# 61 FR 68480: Rules Implementing Amendments to the Investment Advisers Act of 1940 > Federal · Regulations · In force URL: https://www.frixlaw.com/law-library/statutes/FR_PRORULE_96-32799 ## Section - **Citation:** 61 FR 68480 - **Heading:** Rules Implementing Amendments to the Investment Advisers Act of 1940 - **Jurisdiction:** Federal - **Kind:** Regulations - **Status:** In force - **Text as of:** August 14, 2026 - **Source:** Compiled text - **Location:** Federal Register / Vol. 61 / 61 FR 68480 ## Text Part VIII Securities and Exchange Commission _______________________________________________________________________ 17 CFR Parts 275 and 279 Rules Implementing Amendments to the Investment Advisers Act of 1940; Proposed Rule and Suspension of Form ADV-S; Final Rule Proposed Rules SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 275 and 279 [Release No. IA-1601, File No. S7-31-96] RIN 3235-AH07 Rules Implementing Amendments to the Investment Advisers Act of 1940 AGENCY: Securities and Exchange Commission. ACTION: Proposed rules. ----------------------------------------------------------------------- SUMMARY: The Commission is publishing for comment 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 proposed rules would establish the process by which certain advisers would withdraw from Commission registration, exempt certain advisers from the prohibition on Commission registration, and define certain terms. The Commission also is proposing amendments to several rules under the Advisers Act to reflect the changes made by the Coordination Act. The proposed rules and rule amendments are intended to clarify provisions of the Coordination Act and assist investment advisers in ascertaining their regulatory status. DATES: Comments must be received on or before February 10, 1997. define certain terms. The Commission also is proposing amendments to several rules under the Advisers Act to reflect the changes made by the Coordination Act. The proposed rules and rule amendments are intended to clarify provisions of the Coordination Act and assist investment advisers in ascertaining their regulatory status. DATES: Comments must be received on or before February 10, 1997. ADDRESSES: Comments should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Stop 6-9, Washington, D.C. 20549. Comments also may be submitted electronically at the following E-mail address: [email protected]. All comment letters should refer to File No. S7-31-96; this file number should be included on the subject line if E-mail is used. Comment letters will be available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549. Electronically submitted comment letters will be posted on the Commission's Internet web site (http://www.sec.gov). FOR FURTHER INFORMATION CONTACT: Catherine M. Saadeh, Staff Attorney, or Cynthia G. Pugh, Staff Attorney, at (202) 942-0690, Office of Regulatory Policy, Division of Investment Management, Stop 10-2, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. SUPPLEMENTARY INFORMATION: The Commission today is requesting public comment on 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 proposed amendments to rules 204-1, 204-2, 205-3, 206(4)-1, 206(4)-2, and 206(4)-4 [17 CFR 275.204-1, 275.204-2, 275.205-3, 275.206(4)-1, 275.206(4)-2, and 275.206(4)-4], and Form ADV and Form ADV-S [17 CFR 279.1 and 279.3] under the Investment Advisers Act of 1940 [15 USC 80b-1 et seq.] (the ``Advisers Act'' or the ``Act''). Table of Contents A-4, 275.203A- 5, 275.222-1, and 275.222-2], and proposed amendments to rules 204-1, 204-2, 205-3, 206(4)-1, 206(4)-2, and 206(4)-4 [17 CFR 275.204-1, 275.204-2, 275.205-3, 275.206(4)-1, 275.206(4)-2, and 275.206(4)-4], and Form ADV and Form ADV-S [17 CFR 279.1 and 279.3] under the Investment Advisers Act of 1940 [15 USC 80b-1 et seq.] (the ``Advisers Act'' or the ``Act''). Table of Contents Executive Summary I. Background II. Discussion A. Form ADV-T B. Assets Under Management 1. Securities Portfolios 2. Valuation and Reporting of Securities Portfolios 3. Continuous and Regular Supervisory or Management Services 4. Proposed Safe Harbor for State-Registered Investment Adviser C. Transitions Between State and Commission Registration 1. Transition from State to Commission Registration 2. Transition from Commission to State Registration 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 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'' 2. ``Place of Business'' 3. Solicitors G. National De Minimis Standard H. 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 105-3--Performance Fee Arrangements 4. Rules 206(4)-1, 106(4)-2, and 206(4)-4--Anti Fraud Rules I. Provisions of the Advisers that Continue to Apply to State- Registered Investment Advisers III. General Request for Comments IV. Cost Benefit Analysis V. Summary of Regulatory Flexibility Analysis VI. Paperwork Reduction Act VII. Statutory Authority Text of Proposed Rules and Form Executive Summary 05-3--Performance Fee Arrangements 4. Rules 206(4)-1, 106(4)-2, and 206(4)-4--Anti Fraud Rules I. Provisions of the Advisers that Continue to Apply to State- Registered Investment Advisers III. General Request for Comments IV. Cost Benefit Analysis V. Summary of Regulatory Flexibility Analysis VI. Paperwork Reduction Act VII. Statutory Authority Text of Proposed Rules and Form Executive Summary The Commission is proposing rules and rule amendments to implement certain provisions of the Investment Advisers Supervision Coordination Act (``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 requires advisers with $25 million or more of assets under management to register with the Commission; advisers with less than $25 million of assets under management that are registered with a state may not register with the Commission. The proposed rules and rule amendments would: Establish the process by which advisers that are currently registered with the Commission will determine their status as Commission- or state-registered advisers after the effective date of the Coordination Act; Amend Form ADV to require advisers to report information relevant to their status as Commission-registered advisers annually to the Commission; Relieve advisers from the burden of having to frequently 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 the new national de minim s 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 the new national de minimis standard. 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 22,500 investment advisers currently registered with the Commission.2 These amendments will become effective on April 9, 1997.3 --------------------------------------------------------------------------- \1\ National Securities Markets Improvement Act of 1996, Pub. L. 104-290, 110 Stat. 3416 (1996) (to be codified in scattered sections of 15 U.S.C.). \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 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-sponsored employee pension plans. See 1996 Act sections 210, 304, 305(a), and 508(d). \3\ See Coordination Act section 308(a). --------------------------------------------------------------------------- ion 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-sponsored employee pension plans. See 1996 Act sections 210, 304, 305(a), and 508(d). \3\ See Coordination Act section 308(a). --------------------------------------------------------------------------- The reallocation of regulatory responsibilities primarily grew out of Congress' concern 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 --------------------------------------------------------------------------- \4\ The number of investment advisers registered with the Commission increased dramatically from 5,680 in 1980 to approximately 22,500 today. By 1995, the Commission was able to examine smaller advisers on a routine basis on average only once every forty-four years. See Testimony of Arthur Levitt, Chairman, SEC, Concerning S. 1815, the ``Securities Investment Promotion Act of 1996,'' Hearing Before the Senate Comm. on Banking, Housing, and Urban Affairs (June 5, 1996) (hereinafter Senate Hearing), app. at 2. \5\ See S. Rep. No. 293, 104th Cong., 2d Sess. 3-4 (1996) (hereinafter Senate Report). --------------------------------------------------------------------------- f Arthur Levitt, Chairman, SEC, Concerning S. 1815, the ``Securities Investment Promotion Act of 1996,'' Hearing Before the Senate Comm. on Banking, Housing, and Urban Affairs (June 5, 1996) (hereinafter Senate Hearing), app. at 2. \5\ See S. Rep. No. 293, 104th Cong., 2d Sess. 3-4 (1996) (hereinafter Senate Report). --------------------------------------------------------------------------- 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. 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. --------------------------------------------------------------------------- \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 et seq. (1994); Guam Gov't Code section 45201 duce these burdens by subjecting large advisers to a single regulatory program administered by the Commission. --------------------------------------------------------------------------- \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 et seq. (1994); Guam Gov't Code section 45201 (1996); P.R. Laws Ann. tit. 10, sections 861 et seq. (1992). 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 203 (1985); Ark. Stat. Ann. section 23-42-301(c) (1996); Md. Code Ann., Corps & Ass'ns section 11-401(b) (1993). \9\ See Testimony of Mark D. Tomasko, Executive Vice President, Investment Counsel Association of America, Inc., Senate Hearing, at 3 (``In some [advisory] firms, there are one or more persons whose sole job is to work on state registrations and requirements.''). --------------------------------------------------------------------------- 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,10 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'').11 The Commission is authorized to deny registration to any applicant that does not meet the criteria for Commission registration,12 and is directed to cancel the registration of any adviser that no longer meets the criteria for registration.13 ----- propriate), or (ii) is an adviser to an investment company registered under the Investment Company Act of 1940 (the ``Investment Company Act'').11 The Commission is authorized to deny registration to any applicant that does not meet the criteria for Commission registration,12 and is directed to cancel the registration of any adviser that no longer meets the criteria for registration.13 --------------------------------------------------------------------------- \10\ 15 USC 80b-3A(a). \11\ 15 USC 80a-1 et seq. The definition of ``investment adviser'' in the Investment Company Act includes any person who, pursuant to contract, regularly performs investment advisory services on behalf of an adviser. See section 2(a)(20) of the Investment Company Act [15 USC 80a-2(a)(20)]. Thus, any adviser that provides advisory services to a registered investment company pursuant to a contract (including a ``sub-adviser'') would be eligible to register with the Commission, regardless of the amount of assets under management. \12\ Section 203(c) of the Advisers Act [15 USC 80b-3(c)] (as amended by section 303(b)(1) of the Coordination Act). \13\ Section 203(h) of the Advisers Act [15 USC 80b-3(h)] (as amended by section 303(b)(2) of the Coordination Act). --------------------------------------------------------------------------- The requirement that an adviser have assets under management of at least $25 million in order to register with the Commission was designed to limit Commission regulation to advisers likely to be subject to multiple state registration requirements and whose activities affect national markets.14 Congress recognized, however, that some advisers that do not have $25 million of assets under management may still have national businesses.15 Therefore, the Commission was given the authority to exempt advisers from the prohibition on Commission registration if the application of the prohibition would be ``unfair, a burden on interstate commerce, or otherwise inconsistent with the purp s.14 Congress recognized, however, that some advisers that do not have $25 million of assets under management may still have national businesses.15 Therefore, the Commission was given the authority to exempt advisers from the prohibition on Commission registration if the application of the prohibition would be ``unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes'' of section 203A.16 --------------------------------------------------------------------------- \14\ Congress has recognized that securities offerings of investment companies are ``inherently national in nature.'' See H.R. Conf. Rep. No. 864, 104th Cong., 2d Sess. 40 (1996). Therefore, advisers to registered investment companies are permitted to (and, in fact, must) register with the Commission, regardless of the amount of their assets under management. \15\ See Senate Report at 5. \16\ Section 203A(c) of the Advisers Act [15 USC 80b-3A(c)]. The exercise of this exemptive authority would not only permit registration with the Commission, but would preempt state law with respect to the exempted advisers. See section II.D. of this Release. --------------------------------------------------------------------------- By prohibiting certain state-regulated advisers from registering with the Commission, section 203A(a) gives the states the