Chapter 3 17 Qs Federal And State Regulation Of Investment Advisers And Their Reps Flashcards
Investment advisers act of 1940
Defines Investment adviser
IA’s must register with SEC or states doing business with
Only have to register with one due to national securities markets improvement
Regulates investment advisers
Establishes ethical business conduct
Broker
Dealer
Broker- making transactions for others
Dealer- Buying for your own account, not including banks, insurance companies or investment company’s
Fiduciary
Person associated with an IA
Person legally appointed an authorized to hold assets for someone in trust. Manages them for persons benefit
- Partner, officer or director of Investment adviser, or any person directly or indirectly controlled by IA
Students taking 66 are IA representatives
Supervised Persons
Anyone who provides investment advice on behalf of an IA
Includes all persons, including those who perform clerical work and do not become registered
Principal office and place of business
The executive office of the IA from which officers, partners or managers of the IA direct, control and coordinate activities
Investment Adviser
Any person who gets compensated for advice in regards to value of securities or issues reports concerning securities
Must be for regular business
IA-1092 (SEC release on who is an IA)
Includes financial planners, pension consultants and others who offer investment advice
Anyone who:
- Provides investment advice, reports or analyses on securities
- In the business of providing advice or analyses
- Receives comp for service
SEC believes no comprehensive financial plan leaves out use of securities
Must give advice on a somewhat regular basis (does not have to be principal activity) and present to public that you give investment advice to be in business of giving advice
Does not have to be specific companies but could be sectors for it to be advice. Someone who exclusively offers only vague advice might be excluded though.
Compensation is anything related to sale of securities or advice given, anyone receiving comp is an investment adviser
Exclusions from investment adviser definition
- Any bank not including a saving and loan association, or foreign bank
- Any lawyer, CPA, teacher or engineer giving advice incidental to profession, unless offering to public.
- Incidental advice from broker/dealer without special comp (i.e. Registered reps). Special comp is any definable fee on top of norm.
- (Lowe vs SEC) Publishers of bona fide newspapers, news, magazines, or business/financial publication of general and regular circulation
Advice given can not be adapted to a specific portfolio, must be disinterested and not promotional, and not timed to specific market activity
Investment newsletters are typically not excluded
- Any person issuing advice only on US gov and US gov sponsored corps
- Nationally recognized rating orgs, unless issuing recommendation on behalf of others (buy, sell, hold)
Additional Exclusions under state law:
Investment adviser representatives
Federal covered advisers
Anyone excluded from 1940 or by administrator
Publishers only have to avoid being specific to all their readers
State exclusions (delete card)
Different except for the following:
- US government only is not excluded under state law, unless federal covered adviser
Exempt under Investment Advisers Act of 1904 (normally qualify but do not have to)
FEDERAL VERSION
- Intrastate advisers who do not give advice on securities listed on national exchange (except private funds under 150 MM)
- Advisers to insurance companies only
Dodd-Frank Title IV exemptions:
2b. Venture capital funds (cannot offer redemption rights or be registered under 1940)
- Private funds under 150 MM, without regard to number or type (Quarterly calculation, one quarter to get registered if go over)
- Non-US advisers (no place of business) with under 25MM from US investors. 15 client max, cannot hold itself out to be IA
May still have to report info as an Exempt Reporting Adviser (ERA)
Private fund has less than 100 persons and no public offering
Must be made up of qualified investors (5mm up or 25mm for business entities)
Section 402 of Dodd-Frank Act
Defines a private fund on federal basis
A fund that would be considered an investment company except for:
- Only having 100 or less and not wanting to issue a public offering
- Limit of only qualified purchases (5 MM in assets or more or 25 for businesses), no public offering
Given one calendar quarter after exceeding 150 MM in assets to register
Federal covered Advisers
National Securities markets Improvement Act of 1996 divided registration requirements between states and fed
Includes:
1. Investment Advisers with SEC meeting minimum AUM of $110 MM
- Under contract to manage an investment company
- Those excluded from definition of an investment adviser
Different sizes of IAs as determined by Dodd-Frank
Large- 100 MM or more, must register unless exempt at $110 MM. Do not have to register at state
Small- 25MM and below. Unless advising an investment company, prohibited from SEC register. Would be allowed if having to register with 15 plus states or in Wyoming.
