordination Act. The Commission also proposed to amend several rules
under the Advisers Act to reflect the changes made by the Coordination
Act.
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\15\ Rules Implementing Amendments to the Investment Advisers
Act of 1940, Investment Advisers Act Rel. No. 1601 (Dec. 20, 1996)
(61 FR 68480 (Dec. 27, 1996)) (``Proposing Release'').
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The Commission received 105 comment letters in response to the
proposal, most of which were from investment advisers and their trade
groups and counsel (hereinafter collectively referred to as
``investment adviser commenters''). Twenty-six comment letters were
received from state securities regulators (hereinafter referred to as
``states''), including the North American Securities Administrators
Association, Inc. (``NASAA'').16
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\16\ NASAA represents the 50 U.S. state securities agencies
responsible for the administration of state securities laws, also
known as ``blue sky laws.''
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In preparing these implementing rules for adoption, the Commission
has been guided by the language of the Coordination Act and the policy
considerations that led to its enactment. The Commission does not
believe that it would be appropriate or within its proper authority to
revisit policy decisions made by Congress, as some commenters appear to
have suggested.
II. Discussion
The Commission is adopting several rules implementing the
provisions of the Coordination Act designed to reallocate the
regulatory responsibilities for investment advisers between the
Commission and the states.
A. Form ADV-T
Approximately 23,350 investment advisers currently are registered
with the Commission. Based on information provided by these advisers,
the Commission estimates that more than two-thirds of them would not be
eligible to register with the Commission after July 8, 1997. These
advisers must withdraw from registration or their registrations will be
subject to
[[Page 28114]]
cancellation.17 To allow the Commission to determine each
adviser's status under the Advisers Act, as amended by the Coordination
Act, and to provide for the orderly withdrawal from Commission
registration of advisers that are no longer eligible, the Commission
proposed a transition rule, rule 203A-5.18 Among other
things, rule 203A-5 would require all Commission-registered advisers to
make a one-time filing of a new form, Form ADV-T. The Commission is
adopting the rule and the form largely as proposed.19
Paragraph (a) of rule 203A-5 requires all advisers registered with the
Commission on July 8, 1997 to file a completed Form ADV-T with the
Commission no later than that date.20 Form ADV-T contains
instructions designed to assist an adviser in determining whether it
meets the criteria for Commission registration set forth in the
Coordination Act and the exemptive rules adopted by the
Commission.21 Form ADV-T requires each adviser to indicate
whether it remains eligible for Commission registration. For an adviser
that indicates that it is not eligible for Commission registration,
filing of Form ADV-T serves as the adviser's request for withdrawal
from registration as of July 8, 1997.22 An adviser that does
not return the form or that fails to withdraw voluntarily from
Commission registration if no longer eligible will be subject to having
its registration canceled pursuant to section 203(h).23
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\17\ See supra note 14 and accompanying text.
\18\ See Proposing Release at section II.A.
\19\ 17 CFR 275.203A-5; 17 CFR 279.3.
\20\ 17 CFR 275.203A-5(a). Although Form ADV-T will not be
effective until July 8, 1997, advisers may file Form ADV-T prior to
that date. The registrations of advisers that indicate on Form ADV-T
that they are no longer eligible to be registered with the
Commission will not be withdrawn until July 8, 1997. See rule 203A-
5(c)(1) (17 CFR 275.203A-5(c)(1)).
\21\ See infra sections II.B, II.D, and II.E of this Release.
\22\ See rule 203A-5(c) (17 CFR 275.203A-5(c)); Instruction 6 to
Form ADV-T. An adviser that indicates that it is not eligible for
Commission registration on Form ADV-T is not required to file
separately Form ADV-W (17 CFR 279.2) to withdraw from registration
with the Commission. Commission-registered advisers seeking to
withdraw their state registrations should contact their state
regulators. The Commission will provide NASAA with a copy of each
Form ADV-T filed with the Commission.
\23\ See Instruction 1(f) to Form ADV-T.
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Form ADV-T is attached as Appendix A to this Release. Shortly after
the publication of this Release, the Commission will mail a copy of
Form ADV-T to each investment adviser registered with the Commission.
In addition to a copy of Form ADV-T, each adviser will receive pre-
printed address labels that will assist the Commission in processing
the forms. The Commission asks advisers to return the Form ADV-T they
receive in the mail using these pre-printed labels.
B. Assets Under Management
In most cases, the amount of assets an adviser has under management
will determine whether the adviser will be registered with the
Commission or the states. Section 203A(a)(2) of the Advisers Act
defines ``assets under management'' as the ``securities portfolios''
with respect to which an investment adviser provides ``continuous and
regular supervisory or management services.'' 24 Form ADV-T
contains instructions that clarify when an account is a ``securities
portfolio,'' what services constitute ``continuous and regular
supervisory or management services,'' and the appropriate method of
valuing the account.25
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\24\ 15 U.S.C. 80b-3A(a)(2).
\25\ Instruction 8 to Form ADV-T. Several commenters believed
that the proposed three-step process for determining assets under
management was unnecessarily complex. Each step, however, is
contemplated by section 203A(a), which limits assets under
management to ``securities portfolios'' with respect to which the
adviser provides ``continuous and regular supervisory or management
services,'' and requires that the amount of assets under management
equal or exceed $25 million for Commission registration.
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1. Securities Portfolios
The Commission proposed an instruction to Form ADV-T to define a
``securities portfolio'' as any account at least fifty percent of the
total value of which consists of securities.26 Some
commenters argued that the fifty percent test was too low and suggested
a higher percentage, such as eighty percent. The Commission believes
that Congress used the term ``securities portfolio'' to refer to the
types of accounts typically managed by investment advisers, which
include investments other than securities. The Commission believes that
an account fifty percent of the total value of which consists of
securities may be fairly characterized as a securities portfolio, and
is adopting the fifty percent test substantially as
proposed.27
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\26\ See Proposing Release at section II.B.1.
\27\ Instruction 8(a) to Form ADV-T. Real estate, commodities,
and collectibles are not securities, and therefore should not be
included as securities in determining whether an account meets the
fifty percent test.
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Because advisers in the normal course of business maintain portions
of client accounts in cash, the Commission proposed that cash and cash
equivalents be excluded by an adviser in determining whether an account
is a securities portfolio.28 Two commenters expressed
concern that, under the proposal, if securities in a client's account
were converted to cash to create a defensive investment position, and
the remaining investments in the account were held, for example, in
real estate, the account would not be deemed to be a securities
portfolio. Such a result, one commenter pointed out, seemed at odds
with the purpose of excluding cash when determining whether an account
is a securities portfolio. To avoid such a result, the Commission has
revised the instruction to permit an adviser to treat cash and cash
equivalents as securities for the purpose of determining whether an
account is a securities portfolio.29
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\28\ See Proposing Release at section II.B.1.
\29\ See Instruction 8(a). ``Cash equivalents'' include bank
deposits, certificates of deposit, bankers acceptances, and similar
bank instruments. Instruction 8(a) permits, but does not require,
cash and cash equivalents to be treated as securities. Because cash
and cash equivalents typically comprise a small component of most
advisory accounts, the Commission believes that allowing advisers to
treat these items as securities will not have a significant effect
on the number of advisers that are eligible to register with the
Commission.
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2. Continuous and Regular Supervisory or Management Services
The Commission proposed to provide guidance in an instruction to
Form ADV-T for determining whether an adviser provides an account with
``continuous and regular supervisory or management services'' within
the meaning of section 203A(a)(2). As proposed, the instruction
provided several examples of advisory arrangements and drew conclusions
whether the accounts were provided with continuous and regular
supervisory or management services. Commenters requested that the
Commission provide greater clarity in the instruction, disagreed with
some of the conclusions the Commission drew, and provided the
Commission with examples of additional arrangements that would and
would not receive continuous and regular supervisory or management
services.
The Commission has redrafted the instruction in light of the
commenters' suggestions. As adopted, Instruction 8(c) to Form ADV-T
sets forth general criteria, lists certain factors that should be
considered in determining whether the criteria apply to an account, and
provides examples designed to apply those criteria and factors. This
approach should be more helpful to advisers in determining whether an
account is provided continuous and regular supervisory or management
services.
Instruction 8(c) states that accounts over which an adviser has
discretionary authority and for which it provides ongoing supervisory
or management services receive continuous and regular
[[Page 28115]]
supervisory or management services. The Commission expects that most
discretionary accounts would meet this standard. In addition, a limited
number of non-discretionary advisory arrangements may receive
continuous and regular supervisory or management services, but only if
the adviser ``has an ongoing responsibility to select or make
recommendations, based upon the needs of the client, as to specific
securities or other investments the account may purchase or sell and,
if such recommendations are accepted by the client, is responsible for
arranging or effecting the purchase or sale.'' 30 Thus, an
advisory relationship under which the adviser does not have
discretionary authority must assign to the adviser other
responsibilities typically associated with a discretionary
account.31
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\30\ See Instruction 8(c).
\31\ To enable the Commission to evaluate the claims of advisers
relying on the non-discretionary management of assets as the basis
of eligibility to remain registered with the Commission, Form ADV-T
requires these advisers to append a written statement explaining the
nature of the non-discretionary supervisory or management services.
See Part III, Item (c) of Form ADV-T; Instruction 9 to Form ADV-T.
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Instruction 8(c) provides three factors that advisers should use
(and which the Commission will use) in applying these general
principles. These factors are the terms of the advisory contract, the
form of compensation, and the management practice of the adviser. No
single factor is determinative. For example, advisers that provide
portfolio management services are typically compensated on the basis of
a percentage of the amount of assets under management averaged over
some period of time. The use of this type of a compensation arrangement
would tend to suggest that the account receives continuous and regular
supervisory or management services, although a different compensation
arrangement would not preclude that conclusion.
3. Safe Harbor for State-Registered Investment Advisers
The Commission recognizes that section 203A(a)(2) does not and the
instructions to Form ADV-T do not provide a ``bright line'' test as to
whether a particular arrangement involves the provision of continuous
and regular supervisory or management services. The Commission,
therefore, is adopting rule 203A-4, which provides a safe harbor from
Commission registration for an adviser that is registered with a state
securities authority (rather than the Commission) based on a reasonable
belief that it is not required to register with the Commission because
it does not have sufficient assets under management.32
Commenters strongly supported the rule's adoption.
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\32\ 17 CFR 275.203A-4.
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Under rule 203A-4, the Commission will not assert a violation of
the Advisers Act for failure to register with the Commission (or to
comply with the provisions of the Advisers Act to which an adviser is
subject if required to register) if the adviser reasonably believes
that it does not have sufficient assets under management (at least $30
million) and is therefore not required to register with the
Commission.33 This safe harbor is available only to an
adviser that is registered with the state in which it has its principal
office and place of business.
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\33\ As discussed infra, the Commission is increasing the $25
million assets under management threshold for mandatory Commission
registration to $30 million, and providing an optional exemption
from the prohibition on registering with the Commission for advisers
having between $25 and $30 million of assets under management. See
infra section II.C.2.a of this Release.
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4. Valuation and Reporting of Securities Portfolios
Under a proposed instruction to Form ADV-T, once an adviser has
determined that an account is a ``securities portfolio'' that receives
``continuous and regular supervisory or management services,'' the
entire value of the account would be included in determining the amount
of the adviser's assets under management. Several commenters objected
to this approach, arguing that only the value of securities should be
included as assets under management. The Commission believes that
including only the value of securities would be inconsistent with
section 203A(a)(2), which requires that ``securities portfolios,'' not
``securities,'' be included in assets under management. The use of the
term ``securities portfolios'' rather than ``securities'' suggests that
once an account is determined to be a securities portfolio, all assets
in the account should be included as assets under
management.34
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\34\ In addition, the Commission believes that a requirement
that advisers segregate the securities components of an account
principally consisting of securities holdings would be unnecessarily
burdensome.
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The Commission is aware that in some cases an adviser may have
responsibility for an account only a portion of which receives
continuous and regular supervisory or management services. As adopted,
Instruction 8(b) to Form ADV-T provides that only the portion of a
securities portfolio that receives continuous and regular supervisory
or management services may be included as part of the adviser's assets
under management.
Under a proposed instruction to Form ADV-T, the value of a
securities portfolio would be determined as of a date no more than ten
business days before the filing of Form ADV-T. Several commenters said
that more time was needed because some advisers obtain information on
the value of client accounts from third parties that provide the
information on a monthly or quarterly basis.35 To provide
advisers with greater flexibility, the Commission has revised the
instruction so that the value of securities portfolios may be
determined as of a date no more than 90 days prior to the date Form
ADV-T is filed with the Commission.36
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\35\ Other commenters noted that additional time may be needed
to value illiquid securities, closely-held businesses, and other
difficult-to-value assets.
\36\ Instruction 8(d) to Form ADV-T. Instruction 8(d) does not
require all the assets in a securities portfolio to be valued as of
the same date. An adviser, however, may not select the dates for
valuation of assets so as to maximize (or minimize) the value of the
adviser's assets under management. An amount determined by such a
method would not, in the Commission's view, reflect the adviser's
actual assets under management.
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The Commission proposed that the method by which the accounts are
valued for purposes of determining assets under management be the same
as that used to value the accounts for purposes of client reporting or
to determine fees for investment advisory services. Commenters
supported this proposal, which the Commission is adopting substantially
as proposed.37
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\37\ See Instruction 8(d).