primary, although not exclusive, responsibility to regulate those advisers. Section 206 of the Advisers Act, which contains the anti-fraud provisions of the Act, will continue to apply to state-registered advisers,17 and the Commission retains the authority in section 209 of the Advisers Act to investigate and bring enforcement actions against state-registered advisers for violating applicable provisions of the Act.18 --------------------------------------------------------------------------- s Act, which contains the anti-fraud provisions of the Act, will continue to apply to state-registered advisers,17 and the Commission retains the authority in section 209 of the Advisers Act to investigate and bring enforcement actions against state-registered advisers for violating applicable provisions of the Act.18 --------------------------------------------------------------------------- \17\ 15 USC 80b-6. By its terms, section 206 applies to all persons who meet the definition of ``investment adviser'' in section 202(a)(11) of the Advisers Act [15 USC 80b-2(a)(11)], regardless of whether they are registered with the Commission. \18\ 15 USC 80b-9. Paragraphs (a) and (d) of section 209 of the Advisers Act [15 USC 80b-9(a),(d)] give the Commission authority to investigate all persons who violate provisions of the Advisers Act, to bring actions in federal court to enforce compliance with the Advisers Act, and, if proper showings are made, to obtain permanent or temporary restraining orders or injunctions with respect to these persons. The Commission may bring administrative actions against ``any investment adviser'' under section 203(e) of the Advisers Act, and has cease-and-desist authority under section 203(k) of the Advisers Act [15 USC 80b-3(k)] against any person who ``is violating, has violated, or is about to violate'' any provision of the Act, or who ``is, was, or would be a cause'' of such violation. --------------------------------------------------------------------------- investment adviser'' under section 203(e) of the Advisers Act, and has cease-and-desist authority under section 203(k) of the Advisers Act [15 USC 80b-3(k)] against any person who ``is violating, has violated, or is about to violate'' any provision of the Act, or who ``is, was, or would be a cause'' of such violation. --------------------------------------------------------------------------- The Coordination Act gives the Commission primary responsibility to regulate advisers that remain registered with the Commission by preempting certain state laws with respect to those advisers. New section 203A(b) of the Advisers Act 19 provides that state laws requiring the ``registration, licensing, or qualification as an investment adviser'' do not apply to any adviser registered with the Commission or excepted from the definition of investment adviser under section 202(a)(11) of the Advisers Act. Section 203A(b) preempts not only a state's specific registration, licensing, or qualification requirements, but all regulatory requirements imposed by state law on such investment advisers relating to their advisory activities or services, except those provisions that are specifically preserved by the Coordination Act.20 After April 9, 1997, state investment adviser laws that, for example, establish recordkeeping, disclosure, and capital requirements will no longer apply to advisers registered with the Commission.21 --------------------------------------------------------------------------- heir advisory activities or services, except those provisions that are specifically preserved by the Coordination Act.20 After April 9, 1997, state investment adviser laws that, for example, establish recordkeeping, disclosure, and capital requirements will no longer apply to advisers registered with the Commission.21 --------------------------------------------------------------------------- \19\ 15 USC 80b-3A(b). \20\ If Congress had intended section 203A(b) to preempt only the specific registration, licensing, and qualification requirements of state investment adviser statutes, it would not have had to preserve the authority of states to investigate fraud, require notice filings, and collect fees. See infra notes 22-26 and accompanying text. \21\ See, e.g., Unif. Sec. Act Model Rules 202(d)-1 (minimum financial requirements), 202(e)-1 (bonding requirements), 203(a)-1 (recordkeeping requirements), 203(b)-1 (brochure rule), and 203(c)-1 (financial reporting requirements); N.C. Admin. Code tit. 18 r. 18.1704 (1995) (minimum financial requirements); N.J. Admin. Code tit. 13, section 13:47A-2.3 (1992) (bonding requirements); Conn. Agencies Regs. section 36b-31-14b (1995) (recordkeeping requirements); Md. Regs. Code tit. 2, ch. 5 r. .05 (1994) (brochure rule); Ga. Comp. R. & Regs. r. 590-4-8.14 (1989) (financial reporting requirements). --------------------------------------------------------------------------- mum financial requirements); N.J. Admin. Code tit. 13, section 13:47A-2.3 (1992) (bonding requirements); Conn. Agencies Regs. section 36b-31-14b (1995) (recordkeeping requirements); Md. Regs. Code tit. 2, ch. 5 r. .05 (1994) (brochure rule); Ga. Comp. R. & Regs. r. 590-4-8.14 (1989) (financial reporting requirements). --------------------------------------------------------------------------- The Coordination Act preserves state authority over Commission- registered advisers in three areas.22 First, states may investigate and bring enforcement actions against Commission-registered advisers with respect to fraud and deceit.23 States may not, however, indirectly regulate activities of Commission-registered advisers by enforcing state requirements that define ``dishonest'' or ``unethical'' business practices unless the prohibited practices would be fraudulent absent the requirements.24 Second, states may require Commission-registered advisers to file, for notice purposes only, documents filed with the Commission.25 Thus, for example, a state could require a Commission-registered adviser to file its Form ADV with the state, but could not require the adviser to provide any information on the state filing other than the information that is required by the Commission. Third, states may require Commission- registered advisers to continue to pay state filing, registration, and licensing fees.26 --------------------------------------------------------------------------- ered adviser to file its Form ADV with the state, but could not require the adviser to provide any information on the state filing other than the information that is required by the Commission. Third, states may require Commission- registered advisers to continue to pay state filing, registration, and licensing fees.26 --------------------------------------------------------------------------- \22\ The Coordination Act also preserves state authority over certain persons who act on behalf of Commission-registered advisers. See section II.F. of this Release. \23\ Section 203A(b)(2) of the Advisers Act [15 U.S.C. 80b- 3A(b)(2)]. \24\ 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 U.S.C. 77r(c)(1)] (``the [state] securities commission[s] * * * shall retain jurisdiction under the laws of such [s]tate[s] to investigate and bring enforcement actions with respect to fraud or deceit * * *.''). The House report discussing that section explained that ``[i]n preserving [s]tate laws against fraud and deceit * * * the Committee intends to prevent the [s]tates from indirectly doing what they have been prohibited from doing directly * * *. The legislation preempts authority that would allow the [s]tates to employ the regulatory authority they retain to reconstruct in a different form the regulatory regime * * * that [s]ection 18 has preempted.'' H.R. Rep. No. 622, 104th Cong., 2d Sess. 34 (1996) (hereinafter House Report). \25\ Coordination Act section 307(a). \26\ Coordination Act section 307(b). --------------------------------------------------------------------------- II. Discussion tes to employ the regulatory authority they retain to reconstruct in a different form the regulatory regime * * * that [s]ection 18 has preempted.'' H.R. Rep. No. 622, 104th Cong., 2d Sess. 34 (1996) (hereinafter House Report). \25\ Coordination Act section 307(a). \26\ Coordination Act section 307(b). --------------------------------------------------------------------------- II. Discussion The Commission is proposing 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 22,500 investment advisers are currently 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 April 9, 1997. These advisers must withdraw from registration or their registrations will be subject to cancellation. To help 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 for advisers that are no longer eligible, the Commission is proposing a transition rule, rule 203A-5, and Form ADV-T. Under proposed rule 203A-5, all advisers registered with the Commission on April 9, 1997 would be required to file a completed Form ADV-T with the Commission no later than that date. Form ADV-T would enable an adviser to determine whether it meets the criteria set forth in the Coordination Act for Commission registration, as well as the criteria in the exemptive rules being proposed by the Commission.27 Form ADV-T would require each adviser to declare whether or not it remains eligible for Commission registration d Form ADV-T with the Commission no later than that date. Form ADV-T would enable an adviser to determine whether it meets the criteria set forth in the Coordination Act for Commission registration, as well as the criteria in the exemptive rules being proposed by the Commission.27 Form ADV-T would require each adviser to declare whether or not it remains eligible for Commission registration. For an adviser that declares itself not eligible for Commission registration, Form ADV-T would serve as the adviser's request for withdrawal from registration as of April 9, 1997.28 --------------------------------------------------------------------------- \27\ See section II.D. of this Release. \28\ An adviser that declares itself not eligible for Commission registration on Form ADV-T would not be required to separately file a Form ADV-W [17 CFR 279.2] in order to withdraw from registration with the Commission. --------------------------------------------------------------------------- Proposed rule 203A-5 would require every currently registered adviser to complete, sign, and return Form ADV-T by April 9, 1997. Failure to return the form would be a violation of a Commission rule. Advisers that do not return the form or that fail to voluntarily withdraw from Commission registration despite no longer being eligible would be subject to a cancellation proceeding under section 203(h) of the Advisers Act. Proposed Form ADV-T is attached as an appendix to this release. Comment is requested on proposed Form ADV-T, proposed rule 203A-5, and the proposed process to de-register advisers that are no longer eligible for Commission registration. B. Assets Under Management stration despite no longer being eligible would be subject to a cancellation proceeding under section 203(h) of the Advisers Act. Proposed Form ADV-T is attached as an appendix to this release. Comment is requested on proposed Form ADV-T, proposed rule 203A-5, and the proposed process to de-register advisers that are no longer eligible for Commission registration. 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. The Commission recognizes that it is important that advisers understand how to determine the amount of assets under management and is proposing instructions to Form ADV-T that would provide guidance in this area. 1. Securities Portfolios 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.'' 29 Proposed instruction 7(a) to Form ADV-T would provide that a ``securities portfolio'' means any account at least fifty percent of the total value of which consists of securities. Real estate, commodities, and collectibles are not securities and would not be included. In order to prevent an account in which the adviser has taken a defensive position in cash from being excluded as a ``securities portfolio,'' the instruction would require an adviser to exclude cash and cash equivalents (e.g., demand deposits) in determining whether an account is a securities portfolio.30 --------------------------------------------------------------------------- be included. In order to prevent an account in which the adviser has taken a defensive position in cash from being excluded as a ``securities portfolio,'' the instruction would require an adviser to exclude cash and cash equivalents (e.g., demand deposits) in determining whether an account is a securities portfolio.30 --------------------------------------------------------------------------- \29\ 15 U.S.C. 80b-3A(a)(2). \30\ Instruction 7(a) also would explain that the following securities portfolios should be included in the determination of the amount of assets under management: (i) Family or proprietary accounts (except the personal assets of a sole proprietor), (ii) accounts for which the adviser receives no compensation, and (iii) accounts of foreign clients. --------------------------------------------------------------------------- Instruction 7(b) would require that, once the adviser has determined that an account is a ``securities portfolio,'' the entire value of the account, including cash and any non-securities positions, be included in the value of the adviser's assets under management. Exclusion of any component of a securities portfolio is not expressly required by section 203A(a)(2), and would be inconsistent with the manner in which the value of client portfolios is traditionally calculated. Comment is requested whether there are types of assets that nonetheless should be excluded from a securities portfolio, and therefore from the amount of assets under management. 