Regulation of Investment Advisers and Their Reps under the USA Flashcards
What two criteria must be met for someone to be “investment
counsel”?
a. Their principal business must be giving investment advice (excludes financial planners)
b. Provide investment supervisory services: “Continuous and Regular Supervisory or Management Services”
- discretionary authority over & provide ongoing supervisory services to the account
- ongoing responsibility to select or make recommendations based on client needs and arranging purchase or sale
What do you have to do to “provide continuous and regular
supervisory or management services re: an account”?
a. Discretionary authority over and provide ongoing
supervisory/mgmt services
b. You don’t have discretionary authority, but you have ongoing responsibility to select or make recommendations re: securities, based on needs of client
Are you providing continuous/regular supervisory/management services if you provide advice on intermittent or periodic basis (e.g. client request re: a market event) or on a specific date (e.g. account is reviewed and adjusted quarterly)?
NOPE!
Would an agent who secures a favorable contract for a football
player and receives 10% of the player’s salary be an investment
adviser?
No–only if they also advise the player to invest the money in
specific securities.
Difference between exclusion from a definition and exemption from a provision.
Exclusion = excluded from a definition
Exempt = person meets definition, but is not subject to
provision
How many exclusions are there from the definition of an
investment adviser under USA?
7
What are the 7 exclusions from the definition of an investment
adviser under USA (State)?
- Any bank or
- bank holding company,
- savings institution, or
-trust company.
(does NOT include savings and loan associations or foreign banks)
- Any lawyer, accountant, teacher, or engineer
whose advice is solely incidental to the practice of his profession (LATE)
- Any Broker-Dealer
includes those whose advisory services are incidental to business and doesn’t get special compensation (e.g. wrap fee) - Publishers meeting certain criteria
(general and impersonal, not adapted to specific customer needs)
These are only for USA (state)
- Investment adviser representatives
- Federal covered advisers
- Any other person the Administrator specifies as excluded
What are the 5 exclusions from the definition of an investment
adviser under Investment Advisers Act of 1940?
Same first 4 as USA
- Any bank or
- bank holding company,
- savings institution, or
-trust company.
(does NOT include savings and loan associations or foreign banks) - Any lawyer, accountant, teacher, or engineer
whose advice is solely incidental to the practice of his profession (LATE) - Any Broker-Dealer
includes those whose advisory services are incidental to the business and doesn’t get special compensation (e.g. wrap fee) - Publishers meeting certain criteria
(general and impersonal, not adapted to specific customer needs) - any person who advise, analyses, or reports are related only to securities direct obligation of / obligations guaranteed by US Gov
What is a “wrap fee” program i.e. which services are provided?
- Advisory program where specified fee(s) are not based on # of transactions but rather for investment advisory services and the execution of the transactions to fulfill that advice.
- NOT financial planning or recommendations
Who are the 2 exemptions from registration as an investment
adviser (firm) under the federal Investment Advisors Act of
1940?
a. Intrastate advisers (only within 1 state) - clients and place of
business and not national exchange securities advice.
b. Advisers who ONLY work with insurance companies
Who is defined as an intrastate adviser?
- Someone whose clients are residents of the state in which the
adviser has principal office and only place of business - Someone who doesn’t give any advice dealing with securities listed on a national exchange (e.g. NYSE)
Are advisers to ONLY banks exempt from federal registration or
state registration?
only state registration
Who are the 6 exemptions as an investment adviser (firm) from
state registration under the USA?
Those who have no place of business in the state but are registered in another state AND
only clients in the state are:
1. Broker-Dealers registered under the USA
2. Other investment advisers
3. Institutional investors
4. Existing clients who are not residents but are temporarily in the state
5. de minimus exemption (5 or fewer, less than 6), or
6. any others the Administrator exempts by rule or order
If a question refers to an “individual,” do they mean
institutional or retail client?
Retail
What is a federal covered adviser?
Well, they:
- They must be SEC-registered as an investment adviser and work with assets under management of $110 million (the current threshold).
- SEC registration is necessary as they are part of a contract under the Investment Company Act (1940) to manage an investment company.