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C. Transitions Between State and Commission Registration
The Coordination Act contemplates that a state-registered adviser
whose assets under management increase to $25 million will withdraw its
state registration and register with the Commission. Conversely, an
adviser whose assets under management decrease below $25 million will
withdraw its Commission registration and register with a state (or
states). The Commission proposed to use its rulemaking authority under
the Advisers Act, as amended, to reduce the regulatory burdens that may
be caused by these transitions.38
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\38\ See Proposing Release at section II.C.
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1. Transition From Commission to State Registration
a. Annual reporting of continued eligibility. The Commission is
amending Form ADV by adding new Schedule I (``eye'') that requires
advisers to report
[[Page 28116]]
information on an ongoing basis similar to that reported on Form ADV-
T.39 Schedule I will be used both to determine whether new
applicants are eligible for Commission registration, and to determine
whether advisers registered with the Commission continue to be eligible
for such registration. Schedule I must be updated annually, within 90
days after the end of the adviser's fiscal year.40
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\39\ Schedule I is attached to this Release as Appendix B. For a
discussion of the reporting requirements of Form ADV-T, see supra
sections II.A and II.B and of this Release.
\40\ Rule 204-1(a)(1) (17 CFR 275.204-1(a)(1)). As amended, rule
204-1(a) (17 CFR 275.204-1(a) requires advisers to amend Form ADV
annually, regardless of whether data reported on the form changes.
This annual amendment replaces Form ADV-S, which the Commission is
rescinding. Because Form ADV-S is being rescinded, advisers are no
longer required to file the written disclosure statement
(``brochure'') required by rule 204-3 (17 CFR 275.204-3) with the
Commission. The brochure, however, must be maintained as part of the
adviser's books and records, and the Commission will continue to
review these brochures during investment adviser examinations.
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The Commission proposed to require advisers to determine and report
their assets under management annually in order to reduce the frequency
with which advisers are required to change regulators as a result of a
decrease in the amount of assets they have under
management.41 Under the proposal, an adviser whose assets
under management fell below $25 million would not be required to report
this event until after the end of its fiscal year (and not at all
unless its assets under management remained below $25 million at the
time it filed its Schedule I). Some state commenters asserted that an
adviser should be required to withdraw its Commission registration
promptly when its assets under management decrease below $25 million,
or decrease by some percentage below $25 million. The Commission
believes that these approaches could result in some advisers changing
regulators too frequently, and is adopting the annual reporting
requirement as proposed.42
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\41\ See Proposing Release at section II.C.2.
\42\ Commission data suggests that most advisers that will
remain registered with the Commission have assets under management
well in excess of $25 million. It is likely that only a few advisers
each year will be required to move from Commission to state
registration as a result of a decrease of assets under management,
and thus few advisers will be registered temporarily with the
Commission prior to reporting a reduced amount of assets under
management on Schedule I.
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Under rule 204-1(a), a Commission-registered adviser must evaluate
and report its continued eligibility for Commission registration once a
year. An adviser that reports that it is no longer eligible must
withdraw its registration within the 90-day grace period provided by
rule 203A-1(c), discussed below, or be subject to a cancellation
proceeding under section 203(h).43
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\43\ 17 CFR 275.203A-1(c). See Instruction 6 to Schedule I. An
adviser may withdraw from Commission registration as soon as it is
no longer eligible to maintain its registration with the Commission,
or it may wait until filing its annual Schedule I to withdraw. An
adviser who becomes ineligible for Commission registration for
reasons other than the amount of its assets under management also is
permitted to wait until filing its annual Schedule I to withdraw.
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b. 90-day grace period. An adviser that withdraws from Commission
registration will be subject to the registration requirements of one or
more states. To allow such an adviser sufficient time to register under
applicable state statutes, the Commission proposed to provide a ``grace
period'' of 90 days after the date the adviser files its Schedule I
indicating that it would not be eligible for Commission
registration.44 Several commenters argued that 90 days was
insufficient, while a number of state commenters requested that the 90-
day period be shortened, asserting that state registration generally is
effected quickly.
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\44\ See Proposing Release at section II.C.2. The Commission did
not propose a similar grace period in connection with the filing of
Form ADV-T. The Commission presumes that an adviser not eligible to
maintain its registration with the Commission on July 8, 1997 would
already be registered with the appropriate state or states at the
time of filing Form ADV-T. See Proposing Release at note 43.
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In light of these conflicting views, the Commission is adopting the
90-day grace period substantially as proposed.45 A shorter
period may not provide advisers with sufficient time to comply with the
registration requirements of multiple states, particularly where the
adviser must change its business practices or ensure that its employees
prepare for and pass qualification examinations. On the other hand, a
longer period may be unnecessary because, as a result of the annual
determination of eligibility discussed above, a withdrawing adviser
usually will have more than 90 days to come into compliance with state
law. The Commission will monitor the operation of the rule and, if
necessary, will shorten or lengthen the grace period.
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\45\ Rule 203A-1(c). The Commission is adopting rule 203A-1(c)
with a slight revision. Under the rule as proposed, the grace period
would have run from the date on which the adviser filed its Schedule
I to indicate that it was no longer eligible to maintain its
registration. As adopted, however, the grace period begins to run on
the date on which the adviser was obligated by rule 204-1(a) to file
such amendment. Thus, an adviser could not extend the grace period
by failing to timely file Schedule I.
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c. Cancellation of Commission registration. Upon the expiration of
the grace period, the Commission may institute proceedings to cancel
the adviser's registration if it has not yet been
withdrawn.46 As provided under the Advisers Act, the adviser
will be given notice and an opportunity to show why its registration
should not be cancelled.47 Upon a showing by the adviser
that it requires additional time to comply with state registration
requirements, the Commission may stay the cancellation proceeding for a
reasonable period, provided that the adviser has made a good faith
effort to meet the registration requirements of state law and complied
in good faith with the obligation to update Schedule I.
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\46\ If the adviser amends Schedule I during the grace period to
report that it once again has become eligible for Commission
registration (for example, because the amount of its assets under
management increased since the adviser filed its Schedule I), the
Commission will not institute cancellation proceedings.
\47\ See section 211(c) of the Advisers Act (15 U.S.C. 80b-
21(c)); rule 0-5 (17 CFR 275.0-5).
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2. Transition From State to Commission Registration
a. The $5 million ``window''. The Commission proposed to make
Commission registration optional for an adviser having between $25 and
$30 million of assets under management.48 The proposed rule
would permit such an adviser to determine whether and when to change
from state to Commission registration. In order to avoid having to de-
register shortly after registering with the Commission, an adviser
reaching the $25 million assets under management threshold could defer
registration with the Commission. The adviser would not be required to
register with the Commission until its assets under management reached
$30 million, and would not be subject to Commission cancellation of its
registration until its assets under management had fallen below $25
million.
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\48\ See Proposing Release at section II.C.1.
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Most commenters supported the proposed rule as providing useful
flexibility, although some commenters urged that the ``window'' be
increased from $5 to $10 million. The Commission is adopting the rule
as proposed, but will monitor its operation.49 If the $5
million window proves to be inadequate to prevent transient
registration, the Commission will consider expanding the provision.
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\49\ Rule 203A-1 (a), (b) (17 CFR 275.203A-1 (a), (b)).
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b. Registration with the Commission. Under the proposal, a state-
registered adviser would have been required to register with the
Commission promptly when the adviser's assets under
[[Page 28117]]
management reached $30 million.50 In response to the
suggestion of several commenters, the Commission is adopting paragraph
(d) to rule 203A-1 to make the transition from state to Commission
registration parallel with the transition from Commission to state
registration.51
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\50\ See Proposing Release at section II.C.1.
\51\ Rule 203A-1(d) (17 CFR 275.203A-1(d)). Rule 203A-1(d) does
not affect the operation of the $5 million window. An adviser that
has between $25 and $30 million of assets under management is
permitted, but not required, to register with the Commission. Such
an adviser may register with the Commission at any time. Rule 203A-
1(d) addresses only the question of when an adviser is required to
register with the Commission.
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Under rule 203A-1(d), certain advisers whose assets under
management grow to $30 million may (but are not required to) postpone
Commission registration until 90 days after the date the adviser is
required to report $30 million or more of assets under management to
its state securities authority.52 If, however, the assets of
an adviser relying on the rule are less than $30 million when it
registers with the Commission, the adviser's application for
registration would not be made effective.
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\52\ Rule 203A-1(d) is available only to advisers that are
registered in a state that requires Schedule I (or a substantially
similar form or rule) to be filed and annually updated. An adviser
not registered in such a state must register promptly with the
Commission upon reaching $30 million of assets under management.
Rule 203A-1(d) is not available to an adviser whose eligibility for
registration is based on becoming an adviser to an investment
company or becoming eligible for one of the exemptions provided by
rule 203A-2 (17 CFR 275.203A-2). See section II.D of this Release.
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D. Exemptions From Prohibition on Registration With the Commission
Section 203A(c) of the Advisers Act 53 authorizes the
Commission to exempt advisers from the prohibition on Commission
registration if the prohibition would be ``unfair, a burden on
interstate commerce, or otherwise inconsistent with the purposes'' of
section 203A of the Act.54 Pursuant to this authority, the
Commission proposed a new rule, rule 203A-2, that would exempt from the
prohibition on Commission registration four types of advisers that
otherwise would not be eligible for Commission registration. The
Commission is adopting rule 203A-2 substantially as proposed. An
adviser that meets the conditions of a rule 203A-2 exemption is
required by section 203 of the Advisers Act to register with the
Commission, unless it qualifies for an exemption from registration
under section 203(b) of the Act.55
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\53\ 15 U.S.C. 80b-3A(c).
\54\ 15 U.S.C. 80b-3A.
\55\ 15 U.S.C. 80b-3, 80b-3(b).
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1. Nationally Recognized Statistical Rating Organizations
The Commission proposed to exempt from the prohibition on
Commission registration ``nationally recognized statistical rating
organizations'' (``NRSROs''), commonly referred to as rating agencies,
which are registered with the Commission as investment
advisers.56 The Proposing Release explained that, while
NRSROs do not themselves have assets under management, their activities
have a significant effect on the national securities markets and the
operation of federal securities laws. All commenters addressing this
exemption supported it, and the Commission is adopting the exemption as
proposed.57
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\56\ See Proposing Release at section II.D.1.
\57\ Rule 203A-2(a) (17 CFR 275.203A-2(a)).
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2. Pension Consultants
The Commission proposed to exempt from the prohibition on
Commission registration pension consultants that provide investment
advice to employee benefit plans with respect to assets having an
aggregate value of at least $50 million during the adviser's last
fiscal year.58 Pension consultants provide various advisory
services to plans and plan fiduciaries, including assistance in
selecting and monitoring investment advisers that manage assets of such
plans, but may not themselves have assets under management. In the
Proposing Release, the Commission explained that the activities of
pension consultants have a direct effect on the management of billions
of dollars of plan assets, and that it would be inconsistent with the
purposes of the Coordination Act for these advisers to be regulated by
the states, rather than by the Commission.
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\58\ See Proposing Release at section II.D.2.
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Most commenters addressing this exemption supported it, and the
Commission is adopting the exemption substantially as
proposed.59 Several commenters raised questions, however, as
to the scope of the exemption. The exemption is available to advisers
that provide advice to employee benefit plans--not to plan
participants. An adviser that provides advice to plan participants
(e.g., regarding the allocation of the participant's contributions in
an employee directed defined contribution plan) would not be eligible
for the exemption unless the adviser also provides advice to employee
benefit plans with respect to $50 million of plan assets.60
The advice, for example, could concern the funding of a defined benefit
plan or the selection of funding vehicles for a defined contribution
plan, but would have to be provided to the plan or the plan
fiduciary.61
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\59\ Rule 203A-2(b) (17 CFR 275.203A-2(b)). The proposed rule
would have exempted pension consultants to employee benefit plans,
governmental plans, and church plans, each as defined in the
Employee Retirement Income Security Act of 1974 (``ERISA'') (29
U.S.C. 1001), as well as ``(a)ny plan established and maintained by
a state, its political subdivisions, or any agency or
instrumentality of a state or its political subdivisions for the
benefit of its employees.'' The Commission has withdrawn this latter
category in response to a comment noting that these plans come
within ERISA's definition of ``governmental plan.'' The deletion of
this category does not affect the scope of the exemption.
\60\ Although the Coordination Act provides a $25 million
threshold for Commission registration, the Commission is adopting a
$50 million threshold for the pension consultant exemption. This
higher threshold reflects the fact that a pension consultant has
substantially less control over client assets than an adviser that
has assets under management. A higher threshold is necessary to
demonstrate that a pension consultant's activities have an effect on
national markets.
\61\ In determining the aggregate value of advised assets, the
adviser may include only that portion of a plan's assets for which
the adviser provided investment advice (including any advice with
respect to the selection of an investment adviser to manage the
assets). The value of assets must be determined as of the date
during the adviser's most recently completed fiscal year that the
adviser was last employed or retained by contract to provide
investment advice to the plan or plan fiduciary with respect to
those assets. See rule 203A-2(b)(3) (17 CFR 275.203A-2(b)(3)).