2 . Exclusion of any component of a securities portfolio is not expressly required by section 203A(a)(2), and would be inconsistent with the manner in which the value of client portfolios is traditionally calculated. Comment is requested whether there are types of assets that nonetheless should be excluded from a securities portfolio, and therefore from the amount of assets under management. 2. Valuation and Reporting of Securities Portfolios Instruction 7(d) to proposed Form ADV-T would address the method and timing of the valuation of an adviser's securities portfolios.31 The value of a securities portfolio would be required to be determined as of a date no more than ten business days before the filing of Form ADV-T.32 The instruction would require that the methodology by which the securities are valued be the same as that used to value the securities for purposes of client reporting or to determine fees for investment advisory services. --------------------------------------------------------------------------- \31\ In general, the value of assets under management would be required to be included on Form ADV-T only if the amount of assets under management is the sole basis upon which the adviser is eligible for Commission registration. See Part III of proposed Form ADV-T. \32\ See Instruction 7(d) to proposed Form ADV-T. --------------------------------------------------------------------------- - \31\ In general, the value of assets under management would be required to be included on Form ADV-T only if the amount of assets under management is the sole basis upon which the adviser is eligible for Commission registration. See Part III of proposed Form ADV-T. \32\ See Instruction 7(d) to proposed Form ADV-T. --------------------------------------------------------------------------- 3. Continuous and Regular Supervisory or Management Services Instruction 7(c) to proposed Form ADV-T would provide guidance for determining whether an adviser provides an account with ``continuous and regular supervisory or management services'' within the meaning of section 203A(a)(2). The Commission would consider accounts over which advisers have discretionary authority and for which they provide ongoing management services to receive continuous and regular supervisory or management services (and therefore the assets of such accounts to be ``assets under management''). In addition, the Commission believes that a limited number of non-discretionary advisory arrangements involve such services. Whether an adviser that does not have discretionary authority will be considered to provide continuous and regular management or supervisory services with respect to an account would depend upon the nature of the adviser's responsibilities. The greater the amount of day-to-day responsibility an adviser has, the more likely the adviser would be providing continuous and regular supervisory or management services. For example, an adviser that has traditional portfolio management responsibilities but must obtain client consent before executing a trade would provide continuous and regular management or supervisory services with respect to the account.33 --------------------------------------------------------------------------- would be providing continuous and regular supervisory or management services. For example, an adviser that has traditional portfolio management responsibilities but must obtain client consent before executing a trade would provide continuous and regular management or supervisory services with respect to the account.33 --------------------------------------------------------------------------- \33\ The frequency with which an adviser initiates trades, provides reports to clients, or has contacts with clients would not necessarily determine whether the adviser provides continuous and regular supervisory or management services. --------------------------------------------------------------------------- The Commission believes that Congress intended to exclude from Commission registration most advisers that do not engage in traditional ongoing portfolio management, including most financial planners and consultants. Under the proposed instructions, a financial planner that merely undertakes to monitor the markets and advise its clients as to the advisability of changes to their portfolios would not be providing continuous and regular management or supervisory services.34 A financial planner that otherwise would be regulated by the states could not ``opt'' to be regulated by the Commission by revising its financial planning agreements to include the statutory language or similar language unless such a revision materially changes the nature of the services being provided.35 --------------------------------------------------------------------------- services.34 A financial planner that otherwise would be regulated by the states could not ``opt'' to be regulated by the Commission by revising its financial planning agreements to include the statutory language or similar language unless such a revision materially changes the nature of the services being provided.35 --------------------------------------------------------------------------- \34\ 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, proposed Form ADV-T would require these advisers to append a written statement explaining the nature of the non-discretionary supervisory or management services. See Part III, Item (c) of proposed Form ADV- T. \35\ The Commission is concerned that, if financial planners were permitted to treat assets they ``monitor'' as assets under management and therefore remain registered with the Commission, the intent of Congress to reallocate regulatory responsibilities by making ``almost 72 [percent] of Commission [investment adviser] registrants'' subject primarily to state regulation would not be effected. See Senate Report at 4. --------------------------------------------------------------------------- In evaluating the effect that the $25 million threshold would have on the number of investment advisers registered with the Commission, Congress relied on data provided by the Commission that was derived from responses on Form ADV.36 Thus, the Commission believes that Congress intended to include as assets under management the types of assets advisers have reported on Form ADV. The Commission is proposing to require advisers to report on Form ADV-T the amount of assets under management reported on Form ADV.37 An adviser that reports substantially more assets under management on its Form ADV-T than on its Form ADV could be asked to explain the difference t Congress intended to include as assets under management the types of assets advisers have reported on Form ADV. The Commission is proposing to require advisers to report on Form ADV-T the amount of assets under management reported on Form ADV.37 An adviser that reports substantially more assets under management on its Form ADV-T than on its Form ADV could be asked to explain the difference. --------------------------------------------------------------------------- \36\ See Testimony of Arthur Levitt, Chairman, SEC, Senate Hearing, app. at 2 (providing data reflected in Senate Report). The Form ADV data provided in the Commission's testimony was extracted from responses to Items 18 and 19 of Part I of Form ADV, which require information on the market value of client securities portfolios managed on a discretionary basis and managed or supervised on a non-discretionary basis. \37\ See Part III, Item (b) of proposed Form ADV-T. --------------------------------------------------------------------------- Comment is requested on the Commission's proposed interpretation of ``assets under management'' and the related proposed instructions to Form ADV-T. Comment also is requested on the proposed examples provided on Form ADV-T of accounts that receive continuous and regular supervisory or management services. Commenters are requested to provide additional examples. The Commission is also interested in commenters' views whether the proposed form and instructions would allow manipulation of the amount of an adviser's assets under management in order to evade the eligibility requirements and, if so, whether there are any alternative methods to address that potential problem. 4 or management services. Commenters are requested to provide additional examples. The Commission is also interested in commenters' views whether the proposed form and instructions would allow manipulation of the amount of an adviser's assets under management in order to evade the eligibility requirements and, if so, whether there are any alternative methods to address that potential problem. 4. Proposed Safe Harbor for State-Registered Investment Advisers The Commission recognizes that section 203A(a)(2) does not, and proposed Form ADV-T would not, provide a bright-line test by which an adviser that does not have discretionary authority over client assets may determine whether it is eligible to register with the Commission. The Commission therefore is proposing rule 203A-4 to provide a safe harbor from Commission registration for an adviser that is registered with state securities authorities (rather than the Commission) based on a reasonable belief that it is prohibited from registering with the Commission because it has insufficient assets under management. Under proposed rule 203A-4, the Commission would 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.38 This safe harbor would be available only to an adviser that is registered with the state in which it has its principal office and place of business. --------------------------------------------------------------------------- viser 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.38 This safe harbor would be available only to an adviser that is registered with the state in which it has its principal office and place of business. --------------------------------------------------------------------------- \38\ As discussed infra, the Commission is proposing to increase the $25 million threshold for Commission registration to $30 million, and to provide an optional exemption from the prohibition on registering with the Commission for advisers having between $25 and $30 million of assets under management. See section II.C.1. of this Release. --------------------------------------------------------------------------- C. Transitions Between State and Commission Registration The Coordination Act contemplates that a state-registered adviser whose assets under management increase to over $25 million will withdraw its state registration and register with the Commission. Conversely, an adviser whose assets under management decline below $25 million will withdraw its Commission registration and register with a state (or states). The Coordination Act could require an adviser that has close to $25 million of assets under management to register with the Commission only to de-register and re-register with a state shortly thereafter. This could occur because of a small decrease in the value of client assets (as a result of a market decline) or the departure of one or a few clients. The Commission recognizes that this process would be burdensome and costly to advisers and therefore is proposing to use the authority provided to it in the Coordination Act to adopt a new rule, rule 203A-1, that would create a more flexible regime to avoid ``transient'' registration problems. 1 alue of client assets (as a result of a market decline) or the departure of one or a few clients. The Commission recognizes that this process would be burdensome and costly to advisers and therefore is proposing to use the authority provided to it in the Coordination Act to adopt a new rule, rule 203A-1, that would create a more flexible regime to avoid ``transient'' registration problems. 1. Transition from State to Commission Registration Section 203A(a)(1)(A) of the Advisers Act authorizes the Commission to adopt a rule to increase the $25 million of assets under management threshold for Commission registration.39 In addition, as discussed above, the Commission has authority to exempt persons not meeting the threshold from the prohibition on registering with the Commission.40 The Commission is proposing to use these grants of authority to increase the $25 million threshold to $30 million, and to provide an optional exemption from the prohibition on registering with the Commission for advisers having between $25 and $30 million of assets under management.41 --------------------------------------------------------------------------- \39\ 15 USC 80b-3A(a)(1)(A). \40\ See supra note and accompanying text. \41\ Paragraphs (a) and (b) of proposed rule 203A-1. --------------------------------------------------------------------------- Proposed rule 203A-1 would permit advisers having between $25 and $30 million of assets under management 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 of assets under management threshold could defer registration with the Commission. An 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 had fallen below $25 million fter registering with the Commission, an adviser reaching the $25 million of assets under management threshold could defer registration with the Commission. An 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 had fallen below $25 million. A state-registered adviser whose assets under management grew to $30 million or more would be required to register with the Commission promptly when the assets reached $30 million (not when the adviser subsequently reported its assets under management to the state). Comment is requested whether the proposed $5 million ``window'' would provide advisers with sufficient flexibility to avoid the costly process of periodically registering and de-registering with the Commission and the states. Comment is also requested on other alternatives that could meet the needs of such advisers, for example, by providing a grace period for the transition from state to Commission registration, or by determining whether Commission registration is required on an annual basis. 