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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release No. IA-1633, File No. S7-31-96]
RIN 3235-AH07
Rules Implementing Amendments to the Investment Advisers Act of
1940
AGENCY: Securities and Exchange Commission.
ACTION: Final rules.
SUMMARY: The Commission is adopting new rules and rule
amendments under the Investment Advisers Act of 1940 ("Advisers
Act") to implement provisions of the Investment Advisers
Supervision Coordination Act ("Coordination Act") that reallocate
regulatory responsibilities for investment advisers between the
Commission and the states. The rules establish the process by
which certain advisers will withdraw from Commission
registration, exempt certain advisers from the prohibition on
Commission registration, and define certain terms. The
Commission also is amending several rules under the Advisers Act
to reflect the changes made by the Coordination Act. The rules
and rule amendments are intended to clarify provisions of the
Coordination Act and assist investment advisers in ascertaining
their regulatory status.
EFFECTIVE DATES: July 8, 1997, except for sect. 275.203A-2, which
will become effective on [Insert date 60 days after publication
in the Federal Register]. See section III of this Release.
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FOR FURTHER INFORMATION CONTACT: Catherine M. Saadeh, Staff
Attorney, or Cynthia G. Pugh, Staff Attorney, at (202) 942-0691,
Task Force on Investment Adviser Regulation, Division of
Investment Management, Stop 10-2, Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. The
Commission has placed a list of frequently asked questions and
answers about Form ADV-T and the changes in the regulation of
investment advisers on the Commission's Internet web site. This
list is located at http://www.sec.gov/rules/othern/advfaq.htm.
The Commission staff will update these questions and answers from
time to time. The Commission urges interested persons with
access to the World Wide Web to review these questions and
answers before contacting Commission staff.
SUPPLEMENTARY INFORMATION: The Commission is adopting new rules
203A-1, 203A-2, 203A-3, 203A-4, 203A-5, 222-1, and 222-2 [17 CFR
275.203A-1, 275.203A-2, 275.203A-3, 275.203A-4, 275.203A-5,
275.222-1, and 275.222-2], and amendments to rules 203(b)(3)-1,
204-1, 204-2, 205-3, 206(3)-2, 206(4)-1, 206(4)-2, 206(4)-3, and
206(4)-4 [17 CFR 275.203(b)(3)-1, 275.204-1, 275.204-2, 275.205-
3, 275.206(3)-2, 275.206(4)-1, 275.206(4)-2, 275.206(4)-3, and
275.206(4)-4], and Form ADV [17 CFR 279.1] under the Investment
Advisers Act of 1940 [15 USC 80b-1] (the "Advisers Act" or the
"Act"). The Commission is rescinding Form ADV-S [17 CFR 279.3]
under the Advisers Act.
TABLE OF CONTENTS
EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . .
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I. BACKGROUND . . . . . . . . . . . . . . . . . . . . . . .
II. DISCUSSION . . . . . . . . . . . . . . . . . . . . . . .
A. Form ADV-T . . . . . . . . . . . . . . . . . . . .
B. Assets Under Management . . . . . . . . . . . . . . .
1. Securities Portfolios . . . . . . . . . . . . .
2. Continuous and Regular Supervisory or
Management Services . . . . . . . . . . . . . .
3. Safe Harbor for State-Registered Investment
Advisers . . . . . . . . . . . . . . . . . . . .
4. Valuation and Reporting of Securities
Portfolios . . . . . . . . . . . . . . . . . . .
C. Transitions Between State and Commission
Registration . . . . . . . . . . . . . . . . . . . .
1. Transition from Commission to State
Registration . . . . . . . . . . . . . . . . . .
a. Annual Reporting of Continued
Eligibility . . . . . . . . . . . . . . . .
b. 90-Day Grace Period . . . . . . . . . . . .
c. Cancellation of Commission Registration . .
2. Transition from State to Commission
Registration . . . . . . . . . . . . . . . . . .
a. The $5 Million "Window" . . . . . . . . . .
b. Registration with the Commission . . . . .
D. Exemptions from Prohibition on Registration with
the Commission . . . . . . . . . . . . . . . . . . .
1. Nationally Recognized Statistical Rating
Organizations . . . . . . . . . . . . . . . . .
2. Pension Consultants . . . . . . . . . . . . . .
3. Certain Affiliated Investment Advisers . . . . .
4. Investment Advisers With Reasonable
Expectation of Eligibility . . . . . . . . . . .
5. Advisers to ERISA Plans . . . . . . . . . . . .
E. Investment Advisers Not Regulated or Required to
be Regulated by States . . . . . . . . . . . . . . .
1. "Regulated or Required to be Regulated" . . . .
2. "Principal Office and Place of Business" . . . .
F. Persons Who Act on Behalf of Investment Advisers . .
1. "Investment Adviser Representative" . . . . . .
a. Retail Clients . . . . . . . . . . . . . .
b. Accommodation Clients . . . . . . . . . . .
c. Supervised Persons Providing Indirect or
Impersonal Advice . . . . . . . . . . . . .
d. Dually Registered Investment Adviser
Representatives . . . . . . . . . . . . . .
e. Solicitors . . . . . . . . . . . . . . . .
2. "Place of Business" . . . . . . . . . . . . . .
G. National De Minimis Standard . . . . . . . . . . . .
H. Scope of State Authority Over Commission-
Registered Investment Advisers . . . . . . . . . . .
1. Preemption of State Regulatory Authority . . . .
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2. Preservation of State Anti-Fraud Authority . .