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Several commenters requested clarification whether the exemption
would apply to an investment adviser that provides advisory services to
pension plans, but not with respect to ``securities portfolios'' of
those plans. These commenters are (or represent) firms that provide
advice to plans regarding large real estate investments that are held
both directly and indirectly through real estate investment trusts or
other investment vehicles. Many of these firms provide advice with
respect to plan assets worth hundreds of millions of dollars and are
clearly ``large'' enterprises whose activities have an effect on
national markets. As used in rule 203A-2(b), the term ``assets of
plans'' is not limited to securities portfolios, and thus such
investment advisers are eligible for the exemption.
3. Certain Affiliated Investment Advisers
The Commission proposed to exempt from the prohibition on
Commission registration advisers that are affiliated with a Commission-
registered adviser if the principal office and place of business of the
affiliate is the same as
[[Page 28118]]
that of the registered adviser.62 In proposing the
exemption, the Commission explained that when the activities of
affiliated advisers are centrally managed, subjecting them to different
regulatory schemes would be burdensome and inefficient.
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\62\ See Proposing Release at section II.D.3.
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Most commenters that addressed this exemption supported it, stating
that Commission registration of affiliated advisers would be more
efficient. Many, however, urged that the availability of the exemption
not be limited to advisers having the same principal office. In
particular, some commenters suggested that the exemption be expanded to
permit Commission registration of affiliated advisers whose compliance
or books and records systems are integrated with those of a Commission-
registered adviser.
The Commission is not expanding the exemption as suggested because
it is concerned that such an expansion could result in Commission
registration of a large number of small, locally operated advisers,
which Congress intended to be registered with the states.63
The Commission understands that, as a result, some advisers whose
operations are integrated with those of a Commission-registered adviser
will be prohibited from registering with the Commission.64
The Commission will entertain requests for exemptive relief from these
advisers on a case-by-case basis under section 203A(c), and may
consider expanding the exemption if experience suggests expansion would
be appropriate.
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\63\ This could occur as a result of the National Association of
Securities Dealers' (``NASD'') requirement that its member broker-
dealer firms supervise and keep books and records regarding certain
private securities transactions of their registered representatives
who also are registered individually as investment advisers. See
NASD Notice to Members No. 94-44 (May 1994); see also NASD Notice to
Members No. 96-33 (May 1996). Many of these broker-dealer firms are
themselves registered investment advisers that will remain eligible
for Commission registration after July 8, 1997. In some cases, a
firm's registered representatives form a large network of
individually registered investment advisers that use a broker-dealer
firm to effect certain securities transactions on behalf of advisory
clients. A broker-dealer firm's compliance with the obligation to
supervise both its own trades and those that are effected through
unaffiliated broker-dealers may result in its control of these
registered advisers. Under the commenters' suggested approach, this
control, together with the books and records the NASD requires,
might qualify each individually registered adviser for the
exemption, even though each such adviser has only a small, local
business and would not otherwise be eligible for Commission
registration.
\64\ Of course, an adviser may choose to register its affiliates
under its registration as a single registrant. If the adviser and
its affiliates have aggregate assets under management of $25 million
or more, the registrant would meet the threshold for Commission
registration, regardless of whether the operations of the adviser
and the affiliates are integrated.
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Under rule 203A-2(c) as adopted, an adviser that controls, is
controlled by, or is under common control with an adviser eligible to
register (and in fact registered) with the Commission must register
with the Commission if the two advisers have the same principal office
and place of business.65 The rule defines ``control'' as the
power to direct or cause the direction of the management or policies of
an adviser, whether through ownership of securities, by contract, or
otherwise.66
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\65\ 17 CFR 275.203A-2(c). The definition of principal office
and place of business in rule 203A-3(c) (17 CFR 275.203A-3(c))
applies to this rule. See infra section II.E.2 of this Release. The
Commission will consider a Commission-registered adviser and an
affiliated adviser to have the same principal office and place of
business if the principal office of the affiliate is in the
proximate geographic area as the principal office of the registered
adviser.
\66\ In the Proposing Release, the Commission explained that by
proposing rule 203A-2(c), it did not intend to suggest that an
advisory firm may reorganize its operations in order to circumvent
the requirements of the Advisers Act. See Proposing Release at note
54. Thus, for example, an adviser may not avoid application of the
Advisers Act by creating a state-registered affiliate that is not
separately and independently organized.
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4. Investment Advisers With Reasonable Expectation of Eligibility
The Commission proposed an exemption to permit a newly formed
adviser to register with the Commission at the time of its formation if
the adviser has a reasonable expectation that within 90 days it will
become eligible for Commission registration.67 All
commenters addressing this exemption supported it. Many, however, urged
the Commission to give newly formed advisers a longer period than 90
days to become eligible for Commission registration. Some pointed out
that even if the start-up adviser has obtained commitments from
prospective clients for more than $25 million of assets, it may take
more than 90 days for clients (particularly institutional clients) to
transfer their assets to the adviser. To address this concern, the rule
as adopted allows for a period of 120 days.68
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\67\ See Proposing Release at section II.D.4.
\68\ Rule 203A-2(d) (17 CFR 275.203A-2(d)). Some commenters also
asked for clarification as to what constitutes a ``reasonable
expectation.'' In proposing the exemption, the Commission
anticipated that it would be used primarily by persons who start
their own advisory firms after having been employed by or affiliated
with other advisers, and that have received an indication from
clients with substantial assets that they will transfer those assets
to the management of the newly formed adviser. In such a case, an
adviser would have a ``reasonable expectation'' that it would become
eligible for Commission registration in the prescribed time. Other
circumstances, however, also could support an adviser's reasonable
expectation of becoming eligible.
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Under rule 203A-2(d), an adviser is exempt from the prohibition on
Commission registration if, at the time of registration, it is not
registered (or required to be registered) with the Commission or any
state and has a reasonable expectation that it would be eligible for
Commission registration within 120 days after the date its registration
becomes effective.69 At the end of the 120-day period, the
adviser is required to file an amended Schedule I.70 If the
adviser indicates on the amended Schedule I that it has not become
eligible to register with the Commission (e.g., it does not have at
least $25 million of assets under management), the adviser is required
to file a Form ADV-W concurrently with the Schedule I, thereby
withdrawing from registration with the Commission.71
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\69\ The requirement that the adviser not be registered or
required to be registered with the Commission or any state is
designed to ensure that the exemption is available only to start-up
advisers. This requirement must be met at the time the adviser
registers with the Commission. Rule 203A-2(d)(1) (17 CFR 275.203A-
2(d)(1)). A newly formed adviser that registers with the Commission
in reliance on this exemption, however, subsequently may register
with a state or states during the 120-day period in anticipation of
failing to become eligible for Commission registration.
\70\ Rule 203A-2(d)(3) (17 CFR 275.203A-2(d)(3)).
\71\ Id. When registering with the Commission, an adviser
relying on this exemption must include on Schedule E to Form ADV an
undertaking to withdraw from registration if, at the end of the 120-
day period, the adviser would be prohibited from registering with
the Commission. Rule 203A-2(d)(2) (17 CFR 275.203A-2(d)(2)). An
adviser required by rule 203A-2(d)(3) to withdraw from Commission
registration at the end of the 120-day period will not have
available the additional 90-day grace period provided by rule 203A-
1(c) in which to effect the appropriate state registrations.
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5. Advisers to ERISA Plans
Many investment advisers provide advice to employee benefit plans
governed by the Employee Retirement Income Security Act of 1974
(``ERISA''). ERISA protects a plan's named fiduciary from liability for
the individual decisions of an investment manager appointed by the
fiduciary to manage the plan's assets.72 The term investment
manager is defined by ERISA to include certain investment advisers
registered under the Advisers Act, as well as certain banks and
insurance companies.73 Although the Coordination Act amended
ERISA to include state-
[[Page 28119]]
registered investment advisers as investment managers, that amendment
expires two years after enactment, on October 11, 1998.74
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\72\ Section 405(d)(1) of ERISA (29 U.S.C. 1105(d)(1)). See 29
CFR 2509.75-8 (Department of Labor regulations providing
interpretative guidance on ability of plan fiduciaries to delegate
management and control of plan assets to other persons under ERISA).
\73\ Section 3(38) of ERISA (29 U.S.C. 1002(38)). See 29 CFR
2509.75-5 (Department of Labor regulations providing interpretative
guidance on definition of ``investment manager'' under ERISA).
\74\ Section 308(b) of the Coordination Act.
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Several commenters urged the Commission to use its authority under
the Coordination Act to exempt advisers that manage accounts subject to
ERISA. These commenters expressed concern that unless they were
permitted to remain registered with the Commission, they effectively
would be denied the ability to manage ERISA accounts and would be
harmed competitively.
Although the Commission shares these commenters' concerns, the
Commission believes such an exemption would be inconsistent with the
purposes of the Coordination Act and outside the scope of the
Commission's authority. As described above, the grant of exemptive
authority in section 203A(c) was designed to permit Commission
registration of advisers that are larger, national firms, but do not
have $25 million of assets under management. An exemptive rule
conditioned solely on the management of assets of accounts subject to
ERISA could exempt a large number of small, locally operated
advisers.75 In the Commission's view, in order for such a
rule not to be anti-competitive, the rule would have to exempt all
advisers that propose to serve clients regulated under ERISA. If not,
the rule would preclude advisers from entering that market. Thus, such
an exemption could result in most smaller advisers remaining registered
with the Commission--completely frustrating a principal purpose of the
Coordination Act.76
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\75\ To reflect Congress' intent that the Commission regulate
only large, national advisers, the Commission's exemption for
pension consultants is conditioned on the pension consultant's
management of over $50 million of plan assets. See supra note 60.
\76\ The Commission also believes its authority to exempt
advisers to ERISA plans is circumscribed by the express
Congressional determination that the amendment to ERISA provided in
the Coordination Act expire after two years.
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On April 7, 1997, Chairman Levitt wrote to the leadership of the
Congressional committees with jurisdiction over ERISA, urging that
legislation be enacted eliminating the ``sunset'' provision in the
Coordination Act, thus making permanent the amendment of ERISA that
permits state-registered advisers to serve as investment
managers.77
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\77\ Letters from Arthur Levitt, Chairman, SEC (Apr. 7, 1997) to
The Honorable James M. Jeffords, Chairman, Committee on Labor and
Human Resources, U.S. Senate, and The Honorable William F. Goodling,
Chairman, Committee on Education and the Work Force, U.S. House of
Representatives (available in SEC File No. S7-31-96).
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E. Investment Advisers Not Regulated or Required To Be Regulated by
States
Under section 203A(a)(1) of the Advisers Act, advisers that are not
regulated or required to be regulated as investment advisers in the
state in which they have their principal office and place of business
must register with the Commission regardless of the amount of assets
they have under management.78 This provision makes clear
that the Commission will retain regulatory responsibility for an
adviser with a principal office and place of business in a state that
has not enacted an investment adviser statute,79 and for
foreign advisers doing business in the United States. The Coordination
Act, however, does not provide an explanation of when an adviser is
``regulated or required to be regulated'' as an investment adviser, nor
does it define ``principal office and place of business.''
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\78\ 15 U.S.C. 80b-3A(a)(1). The term ``state'' is defined in
section 202(a)(19) of the Advisers Act (15 U.S.C. 80b-2(a)(19)) to
include the District of Columbia, Puerto Rico, the Virgin Islands,
and any other possession of the United States.
\79\ As discussed supra note 7, Colorado, Iowa, Ohio, and
Wyoming currently do not have investment adviser statutes.
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1. ``Regulated or Required To Be Regulated''
Under the proposal, the Commission would have interpreted the
phrase ``regulated or required to be regulated'' in section 203A(a)(1)
to mean ``registered'' with a state.80 Under this
interpretation, an investment adviser exempt from registration with the
state in which it has its principal office and place of business would
be eligible for registration with the Commission, even if it has less
than $25 million of assets under management.
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\80\ See Proposing Release at section II.E.1.
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Most commenters that addressed this issue, including several state
commenters, supported the Commission's proposed interpretation. These
commenters expressed concern that an alternative interpretation under
which an adviser would be deemed ``regulated'' by a state if that state
has in effect an investment adviser statute would result in a
regulatory ``gap'' that leaves clients of advisers exempt from state
registration and below the threshold for Commission registration at
risk. Two commenters, however, objected to the proposed interpretation.
One of these commenters argued that the proposed interpretation would
be inconsistent with the goal of the Coordination Act, which was to
make the Commission primarily responsible for larger advisers with
national businesses and the state primarily responsible for smaller
advisers. This commenter also disagreed with the reading of the
legislative history of the Coordination Act reflected in the Proposing
Release. According to the commenter, the legislative history supports
the view that all advisers with a principal office in a state that has
enacted a statute regulating advisers are prohibited from registering
with the Commission if they do not meet the criteria for Commission
registration.
These comments have caused the Commission to reconsider its
proposed interpretation. As discussed above, the legislative history of
the Coordination Act makes clear that Congress intended the
Coordination Act to result in the Commission regulating larger advisers
and the states regulating smaller advisers.81 The proposed
interpretation, however, would result in the Commission being
responsible for a large number of very small advisers that are not
registered under state law because they qualify for state de minimis
exemptions. It would be inconsistent with the purposes of the
Coordination Act for the Commission to retain responsibility for
advisers whose business activities states have determined are so
limited that they do not warrant their regulatory attention. The
proposed interpretation also would seem to frustrate the purpose of the
Coordination Act to limit significantly the number of advisers
registered with the Commission, since it would permit a substantial
number of very small advisers to remain registered with the
Commission.82
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\81\ See supra notes 4 and 5 and accompanying text.