2. Transition from Commission to State Registration The Commission is proposing to amend Form ADV by adding new Schedule I (``eye'') that would require advisers to report information necessary to determine continued eligibility for Commission registration similar to that required by Form ADV-T.42 The information on Schedule I would be used to determine whether the Commission should cancel the registration of an adviser because the adviser no longer meets the criteria for Commission registration. Schedule I would be required to be updated annually, within 90 days after the end of the adviser's fiscal year ligibility for Commission registration similar to that required by Form ADV-T.42 The information on Schedule I would be used to determine whether the Commission should cancel the registration of an adviser because the adviser no longer meets the criteria for Commission registration. Schedule I would be required to be updated annually, within 90 days after the end of the adviser's fiscal year. 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 of filing its Schedule I). Thus, eligibility for Commission registration would be determined annually based upon the value of assets under management at a single point in time. Comment is requested whether the Commission should measure assets under management more frequently, or based on the average value of assets at the end of certain periods (e.g., calendar quarters). --------------------------------------------------------------------------- \42\ See section II. A of this Release. --------------------------------------------------------------------------- Section 203A(b) of the Advisers Act, together with most state investment adviser statutes, will cause state registration requirements to be triggered by either a withdrawal from, or by the Commission's cancellation of, registration with the Commission. To allow an adviser facing potential cancellation of its Commission registration sufficient time to register under applicable state statutes, the Commission is proposing 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.43 Upon the expiration of this period, the Commission would institute proceedings to cancel the adviser's registration if the adviser had not withdrawn its registration on its own r applicable state statutes, the Commission is proposing 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.43 Upon the expiration of this period, the Commission would institute proceedings to cancel the adviser's registration if the adviser had not withdrawn its registration on its own. As provided under the Advisers Act, an adviser would be given notice and an opportunity to show why its registration should not be cancelled (i.e., because since the time the adviser had filed its Schedule I to Form ADV, its amount of assets under management had grown).44 Comment is requested whether a 90-day grace period would allow sufficient time for an adviser to register with the states. --------------------------------------------------------------------------- \43\ Paragraph (c) of proposed rule 203A-1. The Commission is not proposing a similar grace period after the filing of Form ADV-T. The Commission presumes that an adviser not eligible to maintain its registration with the Commission on April 9, 1997 would already be registered with the appropriate state(s) at the time of filing Form ADV-T. \44\ Section 211(c) of the Advisers Act [15 USC 80b-11(c)]. --------------------------------------------------------------------------- D. Exemptions from Prohibition on Registration with the Commission As discussed above, the Coordination Act gives the Commission authority 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.45 Congress intended the Commission to grant these exemptions to advisers having ``a national or multistate practice.'' 46 The Commission is proposing a new rule, rule 203A-2, that would exempt four types of advisers from the prohibition on Commission registration the prohibition would be ``unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes'' of section 203A.45 Congress intended the Commission to grant these exemptions to advisers having ``a national or multistate practice.'' 46 The Commission is proposing a new rule, rule 203A-2, that would exempt four types of advisers from the prohibition on Commission registration. The effect of the first three exemptions would be to make section 203 of the Advisers Act applicable to exempted advisers and, thus, require them to register with the Commission (unless exempted from Commission registration under section 203(b) of the Act). The fourth exemption would enable newly formed advisers to register with the Commission if they have a reasonable expectation that they will be eligible for Commission registration within 90 days. --------------------------------------------------------------------------- \45\ Section 203A(c). See supra notes and accompanying text. As discussed above, the exercise of this exemptive authority would not only permit registration with the Commission, but would preempt state law with respect to the exempted advisers. See supra notes 19- 21 and accompanying text. \46\ Senate Report at 5. --------------------------------------------------------------------------- 1. Nationally Recognized Statistical Rating Organizations ``Nationally recognized statistical rating organization'' (``NRSRO'') is a term used in several Commission rules ommission, but would preempt state law with respect to the exempted advisers. See supra notes 19- 21 and accompanying text. \46\ Senate Report at 5. --------------------------------------------------------------------------- 1. Nationally Recognized Statistical Rating Organizations ``Nationally recognized statistical rating organization'' (``NRSRO'') is a term used in several Commission rules to identify a type of entity, often referred to as a ``rating agency,'' that provides ratings of securities, on the basis of which the securities receive special treatment under Commission rules.47 All of the entities currently designated as NRSROs are registered with the Commission as investment advisers.48 While NRSROs do not have assets under management, their activities have a significant effect on the national securities markets and the operation of federal securities laws.49 The Commission believes that it would be inconsistent with the purposes of the Coordination Act for this type of entity to be regulated by the states rather than by the Commission, and is proposing to exempt NRSROs from the prohibition on registering with the Commission.50 --------------------------------------------------------------------------- \47\ See, e.g., rule 15c3-1 under the Securities Exchange Act of 1934 (``Exchange Act'') [17 CFR 240.15c3-1] (broker-dealer net capital); rule 2a-7 under the Investment Company Act [17 CFR 270.2a- 7] (money market funds). \48\ The Commission's Division of Market Regulation responds to requests for NRSRO designation through no-action letters, and has designated six rating agencies as NRSROs for purposes of the net capital rule (rule 15c3-1 under the Exchange Act). \49\ See Exchange Act Rel. No. 34616 (Aug. 31, 1994) [59 FR 46314 (Sept. 7, 1994)] (describing the use of NRSRO ratings by Congress and the Commission). \50\ Paragraph (a) of proposed rule 203A-2. --------------------------------------------------------------------------- d has designated six rating agencies as NRSROs for purposes of the net capital rule (rule 15c3-1 under the Exchange Act). \49\ See Exchange Act Rel. No. 34616 (Aug. 31, 1994) [59 FR 46314 (Sept. 7, 1994)] (describing the use of NRSRO ratings by Congress and the Commission). \50\ Paragraph (a) of proposed rule 203A-2. --------------------------------------------------------------------------- 2. Pension Consultants Pension consultants provide various advisory services to fiduciaries of pension plans, including assistance in selecting and monitoring investment advisers that manage assets of such plans.51 Pension consultants may not have assets under management, but their activities have a direct effect on the management of billions of dollars of pension plan assets. The Commission believes 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, and is proposing to exempt certain pension consultants, as defined under the proposed rule, from the prohibition on registering with the Commission. --------------------------------------------------------------------------- \51\ See Investment Advisers Act Rel. No. 1092 (Oct. 8, 1987) [52 FR 38400, 38401 (Oct. 16, 1987)]. --------------------------------------------------------------------------- Not all pension consultants, however, are engaged in activities that substantially affect national markets. Under paragraph (b) of proposed rule 203A-2, a pension consultant would be defined as an investment adviser that provides investment advice to certain employee benefit plans with respect to assets having an aggregate value of at least $50 million during the adviser's last fiscal year.52 Comment is requested as to the appropriateness of the proposed exemption, and the proposed criteria for determining whether a pension consultant's activities warrant exemption. --------------------------------------------------------------------------- rtain employee benefit plans with respect to assets having an aggregate value of at least $50 million during the adviser's last fiscal year.52 Comment is requested as to the appropriateness of the proposed exemption, and the proposed criteria for determining whether a pension consultant's activities warrant exemption. --------------------------------------------------------------------------- \52\ In determining the aggregate value of advised assets, the adviser would be able to 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 would 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 with respect to those assets. See paragraph (b)(3) of proposed rule 203A-2. --------------------------------------------------------------------------- 3. Certain Affiliated Investment Advisers Some firms conduct their advisory activities through separately registered advisers, not all of which may meet the criteria for Commission registration. For example, a firm may conduct its portfolio management activities in Subsidiary A, while conducting its financial planning activities in Subsidiary B, each of which is separately registered as an investment adviser. As a result, Subsidiary B may have no assets under management and, unless another exemption is available, would be regulated by the states rather than by the Commission. This result may be appropriate for affiliated advisers that are related only by ownership.53 The activities of affiliated advisers, however, may be centrally managed, and the effect of the Coordination Act's prohibition on registration would be either to subject an advisory firm to different schemes of regulation or force it to reorganize its operations states rather than by the Commission. This result may be appropriate for affiliated advisers that are related only by ownership.53 The activities of affiliated advisers, however, may be centrally managed, and the effect of the Coordination Act's prohibition on registration would be either to subject an advisory firm to different schemes of regulation or force it to reorganize its operations. The Commission believes that either result could be unfair to the adviser and a burden on interstate commerce and is therefore proposing to exempt from the prohibition on Commission registration any adviser that directly or indirectly controls, is controlled by, or is under common control with an investment adviser that is eligible to register (and is, in fact, registered) with the Commission.54 ``Control'' would be defined, for purposes of the rule, 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.55 The exemption would be available only if the principal office and place of business of the adviser is the same as that of the affiliated registered adviser.56 --------------------------------------------------------------------------- \53\ The Commission does not believe that Congress intended to permit an adviser to register with the Commission merely because it is an affiliate of a Commission-registered adviser. In section 203A(b)(1)(A) of the Advisers Act [15 USC 80b-3A(b)(1)(A)], Congress preempted state regulation of advisers and certain ``supervised persons.'' Congress