Module 5 Flashcards
Describe and apply the IAA’s registration requirement, the exemptions from that requirement, the prohibition on registration by certain investment advisers, and special rules for “exempt report advisers”.
Investment advisers must register with the SEC unless
1. They are prohibited from registering (they are too small) or
2. They qualify for an exception from the registration requirements.
An investment adviser that is prohibited from registering with the SEC may be
required, by state law, to register with one (or more) state securities regulators.
Many IAs prefer SEC registration (a) to avoid regulation by the several states in
which they do business and (b) because they believe that advisory clients prefer
SEC-registered advisers (perception of greater protection and federal government
“blessing.”
Employees of investment advisers are NOT required by the SEC to register as
investment advisers with the SEC.
The investment advisory firm’s registration with the SEC covers its employees and
others under its control and supervision, so long as their advisory activities are
undertaken on the firm’s behalf.
Prohibition:
Most small and mid-sized IAs are subject to state regulation and are prohibited
from registering with the SEC.
Large advisers are required to register with the SEC, unless they rely on an
exemption from registration (exemptions are discussed later)
Registration largely depends on the amount of an adviser’s “regulatory assets
under management” (RAUM).
Foreign advisers that advise U.S. persons are treated as large advisers
Small advisers, i.e, with less than $25 million of “regulatory assets under
management” (RAUM), may NOT register with the SEC.
Mid-size advisers, i.e., with between $25 million and $100 million of RAUM may
NOT register with the SEC (exceptions: if the adviser relies on an exemption from
state registration in the state in which it has its principal office and place of
business, or if the adviser is not subject to examination in that state).
For purposes of this class, you should know that investment advisers with RAUM
up to $100 million are generally prohibited from registering with the SEC.
- Advisers to investment companies registered under the Investment Company
Act of 1940 (ICA) (RICs).* - Advisers to business development companies (BDCs)(regulated by the ICA).*
- Pension consultants to employee benefit plans with $200 million of more.*
- Advisers that reasonably expect to have $100 million or more of RAUM within
120 days of registering with the SEC.** - Multi-state advisers (if otherwise obligated to register in 15 or more states).**
- Internet advisers (provide advice exclusively through an interactive website.)**
*Mandatory registration **Voluntary registration
Describe the reporting and recordkeeping requirements of the IAA.
Form PF is required to be filed on a quarterly or annual basis by
SEC-registered investment advisers who manage any number of private
funds with at least $150 million in private fund RAUM.
The purpose of Form PF is to provide the Financial Stability Oversight
Council (FSOC) with data to identify systemic trends in the private fund
industry and to assist in monitoring systemic risks to the U.S. financial
markets.
Detailed information required to be reported encompasses, among other
things, (i) exposure to specific financial institutions and credit
counterparties, (ii) concentration of fund investments by industry and
geography, and (iii) concentration of investor base.
Form 13F requires IAs with $100 million or more invested in
exchange-traded equities to publicly report their holdings to the SEC
quarterly. Can request confidential treatment.
The $100 million threshold was established in 1978.
The SEC recently proposed to amend the Form 13F requirements, including
raising the reporting threshold to $3.5 billion, reflecting proportionally the
same market value of U.S. equities that $100 million represented in 1975.
Describe the scope of the SEC’s authority to conduct examinations of the records of investment advisers.
Recall that the Act was amended in 1960 to require every investment adviser
(except those exempt from registration) to keep certain books and records, and
authorized the SEC to examine all books and records of SEC-registered
investment advisers (not just those records required to be kept).
See section 204 of the IAA and rule 204(a) thereunder.
Records of private funds are deemed to be the records of their advisers, and thus
subject to SEC examination.
Unlawful for SEC to make public the existence of any examination or the results of
or facts ascertained during any examination. Section 210(b).
SEC staff regularly conducts examinations of investment advisers. Examination
staff are located throughout the US.
Approximately 95% of exams uncover deficiencies; in most cases, the advisers
remedy the deficiencies and no further action is taken.
Approximately 10% of exams result in referrals to the SEC enforcement staff for
investigation. Enforcement staff are also is located throughout the US.
There are far more investment advisers than SEC examiners; SEC examination
staff uses risk-based factors to choose investment advisers for examination.
Describe the scope of the SEC’s authority to enforce the provisions of the IAA against investment advisers.
The SEC is authorized to investigate and to bring enforcement actions in
federal courts and in administrative proceedings against investment advisers and
their “associated persons” (i.e., employees).