I. Other Amendments to Advisers Act Rules . . . . . . .
1. Amendments to Form ADV; Elimination of Form
ADV-S . . . . . . . . . . . . . . . . . . . . .
2. Rule 204-2 -- Books and Records . . . . . . . .
3. Rule 205-3 -- Performance Fee Arrangements . . .
4. Rule 206(3)-2 -- Agency Cross Transactions . . .
5. Rules 206(4)-1, 206(4)-2, and 206(4)-4 --
Anti-Fraud Rules . . . . . . . . . . . . . . . .
III. EFFECTIVE DATES . . . . . . . . . . . . . . . . . . . . .
IV. PAPERWORK REDUCTION ACT . . . . . . . . . . . . . . . . .
V. COST/BENEFIT ANALYSIS . . . . . . . . . . . . . . . . . .
VI. SUMMARY OF REGULATORY FLEXIBILITY ANALYSIS . . . . . . . .
VII. STATUTORY AUTHORITY . . . . . . . . . . . . . . . . . . .
TEXT OF RULES AND FORMS . . . . . . . . . . . . . . . . . . . .
APPENDIX A: FORM ADV-T . . . . . . . . . . . . . . . . . . . . .
APPENDIX B: SCHEDULE I TO FORM ADV . . . . . . . . . . . . . . .
EXECUTIVE SUMMARY
The Commission is adopting rules and rule amendments to
implement certain provisions of the Investment Advisers
Supervision Coordination Act. The Coordination Act amended the
Advisers Act to, among other things, reallocate the
responsibilities for regulating investment advisers ("investment
advisers" or "advisers") between the Commission and the
securities regulatory authorities of the states. Generally, the
Coordination Act provides for Commission regulation of advisers
with $25 million or more of assets under management, and state
regulation of advisers with less than $25 million of assets under
management. The rules and rule amendments:
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-- Establish the process by which advisers that are
currently registered with the Commission determine
their status as Commission- or state-registered
advisers after July 8, 1997, the effective date of the
Coordination Act;
-- Amend Form ADV to require advisers to report annually
to the Commission information relevant to their status
as Commission-registered advisers;
-- Relieve advisers of the burden of frequently having to
register and then de-register with the Commission as a
result of changes in the amount of their assets under
management;
-- Provide certain exemptions from the prohibition on
registration with the Commission;
-- Define certain terms used in the Coordination Act,
including "investment adviser representative,"
"principal office and place of business," and "place of
business"; and
-- Clarify how advisers should count clients for purposes
of both the new national de minimis exemption from
state regulation and the federal de minimis exemption
from Commission registration.
I. BACKGROUND
On October 11, 1996, President Clinton signed into law the
National Securities Markets Improvement Act of 1996 ("1996
Act").<<1>> Title III of the 1996 Act, the Coordination
Act, makes several amendments to the Advisers Act. The most
significant of these amendments reallocates federal and state
responsibilities for the regulation of the approximately 23,350
investment advisers currently registered with the
<<1>> Pub. L. No. 104-290, 110 Stat. 3416 (1996) (codified in
scattered sections of the United States Code).
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Commission.<<2>> These amendments will become effective on
July 8, 1997.<<3>>
The reallocation of regulatory responsibilities grew out of
a number of Congressional concerns regarding the regulation of
investment advisers. Congress was concerned that the
Commission's resources are inadequate to supervise the activities
of the growing number of investment advisers registered with the
Commission, many of which are small, locally operated, financial
planning firms.<<4>> Congress concluded that if the
<<2>> Other amendments made by the 1996 Act to the Advisers
Act include revisions to (i) section 205 [15 USC 80b-5]
to create additional exceptions to the Advisers Act's
limitations on performance fee arrangements, (ii)
section 222 [15 USC 80b-18a] to impose certain
uniformity requirements on state investment adviser
laws (see infra section II.G of this Release),
(iii) section 203(e) [15 USC 80b-3(e)] to permit the
Commission to deny or revoke the registration of any
person convicted of any felony (or of any adviser
associated with such a person), and (iv) section 203(b)
[15 USC 80b-3(b)] to exempt from registration certain
advisers to church employee pension plans. See
sections 210, 304, 305(a), and 508(d) of the 1996 Act.
<<3>> See section 308(a) of the Coordination Act. The
effective date of the Coordination Act was originally
April 9, 1997. On March 31, 1997, President Clinton
signed into law Pub. L. No. 105-8, which extended the
effective date of the Coordination Act to July 8, 1997.
See 111 Stat. 15 (1997).
<<4>> See S. REP. NO. 293, 104th Cong., 2d Sess. 3-4 (1996)
[hereinafter Senate Report]. The number of investment
advisers registered with the Commission increased
dramatically from 5,680 in 1980 to approximately 23,350
today. By 1995, the Commission was able to examine
smaller advisers on a routine basis on average only
once every 44 years. See The Securities Investment
Promotion Act of 1996: Hearing on S. 1815 Before the
Senate Comm. on Banking, Housing, and Urban Affairs,
104th Cong., 2d Sess. 36 (1996) [hereinafter Senate
Hearing] (testimony of Arthur Levitt, Chairman, SEC).
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overlapping regulatory responsibilities of the Commission and the
states were divided by making the states primarily responsible
for smaller advisory firms and the Commission primarily
responsible for larger firms, the regulatory resources of the
Commission and the states could be put to better, more efficient
use.<<5>>
Congress also was concerned with the cost imposed on
investment advisers and their clients by overlapping, and in some
cases, duplicative, regulation.<<6>> In addition to the
Commission, forty-six states regulate the activities of
investment advisers under state investment adviser
statutes.<<7>> States generally have asserted jurisdiction
over investment advisers that "transact business" in their
state.<<8>> Consequently, many large advisers operating
nationally have been subject to the differing laws of many
states. Industry participants strongly asserted that compliance
with differing state laws has imposed significant regulatory
<<5>> See Senate Report, supra note 4, at 3-4.