defined supervised persons as persons who provide investment advice on behalf of the adviser. See section 202(a)(25) of the Advisers Act [15 USC 80b-2(a)(25)] n merely because it is an affiliate of a Commission-registered adviser. In section 203A(b)(1)(A) of the Advisers Act [15 USC 80b-3A(b)(1)(A)], Congress preempted state regulation of advisers and certain ``supervised persons.'' Congress defined supervised persons as persons who provide investment advice on behalf of the adviser. See section 202(a)(25) of the Advisers Act [15 USC 80b-2(a)(25)]. The principal effect of using this new defined term, rather than the term ``persons associated with an investment adviser,'' which is defined in section 202(a)(17) of the Advisers Act [15 USC 80b-2(a)(17)], is to exclude any person controlling or controlled by the adviser unless the person provides investment advice on behalf of the adviser. See section F.1. of this Release. \54\ Paragraph (c) of proposed rule 203A-2. By proposing rule 203A-2(c), the Commission is not suggesting that an advisory firm may reorganize its operations in order to circumvent the requirements of the Advisers Act. See section 208(d) of the Advisers Act [15 USC 80b-8(d)] (making unlawful for any person ``indirectly, or through or by any other person, to do any act or thing which it would be unlawful for such person to do directly'' under the Advisers Act). Cf. Preliminary Note 2 to rule 203(b)(3)-1 [17 CFR 275.203(b)(3)-1] under the Advisers Act. \55\ Under this definition, any person that directly or indirectly has the right to vote 25 percent or more of the voting securities or is entitled to 25 percent or more of the profits of an adviser would be presumed to control that adviser. \56\ The definition of ``principal office and place of business'' in proposed rule 203A-3(c) would also apply to this rule. See section II.E.2. of this Release. --------------------------------------------------------------------------- vote 25 percent or more of the voting securities or is entitled to 25 percent or more of the profits of an adviser would be presumed to control that adviser. \56\ The definition of ``principal office and place of business'' in proposed rule 203A-3(c) would also apply to this rule. See section II.E.2. of this Release. --------------------------------------------------------------------------- Affiliated advisers having the same principal office and place of business are likely to have overlapping operations, similar books and records, and integrated compliance systems. Compliance with separate schemes of regulation may not permit the integration of such systems and therefore would be burdensome for these advisers. Moreover, the Commission has found that it is more efficient to examine all of the activities of such affiliated advisers at the same time. Comment is requested whether the proposed conditions for exempting an affiliated adviser from the prohibition on registering with the Commission are appropriate. Is having the same principal office and place of business an appropriate criterion by which to assume the integration of operations of affiliated advisers? If not, commenters are requested to provide alternative criteria. 4. Investment Advisers With Reasonable Expectation of Eligibility A newly formed adviser may not be eligible to register with the Commission at the time of its formation, but may have a reasonable expectation that within a short period of time it will become eligible to register. For example, an adviser may not initially have assets under management, but may anticipate an inflow of assets shortly after commencing operations. The Commission recognizes that requiring a newly formed adviser to register with the states, only to de-register and me of its formation, but may have a reasonable expectation that within a short period of time it will become eligible to register. For example, an adviser may not initially have assets under management, but may anticipate an inflow of assets shortly after commencing operations. The Commission recognizes that requiring a newly formed adviser to register with the states, only to de-register and register with the Commission shortly thereafter, would be unfair, burdensome, and inconsistent with the purposes of section 203A. Therefore, the Commission is proposing to exempt certain newly formed advisers from the prohibition on Commission registration. Under proposed rule 203A-2(d), an adviser with a reasonable expectation that it will be eligible for Commission registration within 90 days after the date the adviser's registration becomes effective would be permitted to register with the Commission. At the end of the 90-day period, the adviser would be required to file an amended Schedule I. If the adviser indicates on the amended Schedule I that it has not become eligible to register with the Commission, the adviser would be required to file a Form ADV-W concurrently with the Schedule I, thereby withdrawing from registration with the Commission. The proposed exemption would be available only to advisers that are not registered or required to be registered with either the states or the Commission. The Commission requests comment on the utility, scope, and conditions of the proposed exemptions, including whether the exemptions should require Commission registration for advisers meeting the exemptive criteria. Are there other classes of advisers that the Commission should exempt because their prohibition from registering with the Commission would be unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes of section 203A? Comment is also requested whether the 90-day period is adequate or whether it should be longer. istration for advisers meeting the exemptive criteria. Are there other classes of advisers that the Commission should exempt because their prohibition from registering with the Commission would be unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes of section 203A? Comment is also requested whether the 90-day period is adequate or whether it should be longer. 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 57 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.58 This provision makes clear that the Commission will retain regulatory responsibility for advisers with a principal office and place of business in states that have not enacted investment adviser statutes, and for foreign advisers doing business in the United States. The Coordination Act does not, however, provide an explanation of when an adviser is ``regulated or required to be regulated'' as an investment adviser, nor does it define ``principal office or place of business.'' --------------------------------------------------------------------------- \57\ The term ``state'' is defined in section 202(a)(19) of the Advisers Act [15 USC 80b-2(a)(19)] to include the District of Columbia, Puerto Rico, the Virgin Islands, and any other possession of the United States. \58\ 15 USC 80b-3A(a)(1). --------------------------------------------------------------------------- --------------------------------------------------------------------------- \57\ The term ``state'' is defined in section 202(a)(19) of the Advisers Act [15 USC 80b-2(a)(19)] to include the District of Columbia, Puerto Rico, the Virgin Islands, and any other possession of the United States. \58\ 15 USC 80b-3A(a)(1). --------------------------------------------------------------------------- 1. ``Regulated or Required To Be Regulated'' Although the phrase ``regulated or required to be regulated'' is used in section 203A(a)(1), the legislative history of this provision suggests that Congress equated regulation by a state with registration with the state.59 This interpretation seems appropriate since an adviser exempt from registering under a state statute typically is subject only to the anti-fraud provisions of the state statute and not to substantive regulatory provisions. Accordingly, the Commission proposes to interpret section 203A(a)(1) as requiring any person who meets the definition of investment adviser in section 202(a)(11) of the Advisers Act (and that is not otherwise exempt from registration by section 203(b) of the Act) 60 to register with the Commission if the person has a principal office and place of business in a state that has an investment adviser statute, but is not required to be registered (and, in fact, is not registered) under that statute. The person may not be required to register with the state as a result of an exemption from registration or an exception from the definition of ``investment adviser'' in that state's statute.61 --------------------------------------------------------------------------- \59\ Senate Report at 4 (``The Commission will continue to supervise all advisers that are based in a state that does not register investment advisers.''). \60\ 15 USC 80b-3(b). Section 203(b) exempts from registration istration or an exception from the definition of ``investment adviser'' in that state's statute.61 --------------------------------------------------------------------------- \59\ Senate Report at 4 (``The Commission will continue to supervise all advisers that are based in a state that does not register investment advisers.''). \60\ 15 USC 80b-3(b). Section 203(b) exempts from registration (i) any adviser whose clients are all residents of the state within which the adviser maintains its principal office and place of business, and that does not furnish advice or issue reports with respect to securities listed or admitted to unlisted trading privileges on any national securities exchange (the ``intrastate'' exemption); (ii) any adviser whose only clients are insurance companies (the ``insurance company'' exemption); (iii) any adviser that, among other things, does not hold itself out generally to the public as an adviser and during the course of the preceding twelve months had fewer than fifteen clients (the ``small adviser'' exemption); (iv) any adviser that is a charitable organization and that provides advice only to other charitable organizations (the ``charitable adviser'' exemption, added by section 5 of the Philanthropy Protection Act of 1995, Pub. L. 104-62, 109 Stat. 682, 685 (1995) (codified in scattered sections of 15 U.S.C.)); and (v) any adviser that provides advice solely to church plans (the ``church plan adviser'' exemption, added by section 508(d) of the 1996 Act). \61\ For example, a lawyer who provides discretionary advisory services as a ``bona fide fiduciary'' may not be required to register as an investment adviser under Massachusetts law. Unless the lawyer's performance of such services is solely incidental to the practice of law (within the meaning of section 202(a)(11)(B) of the Advisers Act), the lawyer would likely be required to register under the Advisers Act even if the lawyer provides such services with respect to less than $25 million of assets be required to register as an investment adviser under Massachusetts law. Unless the lawyer's performance of such services is solely incidental to the practice of law (within the meaning of section 202(a)(11)(B) of the Advisers Act), the lawyer would likely be required to register under the Advisers Act even if the lawyer provides such services with respect to less than $25 million of assets. Compare Mass. Ann. Laws ch. 110A, section 401(m) (1996) with section 202(a)(11)(B) of the Advisers Act [15 USC 80b-2(a)(11)(B)]. --------------------------------------------------------------------------- One effect of this proposed interpretation would be that all advisers will be regulated either by the Commission or the states, except for advisers that are exempt from registration under both the Advisers Act and state statutes. Another effect would be that some advisers a state has determined not to regulate would be registered with the Commission even though their operations may be very limited. The Commission requests comment whether it should recommend that Congress amend section 203A(a)(1) to prohibit an adviser from registering with the Commission if it has its principal office and place of business in a state that has enacted an investment adviser statute (regardless of whether that statute requires the adviser to register). ``Principal Office and Place of Business'' Currently, advisers are required to identify their principal place of business in response to Item 2A of Form ADV. Form ADV does not, however, define the term principal place of business ncipal office and place of business in a state that has enacted an investment adviser statute (regardless of whether that statute requires the adviser to register). ``Principal Office and Place of Business'' Currently, advisers are required to identify their principal place of business in response to Item 2A of Form ADV. Form ADV does not, however, define the term principal place of business. Because of the added regulatory significance of the determination of the state in which the adviser has its principal place of business, the Commission is proposing 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.'' 62 --------------------------------------------------------------------------- \62\ Paragraph (c) of proposed rule 203A-3. --------------------------------------------------------------------------- 2. F. Persons Who Act on Behalf of Investment Advisers In addition to preempting state law with respect to investment advisers that are registered with the Commission, the Coordination Act preempts state law with respect to ``supervised persons'' of Commission-registered advisers.63 The Coordination Act defines a supervised person 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.'' 