\82\ One commenter stated that it believes that there are 600
such advisers in New York alone. The proposed interpretation also
seems inconsistent with the goal of the Coordination Act to reduce
regulatory burdens, since it could require a start-up adviser to
first register with the Commission, then move to state registration
as it outgrows the state de minimis exemption, and later, if it
continues to grow, return to Commission registration.
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The Commission believes a better interpretation of section
203A(a)(1) is that an adviser is ``regulated or required to be
regulated'' in the state in which it has its principal office and place
of business if that state has enacted an investment adviser
statute.83 Such a state has asserted its interest in
regulating investment advisers. While a state may provide for
exemptions from its registration requirements or exceptions to its
definition of investment adviser, it does not thereby delegate
regulatory responsibility for
[[Page 28120]]
such advisers to the Commission.84 Upon reconsideration, the
Commission believes the Coordination Act's legislative history supports
this position.85
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\83\ See supra note 7 and accompanying text.
\84\ If a state repeals its investment adviser statute, the
Commission will assume regulatory responsibility for all investment
advisers with a principal office and place of business in that
state.
\85\ The Senate Report explains that the Commission ``will
continue to supervise all advisers that are based in a state that
does not register investment advisers.'' Senate Report, supra note
4, at 4. The Proposing Release and a number of commenters cited this
sentence for the proposition that an adviser is regulated by a state
if it is registered with that state. See Proposing Release at note
59 and accompanying text. In context, however, it appears that the
sentence means that the Commission will retain regulatory
responsibility for small advisers in states that do not register any
advisers.
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State commenters supporting the Commission's proposed
interpretation argued that Congress intended to eliminate regulatory
overlap, not to create a regulatory ``gap'' in which some advisers are
left unregulated. Even under the proposed interpretation, however,
advisers that qualify for registration exemptions under both federal
and state law would continue to be unregulated, and thus it is
difficult to draw any conclusions from the fact that some advisers will
not be registered. To the extent there is a ``gap,'' the Commission
believes that it is more consistent with the Coordination Act for the
gap to be closed by the states, which are given primary responsibility
for regulating advisers that are not eligible for Commission
registration.
2. ``Principal Office and Place of Business''
The Commission is adopting, as proposed, a new rule to define the
term ``principal office and place of business'' to mean the ``executive
office of the investment adviser from which the officers, partners, or
managers of the investment adviser direct, control, and coordinate the
activities of the investment adviser.'' 86
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\86\ Rule 203A-3(c).
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F. Persons Who Act on Behalf of Investment Advisers
In addition to preempting state law with respect to investment
advisers registered with the Commission, the Coordination Act preempts
state law with respect to their ``supervised persons.'' 87 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.'' 88
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\87\ Section 203A(b)(1)(A) of the Advisers Act [15 U.S.C. 80b-
3A(b)(1)(A)].
\88\ Section 202(a)(25) of the Advisers Act (15 U.S.C. 80b-
2(a)(25)).
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The Coordination Act preserves certain state laws with respect to
certain supervised persons of Commission-registered advisers by
providing that a ``State may license, register, or otherwise qualify
any investment adviser representative who has a place of business
located within that State.'' 89 The Coordination Act does
not define ``investment adviser representative,'' nor does it describe
what constitutes a ``place of business.'' In order to provide
clarification, the Commission is adopting definitions of these terms.
The Commission also is providing guidance as to the status of
solicitors for Commission-registered advisers.
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\89\ Section 203A(b)(1)(A).
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1. ``Investment Adviser Representative''
Rule 203A-3(a), as adopted, defines the term ``investment adviser
representative'' to mean a supervised person more than ten percent of
whose clients are natural persons.90 Natural persons who
have at least $500,000 under management with the adviser
representative's investment advisory firm immediately after entering
into the advisory contract with the firm, or who the advisory firm
reasonably believes have a net worth in excess of $1 million (together
with assets held jointly with a spouse) immediately prior to entering
into the advisory contract, are not counted towards the ten percent
threshold.91 Supervised persons who do not, on a regular
basis, solicit, meet with, or otherwise communicate with clients of the
investment adviser, or who provide only impersonal investment advice,
are excluded from the definition of investment adviser
representative.92
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\90\ 17 CFR 203A-3(a).
\91\ Rule 203A-3(a)(3)(i) (17 CFR 275.203A-3(a)(3)(i)). See
infra notes 110-112 and accompanying text.
\92\ Rule 203A-3(a)(2) (17 CFR 275.203A-3(a)(2)). See infra
section of this Release.
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The Commission received extensive comment on the proposed
definition of investment adviser representative. Most investment
adviser commenters asserted that it was important for the Commission to
adopt a single definition of the term in order to effect the purpose of
Congress in creating a more uniform, rational system of adviser
regulation. NASAA and most of the states opposed the adoption of any
Commission definition, arguing that (i) the Commission has no authority
to define the term, (ii) Congress intended for the states to define the
term, and (iii) the states have already defined the term.
There is no contemporaneous legislative history explaining what
Congress meant by the term investment adviser representative in section
203A(b)(1)(A).93 The definition of investment adviser
representative varies substantially from state to state.94
As a result, the incorporation of state law would conflict with one of
the primary goals of the Coordination Act, which is to promote
uniformity of regulation.95 Likewise, the incorporation of
state law would be at odds with Congress' determination to preempt
state laws regulating the offering of mutual fund shares,96
as state investment adviser representative definitions generally
encompass persons who provide
[[Page 28121]]
advisory services to mutual funds.97 Incorporation of state
law also would be inconsistent with Congress' intention to limit the
application of state law to at least some supervised persons. If a
state adopted a sufficiently broad definition of the term investment
adviser representative, the Coordination Act would have no preemptive
effect, since all supervised persons would be subject to state
licensing, registration, or qualification (hereinafter, ``state
qualification requirements.'') 98
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\93\ The House bill, H.R. 3005, 104th Cong., 2d Sess. (1996),
did not, in its original form, address the regulation of investment
advisers. The Senate bill, which is the source of the Coordination
Act, preempted state qualification requirements with respect to
Commission-registered advisers and, as originally introduced, their
employees. See S. 1815, 104th Cong., 2d Sess. section 103 (1996).
The provision preserving state authority over investment adviser
representatives was added by the conference committee. The ``Joint
Explanatory Statement of the Committee of Conference,'' however,
states only that ``[t]he Managers agreed to include certain
amendments to the Investment Advisers Act of 1940 to eliminate
duplication, promote efficiency, and protect investors.'' H.R. Conf.
Rep. No. 864, 104th Cong., 2d Sess. 41 (1996), reprinted in 1996
U.S.C.C.A.N. 3920, 3922. The debates in Congress that preceded final
adoption of the bill reported by the conference committee note only
that the states were given authority under the bill to continue to
regulate ``investment adviser representatives.'' 142 Cong. Rec.
H12,047-01, H12,050 (daily ed. Sept. 28, 1996) (statement of Rep.
Markey) (``At the same time, we agreed that the States should
continue to have authority to license the individual representatives
of investment advisers.'').
\94\ Although most states that require registration of
investment adviser representatives have patterned their definition
of investment adviser representative on the NASAA model definition,
see Unif. Sec. Act section 401(g) (1986), many have modified this
definition, both legislatively and administratively, to include, for
example, any person: who holds himself out as an investment adviser
(Md. Code Ann., Corps & Ass'ns section 11-101(g)(vii) (1993)); who
deals directly with clients of the investment adviser (Arkansas Blue
Sky Rule 102.01); or who prepares reports or analyses concerning
securities (Okla. Stat. Ann. tit. 71 section 2(l) (West Supp. 1997);
Va. Code Ann. section 13.1-501(A) (1993); Definitions and Procedures
for Investment Advisor Representatives and Branch Offices (Order of
Deputy Commissioner of Securities, West Virginia Securities
Division, May 25, 1993, amended eff. Oct. 11, 1995)).
\95\ See Senate Report, supra note 4, at 4 (``Larger advisers,
with national businesses, should be * * * subject to national
rules.'').
\96\ See 1996 Act section 102 (amending section 18(b)(2) of the
Securities Act of 1933 [(15 USC 77r(b)(2)] to preempt state laws
requiring registration of securities issued by investment companies
that are registered or that have filed a registration statement with
the Commission); Senate Report, supra note 4, at 6-7; H. Rep. No.
622, 104th Cong., 2d Sess. 30-31 (1996) [hereinafter House Report].
\97\ The NASAA model definition of investment adviser
representative includes any employee (except clerical or ministerial
personnel) of an investment adviser who ``manages accounts or
portfolios of clients.'' See Unif. Sec. Act section 401(g)(2)
(1986). Most states that define investment adviser representative
include this provision in their definitions. See, e.g., Md. Code
Ann., Corps. & Ass'ns, section 11-101(g)(1)(v) (1993); Mass. Gen.
Laws Ann. ch. 110A, section 401(n) (West Supp. 1996); Nev. Rev.
Stat. section 90.278(1)(d) (Michie Supp. 1995).
\98\ Thus, such a definition would have the effect of reading
out of the Coordination Act the provision in section 203A(b)(1)(A)
preempting state qualification requirements as to supervised persons
of Commission-registered advisers, violating the principle of
statutory interpretation that a statute is to be construed so as to
give effect to all of its language. See, e.g., United States v.
Menasche, 348 U.S. 528, 538-39 (1955).
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The Coordination Act does not contain any direction to incorporate
state law. In light of the many provisions in the 1996 Act designed to
promote uniformity of regulation, the decision of Congress to preempt
state mutual fund regulation, and the preemptive language used by
Congress, the Commission does not believe that Congress intended the
definition of investment adviser representative to incorporate state
law. Rather, the Commission believes that Congress left the term
investment adviser representative undefined with the expectation that
the Commission would use its rulemaking authority to define the term.
The Commission's authority to adopt a rule classifying certain
supervised persons as investment adviser representatives is
clear.99 The ambiguities created by Congress' use of the
undefined term investment adviser representative make it important that
the Commission, as the federal agency charged with administering the
Advisers Act, define the term so that the substantial uncertainties and
costly disputes likely to occur in the absence of such a definition may
be avoided.100 Only by adopting a uniform, national
definition of investment adviser representative can Congress' intent to
``delineate more clearly the securities law responsibilities of federal
and state governments'' be achieved.101
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\99\ Section 211(a) of the advisers Act (15 USC 80b-21(a))
authorizes the Commission to adopt rules ``as are necessary or
appropriate to the exercise of the functions and powers conferred
upon the Commission'' in the Advisers Act and to ``classify persons
and matters within its jurisdiction and prescribe different
requirements for different classes of persons or matters.'' Section
202(a)(17) of the Advisers Act (15 U.S.C. 80b-2(a)(17)) authorizes
the Commission to adopt rules that ``classify, for the purposes of
any portion * * * of (the Advisers Act), persons, including
employees controlled by an investment adviser'' (emphasis added).
\100\ Even if the Commission did not have the explicit grants of
rulemaking authority discussed supra in note 99, the Supreme Court
has recognized that regulatory agencies have authority to adopt
rules to fill any gap left, implicitly or explicitly, by Congress,
see Chevron, U.S.A., Inc. v. Natural Resources Defense Council,
Inc., 467 U.S. 837, 843-44 (1984), and that agency rulemaking may
preempt state law, see City of New York v. Federal Communications
Commission, 486 U.S. 57, 63-64 (1988). The Commission notes that
Congress specifically anticipated that Commission rulemaking would
preempt state law. Section 203A(c) permits the Commission to exempt
advisers from the prohibition on Commission registration, thereby
preempting state law with respect to the exempted advisers.
\101\ See Senate Report, supra note 4, at 2.
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a. Retail clients. As discussed above, Congressional committee
reports provide no indication as to which persons providing investment
advice on behalf of Commission-registered advisers Congress intended
states to continue to register.102 Therefore, in developing
its proposed definition, the Commission examined testimony Congress
received in support of preserving state authority over investment
adviser representatives of Commission-registered
advisers.103 Testimony offered by NASAA urged Congress to
permit states to establish qualification standards for investment
adviser representatives to protect ``retail'' investors.104
The Commission assumed that this testimony persuaded Congress to
preserve state authority over such persons, and proposed to define the
term investment adviser representative in a manner consistent with the
policy concerns expressed in the testimony.105
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\102\ See supra note 93.
\103\ See Proposing Release at note 68 and accompanying text.
\104\ See Senate Hearing, supra note 4, at 125 (testimony of Dee
R. Harris, President, NASAA). See also id. at 178 (statement of
Steven M.H. Wallman, Commissioner, SEC (``My concern is with the
treatment of associated persons of (investment adviser) firms who
provide advice to retail customers.'' (emphasis in original))).
\105\ See Proposing Release at section II.F.1.
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Under the proposed definition, investment adviser representative
would mean a supervised person of an investment adviser, if a
substantial portion of the business of the supervised person is
providing investment advice to clients who are natural persons. The
proposed definition thus drew a distinction between natural persons,
whom the Commission considered to be ``retail investors,'' and
investment companies, businesses, educational institutions, charitable
institutions, and other types of clients. Under the proposed
definition, most investment adviser representatives who provide advice
primarily to natural persons would be subject to state qualification
requirements.