<<6>> Id. at 2.
<<7>> The District of Columbia, Guam, and Puerto Rico also
have enacted statutes regulating investment advisers.
See D.C. CODE ANN. sections 2-2631 to -2651 (1994); 22
GUAM CODE ANN. sections 46201 - 46206 (1995); P.R. LAWS
ANN. tit. 10, sections 861 - 864 (1976). The four
states that currently do not have investment adviser
statutes are Colorado, Iowa, Ohio, and Wyoming.
<<8>> See, e.g., UNIF. SEC. ACT section 201(c) (1988); ARK.
CODE ANN. section 23-42-301(c) (Michie Supp. 1995); MD.
CODE ANN., CORPS & ASS'NS section 11-401(b) (1993).
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burdens on these large advisers.<<9>> Congress intended to
reduce these burdens by subjecting large advisers to a single
regulatory program administered by the Commission.<<10>>
The Coordination Act reallocates regulatory
responsibilities over advisers by limiting the application of
federal law and preempting certain state laws. Under new section
203A(a) of the Advisers Act,<<11>> an investment adviser
that is regulated or required to be regulated as an investment
adviser in the state in which it maintains its principal office
and place of business is prohibited from registering with the
Commission unless the adviser (i) has assets under management of
not less than $25 million (or such higher amount as the
Commission may, by rule, deem appropriate), or (ii) is an adviser
to an investment company registered under the Investment Company
Act of 1940 (the "Investment Company Act").<<12>> The
Commission is authorized to deny registration to any applicant
<<9>> See Senate Hearing, supra note 4, at 153 (Testimony of
Mark D. Tomasko, Executive Vice President, Investment
Counsel Association of America, Inc.) ("In some
[advisory] firms, there are one or more persons whose
sole job is to work on State registrations and
requirements.").
<<10>> See Senate Report, supra note 4, at 2.
<<11>> 15 USC 80b-3A(a).
<<12>> 15 USC 80a. Any person that is an investment adviser
to an investment company under section 2(a)(20) of the
Investment Company Act [15 USC 80a-2(a)(20)], including
a "sub-adviser," is eligible to register with the
Commission, regardless of the amount of assets under
management.
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that does not meet the criteria for Commission
registration,<<13>> and is directed to cancel the
registration of any adviser that no longer meets the criteria for
registration.<<14>>
On December 20, 1996, the Commission proposed rules and rule
amendments to implement the Coordination Act.<<15>> The
proposed rules would establish the process by which advisers no
longer eligible to register with the Commission would withdraw
from Commission registration, exempt certain advisers from the
prohibition on Commission registration, and define certain terms
used in the Coordination Act. The Commission also proposed to
amend several rules under the Advisers Act to reflect the changes
made by the Coordination Act.
The Commission received 105 comment letters in response to
the proposal, most of which were from investment advisers and
their trade groups and counsel (hereinafter collectively referred
to as "investment adviser commenters"). Twenty-six comment
letters were received from state securities regulators
(hereinafter referred to as "states"), including the North
<<13>> Section 203(c) of the Advisers Act [15 USC 80b-3(c)].
<<14>> Section 203(h) of the Advisers Act [15 USC 80b-3(h)].
<<15>> Rules Implementing Amendments to the Investment
Advisers Act of 1940, Investment Advisers Act Rel. No.
1601 (Dec. 20, 1996) [61 FR 68480 (Dec. 27, 1996)]
("Proposing Release").
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American Securities Administrators Association, Inc.
("NASAA").<<16>>
In preparing these implementing rules for adoption, the
Commission has been guided by the language of the Coordination
Act and the policy considerations that led to its enactment. The
Commission does not believe that it would be appropriate or
within its proper authority to revisit policy decisions made by
Congress, as some commenters appear to have suggested.
II. DISCUSSION
The Commission is adopting several rules implementing the
provisions of the Coordination Act designed to reallocate the
regulatory responsibilities for investment advisers between the
Commission and the states.
A. Form ADV-T
Approximately 23,350 investment advisers currently are
registered with the Commission. Based on information provided by
these advisers, the Commission estimates that more than
two-thirds of them would not be eligible to register with the
Commission after July 8, 1997. These advisers must withdraw from
registration or their registrations will be subject to
cancellation.<<17>> To allow the Commission to determine
each adviser's status under the Advisers Act, as amended by the
Coordination Act, and to provide for the orderly withdrawal from
<<16>> NASAA represents the 50 U.S. state securities agencies
responsible for the administration of state securities
laws, also known as "blue sky laws."
<<17>> See supra note 14 and accompanying text.
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Commission registration of advisers that are no longer eligible,
the Commission proposed a transition rule, rule 203A-
5.<<18>> Among other things, rule 203A-5 would require all
Commission-registered advisers to make a one-time filing of a new
form, Form ADV-T. The Commission is adopting the rule and the
form largely as proposed.<<19>> Paragraph (a) of rule
203A-5 requires all advisers registered with the Commission on
July 8, 1997 to file a completed Form ADV-T with the Commission
no later than that date.<<20>> Form ADV-T contains
instructions designed to assist an adviser in determining whether
it meets the criteria for Commission registration set forth in
the Coordination Act and the exemptive rules adopted by the
Commission.<<21>> Form ADV-T requires each adviser to
indicate whether it remains eligible for Commission registration.