According to the NSMIA, federal covered advisors do not need to register with the state based on the assets they manage.
There are various thresholds that cover this, created by Dodd-Frank.
They are for large, mid-sized, and small advisers.
- Large investment advisers with assets of over $110 million under their control, must be SEC-registered.
If they manage between $100 and $110 million in assets, it isn’t mandatory to register, but they can if they’d like and they think they will move past the threshold soon.
- Medium-size advisers
This group of advisers deals with assets between $25 million and $100 million.
They are not permitted to register with the SEC, so they register with the state where they operate.
- Small investment advisers
These investment advisers handle assets of $25 million or less.
SEC registration is only a necessity for advising investment companies registered under the Investment Company Act of 1940.
In the case of others that do not, SEC registration is not allowed; instead, they need to be registered in the state in which they operate unless state rules say something different.
One other scenario requires SEC registration.
Investment advisers operating in 15 or more states are subject to SEC regulation registration.
Here are some Dodd-Frank classifications exceptions:
- Pension consultants who manage more than $200 million
- Investing advisers with assets between $100 and $110 that are registered with the SEC
- Within 120 days of filing a Form ADV, those advisers anticipate being registered with the SEC
While states can’t mandate additional registration requirements for federal covered securities, they can ask for copies of any documents filed with the SEC related to the security in the form of a ?
Notice filing
They may request that future documentation that is sent to the SEC be sent to them as well.
There’s a filing fee that will need to be paid by the adviser as well.
If they have a state-based office or if they have six or more retail clients over the period of a year from the state, they will need to file notice as well.
No notice filing for federal covered investment advisors is necessary if their base of operations is not located in the state and if their only state clients are:
- Investment companies
- nvestment advisers
- Broker-dealers
- Banks
- Insurance companies
- Trust companies
- Employee benefit ($1 million or more asset)
- Savings institutions
- Government agencies
Some investment advisers won’t have to register in the state in which they operate, even when they fall under the definition of an investment adviser.
No place of business in this state is the first exemption to look at.
This is possible when an adviser has state registration elsewhere, has no office in another state but does have certain clients there.
In order for that to be the case, certain conditions regarding clients need to be met.
These can only be:
- Any broker-dealer registered under the Uniform Securities Act
- Investment advisers
- Employee benefit plans or other institutional investors (they must have assets of $1 million or more)
- Clients that are in the state temporarily (in other words, they are state residents)
- Other parties that are ruled exempted by rules or orders passed by the state administrator
There is also a de minimis exemption here.
If they do not have a physical location in the state and have fewer than five state-based retail clients within a 12-month period, they are not required to register.
While investment advisors can provide advice to more than one qualified private fund, they are the only ones who can do so.
What are private funds?
The Investment Company Act says it is an “issuer that would be an investment company”.
So, therefore, only 100 persons or less beneficially own the issuer’s outstanding securities.
At the moment, the issuer has no plans to make a public offering of its securities in the future.
There are additional requirements for these private funds:
- Investments in them must be made by qualified investors (as per the definition).
- The SEC mandates that exempt reporting adviser reports (ERA reports) be filed with the state for public interest and to protect investors.
- Neither private fund advisers’ representatives nor the adviser themselves should have participated in any activity that would disqualify them as described in Regulation D Rule 506 (d)(1).
Form ADV part 1.
It includes these details from Part 1A.
- Where their principal office is located
- If not found at their office, where their books and records are stored
- Business structure (a sole proprietorship, for example)
- The advisory services they provide (for example, individual portfolio management)
- Do they offer other business activities (for example, broker-dealer services)?
- Are they maintaining customer assets?
- Are customer accounts subject to discretionary control?
- Details of all officers, directors, partners, or other relevant control persons
- Disciplinary history
- States where the investment adviser is currently registered/where they will be registered
known as the investment adviser’s brochure.
The emphasis is primarily on customer-related information, including:
- Fees and commissions, hourly charges, and all other forms of compensation
- Client types
- Investment types the adviser recommends
- Investment strategies used
- Analysis methods
- Service of process consent
- Education and business background of the staff providing advice as well having discretionary control
- An audited balance sheet must be presented when the investment adviser retains custody or requests prepayment of fees
Form ADV part 2A
The investment adviser will need to create various supplements to the brochure for part 2b, with a particular focus on the supervised persons.
