Financial Planning Association
FPA Government Relations Office
1615 L Street, N.W., Suite 650
Washington, D.C. 20036
Web site: www.fpanet.org
June 5, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Release No. IA-2028; Exemption for Certain Investment Advisers Operating Through the Internet
Dear Mr. Katz:
The Financial Planning Association ("FPA")1 is pleased to provide comment to the Securities and Exchange Commission ("SEC" or "Commission") with respect to the proposed exemption for certain investment advisers providing Internet-based investment advisory services (hereinafter, the "Rule" or the "Proposed Rule").
FPA commends the SEC for responding to technological changes in the marketplace with a Rule that, in concept, encourages the availability of cost-efficient, automated, and independent investment recommendations on a national scale to investors who may be unable to afford traditional advisory services. Further, FPA believes that the exemption creates an easily identifiable class of advisers - termed Internet Investment Advisers ("Internet Advisers") in the Rule - that is consistent with Section 203A of the Investment Advisers Act of 1940 ("Advisers Act") permitting registration with the Commission of certain advisers if the prohibition on such registration were "unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes" of that section.2 However, notwithstanding the apparent benefits of the Rule, FPA cannot support it in its present form without amendment. The Commission must first address problems in the draft Rule that place traditional, small financial planning firms3 at a competitive disadvantage to the select group of small investment advisers provided exemptive relief under the Rule. As written, the Rule can be manipulated by small firms either starting out with the honest intent of acting as Internet Advisers and then changing their business plan to take advantage of preemption, or by small firms that "front" as Internet Advisers to avoid state registration. Without these changes, the public policy intent of the Rule is thwarted. Small, traditional firms are placed at a disadvantage, by image enhancement for SEC-registered Internet Advisers, and through inequitable compliance costs.
By eliminating the Rule's loopholes, including the "substantial" standard for determining whether a firm is an Internet Adviser, FPA believes that an appropriate exemption could be promulgated consistent with the intent of the division of authority between the states and the SEC mandated by the National Securities Markets Improvement Act of 1996 ("NSMIA"). Our specific comments in connection with these issues follow.
§ 275.203A-2 (ii). Definition of "Substantially all" Should Be Eliminated.
The Proposed Rule would generally permit the delivery of countrywide, automated investment advice generated by software-based applications ("automated advice") without subjecting Internet Advisers to state registration. The automated advice would be based on information provided by clients through the Internet Adviser's interactive website. However, the Rule also would permit the Internet Adviser to provide a limited amount of person-to-person advice ("personalized advice") if substantially all of the firm's clients received automated advice exclusively through the website. The Rule defines "substantially all" as 90 percent of the firm's clients obtaining their advice exclusively through the interactive website.
FPA opposes a "substantially all" standard that permits any personalized advice by the Internet Adviser, whether the de minimis standard is 10 percent or 1 percent.4 The fundamental premise of the Rule -- to grant preemption to a readily identifiable class of adviser that merits special treatment -- is diluted by permitting the new group to provide personalized advice. Ten percent is not a de minimis amount, and the percentage is relative to the size of the firm. Under the Proposed Rule, a thriving Internet Adviser business with 1,800 total clients would be able to retain 180 non-Internet (or combination) clients without jeopardizing the firm's SEC registration. A CFP® practitioner, in turn, has a median number of 180 clients, according to a 1999 survey.5 Yet the Internet Adviser could maintain the same sized financial planning practice (based on number of clients) in compliance with the Rule and avoid state registration.
As a practical matter, many FPA members are dually affiliated with SEC-registered investment advisers and with their own, independent state-registered planning firms,6 in part because the SEC interpreted NSMIA as appropriating to the states authority over locally operated financial planning firms.7 By regulatory design, then, financial planners generally are not able to take advantage of the SEC's exemptions from the prohibition on registration, such as Rule §275.203A-2(c) that requires small investment advisers controlled by, or under common control of an SEC-registered investment adviser, to also register with the Commission if they share the same principal office and place of business. The financial planner typically works in a branch or independent office. FPA believes that providing an exemption to Internet Advisers that also permits the delivery of any traditional advisory services would discriminate against financial planners, particularly if both planners and Internet Advisers offered personalized advisory services similar in scope and business volume.
Potential Gaps in Proposed Rule Should be Eliminated.
In addition to the fairness issue, FPA is concerned about abuse of the exemption by Internet Advisers as outlined in three different examples below.