For an adviser that indicates that it is not eligible for
Commission registration, filing of Form ADV-T serves as the
adviser's request for withdrawal from registration as of July 8,
<<18>> See Proposing Release at section II.A.
<<19>> 17 CFR 275.203A-5; 17 CFR 279.3.
<<20>> 17 CFR 275.203A-5(a). Although Form ADV-T will not be
effective until July 8, 1997, advisers may file Form
ADV-T prior to that date. The registrations of
advisers that indicate on Form ADV-T that they are no
longer eligible to be registered with the Commission
will not be withdrawn until July 8, 1997. See rule
203A-5(c)(1) [17 CFR 275.203A-5(c)(1)].
<<21>> See infra sections II.B, II.D, and II.E of this
Release.
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1997.<<22>> An adviser that does not return the form or
that fails to withdraw voluntarily from Commission registration
if no longer eligible will be subject to having its registration
canceled pursuant to section 203(h).<<23>>
Form ADV-T is attached as Appendix A to this Release.
Shortly after the publication of this Release, the Commission
will mail a copy of Form ADV-T to each investment adviser
registered with the Commission. In addition to a copy of Form
ADV-T, each adviser will receive pre-printed address labels that
will assist the Commission in processing the forms. The
Commission asks advisers to return the Form ADV-T they receive in
the mail using these pre-printed labels.
B. Assets Under Management
In most cases, the amount of assets an adviser has under
management will determine whether the adviser will be registered
with the Commission or the states. Section 203A(a)(2) of the
Advisers Act defines "assets under management" as the "securities
portfolios" with respect to which an investment adviser provides
<<22>> See rule 203A-5(c) [17 CFR 275.203A-5(c)]; Instruction
6 to Form ADV-T. An adviser that indicates that it is
not eligible for Commission registration on Form ADV-T
is not required to file separately Form ADV-W [17 CFR
279.2] to withdraw from registration with the
Commission. Commission-registered advisers seeking to
withdraw their state registrations should contact their
state regulators. The Commission will provide NASAA
with a copy of each Form ADV-T filed with the
Commission.
<<23>> See Instruction 1(f) to Form ADV-T.
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"continuous and regular supervisory or management
services."<<24>> Form ADV-T contains instructions that
clarify when an account is a "securities portfolio," what
services constitute "continuous and regular supervisory or
management services," and the appropriate method of valuing the
account.<<25>>
1. Securities Portfolios
The Commission proposed an instruction to Form ADV-T to
define a "securities portfolio" as any account at least fifty
percent of the total value of which consists of
securities.<<26>> Some commenters argued that the fifty
percent test was too low and suggested a higher percentage, such
as eighty percent. The Commission believes that Congress used
the term "securities portfolio" to refer to the types of accounts
typically managed by investment advisers, which include
investments other than securities. The Commission believes that
an account fifty percent of the total value of which consists of
securities may be fairly characterized as a securities portfolio,
<<24>> 15 USC 80b-3A(a)(2).
<<25>> Instruction 8 to Form ADV-T. Several commenters
believed that the proposed three-step process for
determining assets under management was unnecessarily
complex. Each step, however, is contemplated by
section 203A(a), which limits assets under management
to "securities portfolios" with respect to which the
adviser provides "continuous and regular supervisory or
management services," and requires that the amount of
assets under management equal or exceed $25 million for
Commission registration.
<<26>> See Proposing Release at section II.B.1.
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and is adopting the fifty percent test substantially as
proposed.<<27>>
Because advisers in the normal course of business maintain
portions of client accounts in cash, the Commission proposed that
cash and cash equivalents be excluded by an adviser in
determining whether an account is a securities
portfolio.<<28>> Two commenters expressed concern that,
under the proposal, if securities in a client's account were
converted to cash to create a defensive investment position, and
the remaining investments in the account were held, for example,
in real estate, the account would not be deemed to be a
securities portfolio. Such a result, one commenter pointed out,
seemed at odds with the purpose of excluding cash when
determining whether an account is a securities portfolio. To
avoid such a result, the Commission has revised the instruction
to permit an adviser to treat cash and cash equivalents as
securities for the purpose of determining whether an account is a
securities portfolio.<<29>>
<<27>> Instruction 8(a) to Form ADV-T. Real estate,
commodities, and collectibles are not securities, and
therefore should not be included as securities in
determining whether an account meets the fifty percent
test.
<<28>> See Proposing Release at section II.B.1.
<<29>> See Instruction 8(a). "Cash equivalents" include bank
deposits, certificates of deposit, bankers acceptances,
and similar bank instruments. Instruction 8(a)
permits, but does not require, cash and cash
equivalents to be treated as securities. Because cash
and cash equivalents typically comprise a small
component of most advisory accounts, the Commission
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2. Continuous and Regular Supervisory or Management
Services
The Commission proposed to provide guidance in an
instruction to Form ADV-T for determining whether an adviser
provides an account with "continuous and regular supervisory or
management services" within the meaning of section 203A(a)(2).
As proposed, the instruction provided several examples of
advisory arrangements and drew conclusions whether the accounts
were provided with continuous and regular supervisory or
management services. Commenters requested that the Commission
provide greater clarity in the instruction, disagreed with some
of the conclusions the Commission drew, and provided the
Commission with examples of additional arrangements that would
and would not receive continuous and regular supervisory or
management services.