Commenters were divided over whether the definition should
distinguish between retail and other types of clients. Many state
commenters opposed this distinction, arguing there was no basis in the
Coordination Act or its legislative history for limiting state
oversight to adviser representatives that serve retail
clients.106 Many of these commenters referred to the example
of an adviser representative who provides advisory services to small
businesses as the type of supervised person that should be subject to
state qualification requirements. In contrast, many investment adviser
commenters supported the distinction, arguing that it was consistent
with the legislative history cited by the Commission in the Proposing
Release. Several of these commenters also urged the Commission to treat
certain ``high net worth'' clients as institutional clients.
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\106\ Some of these commenters asserted that the Commission
mischaracterized the intent of NASAA in referring to ``retail''
investors in its testimony. The Commission, however, did not base
the proposed rule on the intent of NASAA in giving its testimony,
but rather, on what the members of the Senate committee receiving
NASAA's testimony (and the other members of Congress reviewing the
legislative record) are reasonably likely to have believed NASAA's
position was at the time of its testimony.
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The Commission continues to believe that it is consistent with the
intent of Congress as reflected in the structure and purpose of the
Coordination Act to distinguish between retail and other clients in
defining the term investment adviser representative. While there are
other possible criteria for distinguishing retail clients from other
clients,107 the Commission believes that treating natural
persons as retail clients is consistent with the Coordination Act and
has the advantage of simplicity and ease of
administration.108
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\107\ Dictionaries typically define ``retail'' as the sale in
small quantities to consumers. See, e.g., Webster's II New Riverside
University Dictionary 1003 (1994). Such a definition is not helpful
in this context because, depending on who is viewed as the
``consumer'' of the advice, it leads to a conclusion either that all
businesses are retail clients (because they are obtaining advice for
their own portfolios), or that no businesses are retail clients
(because the ultimate beneficiaries of the advice are the owners of
the businesses).
\108\ Requiring adviser representatives to determine whether a
client is a ``small business'' would complicate the definition and
create uncertainty as to the applicability of state qualification
requirements. If small businesses were treated as retail persons,
adviser representatives presumably would have to obtain income
statements and/or balance sheets from their small business clients,
and might be required to determine whether the income or assets of a
small business client should be aggregated with the client's parent
or affiliate in order to determine whether state qualification
requirements apply.
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[[Page 28122]]
Although small businesses may not be familiar with investing, they
must be familiar with selecting qualified service providers, suppliers,
and other parties with which they contract as a part of their
businesses. Small businesses will receive a brochure setting forth the
business and educational background of prospective advisers and will
have the opportunity to make an informed decision whether the advisers
are qualified.109 Because adviser representatives providing
advice to small businesses also typically provide advice to individual
investors, it is unlikely that the Commission's decision to treat only
natural persons as retail clients will have a significant effect on the
number of adviser representatives subject to state qualification
requirements.
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\109\ Rule 204-3 requires Commission-registered investment
advisers to provide existing and prospective clients with a written
disclosure statement describing the adviser's services and fees,
investment methods and strategies, and education and business
background, as well as other information. See Part II of Form ADV.
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As suggested by several commenters, the Commission is modifying the
rule to permit adviser representatives to exclude certain ``high net
worth'' individuals from treatment as natural persons. Under the rule,
high net worth individuals are those with whom the Commission permits
advisers to enter into a ``performance fee contract.'' 110
Because of their wealth, financial knowledge, and experience, the
Commission has presumed that these individuals are less dependent on
the protections of the provisions of the Advisers Act that prohibit
such fee arrangements.111 The Commission believes that such
individuals similarly do not need the protections of state
qualification requirements. Because of the historical treatment of
wealthy and sophisticated individuals under the federal securities
laws, Congress reasonably could have expected these persons not to be
considered retail investors.112
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\110\ See rule 205-3 (17 CFR 275.205-3).
\111\ See Investment Advisers Act Rel. No. 966 (Nov. 14, 1985)
(50 FR 48556 (Nov. 26, 1985)) (adopting rule 205-3). Rule 205-3
permits a registered investment adviser to be compensated on the
basis of a share of the capital gains on or capital appreciation of
client assets. See infra section II.I.3 of this Release.
Compensation of this type is prohibited by section 205(a)(1) of the
Advisers Act (15 U.S.C. 80b-5(a)(1)) with certain limited
exceptions.
\112\ This conclusion is supported by the determination by
Congress in section 205(e) of the Advisers Act (15 U.S.C. 80b-5(e))
to broaden the authority of the Commission to permit advisers to
enter into performance fee contracts with these persons.
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b. Accommodation clients. The Commission proposed to include in the
definition of investment adviser representative only those supervised
persons a ``substantial portion'' of whose business is providing advice
to natural persons.113 A substantial portion of a supervised
person's business would be providing advice to natural persons if,
during the preceding twelve months, more than ten percent of the
supervised person's clients consisted of natural persons, or more than
ten percent of the assets under management by the adviser attributable
to the supervised person were assets of clients who are natural persons
(the ``ten percent allowance'').
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\113\ See Proposing Release at section II.F.1.
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Most commenters that addressed the proposed ten percent allowance
supported it. Some investment adviser commenters urged the Commission
to increase the allowance to 25 percent. The Commission is adopting the
ten percent allowance substantially as proposed. The Commission
believes that increasing the allowance to 25 percent could result in
supervised persons accepting natural person clients on more than just
an accommodation basis. The Commission notes, however, that the
exclusion of certain high net worth individuals from the ten percent
allowance likely will have the effect of expanding the number of
accommodation clients an adviser representative may
accept.114
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\114\ See supra notes 110-112 and accompanying text.
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Under the proposed rule, the ten percent allowance would have been
measured either by reference to assets under management attributable to
the supervised person (``asset test'') or by reference to clients of
the supervised person (``client test''). Commenters believed that these
tests were too complicated and that the client test alone was
sufficient. No commenters came forth, as the Commission had requested,
with suggestions for making the asset test workable.115 The
Commission is not adopting the asset test, but is concerned that, as a
result, an adviser representative who works on one or a few
institutional or business client accounts may not be able to accept any
accommodation clients because, if she did, more than 10 percent of her
clients would consist of natural persons. The Commission directs the
staff to work with investment advisers whose adviser representatives
may be so affected. If a workable method of addressing this concern is
developed, the Commission will revise the definition of investment
adviser representative.
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\115\ For example, an asset test would have to provide guidance
on how to attribute assets managed by the adviser to a particular
supervised person.
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The Commission also has revised the method of measuring the ten
percent allowance. As proposed, the allowance would have been measured
over the previous twelve month period. The Commission believes that the
proposed approach is too complicated and would inappropriately delay
the applicability of state qualification requirements.116 As
adopted, therefore, the rule requires a supervised person to determine
compliance with the ten percent allowance at all times, with respect to
current clients.117
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\116\ For example, a supervised person who previously provided
advisory services exclusively to institutional clients and who is
reassigned to retail clients could not have been required, under the
proposed rule, to comply with state qualification requirements for
up to a year after being reassigned to retail clients, because the
supervised person would not have been deemed to be an investment
adviser representative until retail clients represented 10 percent
of his clientele over a 12 month period. Conversely, an investment
adviser representative who previously provided advice to retail
clients and who is reassigned to institutional clients could have
been required to continue to meet state qualification requirements
even though she no longer had retail clients, because under the
proposed rule, she would have continued to be an investment adviser
representative until retail clients represented less than 10 percent
of her clientele over a 12 month period.
\117\ Rule 203A-3(a)(1) (17 CFR 275.203A-3(a)(1)). The client
test is measured with respect to all of an adviser representative's
clients nationwide. Supervised persons may rely on the definition of
``client'' in rule 203(b)(3)-1 (17 CFR 275.203(b)(3)-1) for the
purpose of counting clients, except that supervised persons need not
count clients that are not U.S. residents. Rule 203A-3(a)(4) (17 CFR
275.203A-3(a)(4)).
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The Commission recognizes that some advisory firms consider each
person to whom the firm provides advisory services to be a client only
of the firm and not of any individual supervised person. The Commission
believes that such an approach would be inconsistent with the
Coordination Act, and thus a client also should be treated as a client
of a supervised person if the supervised person has substantial
responsibilities with respect to the client's account or communicates
advice to the client. If more than one supervised person provides
advice to a client, the client should be attributed to each supervised
person.
c. Supervised persons providing indirect or impersonal advice. The
[[Page 28123]]
Commission also is adopting an exception from the definition of
investment adviser representative for supervised persons who provide
advice to natural persons, but who do not ``on a regular basis solicit,
meet with, or otherwise communicate with clients.'' 118 This
exception excludes from state qualification requirements personnel of
an adviser who may be involved in the formulation of investment advice
given to natural persons, but who are not directly involved in
providing advice to (or soliciting) clients. In addition, the
Commission is excepting supervised persons who give only impersonal
investment advice.119 This provision excludes personnel who
may be involved, for example, in preparing a newsletter, providing
general market timing advice, or preparing a list of recommended
purchases for inclusion on a web site. No commenters specifically
addressed these provisions, which are being adopted substantially as
proposed.
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\118\ Rule 203A-3(a)(2)(i) (17 CFR 275.203A-3(a)(2)(i)).
\119\ Rule 203A-3(a)(2)(ii) (17 CFR 275.203A-3(a)(2)(ii)).
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d. Dually registered investment adviser representatives. The
Proposing Release requested comment whether an investment adviser
representative that is dually registered as a broker-dealer agent in a
state should be excepted from the definition of investment adviser
representative.120 A number of investment adviser commenters
expressed support for such an exception, arguing that state investment
adviser representative registration of registered broker-dealer agents
is redundant. Many state and other commenters strongly opposed such an
exception, asserting that it would be inappropriate to treat investment
adviser representatives and broker-dealer agents the same since they
perform different functions, are subject to different state examination
requirements,121 and are governed by different regulations
and fiduciary standards. The Commission agrees, and the rule, as
adopted, provides no exception for dually registered broker-dealer
agents.
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\120\ See Proposing Release at section II.F.1.
\121\ The Commission notes, however, that many states accept a
person's receiving a passing grade on a broker-dealer agent
examination in lieu of an investment adviser representative
examination to satisfy state investment adviser representative
qualification requirements. For example, many states accept passage
of Series 63 (NASAA Uniform State Law Exam) and Series 7 (General
Securities Representative Exam) in lieu of investment adviser
representative examinations. See, e.g., Ala. Admin. Code r. 830-X-
3-.08(4); Or. Admin. R. 441-175-120(4) (1994).
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e. Solicitors. In the Proposing Release, the Coordination Act was
interpreted as not generally preempting state regulation of solicitors
for Commission-registered advisers.122 Several commenters
disagreed with this interpretation and asserted that if a solicitor is
an employee of the adviser for which he or she solicits, the
Coordination Act preempts state law unless the solicitor is an
investment adviser representative. The Commission agrees, and is
revising this interpretation.
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\122\ See Proposing Release at section II.F.3. For a description
of solicitors' activities, see Investment Advisers Act Rel. No. 688
(July 12, 1979) (44 FR 42126 (July 18, 1979)) (adopting rule 206(4)-
3 (17 CFR 275.206(4)-3), the cash solicitation rule).
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Section 203A(b) preempts state regulation of ``supervised persons''
of Commission-registered advisers, except those who are investment
adviser representatives. Whether a solicitor for a Commission-
registered adviser is subject to state qualification requirements thus
turns, first, on whether the solicitor is a supervised person, and
second, on whether he or she is an investment adviser representative. A
supervised person is defined in section 202(a)(25) to be (i) any
partner, officer, director (or other person occupying a similar status
or performing similar functions), or employee of an investment adviser,
or (ii) any other person who provides investment advice on behalf of
the investment adviser and is subject to the supervision and control of
the investment adviser. Because solicitation of clients may not involve
providing investment advice on behalf of the adviser, the status of a
solicitor as a supervised person will depend on the whether the
solicitor is a ``partner, officer, director, or employee'' of the
adviser, or an ``other person.'' 123
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\123\ In the Proposing Release, the Commission interpreted the
``provides investment advice on behalf of'' limitation in section
202(a)(25) as applying to all categories of persons in the
definition of supervised persons. Upon reconsideration, the
Commission believes that this limitation should be applied only to
``other persons,'' and not to persons who are ``partners, officers,
directors, or employees.'' As one commenter pointed out, in a draft
of the Coordination Act that preceded the one in which the
definition of ``supervised person'' was added, state investment
adviser regulations would have been preempted as to all employees of
a Commission-registered adviser. The definition of ``supervised
person'' and the ``other persons who provide investment advice''
language were added not to limit the types of employees of
Commission-registered advisers exempted from state qualification
requirements, but to include persons who may not be employees but
assume a similar function (e.g., independent contractors). See
Senate Report, supra note 4, at 4.
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A solicitor who is a partner, officer, director, or employee of a
Commission-registered adviser is a supervised person, and is subject to
state qualification requirements only if the solicitor is an investment
adviser representative under rule 203A-3(a). A third-party solicitor
for a Commission-registered adviser (i.e., a solicitor who is not a
partner, officer, director, or employee of the adviser) is not a
supervised person unless the solicitor provides investment advice on
behalf of the investment adviser and is subject to the supervision and
control of the adviser. 124 Thus, a third-party solicitor
will be subject to state qualification requirements to the extent state
investment adviser statutes apply to solicitors. 125 In some
cases, a solicitor may solicit on behalf of both a state-registered
adviser and a Commission-registered adviser. The Commission believes
that the Coordination Act does not preempt states from subjecting such
a solicitor to state qualification requirements.