64 Thus, the definition of supervised person parallels the traditional Commission view that persons performing advisory services on behalf of an adviser are not required to 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.'' 64 Thus, the definition of supervised person parallels the traditional Commission view that persons performing advisory services on behalf of an adviser are not required to separately register.65 The definition of supervised person includes a person whose status is an ``employee,'' as well as a person who provides advice on behalf of the adviser pursuant to a contract, as long as the person is under the supervision and control of the adviser.66 --------------------------------------------------------------------------- \63\ Section 203A(b). \64\ Section 202(a)(25). \65\ Persons who perform investment advisory services on behalf of, and under the supervision and control of, a registered adviser are not required to separately register as investment advisers. See, e.g., Abid Mansoor (pub. avail. Feb. 5, 1992); Corinne E. Wood (pub. avail. Apr. 17, 1986); The Burney Company (pub. avail. Feb. 7, 1977). Persons who provide advice on behalf of persons excepted from the definition of investment adviser in section 202(a)(11) are likewise excepted from the definition of investment adviser. See Robert S. Strevell (pub. avail. Apr. 29, 1985). \66\ Senate Report at 4. --------------------------------------------------------------------------- 7, 1986); The Burney Company (pub. avail. Feb. 7, 1977). Persons who provide advice on behalf of persons excepted from the definition of investment adviser in section 202(a)(11) are likewise excepted from the definition of investment adviser. See Robert S. Strevell (pub. avail. Apr. 29, 1985). \66\ Senate Report at 4. --------------------------------------------------------------------------- The Coordination Act, however, does preserve certain state laws with respect to certain supervised persons of Commission-registered advisers by providing that a ``[s]tate may license, register, or otherwise qualify any investment adviser representative who has a place of business located within that [s]tate.'' 67 The Coordination Act does not define ``investment adviser representative,'' nor does it describe what constitutes a ``place of business.'' In order to clarify these terms and thus the scope of state preemption under the Coordination Act, the Commission is proposing a rule defining these terms. --------------------------------------------------------------------------- \67\ Section 203A(b)(1)(A). --------------------------------------------------------------------------- 1. ``Investment Adviser Representative'' The 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. Testimony in support of preserving state authority over investment adviser representatives, however, suggests that Congress intended to permit state securities authorities to establish qualification standards for investment adviser representatives in order to protect individual, or ``retail,'' investors.68 --------------------------------------------------------------------------- o register. Testimony in support of preserving state authority over investment adviser representatives, however, suggests that Congress intended to permit state securities authorities to establish qualification standards for investment adviser representatives in order to protect individual, or ``retail,'' investors.68 --------------------------------------------------------------------------- \68\ The North American Securities Administrators Association (``NASAA'') addressed this matter in its testimony before the Senate committee. Of particular concern to the states is the potential loss of licensing authority over [investment adviser representatives] associated with [advisory] firms operating out of small branch offices nationwide. Typically, a small number of [investment adviser representatives] operate out of each office providing, almost exclusively, retail investment advisory services * * *. Because of the local nature and retail clientele of these [representatives], the states have a strong interest in maintaining oversight of them. See Testimony of Dee R. Harris, President, NASAA, Senate Hearing at 6-7. NASAA recommends * * * requiring all supervised persons that provide advice to retail clients to be licensed with the states regardless of the size of their [advisory] firm. Supervised persons would be exempt from state licensure if they do not solicit retail business nor hold themselves out as providing investment advice to a retail clientele. See NASAA Recommendations Relating to S. 1815 and H.R. 3005 (July 8, 1996), at 1-2. --------------------------------------------------------------------------- h the states regardless of the size of their [advisory] firm. Supervised persons would be exempt from state licensure if they do not solicit retail business nor hold themselves out as providing investment advice to a retail clientele. See NASAA Recommendations Relating to S. 1815 and H.R. 3005 (July 8, 1996), at 1-2. --------------------------------------------------------------------------- While the term ``investment adviser representative'' is used in many states' laws, the Commission believes that it would be inconsistent with the policies underlying the 1996 Act to be guided by individual state's investment adviser statutes. Many states define ``investment adviser representative'' differently,69 and in ways that reach persons who do not provide advice to retail investors (e.g., portfolio managers of mutual funds).70 In light of the many provisions in the Coordination Act designed to promote uniformity of regulation, and the decision of Congress to preempt state laws regulating the offering of shares of investment companies,71 the Commission does not believe that Congress intended the definition of ``investment adviser representative'' to incorporate state law. The Commission thus concludes that Congress used the undefined term ``investment adviser representative'' with the expectation that the Commission would use its existing rulemaking authority to define it.72 The Commission is proposing to adopt a rule defining the term ``investment adviser representative'' in a manner consistent with the policy concerns that appear to have given rise to the exception from the provisions of the Coordination Act that preempt state law with respect to Commission-registered advisers and their supervised persons. --------------------------------------------------------------------------- roposing to adopt a rule defining the term ``investment adviser representative'' in a manner consistent with the policy concerns that appear to have given rise to the exception from the provisions of the Coordination Act that preempt state law with respect to Commission-registered advisers and their supervised persons. --------------------------------------------------------------------------- \69\ The investment adviser statutes of New Hampshire and New Jersey define ``investment adviser representative'' to include any person who is authorized to represent an investment adviser in providing investment advice. See N.H. Rev. Stat. Ann. section 421- B:2(II) (1991 & Supp. 1996). The investment adviser statutes of Oklahoma, Oregon, and Virginia define ``investment adviser representatives'' to include persons who prepare reports or analyses concerning securities. See Okla. Stat Ann. tit. 71 section 2(l) (Supp. 1997); Or. Rev. Stat. section 59.015(16)(a)(B) (1995); Va. Code Ann. section 13.1-501(A) (1993). \70\ See Unif. Sec. Act section 401(g) (1986 amendments) (defining ``investment adviser representative'' to include any person employed by or associated with an investment adviser, other than clerical or ministerial personnel, who manages accounts or portfolios of clients, or who determines which recommendations or advice regarding securities should be given); Definitions and Procedures for Investment Adviser Representatives and Branch Offices (Order of West Virginia Deputy Commissioner of Securities, amended eff. Oct. 11, 1995) (defining ``investment adviser representative'' to include clerical and ministerial employees). \71\ See 1996 Act section 102 (amending section 18(b)(2) of the Securities Act of 1933 [15 USC 77r(b)(2)] to preempt state law requiring registration of securities issued by investment companies that are registered or that have filed a registration statement with the Commission); see also Senate Report at 6-7; House Report at 30- 31 sentative'' to include clerical and ministerial employees). \71\ See 1996 Act section 102 (amending section 18(b)(2) of the Securities Act of 1933 [15 USC 77r(b)(2)] to preempt state law requiring registration of securities issued by investment companies that are registered or that have filed a registration statement with the Commission); see also Senate Report at 6-7; House Report at 30- 31. \72\ This conclusion is also suggested by the fact that, although the drafters of section 203A had available to them two terms--``person associated with an investment adviser'' and ``supervised person''--that could have been used to describe persons the states would have authority to register, the drafters chose to use neither term. ``Person associated with an investment adviser'' is defined in section 202(a)(17), and ``supervised person'' is defined in section 202(a)(25) of the Advisers Act. --------------------------------------------------------------------------- Proposed rule 203A-3(a) would define ``investment adviser representative'' to be 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 term therefore would exclude (and thereby preclude states from registering) supervised persons who provide advice to investment companies, businesses, educational institutions, charitable institutions and other entities that are not natural persons. Supervised persons who provide advice to natural persons, but who do not ``on a regular basis solicit, meet with, or otherwise communicate to clients'' also would be excepted from the definition.73 This exception is intended to exclude 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 dvice to natural persons, but who do not ``on a regular basis solicit, meet with, or otherwise communicate to clients'' also would be excepted from the definition.73 This exception is intended to exclude 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, supervised persons who give only impersonal advice would be excepted.74 This provision is intended to exclude 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. --------------------------------------------------------------------------- \73\ Paragraph (a)(1)(i) of proposed rule 203A-3. \74\ Paragraph (a)(1)(ii) of proposed rule 203A-3. --------------------------------------------------------------------------- As discussed above, the definition of ``investment adviser representative'' would include only those supervised persons a ``substantial portion'' of whose business is providing advice to natural persons. 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.75 This provision is intended to permit representatives who provide advisory services primarily to clients that are not natural persons to accept so-called ``accommodation clients'' without being required to register as investment adviser representatives percent of the assets under management by the adviser attributable to the supervised person were assets of clients who are natural persons.75 This provision is intended to permit representatives who provide advisory services primarily to clients that are not natural persons to accept so-called ``accommodation clients'' without being required to register as investment adviser representatives under state law.76 Comment is requested whether the criteria for determining whether a substantial portion of an investment adviser representative's business is providing advice to retail persons are workable. If not, commenters are requested to provide alternatives. --------------------------------------------------------------------------- \75\ Paragraph (a)(2)(ii) of proposed rule 203A-3. \76\ The proposed exception would be available to all investment adviser representatives, regardless of whether they hold themselves out as providing advisory services to natural persons. Limiting this exception to representatives that do not hold themselves out as providing advisory services to natural persons would be a difficult standard to apply, as representatives may not specify the type of client to whom their advertisements and other communications are directed. --------------------------------------------------------------------------- The Commission notes that persons not falling within the definition of ``investment adviser representative,'' while not subject to state registration and qualification standards, would not be ``unregulated.'' Although the Commission does not separately register persons associated with investment advisers, the Commission regulates their activities in connection with the regulation of investment advisers. These persons are subject to most of the provisions of the Advisers Act, either directly, as persons associated with investment advisers, or indirectly, as aiders and abettors.77 --------------------------------------------------------------------------- xcepted