Next up is Form ADV Part 2B.
With regards to passing on investment advice, clients will deal with certain staff from the firm.
There are six categories of information about these staff in part 2B:
- Cover page: This identifies the supervisory person or persons that part 2B will be covering.
- Educational background, business experience
- Disciplinary information: Over the last 10 years. Any serious offense from more than 10 years ago must be disclosed too.
- Other business activities: For instance, if the supervised person receives commissions, bonuses, or fees for the sale of securities, it must be disclosed.
- Additional compensation
- Supervision: The supervised person’s supervision activities as well as all the details (title, name, contact numbers) of the supervisor will be listed under this heading.
Test Topic Alert
If you’re taking the Series 63 exam, it is important to remember that the administrator can ask for documents that were filed with the SEC if the adviser has an office in their state.
Additionally, the exam could ask which sections of a Form ADV need to be submitted should they make that request:
- Federal covered investment adviser: Only submits Part 1A
- State-registered advisor: Submits Part 1A and 1B
A Customer Relationship Survey (CRS) must be included in this section
This section, however, won’t have to be filled in by all advisers, only those who work with retail clients and are SEC-registered.
Form ADV Part 3.
Updating a Form ADV
Within 90 days from the end of the fiscal year, an updating amendment must be filed for the Form ADV.
Probably the most critical factor here is the total amount of assets under management.
There are various amendments for material changes that can be made.
The investment adviser must amend the Form ADV if any of the following information changes or becomes inaccurate:
- The registrant’s name changes
- The business principal location changes
- The location where records and books are kept changes
- The person who prepares the Form ADV changes
- The organizational structure of the investment adviser changes, for example, it goes from a sole proprietorship to a partnership
- If the brochure’s information has become inaccurate for some reason
- There have been any changes regarding disciplinary actions taken against relevant staff
- Policy changes in relation to customer funds or securities
True or False
Under the Uniform Securities Act, the administrator may establish minimum financial requirements for investment advisers in their state.
True
Financial advisers are subject to net worth requirements:
- Custody of client funds: $35,000 net worth needed.
- Discretionary authority only: $10,000 net worth required.
- Both custody and discretionary authority: Still a $35,000 net worth requirement.
Test Topic Alert
As you prepare for the exam, you need to understand that the Uniform Securities Act provides only guidelines as to what these values can be.
State laws may require higher net worths for investment advisers who have custody of client funds, have discretion over their accounts, or both.
If an investment adviser is registered in multiple states, they only require bonding in the state where their principal office is located as that will be sufficient for the other states too.
When it comes to general business records, investment advisers and broker-dealers have the same requirements.
Broker-dealers and investment advisers have different retention requirements, however.
Broker-dealers: A period of three years is how long records must be kept. If requested, these records should be accessible for the first two years.
Investment advisers: A period of five years is how long records must be kept. If requested, these records should be accessible for the first two years.
It is required to keep separate records for broker-dealers and investment advisers.
A person meets the definition of an investment adviser representative by doing the following on a state and federal level:
- Make recommendations
- Give advice around securities
- Handle client accounts
- Manage client portfolios
- Making recommendations to clients and giving advice to them regarding securities
- Selling their advisory services or using other techniques regarding sales (soliciting, offering, or negotiating)
- Supervise any person who offers any of the above actions
We’ve mentioned the term “individual” here a few times and it’s an important one because the representative of an investment adviser can only be a natural person.
An additional exclusion is if someone represents a federal covered investment advisor.
A special rule applies in this regard as per the Investment Advisers Act (Section 203A).
Those working for a federal covered adviser are only required to register in the state where their business is located.
But what is defined as a place of business?
Uniform Securities Act exemptions from requirements to register as an investment adviser representative
- Their office, from which they operate and provide the various services they provide
- Public locations where they regularly provide the services they offer
Even if a firm has 500 clients in a state, registration of its representatives would not be required as long as they don’t have an office base there.