Mid- 25-100MM. Qualify for SEC registration if:
- not required by principal state (Wyoming)
- not subject to examination by state
- 15 or more states need registering
- advising Investment company
Exceptions to Prohibition of Small and Mid advisers
- Pension consultants with at least 200 MM under control
- Mid advisers between 100-110
- investment advisers affiliated with an adviser registered with SEC
- IAs expecting to be eligible in 120 days of filing form ADV
- 15 or more state
- internet advisers
20 MM buffer
May begin registration process once passing 100 MM
Would not have to withdraw SEC registration until under 90MM
May stay at SEC above 90MM, may stay at state until $110
Only relates to annual update
Must register with appropriate state in 180 day if falling under 90
90 days to register with SEC after passing 110
Investment Advisers exempt from state registration
No place of business and only do business with:
- Investment Companies
- Other broker dealers registered
- Other IA’s
- Institutional investors
- Employee benefit plans over 1 MM
- Temporary residents
- 5 or fewer clients in state (over trailing 12 months) not including those listed above
Client is defined as:
A natural person and:
-Any minor
-Any relative, spouse or relative of spouse in primary residence
-Any accounts or trusts where person is the only primary benefactor
Notice filling not required for fed covered
Office in state
If representative advertises possibility of a meeting in a hotel, country club etc. They are considered to have office in state.
If IA is passing through and offers meeting in hotel room, not considered because it is to an existing client
Private Fund exemption under State (refer to Dodd Frank 402 card for fed)
Both require qualified investors for the under 100 investors part
For state, qualified is 1MM AUM or net worth of 2.1.
Fed = 5MM
Form ADV Uses
Page 2 is now an essay
Use to:
- Register with SEC
- Register with one or more state securities authorities or
- Amend those registrations
Filing is done through the Investment adviser Registration Depository (electronic and FINRA operated)
4 parts of Form ADV
Part 1A- Asks questions about who owns and controls the firm. Along with basic operational questions.
Control an IA if owning 25% or more of voting securities, or has 25% of contributed capital
Schedule A- Direct owners and execs
Schedule B- Indirect Owners
Disclosure Reporting Pages- Details disciplinary events
Part 1b- State securities questions, do not complete if registering with SEC
Part 2A- Narrative brochures on advisory firm. Tends to focus on customer related info like: compensation arrangements, type of clients, investment, strategies employed, qualifications of advisers
Part 2A must also include a BS if IA accepts substantial prepay of fees and under state if custodian is affiliated BD, or using discretion
Part 2b- Brochure supplements containing info on supervised persons
A=Advisors B=Bodies (people who work there
Part 2 is delivered to the client
Part 1A and B to states unless federal covered (only 1A for notice filing)
USA rule on form ADV parts sent to Administrator
A federal covered IA must only submit Part 1A to the administrator upon request. (Notice of filing)
Updating of the Form ADV
Annual, within 90 days of end of fiscal year
Summary of changes must be included in brochure for part 2
Must file timely amendments for major changes such as:
- changing registrant name
- changing principal business location
- Change in location of books and records
- change in preparing person
- change in org structure
- Info becoming materially inaccurate
Changes do not require a fee, but the initial filing and renewals do
If a firm is succeeded (change of business org structure) it would have to pay SEC fee not state
Effective Date of Registration
SEC- Takes place on 45th day after filing complete app
State- 30th day at noon (like securities professionals)
Form ADV-W
Form to withdraw an IA voluntarily