from the definition of ``investment adviser representative''? --------------------------------------------------------------------------- \78\ E.g., clients with whom an adviser may enter into an advisory contract providing performance-based compensation under rule 205-3 of the Advisers Act [17 CFR 275.205-3]. --------------------------------------------------------------------------- 2. ``Place of Business'' While section 203A(b)(1)(A) preserves the ability of a state to register and regulate ``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 Coordination Act does not define the phrase ``place of business.'' The Commission is proposing new rule 203A-3(b) 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.'' Under section 203A(b)(1)(A) and proposed rule 203A-3(b), an investment adviser representative may be required to register in multiple states if the adviser representative has multiple places of business. A place of business need not be a formal office, but it cannot be merely an office of an agent for service of process or a mail box. A place of business may, however, include a hotel room, temporarily rented office space, or even the home of a client, if the adviser representative regularly provides advisory services or solicits, meets with, or otherwise communicates to the client at that location. If, however, an investment adviser representative does not regularly provide advisory services or otherwise solicit, meet with, or communicate to clients at any place or office, proposed rule 203A-3(b) would define the place of business of such investment adviser representative to be the residence of each client solicits, meets with, or otherwise communicates to the client at that location. If, however, an investment adviser representative does not regularly provide advisory services or otherwise solicit, meet with, or communicate to clients at any place or office, proposed rule 203A-3(b) would define the place of business of such investment adviser representative to be the residence of each client. This provision is designed to prevent itinerant investment adviser representatives from claiming that they have no place of business and thus are not subject to any state's registration or qualification requirements. As a practical matter, therefore, an investment adviser representative likely will designate at least one place or office in a state in which he or she regularly communicates to clients as a place of business. Comment is requested whether the proposed rule will provide clear guidance for determining whether an investment adviser representative has a place of business in a particular state. Comment is specifically requested whether additional guidance or criteria would be appropriate to address investment adviser representatives that provide services to clients through electronic media.79 --------------------------------------------------------------------------- \79\ An investment adviser representative that provides investment advisory services through a web site generally would be considered to have its place of business at the physical location where the representative typically conducts his or her web site- related advisory business. For example, a representative works on a computer at home in State X where he or she designs a web site that solicits information from clients and evaluates the information provided by clients in response to the site. The representative e- mails its materials to a web server in State Y for posting on the web. Under the rule, as proposed, the representative's place of business would be considered to be in State X sentative works on a computer at home in State X where he or she designs a web site that solicits information from clients and evaluates the information provided by clients in response to the site. The representative e- mails its materials to a web server in State Y for posting on the web. Under the rule, as proposed, the representative's place of business would be considered to be in State X. --------------------------------------------------------------------------- The Commission is aware that some have suggested that section 203A(b)(1)(A) could be interpreted to permit a state to require every investment adviser representative to establish a place of business in the state (such as the office of the Secretary of State) as a condition of doing business in that state. Under this interpretation, every investment adviser representative doing business in a state would be potentially subject to the state's registration and qualification requirements. The Commission does not believe that the place of business clause should be interpreted in this manner. Interpreting ``place of business'' as the equivalent of ``doing business'' would have the effect of nullifying the restriction that the inclusion of the phrase ``place of business'' places on a state's authority to regulate investment adviser representatives. In the Commission's view, Congress could not have intended this result, or it would not have included the place of business clause in section 203A(b)(1)(A).80 --------------------------------------------------------------------------- \80\ This interpretation would, therefore, violate the principal of statutory interpretation that a statute is to be construed so as to give effect to all its language. See, e.g., United States v. Menasche, 348 U.S. 528, 538-39 (1955). --------------------------------------------------------------------------- )(A).80 --------------------------------------------------------------------------- \80\ This interpretation would, therefore, violate the principal of statutory interpretation that a statute is to be construed so as to give effect to all its language. See, e.g., United States v. Menasche, 348 U.S. 528, 538-39 (1955). --------------------------------------------------------------------------- Moreover, this interpretation would nullify restrictions imposed by Congress in the Coordination Act on the applicability of state adviser laws to out-of-state advisers. In the Coordination Act, Congress amended section 222 of the Advisers Act to create a national de minimis standard that makes state investment adviser laws (other than provisions prohibiting fraud) inapplicable to an adviser that has fewer than six clients who are residents of the state and that does not have a place of business in the state.81 Requiring an adviser to have a place of business in any state in which the adviser has even a single client (because it is doing business in the state), would render the new national de minimis standard meaningless. --------------------------------------------------------------------------- \81\ Section 222(d) of the Advisers Act [15 U.S.C. 80b-18a(d)]; see section II.G. of this Release. --------------------------------------------------------------------------- 3. Solicitors Investment advisers frequently engage others to solicit clients on their behalf. A solicitor is a ``person associated with an investment adviser'' with respect to the adviser for which it solicits.82 An adviser has an obligation to supervise its solicitors with respect to activities performed on its behalf.83 Solicitation of clients, however, may not involve providing investment advice on behalf estment advisers frequently engage others to solicit clients on their behalf. A solicitor is a ``person associated with an investment adviser'' with respect to the adviser for which it solicits.82 An adviser has an obligation to supervise its solicitors with respect to activities performed on its behalf.83 Solicitation of clients, however, may not involve providing investment advice on behalf of the adviser, in which case the solicitor would not be a ``supervised person'' of the adviser within the meaning of section 202(a)(25) of the Advisers Act. The Commission believes, therefore, that section 203A(b) of the Advisers Act does not generally preempt state regulation of a solicitor for a Commission-registered adviser, unless the solicitor is independently registered with the Commission as an investment adviser, or is excepted from the definition of investment adviser in section 202(a)(11) of the Advisers Act.84 --------------------------------------------------------------------------- \82\ Investment Advisers Act Release No. 688 (July 12, 1979) [44 FR 42126 (July 18, 1979)] (adopting rule 206(4)-3). The release noted that a solicitor for an adviser providing solely impersonal advice is not necessarily a ``person associated with an investment adviser.'' Id. at 42129 n.20. \83\ Id. at 42129. \84\ Rule 206(4)-3 under the Advisers Act [17 CFR 275.206(4)-3] would, however, continue to govern cash payments by a Commission- registered adviser to a solicitor. --------------------------------------------------------------------------- G. National De Minimis Standard sonal advice is not necessarily a ``person associated with an investment adviser.'' Id. at 42129 n.20. \83\ Id. at 42129. \84\ Rule 206(4)-3 under the Advisers Act [17 CFR 275.206(4)-3] would, however, continue to govern cash payments by a Commission- registered adviser to a solicitor. --------------------------------------------------------------------------- G. National De Minimis Standard The Coordination Act also amends the Advisers Act to add new section 222(d), which makes state investment adviser statutes inapplicable to advisers that (i) do not have a place of business in the state and (ii) have fewer than six clients who are residents of that state (``national de minimis standard'').85 The Commission believes that the national de minimis standard was intended to ease the regulatory burdens on advisers who may be uncertain as to when they are subject to state registration requirements as a result, for example, of a client moving to another state.86 --------------------------------------------------------------------------- \85\ Because state investment adviser statutes, including state registration requirements, will be preempted with respect to advisers registered with the Commission or excluded from the definition of investment adviser under the Advisers Act, the national de minimis standard affects only advisers subject to state registration. \86\ The legislative history of the Coordination Act does not explain Congress' intent in adopting this national standard. --------------------------------------------------------------------------- s registered with the Commission or excluded from the definition of investment adviser under the Advisers Act, the national de minimis standard affects only advisers subject to state registration. \86\ The legislative history of the Coordination Act does not explain Congress' intent in adopting this national standard. --------------------------------------------------------------------------- Most, but not all, state investment adviser statutes exempt advisers that do not have a place of business in, and have a limited number of clients that are residents of, the state.87 The maximum number of clients an adviser may have before state registration is required varies from state to state.88 Section 222(d) establishes a national de minimis standard of five clients; a state may have a higher, but not a lower, de minimis threshold.89 --------------------------------------------------------------------------- \87\ See, e.g., Unif. Sec. Act section 204(1)(iii) (1985). Delaware, Massachusetts, and Texas, for example, do not have de minimis provisions. \88\ Compare N.Y. Gen. Bus. Law section 359-eee(1)(a)(5) (1996) (forty clients) with Pa. Stat. Ann. tit. 70 section 1-102(j)(vii) (1994) (four clients). \89\ In this sense, although section 222(d) is entitled the ``national de minimis standard,'' the section actually establishes a minimum threshold for state de minimis provisions, rather than a uniform standard that must be applied by each state. --------------------------------------------------------------------------- with Pa. Stat. Ann. tit. 70 section 1-102(j)(vii) (1994) (four clients). \89\ In this sense, although section 222(d) is entitled the ``national de minimis standard,'' the section actually establishes a minimum threshold for state de minimis provisions, rather than a uniform standard that must be applied by each state. --------------------------------------------------------------------------- The term ``client'' is not defined in the Advisers Act, nor is it generally defined in state investment adviser statutes or regulations.90 The scope of a de minimis exemption or exclusion may be broadened or narrowed, depending on who is determined to be a ``client.'' 