Test topic alert
Registration for a representative is only ever with the state and that’s something asked on the exam often.
For those who work for federally covered advisers, this is also true.
Also, in a sole proprietorship, an individual can act as an advisor as well as a representative.
They will not be considered an investment adviser if they act only as a representative, however.
What about the financial requirements of investment adviser representatives?
There aren’t any at all, unlike those imposed on investment advisers.
But, it’s important to note that if a representative goes bankrupt, their registration can be rescinded.
- A major part of their business revolves around securities and executing trades in them
- They are compensated by markups (markdowns) and commissions
Broker Dealers
- are responsible for buying and selling securities in accordance with customer orders.
- Despite the fact that they can work in a large company doing both tasks, they do have separate responsibilities when compared to investment advisers
agents.
- They mainly provide advice to their clients, for example, investment advice
- is compensated through fees and other charges that depend on the size of the assets they manage
investment advisers
- Mostly, they provide investment advice to clients of the adviser.
- After a client has received investment advice, they will then issue a buy/sell order to an agent at the broker-dealer where the client holds a brokerage account
investment adviser representatives.
B.A.I.R. (Pronounced like “bear”)
B - Broker-Dealers: Trades securities. Earns from markups/markdowns and commissions.
A - Agents: Executes orders. Works for broker-dealers, but separate from advisers.
I - Investment Advisers: Gives advice. Earns based on asset size they advise on.
R - Representatives (Investment Adviser): Advises under the main adviser. Sends orders post-advice.
Remember: B.A.I.R. brings clarity to the financial jungle!
Take note!
True or false.
Broker dealers by definition are Investment Advisors
False. Any broker dealer who’s investment advisory services are incidental to their brokerage business and who received no special or separate compensation for offering advice are excluded from this definition
Test topic alert
An investment newsletter is being published for a subscription fee. Rather than being published on a regular basis IE weekly, monthly, quarterly, and so forth, issues are released in response to Market events. In this case, the publisher would be considered an investment advisor requiring registration. Exclusion requires that the publication is published with some sort of regular schedule rather than being time to specific Market events
What are some exceptions under Dodd-Frank
- pension consultants, but only those with at least 200 million under control
- those midsize advisors with at least $100 million in AUM, but less than $110 million in AUM who elect to register with the SEC rather than the states.
- investment advisors expecting to be eligible for SEC registration within 120 days of filing form ADV
Test topic alert
An investment advisor registered under state law whose assets reached 110 million under management has 90 days to register with the sec. A federal covered investment advisor whose assets under management fall below 90 million no longer qualifies for SCC registration and has 180 days to register with the state.
Define a private fund.
One who outstanding securities are beneficially owned by not more than 100 persons and which is not making and does not presently propose to make a public offering of its securities.
True or false.
All private fund investors must be qualified clients
True
Must:
- either have at least $1.1 million in assets managed by the investment advice or a net worth (excluding value of primary residence) of more than $2.2 million.
Qualified clients
- private funds.
- This exemption is often used by hedge funds, venture capital funds, and other types of private funds.
- It’s available to funds whose securities (i.e., its interests in the fund) are owned by not more than 100 persons. Note that there are specific rules around counting investors in this context. These funds cannot make a public offering of their securities.
- No specific net worth or sophistication requirement is prescribed for investors, though many funds still only accept accredited investors to meet other regulatory requirements.
Section 3(c)(1)
- This exemption is tailored for funds that only accept “qualified purchasers.”
- The fund can’t make a public offering of its securities.
- The central tenet of this exemption is the definition of a “qualified purchaser.” In this context, a qualified purchaser includes:
1. Individuals who own at least $5 million in investments.
2. Companies that own at least $25 million in investments. This could be a company formed
for the specific purpose of acquiring the securities being offered, trusts (with some provisions), or an entity in which each equity owner is a qualified purchaser.
3. Family-owned businesses that own at least $5 million in investments.
4. Trusts where each trustee or other person authorized to make decisions concerning the trust, and each settlor or other person who has contributed assets to the trust, is a qualified purchaser.
Section 3(c)(7)