The Commission has redrafted the instruction in light of the
commenters' suggestions. As adopted, Instruction 8(c) to Form
ADV-T sets forth general criteria, lists certain factors that
should be considered in determining whether the criteria apply to
an account, and provides examples designed to apply those
criteria and factors. This approach should be more helpful to
advisers in determining whether an account is provided continuous
and regular supervisory or management services.
believes that allowing advisers to treat these items as
securities will not have a significant effect on the
number of advisers that are eligible to register with
the Commission.
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Instruction 8(c) states that accounts over which an adviser
has discretionary authority and for which it provides ongoing
supervisory or management services receive continuous and regular
supervisory or management services. The Commission expects that
most discretionary accounts would meet this standard. In
addition, a limited number of non-discretionary advisory
arrangements may receive continuous and regular supervisory or
management services, but only if the adviser "has an ongoing
responsibility to select or make recommendations, based upon the
needs of the client, as to specific securities or other
investments the account may purchase or sell and, if such
recommendations are accepted by the client, is responsible for
arranging or effecting the purchase or sale."<<30>> Thus,
an advisory relationship under which the adviser does not have
discretionary authority must assign to the adviser other
responsibilities typically associated with a discretionary
account.<<31>>
Instruction 8(c) provides three factors that advisers should
use (and which the Commission will use) in applying these general
principles. These factors are the terms of the advisory
<<30>> See Instruction 8(c).
<<31>> To enable the Commission to evaluate the claims of
advisers relying on the non-discretionary management of
assets as the basis of eligibility to remain registered
with the Commission, Form ADV-T requires these advisers
to append a written statement explaining the nature of
the non-discretionary supervisory or management
services. See Part III, Item (c) of Form ADV-T;
Instruction 9 to Form ADV-T.
-----Start of Page 17
contract, the form of compensation, and the management practice
of the adviser. No single factor is determinative. For example,
advisers that provide portfolio management services are typically
compensated on the basis of a percentage of the amount of assets
under management averaged over some period of time. The use of
this type of a compensation arrangement would tend to suggest
that the account receives continuous and regular supervisory or
management services, although a different compensation
arrangement would not preclude that conclusion.
3. Safe Harbor for State-Registered Investment
Advisers
The Commission recognizes that section 203A(a)(2) does not
and the instructions to Form ADV-T do not provide a "bright line"
test as to whether a particular arrangement involves the
provision of continuous and regular supervisory or management
services. The Commission, therefore, is adopting rule 203A-4,
which provides a safe harbor from Commission registration for an
adviser that is registered with a state securities authority
(rather than the Commission) based on a reasonable belief that it
is not required to register with the Commission because it does
not have sufficient assets under management.<<32>>
Commenters strongly supported the rule's adoption.
Under rule 203A-4, the Commission will not assert a
violation of the Advisers Act for failure to register with the
Commission (or to comply with the provisions of the Advisers Act
<<32>> 17 CFR 275.203A-4.
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to which an adviser is subject if required to register) if the
adviser reasonably believes that it does not have sufficient
assets under management (at least $30 million) and is therefore
not required to register with the Commission.<<33>> This
safe harbor is available only to an adviser that is registered
with the state in which it has its principal office and place of
business.
4. Valuation and Reporting of Securities Portfolios
Under a proposed instruction to Form ADV-T, once an adviser
has determined that an account is a "securities portfolio" that
receives "continuous and regular supervisory or management
services," the entire value of the account would be included in
determining the amount of the adviser's assets under management.
Several commenters objected to this approach, arguing that only
the value of securities should be included as assets under
management. The Commission believes that including only the
value of securities would be inconsistent with section
203A(a)(2), which requires that "securities portfolios," not
"securities," be included in assets under management. The use of
the term "securities portfolios" rather than "securities"
suggests that once an account is determined to be a securities
<<33>> As discussed infra, the Commission is increasing the
$25 million assets under management threshold for
mandatory Commission registration to $30 million, and
providing an optional exemption from the prohibition on
registering with the Commission for advisers having
between $25 and $30 million of assets under management.
See infra section II.C.2.a of this Release.
-----Start of Page 19
portfolio, all assets in the account should be included as assets
under management.<<34>>
The Commission is aware that in some cases an adviser may
have responsibility for an account only a portion of which
receives continuous and regular supervisory or management
services. As adopted, Instruction 8(b) to Form ADV-T provides
that only the portion of a securities portfolio that receives
continuous and regular supervisory or management services may be
included as part of the adviser's assets under management.
Under a proposed instruction to Form ADV-T, the value of a
securities portfolio would be determined as of a date no more
than ten business days before the filing of Form ADV-T. Several
commenters said that more time was needed because some advisers
obtain information on the value of client accounts from third
parties that provide the information on a monthly or quarterly
basis.<<35>> To provide advisers with greater flexibility,
the Commission has revised the instruction so that the value of
securities portfolios may be determined as of a date no more than
<<34>> In addition, the Commission believes that a requirement
that advisers segregate the securities components of an
account principally consisting of securities holdings
would be unnecessarily burdensome.
<<35>> Other commenters noted that additional time may be
needed to value illiquid securities, closely-held
businesses, and other difficult-to-value assets.