91 In order to effect the intent of Congress to create a uniform minimum de minimis threshold, the Commission is proposing a new rule, rule 222-2, defining the term ``client'' for purposes of section 222(d).92 --------------------------------------------------------------------------- \90\ Several states have addressed the issue of whether a limited partnership should be treated as a single client of an adviser for purposes of their state de minimis provisions. See, e.g., D.C. Mun. Regs. tit. 17 section 1822 (1996); Ga. Comp. R. & Regs. r. 590-4-8-.11 (1989); Pa. Bull., Miscellaneous Interpretations--June 1986. Connecticut, however, appears to be the only state that has adopted a detailed definition of ``client'' for purposes of its de minimis provision. See Conn. Agencies Regs. section 36b-31-3(d)(2)-(4) (1995). \91\ For example, one state may treat a family as a single client while another may require an adviser to count each family member. Although both states may have a five client threshold for registration, the actual thresholds are substantially different. \92\ In addition, the Commission is proposing to adopt a rule defining the terms ``place of business'' and ``principal place of business'' for purposes of section 222 may treat a family as a single client while another may require an adviser to count each family member. Although both states may have a five client threshold for registration, the actual thresholds are substantially different. \92\ In addition, the Commission is proposing to adopt a rule defining the terms ``place of business'' and ``principal place of business'' for purposes of section 222. Proposed rule 222-1(a) would define place of business in the same manner as proposed rule 203A- 3(b), except the term is applied to the adviser rather than the supervised persons of the adviser. Proposed rule 222-1(b) would define principal place of business in the same manner that proposed rule 203A-3(c) would define ``principal office and place of business.'' --------------------------------------------------------------------------- Proposed rule 222-2 would treat as a single client a natural person and (i) any relative or spouse of the natural person sharing the same principal residence, and (ii) all accounts of which such persons are the sole primary beneficiaries.93 The proposed rule also would treat as a single client a corporation, general partnership, trust 94 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. 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 of the Advisers Act.95 Comment is requested on this definition of ``client.'' Are there other typical client relationships that the proposed rule fails to address? --------------------------------------------------------------------------- , members, or beneficial owners. 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 of the Advisers Act.95 Comment is requested on this definition of ``client.'' Are there other typical client relationships that the proposed rule fails to address? --------------------------------------------------------------------------- \93\ A joint account thus would be treated as a separate client under the proposed rule unless the primary beneficiaries are family members who share the natural person's principal residence. See paragraphs (a)(1) and (a)(2) of proposed rule 222-2. \94\ The Division of Investment Management has stated that where several trusts share a common trustee, each trust generally should be treated as a separate client for purposes of section 203(b)(3) of the Advisers Act [15 USC 80b-3(b)(3)]. See OSIRIS Management (pub. avail. Feb. 17, 1984); Philip Eiseman (pub. avail. July 22, 1976). The Division also has stated that trusts with identical beneficiaries could be treated as a single client. See OSIRIS Management, supra; First Security Investment Management (pub. avail. Mar. 25, 1985). Should the rule address these circumstances by treating multiple legal entities with identical shareholders, partners, members or beneficiaries as a single client? \95\ 17 CFR 275.203(b)(3)-1 (providing 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). --------------------------------------------------------------------------- cumstances by treating multiple legal entities with identical shareholders, partners, members or beneficiaries as a single client? \95\ 17 CFR 275.203(b)(3)-1 (providing 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). --------------------------------------------------------------------------- The Commission notes that the manner in which clients are counted has significance under section 203(b)(3), which exempts from registration with the Commission certain advisers having fewer than fifteen clients during the course of the preceding twelve months. Should the Commission adopt a single rule regarding the counting of clients under both sections 203(b)(3) and 222(d)? If so, should the Commission reconsider some of the provisions of rule 203(b)(3)-1, e.g, the requirement that limited partnership interests be securities? 96 Since clients include foreign clients of an adviser,97 should the rule specifically address the status of foreign clients? --------------------------------------------------------------------------- \96\ Rule 203(b)(3)-1(b)(2)(i) [17 CFR 203(b)(3)-1(b)(2)(i)]. \97\ Vocor International Holding S.A. (pub. avail. Apr. 9, 1990); Walter L. Stephens (pub. avail. Nov. 18, 1985). --------------------------------------------------------------------------- H. Other Amendments to Advisers Act Rules tatus of foreign clients? --------------------------------------------------------------------------- \96\ Rule 203(b)(3)-1(b)(2)(i) [17 CFR 203(b)(3)-1(b)(2)(i)]. \97\ Vocor International Holding S.A. (pub. avail. Apr. 9, 1990); Walter L. Stephens (pub. avail. Nov. 18, 1985). --------------------------------------------------------------------------- H. Other Amendments to Advisers Act Rules The Commission is proposing amendments to several rules under the Advisers Act to reflect changes made by the Coordination Act. 1. Amendments to Form ADV; Elimination of Form ADV-S As discussed above,98 the Commission is proposing to amend Form ADV to add a new Schedule I, which would be substantially similar to Form ADV-T.99 Pending future revisions of Form ADV, Schedule I would be used by the Commission to screen applicants as to eligibility for Commission registration. Schedule I would be required to be included with all new registrations filed on or after April 9, 1997. --------------------------------------------------------------------------- \98\ See section II.C.2. of this Release. \99\ Schedule I is not attached to this Release. --------------------------------------------------------------------------- The Commission is also proposing 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.100 Like Form ADV-T, Schedule I would require an adviser to declare whether it remains eligible for Commission registration. Unlike Form ADV-T, however, Schedule I would not operate as a request for withdrawal of the adviser's registration from the Commission; rather, an adviser that declares itself not eligible for Commission registration on Schedule I would be required to withdraw from Commission registration by accompanying the Schedule I with a Form ADV-W.101 --------------------------------------------------------------------------- ver, Schedule I would not operate as a request for withdrawal of the adviser's registration from the Commission; rather, an adviser that declares itself not eligible for Commission registration on Schedule I would be required to withdraw from Commission registration by accompanying the Schedule I with a Form ADV-W.101 --------------------------------------------------------------------------- \100\ 17 CFR 275.204-1. These amendments also establish uniform updating requirements for Commission and state adviser registrations. The Commission is proposing these updating requirements in concurrence with NASAA. \101\ A separate Form ADV-W would continue to be required, in order to assure that the Commission staff is able to act promptly on the withdrawal from registration. Subject to the proposed grace period under rule 203A-1(c), failure to file the completed Form ADV- W would subject an adviser to the commencement of proceedings to cancel its registration. --------------------------------------------------------------------------- If an annual amendment requirement to Form ADV is adopted, the Commission will have no regulatory need for advisers to file Form ADV- S, the annual report for advisers registered under the Advisers Act. The Commission is therefore proposing to amend rule 204-1 to delete references to Form ADV-S, and proposing to repeal Form ADV-S and amend rule 279.3 to refer to Form ADV-T. Because the Commission expects to require Form ADV-T to be filed on or before April 9, 1997, and that filing will achieve the same purpose as Form ADV-S, the Commission is issuing a separate release staying rule 204-1(c) and suspending the requirement to file Form ADV-S.102 --------------------------------------------------------------------------- \102\ 17 CFR 275.204-1(c); see Investment Advisers Act Rel. No. 1602 (Dec. 20, 1996). --------------------------------------------------------------------------- ieve the same purpose as Form ADV-S, the Commission is issuing a separate release staying rule 204-1(c) and suspending the requirement to file Form ADV-S.102 --------------------------------------------------------------------------- \102\ 17 CFR 275.204-1(c); see Investment Advisers Act Rel. No. 1602 (Dec. 20, 1996). --------------------------------------------------------------------------- 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 April 9, 1997, the Commission is proposing to amend rule 204-2 to make the books and recordkeeping requirements of that rule applicable only to advisers registered with the Commission. Additionally, the Commission is proposing to amend rule 204-2 to require advisers that register with the Commission after April 9, 1997 to preserve any books and records the adviser was previously required to maintain under state law.103 These books and records would be required to be maintained in the manner and for the period of time as the other books and records required to be maintained under rule 204- 2(a).104 --------------------------------------------------------------------------- \103\ Proposed paragraph (k) of rule 204-2. \104\ Under the proposed revisions, an adviser changing from state to federal registration would count the period during which the books and records were maintained under state law. --------------------------------------------------------------------------- ule 204- 2(a).104 --------------------------------------------------------------------------- \103\ Proposed paragraph (k) of rule 204-2. \104\ Under the proposed revisions, an adviser changing from state to federal registration would count the period during which the books and records were maintained under state law. --------------------------------------------------------------------------- 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.105 Therefore, advisers prohibited from registering with the Commission after April 9, 1997 would still be subject to the limitations of section 205. Rule 205-3 provides an exemption from these limitations, but applies only to advisers registered with the Commission. The Commission is proposing to amend rule 205-3 to make this exemption available to all advisers, including those registered only under state law after April 9, 1997. --------------------------------------------------------------------------- \105\ Section 205(a)(1) [15 U.S.C. 80b-5(a)(1)]. Section 205(a) states 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. See Section . of this Release. --------------------------------------------------------------------------- ------- \105\ Section 205(a)(1) [15 U.S.C. 80b-5(a)(1)]. Section 205(a) states 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. See Section . of this Release. --------------------------------------------------------------------------- 4. 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.'' 106 These rules prohibit certain abusive advertising practices, govern the adviser's custody of funds and securities of clients, address the payment of cash to persons soliciting on behalf of the adviser, and require certain disclosure to clients regarding the adviser's financial condition and disciplinary history.107 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 proposing to amend these rules to make them applicable only to advisers registered (or required to be registered) with the Commission. By proposing to exclude 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 if they were engaged in by an adviser not registered with the Commission.108 Rather, the Commission recognizes that these rules contain prophylactic provisions, and that the application of these provisions to state-registered advisers may be more appropriately a matter for state law. --------------------------------------------------------------------------- d not be prohibited by section 206 if they were engaged in by an adviser not registered with the Commission.108 Rather, the Commission recognizes that these rules contain prophylactic provisions, and that the application of these provisions to state-registered advisers may be more appropriately a matter for state law. --------------------------------------------------------------------------- \106\ 15 USC 80b-6(4). \107\ See rules 206(4)-1 to -4 [17 CFR 275.206(4)-1 to -4]. \108\ The anti-fraud provisions of the Advisers Act will still apply to state-registered advisers after April 9, 1997. See supra note 17 and accompanying text. --------------------------------------------------------------------------- I. Provisions of the Advisers Act that Continue to Apply to State- Registered Investment Advisers Several provisions of the Advisers Act would continue to apply to advisers no longer registered with the Commission after April 9, 1997. These include the Act's prohibitions on advisory contracts that (i) contain certain performance fee arrangements, (ii [Text truncated at 120,000 characters. 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Check the current official text before relying on it. Not legal advice.