1. Conversion to Traditional Adviser Model. An Internet Adviser may start out exclusively providing automated advisory services. However, an increasing number of its website customers may request comprehensive, personalized advice in addition to the narrow scope of advice provided by the software application, a trend already underway. 8 The Internet Adviser responds favorably with a change to its business model that increases the level and scope of personalized advice. Such a business model may not even require additional resources to open physical offices in states with a significant number of clients, since the Internet (and SEC interpretive policy) permits delivery of adviser documents and transactions electronically. Over time, the Internet Adviser transitions to a traditional adviser model. Assuming the firm maintains at least six clients each in 25 states, it would then be able to rely on the "multi-state" exemption under Rule §275.203A-2(e) without the initial start-up costs associated with registering in at least 30 states.
In contrast, a small investment adviser relying on the traditional, personalized business model would require, as noted by the SEC in its discussion of the Rule, up to $50,000 in startup capital to meet the similar business objective of establishing a national presence. By limiting Internet Adviser activity exclusively to automated advice, the SEC would be able to prevent such firms from latently exploiting the initial exemption and converting to the multi-state exemption and a completely different business model; a consequence unanticipated, or at least not addressed, by the Proposed Rule.
2. Adviser Subsidiary. As mentioned previously, Rule §275.203A-2(c) provides an exemption from state registration for a small adviser that is controlled by, or under common control of, a SEC-registered advisory firm. An Internet Adviser concerned about exceeding the 10 percent client limit in §275.203A-2(f)(2)(ii) would be able to circumvent this restriction by relying on the adviser subsidiary exemption to operate a traditional advisory firm that would otherwise be ineligible for Commission registration. At an absolute minimum, the SEC should amend the latter exemption to prohibit reliance by Internet Advisers on Proposed Rule §275.203A-2(c) to register a subsidiary or affiliated adviser with the Commission.
3. `Shell' Internet Adviser. The Proposed Rule makes no qualitative assessment of the advisory services to be provided on the interactive website. Absent a violation of the antifraud prohibitions of the Advisers Act through misleading representation of the scope or quality of the advice provided, etc., a small adviser intent on avoiding state oversight could develop, purchase, or lease a rudimentary interactive computer application to take advantage of the Proposed Rule. Either through the Internet exemption, or by relying on the two previously mentioned SEC exemptions in (c) and (e), the purported Internet Adviser could avoid state registration.
In summary, FPA believes that the Rule warrants favorable consideration by the SEC, conditioned upon changes to discourage or prevent abuse of the exemption, and that maintains a legitimate, level playing field for traditional, small financial planning firms. Please do not hesitate to contact the undersigned if you have any questions or comments.
Duane R. Thompson
FPA Director of Government Relations
|1||The Financial Planning Association is the largest organization in the United States representing financial planners and affiliated firms, with more than 28,000 members. Most FPA members are affiliated with investment adviser firms registered with either the SEC or state securities administrators, or both. FPA maintains administrative offices in Atlanta and Denver, and a government relations office in Washington, D.C. For additional information, please consult our web site at www.fpanet.org.|
|2||See Proposed Rule, "Exemption for Certain Investment Advisers Operating Through the Internet," at 2.|
|3||Approximately 40 percent of FPA members are sole proprietors and the majority are in firms of four or fewer principals.|
|4||If the Rule is adopted as proposed, the SEC should ensure strict compliance with the states' notice filing requirements and payment of fees required by sharing information from the recordkeeping provision of the Rule with the states if the Internet Adviser has exceeded a state's de minimis client rule but not filed with the state through the Investment Adviser Registration Depository.|
|5||See "First Annual CFP Practitioner Survey," by the Certified Financial Planner Board of Standards, Inc., Summer 1999, at 9.|
|6||The financial planner is typically affiliated with an SEC-registered firm that provides portfolio management services and pays a fee to the financial planner as an investment management consultant, or through a wrap-fee arrangement.|
|7||See SEC Release No. IA-1633, "Rules Implementing Amendments to the Investment Advisers Act of 1940," May 15, 1997, at 6.|
|8||While it is still only conjecture whether Internet Advisers would integrate their platforms with in-house, personalized advice, a recent column in BloomBerg Wealth Manager concluded that interactive website operators are already actively working with financial advisers. "Now they're cozying up to make them their partners," said the writer, Mary Rowland, "and my experiments [using the automated systems] showed me why: self-service stinks." See " Impersonal Planning: In the take-my-word-for-it world of cyberplanning for retirement, very little is explained and key questions may not be asked," June 2002 issue, at 17.|