June 6, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W., Stop 6-9
Washington, DC 20549
RE: Exemption for Certain Investment Advisers Operating Through the Internet
Release No. IA-2028; File No. S7-10-02
Dear Mr. Katz:
I am writing on behalf of the Nebraska Department of Banking and Finance ("Department") in regard to the above-referenced release concerning the proposed rules to provide an exemption from the prohibition on registration with the Securities and Exchange Commission ("Commission") for certain investment advisers that provide advisory services through the Internet. The Department is responsible for enforcing the Securities Act of Nebraska, including the registration and regulation of investment advisers doing business with Nebraska residents. As such, the Department is concerned with the implication of the proposed rules.
The Commission has proposed adding an exemption from the prohibition on registration under the Investment Advisers Act of 1940 for an investment adviser who conducts substantially all of its advisory business through an interactive website on the Internet. "Interactive website" is defined as a website in which computer software-based models or applications provide investment advice to clients based on information that each client supplies through the website. "Substantially all" is defined to mean that at least 90 percent of the investment adviser's clients obtain advice exclusively through the interactive website.
While not opposed to the concept of allowing certain investment advisers who provide advice through interactive websites to register with the Commission, the Department does not support the adoption of the exemptive rule as proposed.
The Commission has not demonstrated that there is a need for the proposed rule. In the Department's view, the Release does not set forth any basis on which to determine that the prohibition on registration with the Commission for Internet Investment Advisers is "unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes" of Section 203A of the Investment Advisers Act of 1940. The Release states that adviser regulations are not uniform and may even be inconsistent. This is not an accurate description of the perception of state regulation of investment advisers. All states accept investment adviser filing through the IARD, thus showing that registration for the most part is uniform among the states. Further, the National Securities Markets Improvement Act of 1996 prohibits states from imposing financial requirements or books and records requirements on an investment adviser whose principal place of business is located in another state provided the adviser is in compliance with its home state's requirements in those areas. This preemption was intended to eliminate the possibility of such contradictory regulation. The Release provides no examples of any contradictory regulations which currently exist among the states.
If a need for such an exemption were demonstrated, the Department has several concerns about the exemption as proposed in the Release.
The Department is concerned about the definition of "substantially all" to determine whether an advisory qualifies for the exemption. As proposed, an adviser would be eligible for registration with the Commission if 90% of its clients received advice exclusively through the Internet. This threshold is not adequate to fulfill the intent of the division of authority over investment advisers set out in the National Securities Markets Improvement Act of 1996. Basing the eligibility to register on the number of clients does not ensure that this exemption is utilized only by advisers who have no physical presence in a state. As proposed, an adviser who provides face-to-face advice to one client, who is a resident of the same state in which the adviser resides, with that client accounting for 50% of the adviser's revenue and consuming 50% of the adviser's time could still register with the Commission if it had an interactive website through which nine other clients received all their advice. This scenario would not appear to be the situation intended to be addressed by the proposed rule.
The Department would propose that any exemption for an Internet Investment Adviser require that the adviser use the Internet as the exclusive method of providing advice to every client. The Department would not oppose the creation of a safe harbor to address a situation where the adviser had limited direct contact with clients such as where a client contacts the adviser regarding a problem with the interactive program which cannot be communicated to the adviser over the Internet.
Alternatively, the Department would propose that the definition of "substantially all" be amended to be based on a percentage of services provided to clients or revenue generated from clients rather than on the number of clients. Such a delineation would eliminate the loophole described in the above example.
Another concern with the rule as proposed is the failure to address the type of services that an Internet Investment Adviser can provide to clients who do not receive advice exclusively through an interactive website. Those clients could receive advice exclusively through direct, face-to-face contact. This type of contact between the adviser and the client contradicts the underlying premise of the proposal that the type of relationship between the adviser and the client does not require the investor protection provided by state regulation.
The Release also asks for comments on whether the 90% threshold is the appropriate threshold. The Department realizes that some accommodation which allows a small percentage of the adviser's business to be transacted through means other than the Internet is necessary. While a higher percentage would not be inappropriate, the Department does not oppose the 90% threshold. However, to ensure that this exemption fulfills the intended purpose of providing relief to advisers with no connection to a particular state, the threshold should not be lowered. As the percentage of non-Internet business that an adviser conducts increases, the adviser's connection to one or more states increases, and those states have a greater concern for protecting their residents through the enforcement of investment adviser regulations.
As previously stated, the Department is not opposed to the concept of allowing certain investment advisers who provide advice to clients through an interactive website to register with the Commission. However, the Commission has failed to demonstrated that this proposed rule is necessary. Further, the proposed rule does not adequately restrict the exemption to make it applicable only to advisers whose business in not connected with any particular state.
The Department appreciates the opportunity to comment on the proposed rules.
Jack E. Herstein
cc: Joseph P. Borg, President, North American Securities Administrators Association