Effective 60 days after filing with SEC
30 days with state
Investment Counsel
2 criteria under Investment Advisers Act of 1940
- IA’s principal business must be giving investment advice
- Provide investment supervisory services, which would apply if:
- you have discretionary authority and manage account
- ongoing responsibility to make recommendations and effect the trades
- compensated based on average value of client assets
- must continuously monitor and reallocate assets
Not included if:
- Only providing market timing recommendations
- Impersonal investment advice
- Not regularly monitoring/reallocating funds
- Only providing on specific date or intermittently
May still use if Investment adviser is insolvent (under USA it is reason for revoking registration)
Insolvency
Insolvency is not cause for cancelation or revocation on federal level
It is however under the Uniform securities act
Substantial prepayment of fees
Extra protection is given to clients
1,200 in fee prepayment per client, six months or more in advance
USA it is $500
State and federal law offer extra protection to clients of IAs who pay early
IAs soliciting clients for substantial prepay must give client balance sheet and ADV part 2a
BS must be audited by a cpa
State- Those who maintain custody of client assets or with an affiliated BD must also deliver ADV part 2a and BS
State registered advisers must file a BS regardless if exercising discretion
Surety Bonds (state)
If an advisor has custody of client assets or discretion, may have to post a surety bond
Net worth (Net capital for BDs) requirement for IAs is 10,000 for discretion, 35k for taking custody
If using surety bond 35,000 either way
Must maintain positive net worth if accepting prepay of fees over $500
Meet requirements in principal state, meet it in all
Failure to meet minimum net worth
If an IA falls under the 10k discretion or 35k custody threshold, then must secure a surety bond for amount in multiple of 5k
Must notify administrator by end of next business day. Must also send a financial report to administrator by close of business on next day
Occurs on Monday, notify by Tuesday, Financial report on Wednesday
Report must include client amount
Net Worth under NASAA
Does not include intangible assets
Includes office furniture
Investment Adviser Rep defined
Partner, director, officer or other employed individual by an IA
Must be registered if state registered IA, if federal only have to register if you have place of business
Defined as doing following:
- Makes any recommendations or otherwise renders advice
- Manages accounts or portfolios of clients
- Determines advice to be given
- Sells, offers or negotiates sale of IA services
- Supervise employees doing tasks
Only an individual can be an IAR
Registration requirements for IAR
Registration not effective if unemployed
Must have.a place of business in state to be required to register if working for a federal covered adviser
Register with IA, include personal info in ADV Part 1
IARs never register with SEC, only with States
No financial requirement, bankruptcy can be cause for denial
Exclusion from IAR
If only providing impersonal investment advice and not actively giving advice, then not an IAR
Only register if over 5 clients in 12 month period
Impersonal investment advice
Written or oral advice given not specific to individuals or accounts
IAR termination
State registered IA- Firm Notify administrator
Federal covered- IAR notifies administrator
Note for agents, all parties notify administrator
File U5
Books and Records required of an IA
USA requires materials distributed to 2 people be documented, SEC=10
If in more than one state, must meet principal state
5 year hold period from end of fiscal year (3 for BD), 2 years physical document needed. IA must follow requirement of register spot (fed or state)
Partnership articles, charters, article of incorporation and stock cert books must be kept at least 3 years after termination of enterprise.