-----Start of Page 20
90 days prior to the date Form ADV-T is filed with the
Commission.<<36>>
The Commission proposed that the method by which the
accounts are valued for purposes of determining assets under
management be the same as that used to value the account for
purposes of client reporting or to determine fees for investment
advisory services. Commenters supported this proposal, which the
Commission is adopting substantially as proposed.<<37>>
C. Transitions Between State and Commission Registration
The Coordination Act contemplates that a state-registered
adviser whose assets under management increase to $25 million
will withdraw its state registration and register with the
Commission. Conversely, an adviser whose assets under management
decrease below $25 million will withdraw its Commission
registration and register with a state (or states). The
Commission proposed to use its rulemaking authority under the
Advisers Act, as amended, to reduce the regulatory burdens that
may be caused by these transitions.<<38>>
<<36>> Instruction 8(d) to Form ADV-T. Instruction 8(d) does
not require all the assets in a securities portfolio to
be valued as of the same date. An adviser, however,
may not select the dates for valuation of assets so as
to maximize (or minimize) the value of the adviser's
assets under management. An amount determined by such
a method would not, in the Commission's view, reflect
the adviser's actual assets under management.
<<37>> See Instruction 8(d).
<<38>> See Proposing Release at section II.C.
-----Start of Page 21
1. Transition from Commission to State Registration
a. Annual Reporting of Continued Eligibility
The Commission is amending Form ADV by adding new Schedule I
("eye") that requires advisers to report information on an
ongoing basis similar to that reported on Form ADV-T.<<39>>
Schedule I will be used both to determine whether new applicants
are eligible for Commission registration, and to determine
whether advisers registered with the Commission continue to be
eligible for such registration. Schedule I must be updated
annually, within 90 days after the end of the adviser's fiscal
year.<<40>>
The Commission proposed to require advisers to determine and
report their assets under management annually in order to reduce
the frequency with which advisers are required to change
regulators as a result of a decrease in the amount of assets they
<<39>> Schedule I is attached to this Release as Appendix B.
For a discussion of the reporting requirements of Form
ADV-T, see supra sections II.A and II.B of this
Release.
<<40>> Rule 204-1(a)(1) [17 CFR 275.204-1(a)(1)]. As amended,
rule 204-1(a) [17 CFR 275.204-1(a) requires advisers to
amend Form ADV annually, regardless of whether data
reported on the form changes. This annual amendment
replaces Form ADV-S, which the Commission is
rescinding. Because Form ADV-S is being rescinded,
advisers are no longer required to file the written
disclosure statement ("brochure") required by rule 204-
3 [17 CFR 275.204-3] with the Commission. The
brochure, however, must be maintained as part of the
adviser's books and records, and the Commission will
continue to review these brochures during investment
adviser examinations.
-----Start of Page 22
have under management.<<41>> Under the proposal, an
adviser whose assets under management fell below $25 million
would not be required to report this event until after the end of
its fiscal year (and not at all unless its assets under
management remained below $25 million at the time it filed its
Schedule I). Some state commenters asserted that an adviser
should be required to withdraw its Commission registration
promptly when its assets under management decrease below $25
million, or decrease by some percentage below $25 million. The
Commission believes that these approaches could result in some
advisers changing regulators too frequently, and is adopting the
annual reporting requirement as proposed.<<42>>
Under rule 204-1(a), a Commission-registered adviser must
evaluate and report its continued eligibility for Commission
registration once a year. An adviser that reports that it is no
longer eligible must withdraw its registration within the 90-day
grace period provided by rule 203A-1(c), discussed below, or be
<<41>> See Proposing Release at section II.C.2.
<<42>> Commission data suggests that most advisers that will
remain registered with the Commission have assets under
management well in excess of $25 million. It is likely
that only a few advisers each year will be required to
move from Commission to state registration as a result
of a decrease of assets under management, and thus few
advisers will be registered temporarily with the
Commission prior to reporting a reduced amount of
assets under management on Schedule I.
-----Start of Page 23
subject to a cancellation proceeding under section
203(h).<<43>>
b. 90-Day Grace Period
An adviser that withdraws from Commission registration will
be subject to the registration requirements of one or more
states. To allow such an adviser sufficient time to register
under applicable state statutes, the Commission proposed to
provide a "grace period" of 90 days after the date the adviser
files its Schedule I indicating that it would not be eligible for
Commission registration.<<44>> Several commenters argued
that 90 days was insufficient, while a number of state commenters
requested that the 90-day period be shortened, asserting that
state registration generally is effected quickly.
<<43>> 17 CFR 275.203A-1(c). See Instruction 6 to Schedule I.
An adviser may withdraw from Commission registration as
soon as it is no longer eligible to maintain its
registration with the Commission, or it may wait until
filing its annual Schedule I to withdraw. An adviser
who becomes ineligible for Commission registration for
reasons other than the amount of its assets under
management also is permitted to wait until filing its
annual Schedule I to withdraw.
<<44>> See Proposing Release at section II.C.2. The
Commission did not propose a similar grace period in
connection with the filing of Form ADV-T. The
Commission presumes that an adviser not eligible to
maintain its registration with the Commission on July
8, 1997 would already be registered with the
appropriate state or states at the time of filing Form
ADV-T. See Proposing Release at note 43.
-----Start of Page 24
In light of these conflicting views, the Commission is
adopting the 90-day grace period substantially as
proposed.<<45>> A shorter period may not provide advisers
with sufficient time to comply with the registration requirements
of multiple states, particularly where the adviser must change
its business practices or ensure that its employees prepare for
and pass qualification examinations. On the other hand, a longer
period may be unnecessary because, as a result of the annual
determination of eligibility discussed above, a withdrawing
adviser usually will have more than 90 days to come into
compliance with state law. The Commission will monitor the
operation of the rule and, if necessary, will shorten or lengthen
the grace period.
c. Cancellation of Commission Registration
Upon the expiration of the grace period, the Commission may
institute proceedings to cancel the adviser's registration if it
has not yet been withdrawn.<<46>> As provided under the
<<45>> Rule 203A-1(c). The Commission is adopting rule
203A-1(c) with a slight revision. Under the rule as
proposed, the grace period would have run from the date
on which the adviser filed its Schedule I to indicate
that it was no longer eligible to maintain its
registration. As adopted, however, the grace period
begins to run on the date on which the adviser was
obligated by rule 204-1(a) to file such amendment.
