The Investment Advisers Act of 1940 (“Act”) was enacted to regulate financial advisers who provide investment advice to the general public.  

 

The baseline principle of the Act is

 

(1) any person

(2) who, for compensation, 

(3) engages in the business of advising others as to the value of or advisability of investing in, purchasing, or selling securities OR as part of a regular business issues or promulgates analyses or reports concerning securities –– will be deemed as an Investment Adviser and be subject to the registration requirements of the Act absent an exclusion or exemption. §§ 202(a)(11); 203(a). 

The application of these three prongs have been liberally construed by the SEC to encompass wide swaths of persons who engage in financial advisory services – including financial planners, pension consultants, sports or entertainment representatives, or anyone who provides financial advisory services. (1)

Let’s break down each prong: 

Any Person
Natural humans or legal entities. 

For Compensation
Any receipt of economic benefit, regardless of its form, but not limited to:

(1) the charging of a transactional fee for specific investment advice rendered;
(2) the charging of a single advisory fee for multiple services, including investment advisory services;
(3) the client reimbursing expenses;
(4) receiving “kickbacks” from brokers for trades made, pursuant to investment advice rendered;
(5) receiving a fee for management of a fund or portfolio;
(6) receiving commissions or fee for recommendation of a financial product;
(7) receiving various forms of “perks” from an advisee, such as expensive gifts, business referrals, et cetera. 

Engages in the Business Of / Part of a Regular Business
In order to satisfy this prong, the person’s activity need not be its principal business, instead, it needs “only [to] be done on such a basis that it constitutes a business activity occurring with some regularity.” (2) Frequency of the activity by its own could be a factor but is not determinative nor conclusive, as to the regularity prong. In other words, if a person assists his friend in picking out stocks once a year and receives a performance fee in return, this activity could be deemed sufficient to satisfy the “engages in the business of” requirement.

The SEC has outlined three factors (3) for this prong – a person is in the business of rendering investment advice if they: 

(1) hold themselves out as an investment adviser or one who provides investment advice;

(2) receive compensation for such investment advice;

(3) provide specific investment advice (a recommendation, analysis, or report about specific securities or specific categories of securities). 

 

Concerning Securities

  • 202(a)(18) of the Act shares the same definition of “security” as § 2(a)(1) of the 33 Act and is broadly defined to include a slew of financial instruments such as stock, US Treasury bonds, equity derivatives (better known as “options”), bonds, and other forms of investment contracts. The Act regulates the securities market; therefore, advice about asset classes that are not deemed as securities do not fall within the regulatory scheme of the Act. If the advice touches or concerns anything that could be deemed as securities, the adviser must then register, absent an exclusion or exemption. 

 

Exclusions from the Definition of an Investment Adviser

(A) Banks
(B) Broker dealers (4)
(C) Lawyer, accountant, engineer, or teacher (5)
(D) Publisher of any bona fide newspaper, news magazine, or financial publication of general and regular circulation
(E) Government securities advisers
(F) Nationally Recognized Statistical Rating Organizations (Moody’s, Fitch, Standard & Poor’s)
(G) Family offices
(H) Federal and state governments (municipalities), including any political subdivisions thereof

 

Available Exemptions from the Investment Advisers Act

Investment Advisers fall within the following exemptions need not register:

(1) Adviser to a private fund, whose clients and advisers are confined to one state
(2) Adviser to insurance companies
(3) Foreign private adviser
(4) Adviser to charitable organizations
(5) Adviser to church plans
(6) Adviser registered with the Commodity Futures Trading Commission (CFTC), if the predominant business is not the provision of securities-related advice
(7) Adviser to venture capital funds (6)
(8) Adviser to private funds, with assets under management of less than $150 million 

 

Private Fund Exemption 

For smaller startup funds, this exemption is extremely popular. Dodd-Frank included the private fund exemption under § 203(m) and directed the SEC to promulgate rules thereunder. 

Rule 203(m)–1 states that an adviser is exempt from registration, if such adviser:

(1) acts solely as an investment adviser to one or more qualifying private funds and
(2) manages private fund assets of less than $150 million.

A “qualifying private fund” means any fund not registered under the Investment Company Act, this includes § 3(c)(1) and § 3(c)(7) funds, and also § 3(c)(5)(C) real estate funds. (7)

Important Side Note: the vanilla real estate syndications are not the type of real estate funds contemplated under § 3(c)(5)(C). These real estate interests stated here pertain to those falling within the meaning of “securities.” As such, this does not apply to a real estate syndication set up to acquire real estate, as opposed to mortgage notes or other mortgage-backed securities.

If you are an adviser to a private fund that has less than $150 million in assets (8), you don’t need to register but may still need to file a Form ADV. The SEC has provided guidance that an adviser may advise an unlimited number of private funds, so long as each of the private funds has less than $150 million in assets. But, private fund advisers must do an annual calculation of assets under management (“AUM”) and must register within 90 days of filing the annual updating amendment if AUM surpasses $150 million. (9) Note: exempt private fund advisers are still be subject to certain reporting requirements and must file a Form ADV with the SEC pursuant to Rule 204-4 promulgated under the Act. 

Danger of Integration

Integration may occur when fund advisers are operationally integrated. When an adviser is managing multiple exempt funds, there is a danger that the funds could be deemed as integrated by the SEC, if the “facts and circumstances surrounding [the] relationship indicate that the two advisers were under common control [and] were not operationally independent of each other.” (10) Fund operators should have policies in place to prevent overlapping operations to not be in danger of integration.

SEC Registration Requirements 

Both the federal government’s SEC and state administrators have regulatory schemes that cover investment advisers. If SEC registration requirements are not triggered, the respective state administrators may have registration requirements that likely apply.  There are mandatory licensing and exam requirements such as Series 65 to needed, depending upon location and role.

Triggering Requirements for SEC Registration

The SEC registration requirements for investment advisers will be triggered when the adviser has:

(1) AUM of at least $110 million; or
(2) AUM of at least $25 million and is not required to register in their state; or
(3) Is an adviser to a registered investment company. 

Eligibility for SEC Registration

A registrant may register with the SEC, if they have AUM of at least $100 million,  but must withdraw registration or becomes ineligible for registration, if AUM falls below $90 million. 

This blog post is for general educational purposes and is not to be construed as legal advice. Please consult an attorney. 

          1. Advisers Act Release No. 1092 (Oct. 8, 1987).
          2. Id.
          3. Id.
          4.  A Broker Dealer will not be excluded from the Act if it provides services that are not solely incidental to its business as a broker-dealer.
          5. For services solely incidental to the profession.
          6. With caveats as stated in Rule 203(l)-1.
          7. § 3(c)(5)(C) of the Investment Company Act exempts funds that are acquiring “mortgages and other liens on and interests in real estate.”
          8. Advisers Act Release No. 3222 (July 21, 2011).
          9.  Id.
          10. Adviser Act Release No. 3058 (Jan. 20, 2014).