Require the followingL
- A journal of cash receipts and disbursements
- General and auxiliary ledgers of assets, liabilities, reserv, capital, income and expense accounts
- Memorandum of each order and any instruction from client
- all checkbooks, bank statements, canceled checks and cash reconciliations
- All bills paid or unpaid
- all trial balances, financials and internal audit workings
- All written communications related to recommendations, receipt, or order except the names/address of those who received a mass communication
- record of discretionary accounts and POA
- Written agreements between the adviser and client
- A copy of recommendations, and a memorandum if no explanation is given
Must also keep audited statements for pooled investment vehicles
Must include:
-Date of the audit
-Copy of audited financial statement
-Evidence of mailing of audited financial statements within 120 days
Not required to keep a copy of the minutes of the BofD, bank statements or trust agreements
Investment adviser code of ethics (FEDERAL only)
Look over Apendix B
Federal covered advisers only under rule 204A-1
Requires:
- A copy of code of ethics developed by IA
- Record of violations and punishments
- Record of all acknowledgements to code of ethics in past 5 years
- Adviser access persons are required to document personal transactions an holdings
Personal trading procedures included in code of ethics created by IA
Should include:
- prior written approval before personal transactions
- list of securities recommended that the advisory firm is analyzing or recommending, and prohibitions on trading in those securities
- Maitenance of restricted lists which firm has inside info
- Reminder that investment opportunities should be presented to clients first
Access person
- Has access to non public info on client transactions or of a reportable fund
- Involved in security recommendations
All directors, officers and partners are presumed to be control persons
Required material:
- record of reports made by access persons
- record of people who are or were access people in past 5 years after end of fiscal year in which the approval was granted
- Record of decision to approve access person trades
Brochure Rule *Part 2 of ADV
Must provide to new and prospective clients:
- 2A Firm brochure
- 2A Appendix 1- Wrap fee program
- 2B- Brochure supplement (describes certain supervised persons)
Must provide Narrative to part 2 questions and must indicate non applicable questions. 18 parts and includes:
- description of services
- fees and comp
- method of analysis, risk loss
- Disciplinary info
- Custody practices
If Fed covered, not required to file through IARD but must have available
If state, must make available to all and part 2B must be filed for each supervised person
Must detail on cover page that additional info is available on SEC web
Detail on 2b
Covers-
- educational background and business experience
- discipline info in past 10 year, unless still material issue
- disclosure of additional compensation
- supervision- provide name, title and telephone number
People included:
- any supervised person who formulates invest advice and contacts clients
- supervised person with discretionary authority (unless part of a team and no contact, only need top 5 in charge of discretionary advice)
Wrap fee programs
Overall fee not dependent on specific advice
Not suitable for buy and hold clients
Supply 2A appendix 1, if only business is wrap fee programs then only supply appendix
Only one brochure need be created if doing multiple wrap fee programs
If separate brochures for rap fee programs are made, then must reference the other programs
If you use but do not sponsor a rap fee program, you do not have to provide an appendix 1, just the normal 2A
May use another sponsors brochure
Must disclose-
- Must identify the brochure as a wrap fee program
- Fee charged
- Negotiability of fee
- Portion paid to advice givers
- Services provided and statement on overall cost possibly being higher than normal fees
- Notice of other fees in addition to wrap fee
- Explain that person selling may be compensated for decision and it may be more than what the adviser would receive otherwise
- Minimum account sizes
- Investment process
- Disclose whether related persons act as portfolio manager of program
- Discuss conflicts of interest
- Describe information about clients that is given to portfolio managers
- Explain any restrictions on talking to portfolio managers
STATE REGISTERED IAs
-must disclose any relationship with any issuer of securities not listed in 2A
SEC Broshure delivery Requirements
(SHOULD ASSUME STATE IF NOT TOLD)
2A Firm brochure- Before or at time an advisory agreement is established
Must deliver updated version by 120 days into new year, unless nothing material changed, for free
May summarize main points changed
Nothing changed, nothing needs to be sent
Only have to deliver an interim amendment if a disciplinary event occurred
State registered advisors delivery requirements for firm brochure
Must deliver brochure to the client within 48 hours before entering into an advisory contract
At time of contract signing if client has 5 business day termination buffer
May be refunded the startup/setup fee if terminated in 5 day buffer (less pro rata amount only on initial fee)
Brochure supplements
Initially and annually must deliver for each supervised person providing advisory service
Not required though if:
1. Clients who a brochure or wrap fee program is not needed
- Clients receiving only impersonal advice, including subscribers paying $500 or more
3, Execs, directors, trustees, general partners or any employee participating in investment activities for at least 12 months
Exemptions to brochure rule (both state and federal)
- Contracts with registered investment companies. Provide info to board due to Invest company act of 1940 so no need.