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\124\ Regardless of whether a solicitor is a ``supervised
person,'' a solicitor is a ``person associated with an investment
adviser'' with respect to the adviser for which he or she solicits.
See section 202(a)(17). The adviser, therefore, has an obligation to
supervise its solicitors with respect to activities performed on its
behalf. See Investment Advisers Act Rel. No. 688, supra note . A
solicitor for an adviser providing solely impersonal advice is not
necessarily a ``person associated with an investment adviser.'' See
Investment Advisers Act Rel. No. 688, supra note 122, at note 20.
\125\ See, e.g., Ala. Code section 8-6-2(19)(d) (1975); Idaho
Code section 30-1402(14)(d) (Michie Supp. 1995) (defining investment
adviser representative to include certain persons associated with an
investment adviser that solicit for the sale of investment advisory
services). Rule 206(4)-3 will continue to govern cash payments by a
Commission-registered adviser to a solicitor who is subject to state
qualification requirements.
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2. ``Place of Business''
While section 203A(b)(1)(A) preserves the ability of a state to
license, register, or otherwise qualify investment adviser
representatives of Commission-registered advisers, the section limits a
state's authority to only those investment adviser representatives who
have a ``place of business'' within the state. The Commission proposed
to clarify that, for purposes of section 203A(b)(1)(A), a place of
business is any place or office from which the investment adviser
representative regularly provides advisory services or otherwise
solicits, meets with, or communicates to clients.126
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\126\ See Proposing Release at section II.F.2.
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Most commenters, while supporting the adoption of a Commission rule
clarifying the term place of business, criticized the proposed
definition as too vague. Investment adviser commenters
[[Page 28124]]
were concerned with the uncertainty the use of the term ``regularly''
would create. They also were concerned that, as a result of the
uncertainty, they would find it difficult to ensure compliance by their
supervised persons with state qualification requirements. State
commenters were concerned that they would find it difficult to enforce
state qualification requirements because states would be required to
prove that advice had been given on a regular basis at a particular
place. The Commission has revised the definition of place of business
to address these concerns.
As adopted, rule 203A-3(b) defines a place of business of an
investment adviser representative to mean (i) an office at which the
investment adviser representative regularly provides investment
advisory services, solicits, meets with, or otherwise communicates with
clients, and (ii) any other location that is held out to the general
public as a location at which the investment adviser representative
provides investment advisory services, solicits, meets with, or
otherwise communicates with clients.127 For the purposes of
rule 203A-3(b), an adviser representative would be considered to hold
himself out to the general public as having a location at which he
conducts advisory business by, for example, 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 adviser representative
is or will be available to meet or communicate with
clients.128
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\127\ 17 CFR 275.203A-3(b). In response to a number of comments,
the Commission is not adopting the ``itinerant representative''
provision contained in the proposed definition that would have
deemed the residence of each client to be the place of business of
an adviser representative that did not regularly provide advisory
services in any location. That provision is unnecessary under the
revised rule.
\128\ An adviser representative who sends a letter to certain
existing clients indicating, for example, that she will be in their
area and available for a meeting would not have held out the
location of the proposed meeting to the general public for purposes
of rule 203A-3(b)(2) (17 CFR 275.203A-3(b)(2)). Similarly, an
adviser representative that communicates to a defined group under
the terms of an advisory contract the location at which she will be
available would not be holding herself out to the general public for
purposes of rule 203A-3(b)(2). For example, in the case of a
national organization that engages an adviser to provide advisory
services to its members, an adviser representative who communicates
its availability at a certain location to the members (even though
those individuals may not yet be clients) would not be holding
himself out to the general public.
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The definition encompasses permanent and temporary offices as well
as other locations at which an adviser representative may provide
advisory services, such as a hotel or auditorium.129 Whether
an adviser representative will be subject to the qualification
requirements of a state in which the hotel or auditorium is located
will turn on whether the adviser representative has let it generally be
known that he or she will conduct advisory business at the location,
rather than on the frequency with which the adviser representative
conducts advisory business there. This definition should provide a
clearer and more enforceable standard for determining when state
qualification requirements are triggered.
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\129\ The following example discusses the application of the
rule to an investment adviser representative who provides investment
advisory services through an Internet web site to clients in many
states: An adviser representative uses a computer at his home or an
office in State W where he prepares material to be placed on the web
site or distributed over the Internet (but where he does not
``regularly provide investment advisory services, solicit, meet
with, or otherwise communicate with clients''). He also maintains an
office in State X where he evaluates the information provided by
clients and provides information in response to clients. The adviser
representative's web site advertises the representative's physical
office in State Y where the representative meets clients. The
adviser representative e-mails its materials to a web server in
State Z for posting on the web and has a post office box or an agent
in State B to whom clients are instructed to mail checks. Under the
rule, the adviser representative would have places of business in
State X (the state in which he has an office for purposes of the
rule) and State Y (the state in which he holds himself out as
conducting his advisory business), but not in any other state.
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G. National De Minimis Standard
The Coordination Act amends the Advisers Act to add new section
222(d), which makes state investment adviser statutes inapplicable to
advisers that do not have a place of business in the state and have
fewer than six clients who are residents of that state (the ``national
de minimis standard'').130 The Commission proposed a new
rule to define the term ``client'' for purposes of section
222(d).131
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\130\ 15 U.S.C. 80b-18a(d).
\131\ See Proposing Release at section II.G.
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The proposed rule would treat as a single client a natural person
and (i) any relative, spouse, or relative of the spouse of the natural
person sharing the same principal residence, and (ii) all accounts of
which the natural person and such persons are the sole primary
beneficiaries. The proposed rule also would treat as a single client a
corporation, general partnership, limited liability company, trust, or
other legal organization (other than a limited partnership) that
receives investment advice based on its investment objectives rather
than the objectives of its shareholders, partners, members, or
beneficial owners. Under the proposal, a limited partnership would be
counted as a single client if it would be counted as a single client
under rule 203(b)(3)-1.132
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\132\ At the time of the Proposing Release, rule 203(b)(3)-1
provided a safe harbor to count a limited partnership, as opposed to
each limited partner, as a client for purposes of section 203(b)(3)
of the Advisers Act (15 U.S.C. 80b-3(b)(3)). As discussed infra, the
Commission is amending rule 203(b)(3)-1 to address additional client
relationships.
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Commenters stated the Commission's definition of the term
``client'' would provide needed uniformity under the national de
minimis standard. The Commission is adopting a rule defining the term
client, but is making several modifications from the
proposal.133 As suggested by commenters, the final rule also
treats as a single client a natural person and (i) that person's minor
children (whether or not they share the natural person's principal
residence), and (ii) all trusts of which the natural person and/or any
relative or spouse of that person sharing the same principal residence
(or any minor children of that person) are the only primary
beneficiaries. The rule also treats as a single client two or more
corporations, partnerships, or other legal organizations that each
receive investment advice based on the organization's investment
objectives and have identical shareholders, partners, or
beneficiaries.134 Under the rule, any person for whom an
investment adviser provides investment advisory services without
compensation is not deemed to be a client.135
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\133\ See rule 203(b)(3)-1. The Commission also is adopting rule
222-1 (17 CFR 275.222-1), which defines other terms used in section
222. Rule 222-1(a) (17 CFR 275.222-1(a)) defines place of business
in the same manner as rule 203A-3(b), except that the term is
applied to investment advisers rather than investment adviser
representatives. Rule 222-1(b) (17 CFR 275.222-1(b)) defines
principal place of business in the same manner that rule 203A-3(c)
defines principal office and place of business. See supra sections
II.F.2 and II.E.2 of this Release.
\134\ This provision codifies the Division's interpretative
position that trusts with identical beneficiaries could be treated
as a single client. See OSIRIS Management, Inc. (pub. avail. Feb.
17, 1984). The final rule does not require that the beneficial
owners have identical ownership interests in each legal
organization. An adviser could not avoid registration, however, by
arranging nominal common ownership. See section 208(d) (15 U.S.C.
80b-8(d)) (which makes it unlawful generally for any person to do
indirectly any act which it would be unlawful for that person to do
directly under the Advisers Act or rules thereunder).
\135\ The adviser, however, has all of the fiduciary obligations
with respect to such a client that it has with respect to a paying
client. In addition, if the assets of such an account are held in a
securities portfolio with respect to which the adviser provides
continuous and regular supervisory or management services, those
assets must be included in the determination of the adviser's assets
under management. See infra section II.B.1 of this Release. The
Commission intends that the term ``compensation,'' as used in the
rule, have the same meaning as the term used in section 202(a)(11)
of the Advisers Act (15 U.S.C. 80b-2(a)(11)). See Applicability of
the Investment Advisers Act to Financial Planners, Pension
Consultants, and Other Persons Who Provide Investment Advisory
Services as a Component of Other Services, Investment Advisers Act
Rel. No. 1092 (Oct. 8, 1987) (52 FR 38400 (Oct. 16, 1987)), in which
the Division explained that ``compensation'' includes any economic
benefit, whether or not in the form of an advisory fee, and that it
need not be paid directly, but can be provided by a third party.
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[[Page 28125]]
Section 203(b)(3), the federal de minimis provision, exempts from
registration with the Commission certain advisers having fewer than
fifteen clients during the preceding twelve months. Rule 203(b)(3)-1
provides a safe harbor permitting the general partner or other
investment adviser to a limited partnership to count the partnership,
rather than each limited partner, as the client for purposes of section
203(b)(3). The Proposing Release requested comment whether the
Commission should adopt one definition of ``client'' for purposes of
both section 222 and section 203(b)(3) and if so, whether certain
provisions of rule 203(b)(3)-1 should be revised.136
Commenters favored the adoption of one definition of ``client'' to
resolve open questions and provide consistency under both sections.
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\136\ See Proposing Release at note 96 and accompanying text.
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The Commission agrees that one definition has advantages and
therefore is amending rule 203(b)(3)-1 to create one definition of the
term ``client'' for purposes of sections 203(b)(3) and
222(d).137 In taking this action, the Commission has
modified certain provisions of rule 203(b)(3)-1 that were not
consistent with proposed rule 222-2's treatment of other legal
organizations.138 The Commission does not expect these
changes to affect the scope of the relief that has been provided by
rule 203(b)(3)-1. The Commission also has modified the proposed rule to
incorporate the safe harbor approach of rule 203(b)(3)-1. As a safe
harbor, the final rule is not intended to specify the exclusive method
for determining who may be treated as a single client for purposes of
sections 203(b)(3) and 222(d).139 In addition, the final
rule clarifies the treatment of foreign clients for purposes of section
203(b)(3).140
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\137\ Rule 222-2 (17 CFR 275.222-2), as adopted, provides that
for purposes of section 222(d)(2) of the Act, an adviser may rely
upon the definition of client provided by rule 203(b)(3)-1.
\138\ Rule 203(b)(3)-1, as amended, no longer contains a
requirement that the limited partnership interests be securities.
\139\ Where 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 must be determined on
the basis of the facts and circumstances involved. In light of the
inherently factual nature of such determinations, the Commission and
its staff generally will not entertain requests for interpretive
advice with respect to client relationships that do not come within
rule 203(b)(3)-1.
\140\ 17 CFR 275.203(b)(3)-1(b)(5). The rule provides that, for
purposes of section 203(b)(3), an adviser with its principal office
and place of business outside the United States must count only
clients that are United States residents. An adviser with its
principal office and place of business in the United States must
count all clients, regardless of their place of residence. See
generally Vocor International Holding S.A. (pub. avail. Apr. 9,
1990). Clients that are not United States residents need not be
counted for purposes of section 222(d), since the availability of
the national de minimis standard turns on the number of clients who
are residents of the state in question.
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Finally, the Commission wishes to emphasize that rules 203(b)(3)-1
and 222-2define the term ``client'' only for purposes of counting
clients under sections 203(b)(3) and 222(d). Persons that are grouped
together for purposes of those sections may be required to be treated
as separate clients for other purposes under the Advisers Act (and
state investment adviser statutes).
H. Scope of State Authority Over Commission-Registered Investment
Advisers
1. Preemption of State Regulatory Authority
The Coordination Act gives the Commission primary responsibility to
regulate advisers that remain registered with the Commission by
preempting state regulation of those advisers. New section 203A(b)(1)
of the Advisers Act provides that ``(n)o law of any State * * *
requiring the registration, licensing, or qualification as an
investment adviser shall apply to any [adviser registered with the
Commission]. * * * '' 141 States retain authority over
Commission-registered advisers under state investment adviser statutes
to investigate and bring enforcement actions with respect to fraud or
deceit against an investment adviser or a person associated with an
investment adviser; to require filings, for notice purposes only, of
documents filed with the Commission; and to require payment of state
filing, registration, and licensing fees.142
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\141\ 15 U.S.C. 80b-3A(b)(1).
\142\ See section 203A(b)(2) of the Advisers Act (15 U.S.C. 80b-
3A(b)(2)); section 307(a), (b) of the Coordination Act.