Thus, an adviser could not extend the grace period by
failing to timely file Schedule I.
<<46>> If the adviser amends Schedule I during the grace
period to report that it once again has become eligible
for Commission registration (for example, because the
amount of its assets under management increased since
the adviser filed its Schedule I), the Commission will
not institute cancellation proceedings.
-----Start of Page 25
Advisers Act, the adviser will be given notice and an opportunity
to show why its registration should not be cancelled.<<47>>
Upon a showing by the adviser that it requires additional time to
comply with state registration requirements, the Commission may
stay the cancellation proceeding for a reasonable period,
provided that the adviser has made a good faith effort to meet
the registration requirements of state law and complied in good
faith with the obligation to update Schedule I.
2. Transition from State to Commission Registration
a. The $5 Million "Window"
The Commission proposed to make Commission registration
optional for an adviser having between $25 and $30 million of
assets under management.<<48>> The proposed rule would
permit such an adviser to determine whether and when to change
from state to Commission registration. In order to avoid having
to de-register shortly after registering with the Commission, an
adviser reaching the $25 million assets under management
threshold could defer registration with the Commission. The
adviser would not be required to register with the Commission
until its assets under management reached $30 million, and would
not be subject to Commission cancellation of its registration
until its assets under management had fallen below $25 million.
<<47>> See section 211(c) of the Advisers Act [15 USC 80b-
21(c)]; rule 0-5 [17 CFR 275.0-5].
<<48>> See Proposing Release at section II.C.1.
-----Start of Page 26
Most commenters supported the proposed rule as providing
useful flexibility, although some commenters urged that the
"window" be increased from $5 to $10 million. The Commission is
adopting the rule as proposed, but will monitor its
operation.<<49>> If the $5 million window proves to be
inadequate to prevent transient registration, the Commission will
consider expanding the provision.
b. Registration with the Commission
Under the proposal, a state-registered adviser would have
been required to register with the Commission promptly when the
adviser's assets under management reached $30
million.<<50>> In response to the suggestion of several
commenters, the Commission is adopting paragraph (d) to rule
203A-1 to make the transition from state to Commission
registration parallel with the transition from Commission to
state registration.<<51>>
Under rule 203A-1(d), certain advisers whose assets under
management grow to $30 million may (but are not required to)
postpone Commission registration until 90 days after the date the
<<49>> Rule 203A-1(a), (b) [17 CFR 275.203A-1(a), (b)].
<<50>> See Proposing Release at section II.C.1.
<<51>> Rule 203A-1(d) [17 CFR 275.203A-1(d)]. Rule 203A-1(d)
does not affect the operation of the $5 million window.
An adviser that has between $25 and $30 million of
assets under management is permitted, but not required,
to register with the Commission. Such an adviser may
register with the Commission at any time. Rule 203A-
1(d) addresses only the question of when an adviser is
required to register with the Commission.
-----Start of Page 27
adviser is required to report $30 million or more of assets under
management to its state securities authority.<<52>> If,
however, the assets of an adviser relying on the rule are less
than $30 million when it registers with the Commission, the
adviser's application for registration would not be made
effective.
D. Exemptions from Prohibition on Registration with the
Commission
Section 203A(c) of the Advisers Act<<53>> authorizes
the Commission to exempt advisers from the prohibition on
Commission registration if the prohibition would be "unfair, a
burden on interstate commerce, or otherwise inconsistent with the
purposes" of section 203A of the Act.<<54>> Pursuant to
this authority, the Commission proposed a new rule, rule 203A-2,
that would exempt from the prohibition on Commission registration
four types of advisers that otherwise would not be eligible for
Commission registration. The Commission is adopting rule 203A-2
substantially as proposed. An adviser that meets the conditions
<<52>> Rule 203A-1(d) is available only to advisers that are
registered in a state that requires Schedule I (or a
substantially similar form or rule) to be filed and
annually updated. An adviser not registered in such a
state must register promptly with the Commission upon
reaching $30 million of assets under management. Rule
203A-1(d) is not available to an adviser whose
eligibility for registration is based on becoming an
adviser to an investment company or becoming eligible
for one of the exemptions provided by rule 203A-2 [17
CFR 275.203A-2]. See section II.D of this Release.
<<53>> 15 USC 80b-3A(c).
<<54>> 15 USC 80b-3A.
-----Start of Page 28
of a rule 203A-2 exemption is required by section 203 of the
Advisers Act to register with the Commission, unless it qualifies
for an exemption from registration under section 203(b) of the
Act.<<55>>
1. Nationally Recognized Statistical Rating
Organizations
The Commission proposed to exempt from the prohibition on
Commission registration "nationally recognized statistical rating
organizations" ("NRSROs"), commonly referred to as rating
agencies, which are registered with the Commission as investment
advisers.<<56>> The Proposing Release explained that,
while NRSROs do not themselves have assets under management,
their activities have a significant effect on the national
securities markets and the operation of federal securities laws.