- Advisers providing impersonal advice. 500 or greater you must offer it though, either 48 hours/ at time of signing for state or at time of signing for Fed
Updating of the brochure
- Each year at time of filing annual update
- Whenever information is materially incorrect
No material change, no need to offer updated brochure
Must send out amended with updated info if a disciplinary action occurs
Federal advisers must file amendments electronically with IARD, but not to SEC just keep a copy in files
State are required to file amendments with IARD through the state
Balance sheet requirement
Only required for clients with 1,200 in fees collected for future 6 months
Custody of funds and securities (SEC and State except when marked)
To maintain custody of assets, IA must:
- Must have a qualified custodian who is putting funds in separate accounts either in clients name or agents name for clients
- Must notify client of account opening holding funds and agents information and changes in the account
- Account statements are delivered by the custodian (who details all quarterly transactions) or adviser (who must give detail quarterly and is subject to an annual CPA audit of the assets at random)
Under NASAA model rule, the IA may maintain custody as long as noted in ADV (exceptions listed below)
- May keep mutual fund shares with transfer agent
- Rule not applicable to investment companies ad they follow Investment Company Acot of 1940
Broker-Dealers only have to prove a receipt of receiving customer funds
Custody defined by NASAA
Custody if third party check held for 3 days
SEC never constitutes a check as custody
Authorization or permission to withdraw funds from a customers account
Fee prepayment is not considered to be of custody of advisor, but a fee would constitute a balance sheet being run
IA is not allowed to forward client funds without consent of client
Checks drawn by a client must be forwarded under NASAA by Third day (not considered custody under SEC)
Discretion and fee prepay is not considered to be custody
Qualified Custodian
Bank or savings association that is FDIC insured
A registered broker-dealer holding in customer-accounts
Foreign institution that segregates accounts
Do IA’s receive assets?
Typically not, usually done by BD
NASAA Model Rule on Custody and fee deduction
Must have written authorization to take fee from account
Must send notice to client when fee is withdrawn
Must notify administrator of safeguards being used in form ADV
Deemed to have custody if checks made payable to an unrelated third party are returned to customer
Will receive a waiver from the net worth and bonding requirements if only taking custody for fee purposes, and from the audited BS
Two exceptions to minimum net worth
- Advisers having custody solely due to direct fee reduction
- Advisers having custody solely due to pooled investments
Form ADV-E
The surprise exam report done by a CPA on IAs who have custody of investments and sending their own quarterly statements
Filled out by adviser in unison with surprise Audit
Fiduciary Responsibility of IAs
Focused on elimination of conflicts of interests that may arise
Investment advisors are defined by law as fiduciaries, broker-dealers are not
Does not require disclosure of IAR personal transactions
Disclosure and Consent of IAs
SEC and State unless specified
Must give option of executing trades with multiple different BDs
Must disclose material disciplinary actions within past 10 years at least 48 hours before contract signing or at signing with 5 day trial
Required Discipline Disclosure would include:
1. Adviser or management being found guilty leading to denial, suspension or revoke of registration(s)
2. Court proceedings, such as an injustice, against management pertaining to investment activity or any felony
3. SRO proceeding leading to loss of registration or fine of over 2,500
4. Do not have to notify of lawsuit if not found guilty
Failure to disclose would include:
-failure to disclose a fee
-failure to disclose an affiliation with another BD
- State rep with discretionary authority or requires $500 or more in fees 6 months in advance not discussing material items impairing ability of adviser to do business ($1,200 for SEC)
- favoring clients in bulk trades
- disclose material legal issues from past 10 years within 48 hours before entering into contract for state, or at beginning of relationship for SEC.
Hedge Clauses
Hedge clauses to reduce liability are illegal and not allowable
Are allowable however in regards to events outside of firm control such as natural disasters or war
May not be used to disclaim statements inheritently misleading
Are you an investment adviser if only clients are banks
Yes, insurance companies however are exempt.
Notice Filing Not Required if:
Dealing only with institutions, other IAs, other BDs and so forth
Electronic Storage Media Requirement
Must maintain and preserve the records to guard against loss
Limit access to authorized personal and Administrator
Non-electronic original records be recorded so to be legible
Investment Adviser Representatives
All must register on the state level, and not with the SEC
Cover page of Brochures
Name, business address, contact information, website address and date of the brochure
Must state it is not approved by either the SEC or States
Additional info available at Advisers info.org
Is it suitable to recommend a buy and hold client participate in a wrap fee account?
No, because the client does not benefit from the fact that commissions on trading are included