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The Proposing Release stated the Commission's view that section
203A(b) preempts not only a state's specific registration, licensing,
or qualification requirements, but all regulatory requirements imposed
by state law on Commission-registered advisers relating to their
advisory activities or services, except those provisions that are
specifically preserved by the Coordination Act.143 As a
result, the Commission concluded that state regulatory provisions, such
as those that establish recordkeeping, disclosure, and capital
requirements, will no longer apply to advisers registered with the
Commission.144
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\143\ See Proposing Release at note 20 and accompanying text.
\144\ See Proposing Release at note 21 and accompanying text.
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The Commission received extensive comment on its interpretation of
the scope of state preemption. Investment adviser commenters strongly
favored the interpretation, while NASAA and many of the state
commenters argued that the interpretation should be narrowed
substantially. NASAA asserted that because the Coordination Act
preempts only state registration requirements, only state regulatory
requirements that ``flow from'' state registration are
preempted.145
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\145\ Several state commenters asserted that, under the
Commission's interpretation of the preemption provision, the
Coordination Act would violate the Tenth Amendment's command that
powers not delegated to the federal government by the Constitution
are reserved to the states. This argument appears to confuse the
scope of preemption (about which some of the commenters and the
Commission disagree) with the constitutional authority of Congress
(and the delegated authority of the Commission) to exclusively
regulate investment advisers registered with the Commission. Section
203A(b) does nothing more than preempt certain state laws regulating
Commission-registered advisers. The Supreme Court has made clear
that the displacement of state law under a federal regulatory scheme
does not violate the Tenth Amendment, provided that it is based on a
valid exercise of Congress' constitutional powers such as those
arising under the Commerce Clause. ``(T)he Federal Government may
displace state regulation even though this serves to `curtail or
prohibit the States' prerogatives to make legislative choices
respecting subjects the States may consider important.'' Federal
Energy Regulatory Commission v. Mississippi, 456 U.S. 742, 759
(1982) (quoting Hodel v. Virginia Surface Mining & Reclamation
Ass'n, Inc., 452 U.S. 264, 290 (1981)). No commenter suggested that
Congress exceeded its Commerce Clause authority in passing the
Coordination Act. See, e.g., section 201 of the Advisers Act (15
U.S.C. 80b-1) (express findings of the effects of investment
advisory activities on interstate commerce).
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The Commission continues to believe that the Coordination Act
broadly preempts state investment adviser statutes with respect to
Commission-registered advisers. While the language of section
203A(b)(1) is not necessarily clear on its face and is susceptible to
different readings,146 in the
[[Page 28126]]
Commission's judgment the legislative history of the Coordination Act
strongly supports broad preemption. Congress intended that Commission-
registered advisers no longer be subject to ``overlapping'' state and
federal regulation,147 but instead be subject to uniform
``national rules.''148 Under NASAA's narrower
interpretation, however, multiple, non-uniform state regulation of
Commission-registered advisers would be preserved. Moreover, the effect
of the preemption provisions of the Coordination Act could be severely
weakened, if not nullified, if a state were to impose regulatory
requirements on advisers not subject to state registration, but who may
be transacting business in the state.149
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\146\ NASAA interprets the language ``[n]o law of any State * *
* requiring the registration, licensing, or qualification'' as
restrictive (i.e., meaning ``no state law that requires * * *''),
while the Commission interprets the same language as descriptive
(i.e., ``no state law, which requires * * *'').
\147\ Senate Report, supra note 4, at 3-4.
\148\ Id. at 4.
\149\ This process could lead to Commission-registered advisers
being subject to a less uniform scheme of regulation than state
advisers, since states are expressly precluded by section 222 (b)
and (c) of the Advisers Act (15 U.S.C. 80b-18a (b), (c)) from
enforcing non-uniform books and records and financial responsibility
rules with respect to state-registered advisers, but not with
respect to Commission-registered advisers.
In its comment letter, NASAA cited Cipollone v. Liggett Group,
Inc., 505 U.S. 504 (1992) for the proposition that the historic
police powers of the states are not to be superseded by a federal
statute unless that is the clear and manifest purpose of Congress.
As discussed in the text above, the Commission believes that such
clear and manifest purpose is demonstrated by the language of the
Coordination Act and the intent of Congress as expressed in the
Coordination Act's legislative history.
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The structure and design of section 203A suggest Congress intended
to broadly preempt state investment adviser law. If Congress simply
preempted all state law with respect to Commission-registered advisers,
such a provision would have been over inclusive.150 If
Congress preempted state investment adviser law by itemizing specific
regulations to be preempted, such a provision would have been under
inclusive and would have led to confusion whether a particular state
regulation was included within a preempted category. Thus, the
Commission believes that section 203A(b)(1) was drafted to describe
what state investment adviser statutes typically require--registration,
licensing, and qualification--in order to preempt statutes containing
these requirements with respect to Commission-registered advisers. This
view of section 203A(b)(1) comports with the express intent of Congress
to subject larger advisers to a uniform, national regulatory regime. It
also explains why Congress believed it was necessary to preserve
certain state authority. If section 203A(b)(1) preempts only the
specific registration, licensing, and qualification requirements of
state investment adviser statutes, Congress would not have had to
preserve the authority of states to investigate and enforce
fraud.151
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\150\ Such a provision, for example, would preempt areas of
state law such as labor and employment laws, commercial codes, and
even criminal law as it applies to Commission-registered advisers.
\151\ See supra note 142 and accompanying text.
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2. Preservation of State Anti-Fraud Authority
Section 203A(b)(2) preserves state authority to investigate and
bring enforcement actions with respect to fraud or deceit against a
Commission-registered adviser or a person associated with a Commission-
registered adviser. In the Proposing Release, the Commission
interpreted section 203A(b)(2) as precluding a state from indirectly
regulating the activities of Commission-registered advisers by applying
state requirements that define ``dishonest'' or ``unethical'' business
practices unless the prohibited practices would be fraudulent or
deceptive absent the requirements.152
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\152\ See Proposing Release at notes 23 and 24 and accompanying
text. The Commission, however, does not view section 203A(b)(2) as
preempting state private civil liability laws or the authority of a
state to bring an action against a Commission-registered adviser for
failure to make notice filings or pay fees.
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NASAA and state commenters took strong exception to this
interpretation. Some argued states could continue to enforce business
practice rules as a means of enforcing anti-fraud rules. The Commission
does not believe that the Coordination Act can be read to preserve such
state regulatory authority over Commission-registered advisers. Under
the design of the Coordination Act, Congress gave the responsibility of
adopting and enforcing prophylactic rules with respect to state-
registered advisers to states, and with respect to Commission-
registered advisers to the Commission.\153\ Both the states and the
Commission, however, retain anti-fraud authority with respect to all
advisers.154 On its face, section 203A(b)(2) preserves only
a state's authority to investigate and bring enforcement actions under
its anti-fraud laws with respect to Commission-registered
advisers.155 The Coordination Act does not limit state
enforcement of laws prohibiting fraud. Rather, states are denied the
ability to reinstitute the system of overlapping and duplicative
regulation of investment advisers that Congress sought to
end.156
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\153\ Senate Report, supra note 4, at 4 (``The states should
play an important and logical role in regulating small investment
advisers whose activities are likely to be concentrated in their
home state. Larger advisers with national businesses, should be
registered with the Commission and be subject to national rules.''
(emphasis added)).
\154\ Id. (``Both the Commission and the states will be able to
continue bringing anti-fraud actions against investment advisers
regardless of whether the investment adviser is registered with the
state or the SEC.'')
\155\ While there is no legislative history addressing the scope
of section 203A(b)(2), Congress used similar language to preserve
state anti-fraud laws when it preempted state regulation of
securities offerings in Title I of the 1996 Act. See section
18(c)(1) of the Securities Act of 1933 (15 USC 77r(c)(1)) (``the
(state) securities commission(s) * * * shall retain jurisdiction
under the laws of such State(s) to investigate and bring enforcement
actions with respect to fraud or deceit. * * *'' (emphasis added)).
The House report discussing that section explained that ``(i)n
preserving State laws against fraud and deceit * * * the Committee
intends to prevent the States from indirectly doing what they have
been prohibited from doing directly. * * * The legislation preempts
authority that would allow the States to employ the regulatory
authority they retain to reconstruct in a different form the
regulatory regime * * * that section 18 has preempted.'' House
Report, supra note 96, at 34. The Senate Report discusses a similar
section in the Senate bill, stating that ``(t)he Committee clearly
does not intend for the ``policing'' authority to provide states
with a means to undo the state registration preemptions.'' Senate
Report, supra note 4, at 15.
\156\ Although the Commission is subject to no similar
prohibition with regard to the application of its prophylactic rules
to state-registered advisers, the Commission is making such rules
inapplicable to state-registered advisers in recognition of the
clearly stated purposes of Congress in passing the Coordination Act.
See infra section II.I of this Release.
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I. Other Amendments to Advisers Act Rules
The Commission proposed to amend several rules under the Advisers
Act to reflect changes made by the Coordination Act.157 The
few commenters that addressed these proposed amendments generally
supported them, and the Commission is adopting the amendments as
proposed.
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\157\ See generally Proposing Release at section II.H.
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1. Amendments to Form ADV; Elimination of Form ADV-S
As proposed, the Commission is amending Form ADV to add a new
Schedule I, which is substantially the same as Form ADV-
T.158 Schedule I will be used by the Commission to screen
applicants as to eligibility for Commission registration. Schedule I is
required to be included with all new registrations filed on or after
July 8, 1997. Additionally, the Commission is adopting amendments to
rule 204-1 to require an adviser to file an amended Schedule I annually
within 90 days of the end of the adviser's fiscal year.159
[[Page 28127]]
The Commission also is amending Items 18 and 19 to Part I of Form ADV
to require advisers to determine discretionary and non-discretionary
assets under management in the same manner as required by Instruction 7
of Schedule I.
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\158\ See supra section II.C.1.a of this Release. Schedule I is
attached to this Release as Appendix B.
\159\ 17 CFR 275.204-1(a)(1).
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Like Form ADV-T, Schedule I requires an adviser to indicate whether
it remains eligible for Commission registration. Unlike Form ADV-T,
however, Schedule I does not operate as a request for withdrawal of the
adviser's registration from the Commission; rather, an adviser that
indicates that it is not eligible for Commission registration on
Schedule I is required to withdraw from Commission registration by
filing Form ADV-W.160
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\160\ Instruction 6 to Schedule I. A separate Form ADV-W
continues to be required in order to assure that the Commission
staff is able to act promptly on the withdrawal from registration.
Subject to the grace period under rule 203A-1(c), failure to file
the completed Form ADV-W will subject an adviser to the commencement
of proceedings to cancel its registration.
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The Commission no longer has any regulatory need for advisers to
file Form ADV-S, the annual report for advisers registered under the
Advisers Act, and therefore is eliminating the requirement to file Form
ADV-S, amending rule 204-1 to delete references to Form ADV-S, and
amending rule 279.3 to refer to Form ADV-T.
2. Rule 204-2--Books and Records
In light of the Congressional determination not to subject advisers
registered with the states to substantive federal regulatory
requirements after July 8, 1997, the Commission is amending rule 204-2
to make the recordkeeping requirements of that rule applicable only to
advisers registered with the Commission.161 Additionally,
the Commission is amending rule 204-2 to require advisers that register
with the Commission after July 8, 1997 to preserve any books and
records the adviser was previously required to maintain under state
law.162 These books and records are required to be
maintained in the same manner and for the same period of time as the
other books and records required to be maintained under rule 204-
2(a).163
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\161\ Rule 204-2(a) (17 CFR 275.204-2(a)).
\162\ Rule 204-2(k) (17 CFR 275.204-2(k)).
\163\ Under rule 204-2(k), an adviser changing from state to
federal registration will count the period during which the books
and records were maintained under state law toward compliance with
the Commission's recordkeeping requirement. For example, an adviser
that was state-registered for one year prior to registering with the
Commission will be required to maintain the books and records
required under state law for an additional four years to fulfill the
requirement of rule 204-2(e) (17 CFR 275.204-2(e)) that books and
records be maintained for five years.
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3. Rule 205-3--Performance Fee Arrangements
By its terms, section 205 prohibits all advisers, except those
exempt from registration under section 203(b), from entering into
advisory contracts in which the adviser would be compensated on the
basis of performance of client accounts.164 Therefore,
advisers prohibited from registering with the Commission after July 8,
1997 will continue to be subject to the limitations of section
205.165 Rule 205-3 provides an exemption from these
limitations, but the rule applies only to advisers registered with the
Commission. The Commission is amending rule 205-3 to make this
exemption available to all advisers, including those registered only
under state law after July 8, 1997.166
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\164\ Section 205(a)(1) (15 U.S.C. 80b-5(a)(1)). Section
205(a)(1) provides that ``[n]o investment adviser, unless exempt
from registration pursuant to section 203(b)'' may enter into,
extend, or renew any investment advisory contract that provides for
performance-based compensation.
\165\ State-registered advisers generally would not be exempted
from registration under section 203(b), but rather, would be
prohibited from registration under section 203A(a).
\166\ The extension of rule 205-3's safe harbor to state-
registered advisers does not preclude a state from further
restricting performance fee arrangements.