The SEC is authorized to seek injunctions in court (orders enjoining future
violations) or cease-and-desist orders in administrative proceedings (same).
The SEC may seek monetary penalties and disgorgement of ill-gotten gains.
See sections 203(e) and (f) (administrative proceedings) and section 209 (courts).
Most enforcement actions are settled before they go to trial.
Thus, only the SEC can file actions in federal court and in administrative proceedings
alleging violations of the Advisers Act. Advisory clients and others seeking monetary
damages are not permitted to do so.
Private actions under the Investment Advisers Act, however, may be instituted in
federal court by persons seeking certain equitable relief, such as the rescission of an
advisory contract or restitution. See section 215 of the IAA.
How do IA’s register and what does the form contain?
Investment Advisers register with the SEC by filing Form ADV Form ADV
Form ADV has two parts:
Part 1A requires information about the adviser’s business,
ownership, clients, employees, business practices, and any
disciplinary events (e.g., felonies, injunctions, etc.) of the adviser or
its employees. The SEC uses this information to grant or deny
registration and to manage its regulatory and examination
programs.
Part 2 contains information that registered advisers are required to provide to their
clients and prospective clients.
Part 2A is a narrative brochure that describes the adviser’s business practices,
investment strategies, conflicts of interest, and disciplinary history, etc.
Part 2B is a brochure supplement with information about each advisory
employee that provides advice to the adviser’s clients (e.g., educational
background, business experience, disciplinary history)
The adviser must file the brochure with the SEC and deliver it to clients annually.
Describe the registration requirements and process?
There are no federal educational or licensing requirements.
There is no federal net capital requirement.
There is no federal requirement that an adviser be insured or bonded.
No investing experience is required.
Once an adviser files an application to register with the SEC, the SEC has 45 days
in which to grant the application or institute proceedings to determine whether the
application should be denied. Section 203(c)(2).
The SEC shall grant such registration if it finds that the adviser (a) made all
required disclosures and (b) is not prohibited from registering as an investment
adviser under section 203A (discussed later).
The SEC shall deny such registration if it (a) does not make such a finding or (b)
finds that if the adviser were SEC-registered, the Commission could suspend or
revoke its registration under section 203(e).
Registration provides clients and prospective advisory clients with
information that they need to know when deciding whether to hire or retain
an investment adviser.
Who are the exemptions to SEC registration?
- Intrastate advisers (all clients reside in adviser’s state of principal office and
business; give no advice about securities traded on a national exchange)
(section 203(b)(1). - Advisers to insurance companies (i.e., have no other advisory clients)
(section 203(b)(2). - Foreign private advisers: no place of business in US, fewer than 15 clients
(including investors in any private funds they manage), fewer than $25 million
RAUM attributable to US persons, and don’t hold themselves out to the public
in the US as an investment adviser. (Recall that most foreign advisers are
treated as large advisers and must register with the SEC, regardless of
RAUM) section 203(b). - Charitable organizations and plans (sections 203(b)(4) and (5)).
- Commodity trading advisors registered as such with the CFTC (a) if primary
business is not acting as an IA and if they don’t advise a RIC or a BDC, or (b) that
advise private funds (unless their business becomes predominantly the provision
of securities advice) (sections 203(b)(6)(A) and (B)) - Certain private fund advisers, i.e., solely advise private funds with less than
$150 million in RAUM in the US (are not publicly offered and either have 100 or
fewer beneficial owners or all of its investors are “qualified purchasers,” which
includes natural persons who own $100 million or more in investments) (section
203(m) and rule 203(m)(l). - Venture capital advisers: if solely advise one or more “venture capital funds”
(regardless of RAUM). See section 203(l) and rule 203(l). Also are “exempt
reporting advisers.”
Venture capital funds are private funds that
a. Represents to investors that it pursues a venture capital strategy
b. Doesn’t provide investors with redemption rights
c. Holds no more than 20% of its assets in non “qualifying investments” (QIs are
directly acquired investments in equity securities of private companies….)
d. Doesn’t borrow or otherwise incur leverage more than 15% of the fund’s
assets and only on a short-term basis (less than 120 days)
What is an Exempt Reporting Adviser?
An exempt reporting adviser is an investment adviser that is not required to
register with the SEC or with state securities authorities but is required to file an
annual report using a truncated version of Form ADV. The requirement to file such
annual report arises from the private fund adviser exemption and/or the venture
capital adviser exemption.