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4. Rule 206(3)-2--Agency Cross Transactions
By its terms, section 206(3) of the Advisers Act prohibits all
advisers from engaging in agency cross transactions.167 Rule
206(3)-2 provides a non-exclusive safe harbor from this prohibition,
but applies only to certain advisers and broker-dealers registered with
the Commission.168 Therefore, advisers prohibited from
registering with the Commission after July 8, 1997 will continue to be
subject to the limitations of section 206(3). The Commission is
amending rule 206(3)-2 to make this safe harbor available to all
advisers, including those registered only under state law after July 8,
1997.169
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\167\ Section 206(3) (15 U.S.C. 80b-6(3)). Section 206(3) makes
it unlawful for any investment adviser acting as principal for its
own account to knowingly sell any security to, or purchase any
security from, a client, without disclosing to the client in writing
before the completion of the transaction the capacity in which the
adviser is acting and obtaining the client's consent. This
limitation also applies if the adviser is acting as a broker for a
person other than the client in effecting such a transaction.
\168\ 17 CFR 275.206(3)-2.
\169\ The amendment to rule 206(3)-2 was not proposed in the
Proposing Release, but the Commission believes that good cause
exists to adopt the amendment without the notice and comment period
required under section 553(b)(B) of the Administrative Procedure Act
(5 U.S.C. 553(b)(B)). In the Proposing Release, the Commission
proposed to amend several rules under the Advisers Act to reflect
changes made by the Coordination Act by exempting state-registered
advisers from Commission regulation. In most cases, these amendments
involved modifying the scope of the rules to apply only to
Commission-registered advisers. See amendments to rules 204-2,
206(4)-1, 206(4)-2, and 206(4)-4 (discussed in sections II.H.2 and
II.H.4 of the Proposing Release and sections II.I.2 and II.I.5 of
this Release). In another case, however, a rule was proposed to be
broadened in order to make an existing exemption available to all
advisers, including state-registered advisers. See amendments to
rule 205-3 (discussed in section II.H.3 of the Proposing Release and
section II.I.3 of this Release). In preparing the Proposing Release,
the Commission staff surveyed the rules under the Advisers Act to
determine which rules needed to be amended. The need to amend rule
206(3)-2, however, was brought to the attention of the Commission
staff after the publication of the Proposing Release in the Federal
Register. The Commission believes good cause exists to amend rule
206(3)-2 without notice and comment. The decision to amend rule
206(3)-2 does not reflect a specific policy decision, but rather, is
part of the technical amendment of all the rules under the Advisers
Act to reflect the changes of the Coordination Act. The public
effectively was on notice that the Commission was undertaking such a
technical revision to the Advisers Act rules. See Proposing Release
at section II.H.1. (``The Commission is proposing amendments to
several rules under the Advisers Act to reflect changes made by the
Coordination Act.'').
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5. Rules 206(4)-1, 206(4)-2, and 206(4)-4--Anti-Fraud Rules
The Commission has adopted four rules pursuant to its authority
under section 206(4) to ``define, and prescribe means reasonably
designed to prevent * * * acts, practices, and courses of business
[that] are fraudulent, deceptive, or manipulative.'' 170
These rules prohibit certain abusive advertising practices, govern an
adviser's custody of client funds and securities, address the payment
of cash to persons soliciting on behalf of an adviser, and require
certain disclosure to clients regarding an adviser's financial
condition and disciplinary history.171 Each of these rules,
other than the cash solicitation rule, applies to all advisers,
regardless of whether they are registered with the Commission. The
Commission is amending these rules to make them applicable only to
advisers registered (or required to be registered) with the Commission.
By excluding advisers not registered with the Commission from these
rules, the Commission is not suggesting that the practices prohibited
by these rules would not be prohibited by section 206.172
Rather, the Commission recognizes that these rules contain prophylactic
provisions, and
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that after the effective date of the Coordination Act, the application
of these provisions to state-registered advisers is more appropriately
a matter for state law.173
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\170\ 15 U.S.C. 80b-6(4).
\171\ See rules 206(4)-1 to -4 [17 CFR 275.206(4)-1 to -4].
\172\ The anti-fraud provisions of the Advisers Act will
continue to apply to state-registered advisers after July 8, 1997.
See Proposing Release at note 108 and accompanying text.
\173\ The Commission also is amending rule 206(4)-3, the cash
solicitation rule, to correct cross-references that were made
incorrect by changes made to the Advisers Act by the Coordination
Act.
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III. Effective Dates
The effective date of the Coordination Act is July 8, 1997. With
the exception of rule 203A-2, the rules and rule amendments adopted in
this Release will take effect on that same date, July 8, 1997.
Rule 203A-2, which provides four exemptions from the prohibition on
Commission registration,174 will become effective July 21,
1997. The Office of Management and Budget has determined that rule
203A-2 is a ``major rule'' under Chapter 8 of the Administrative
Procedure Act,175 which was added by the Small Business
Regulatory Enforcement Fairness Act of 1996 (``SBREFA'').176
SBREFA requires all final agency rules to be submitted to Congress for
review and requires generally that the effective date of a major rule
be delayed for 60 days pending Congressional review. A major rule may
become effective at the end of the 60-day review period, unless
Congress passes a joint resolution disapproving the rule.177
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\174\ See supra section II.D of this Release.
\175\ 5 U.S.C. 801.
\176\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996). Under
SBREFA, a rule is ``major'' if the rule is likely to result in (i)
an annual effect on the economy of $100 million or more, (ii) a
major increase in costs or prices for consumers or individual
industries, or (iii) significant adverse effects on competition,
investment, or innovation. 5 U.S.C. 804(2).
\177\ 5 U.S.C. 801(a)(3).
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As discussed above, all investment advisers registered with the
Commission on July 8, 1997 are required to file a completed Form ADV-T
with the Commission no later than that date.178 Advisers
that are eligible for an exemption from the prohibition on Commission
registration provided by rule 203A-2 must indicate that eligibility by
checking the appropriate box on Form ADV-T. Although the exemptive rule
will not become effective until July 21, 1997, the instructions to Form
ADV-T require an investment adviser to indicate eligibility for an
exemption assuming that rule 203A-2 will become
effective.179 Advisers that will be eligible for an
exemption under rule 203A-2 will remain registered with the Commission
between July 8, 1997 and the rule 203A-2 effective date, although the
exemptive rule will not be effective during that period. If Congress
were to pass a joint resolution during that time period disapproving
rule 203A-2, the Commission would notify all such advisers that those
exemptions are not available.
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\178\ See supra section II.A of this Release.
\179\ See Instruction 5(a) to Form ADV-T. Likewise, investment
advisers registering with the Commission on or after July 8, 1997,
but before July 21, 1997, should indicate eligibility for an
exemption on Schedule I assuming that rule 203A-2 will become
effective.
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IV. Paperwork Reduction Act
Certain provisions of the rules and rule amendments contain
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et seq.). The
Commission submitted them to the Office of Management and Budget
(``OMB'') for review and OMB has approved them in accordance with 44
U.S.C. 3507(d). The title for the collections of information and their
OMB control numbers are: ``Form ADV''--3235-0049, ``Schedule I''--3235-
0490, ``Rule 203A-5 and Form ADV-T''--3235-0483, and ``Rule 204-2''--
3235-0278, all under the Advisers Act. The Commission did not receive
any comments from the public in response to its request for comments in
the Paperwork Reduction Act section of the Proposing Release. The final
rules as adopted do not include any changes that materially affect the
collections of information, including their requirements, purpose, use,
or necessity. In response to comments from OMB, the Commission revised
part of its Paperwork Reduction Act submission to OMB to reflect one
collection of information on Form ADV, as amended, and another
collection of information on new Schedule I to Form ADV. As described
below, this revision, as well as an updated estimate regarding the
number of respondents to the collections of information, has resulted
in a change to the burden estimates for Form ADV and Schedule I. The
collections of information imposed by Form ADV, Schedule I, rule 203A-5
and Form ADV-T, and rule 204-2 are in accordance with 44 U.S.C.
3507(d). An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid OMB control number.
Form ADV
Form ADV is required by rule 203-1 (17 CFR 275.203-1) to be filed
by every applicant for registration with the Commission as an
investment adviser. Rule 204-1 (17 CFR 275.204-1) sets forth the
circumstances requiring the filing of an amended Form ADV. Registrants
must file an amended Form ADV only when information on the initial Form
ADV filing has changed, either at the end of the fiscal year or
``promptly'' for certain material changes. The Commission amended rule
204-1 to require an adviser additionally to file the cover page of Form
ADV annually within 90 days after the end of the adviser's fiscal year
(along with a new Schedule I, discussed below), regardless of whether
other changes have taken place during the year.
The Commission has revised its estimate of the overall burden hours
required by Form ADV as a result of a change in the number of estimated
respondents. The likely respondents to this collection of information
are all applicants for registration with the Commission after July 8,
1997 as well as all currently-registered advisers who will remain
registered after July 8, 1997. The number of currently-registered
advisers is 23,350, and the Commission estimates that approximately 28
percent of these advisers (6,538) will remain registered after July 8,
1997. The Commission estimates that it will take currently-registered
advisers 1.0672 hours, on average, to fill out and file an amended Form
ADV, and that currently-registered advisers will, on average, file Form
ADV 1.5 times per year. The Commission also estimates that it will take
new applicants 9.0063 hours, on average, to fill out and file their
first Form ADV. The Commission estimates that approximately 750 new
applicants will register with the Commission per year. Of the 750 new
applicants per year, 650 will amend Form ADV an average of 1 time
annually. The estimated 100 newly-formed investment advisers that will
rely on the exemption provided by 203A-2(d) will amend Form ADV an
average of 2 times annually (for purposes of updating their Schedule I
120 days after initial registration). Accordingly, the revised annual
burden estimate is 18,128 total hours in the aggregate for all
respondents to Form ADV.
The collection of information required by Form ADV is mandatory,
and responses are not kept confidential. The amendments to the
instructions to Form ADV and rule 204-1 do not affect the burden of
filing Form ADV itself. The additional burden of filing the Schedule I
is included in the analysis of Schedule I (below).
Schedule I
Schedule I is a new schedule to Form ADV. Schedule I requires an
adviser to declare whether it is eligible for Commission registration.
Schedule I, as
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part of Form ADV, is required to be filed with an investment adviser's
initial application on Form ADV. The rules imposing this collection of
information are found at 17 CFR 275.203-1 and 17 CFR 279.1. The
Commission has not amended rule 203-1 or rule 279.1. Rule 204-1 (17 CFR
275.204-1) sets forth the circumstances requiring the filing of an
amended Form ADV. The Commission amended rule 204-1 to require an
adviser to file an amended Schedule I annually within 90 days after the
end of the adviser's fiscal year. In addition, an investment adviser
relying on the ``reasonable expectation'' exemption from the
prohibition on Commission registration provided by rule 203A-2(d) is
required to file an amended Schedule I to Form ADV at the end of 120
days after its initial registration with the Commission. If the adviser
indicates on the amended Schedule I that it has not become eligible to
register with the Commission, the adviser is required to file a Form
ADV-W concurrently with the Schedule I, thereby withdrawing its
registration with the Commission.180 The collection of the
information required by Schedule I is mandatory and responses will not
be kept confidential.
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\180\ Such an adviser also is required to file a short written
undertaking on Schedule E to Form ADV, simply stating that the
adviser ``will withdraw from registration'' if on the 120th day
after registering with the Commission the adviser does not meet the
eligibility requirements for registration under section 203A of the
Advisers Act and rules thereunder. This requirement imposes only a
nominal burden, subsumed under the burden attributed to the Form
ADV.
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The Commission has revised its estimate of the overall burden hours
required by Schedule I as a result of a change in the number of
estimated respondents and by considering Schedule I as a separate
collection of information from Form ADV. The likely respondents to this
collection of information are all applicants for registration with the
Commission after July 8, 1997 as well as all currently-registered
advisers who will remain registered after July 8, 1997. As noted above,
the Commission estimates that approximately 6,538 advisers will remain
registered with the Commission after July 8, 1997. These currently-
registered advisers will file Schedule I once per year. Of the 750 new
applicants per year, 650 will file Schedule I once per year. The
Commission estimates that approximately 100 newly registered advisers
each year will rely on the ``reasonable expectation'' exemption
provided by rule 203A-2(d), and that these advisers will file Schedule
I twice per year. The Commission estimates that it will take all
advisers, whether currently-registered or new applicants, 52.13
minutes, on average, to fill out and file Schedule I. Accordingly, the
revised annual burden estimate is 6,419 total hours in the aggregate
for all respondents to Schedule I.
Rule 203A-5 and Form ADV-T
Providing the information required by Form ADV-T is mandatory, and
responses will not be kept confidential. Rule 203A-5 and Form ADV-T are
being adopted substantially as proposed, and the burden estimate has
not changed.
Rule 204-2
Providing the information and keeping the books and records
required by rule 204-2 is mandatory, and responses generally are kept
confidential. The amendments to rule 204-2 were adopted substantially
as proposed, and the burden estimate has not changed.
V. Cost/Benefit Analysis
In adopting these rules the Commission has given consideration to
their benefits as well as their costs. Certain of the new rules and
rule amendments, as well as Form ADV-T and new Schedule I to Form ADV,
are necessary to implement the Coordination Act, both initially and on
an on-going basis.181 They will establish the process by
which the Commission will identify those larger advisers that will
remain registered with the Commission and those smaller advisers that
are not eligible for Commission registration. This process will
implement Congress' determinatio
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