All commenters addressing this exemption supported it, and the
Commission is adopting the exemption as proposed.<<57>>
2. Pension Consultants
The Commission proposed to exempt from the prohibition on
Commission registration pension consultants that provide
investment advice to employee benefit plans with respect to
assets having an aggregate value of at least $50 million during
the adviser's last fiscal year.<<58>> Pension consultants
<<55>> 15 USC 80b-3, 80b-3(b).
<<56>> See Proposing Release at section II.D.1.
<<57>> Rule 203A-2(a) [17 CFR 275.203A-2(a)].
<<58>> See Proposing Release at section II.D.2.
-----Start of Page 29
provide various advisory services to plans and plan fiduciaries,
including assistance in selecting and monitoring investment
advisers that manage assets of such plans, but may not themselves
have assets under management. In the Proposing Release, the
Commission explained that the activities of pension consultants
have a direct effect on the management of billions of dollars of
plan assets, and that it would be inconsistent with the purposes
of the Coordination Act for these advisers to be regulated by the
states, rather than by the Commission.
Most commenters addressing this exemption supported it, and
the Commission is adopting the exemption substantially as
proposed.<<59>> Several commenters raised questions,
however, as to the scope of the exemption. The exemption is
available to advisers that provide advice to employee benefit
plans -- not to plan participants. An adviser that provides
advice to plan participants (e.g., regarding the allocation of
the participant's contributions in an employee directed defined
contribution plan) would not be eligible for the exemption unless
<<59>> Rule 203A-2(b) [17 CFR 275.203A-2(b)]. The proposed
rule would have exempted pension consultants to
employee benefit plans, governmental plans, and church
plans, each as defined in the Employee Retirement
Income Security Act of 1974 ("ERISA") [29 USC 1001], as
well as "[a]ny plan established and maintained by a
state, its political subdivisions, or any agency or
instrumentality of a state or its political
subdivisions for the benefit of its employees." The
Commission has withdrawn this latter category in
response to a comment noting that these plans come
within ERISA's definition of "governmental plan." The
deletion of this category does not affect the scope of
the exemption.
-----Start of Page 30
the adviser also provides advice to employee benefit plans with
respect to $50 million of plan assets.<<60>> The advice,
for example, could concern the funding of a defined benefit plan
or the selection of funding vehicles for a defined contribution
plan, but would have to be provided to the plan or the plan
fiduciary.<<61>>
Several commenters requested clarification whether the
exemption would apply to an investment adviser that provides
advisory services to pension plans, but not with respect to
"securities portfolios" of those plans. These commenters are (or
represent) firms that provide advice to plans regarding large
real estate investments that are held both directly and
indirectly through real estate investment trusts or other
investment vehicles. Many of these firms provide advice with
respect to plan assets worth hundreds of millions of dollars and
<<60>> Although the Coordination Act provides a $25 million
threshold for Commission registration, the Commission
is adopting a $50 million threshold for the pension
consultant exemption. This higher threshold reflects
the fact that a pension consultant has substantially
less control over client assets than an adviser that
has assets under management. A higher threshold is
necessary to demonstrate that a pension consultant's
activities have an effect on national markets.
<<61>> In determining the aggregate value of advised assets,
the adviser may include only that portion of a plan's
assets for which the adviser provided investment advice
(including any advice with respect to the selection of
an investment adviser to manage the assets). The value
of assets must be determined as of the date during the
adviser's most recently completed fiscal year that the
adviser was last employed or retained by contract to
provide investment advice to the plan or plan fiduciary
with respect to those assets. See rule 203A-2(b)(3)
[17 CFR 275.203A-2(b)(3)].
-----Start of Page 31
are clearly "large" enterprises whose activities have an effect
on national markets. As used in rule 203A-2(b), the term "assets
of plans" is not limited to securities portfolios, and thus such
investment advisers are eligible for the exemption.
3. Certain Affiliated Investment Advisers
The Commission proposed to exempt from the prohibition on
Commission registration advisers that are affiliated with a
Commission-registered adviser if the principal office and place
of business of the affiliate is the same as that of the
registered adviser.<<62>> In proposing the exemption, the
Commission explained that when the activities of affiliated
advisers are centrally managed, subjecting them to different
regulatory schemes would be burdensome and inefficient.
Most commenters that addressed this exemption supported it,
stating that Commission registration of affiliated advisers would
be more efficient. Many, however, urged that the availability of
the exemption not be limited to advisers having the same
principal office. In particular, some commenters suggested that
the exemption be expanded to permit Commission registration of
affiliated advisers whose compliance or books and records systems
are integrated with those of a Commission-registered adviser.
The Commission is not expanding the exemption as suggested
because it is concerned that such an expansion could result in
Commission registration of a large number of small, locally
operated advisers, which Congress intended to be registered with
<<62>> See Proposing Release at section II.D.3.
-----Start of Page 32
the states.<<63>> The Commission understands that, as a
result, some advisers whose operations are integrated with those
of a Commission-registered adviser will be prohibited from
registering with the Commission.<<64>> The Commission will
entertain requests for exemptive relief from these advisers on a
case-by-case basis under section 203A(c), and may consider
expanding the exemption if experience suggests expansion would be
appropriate.
<<63>> This could occur as a result of the National
Association of Securities Dealers' ("NASD") requirement
that its member broker-dealer firms supervise and keep
books and records regarding certain private securities
transactions of their registered representatives who
also are registered individually as investment
advisers. See NASD Notice to Members No. 94-44 (May
1994); see also NASD Notice to Members No. 96-33 (May
1996). Many of these broker-dealer firms are
themselves registered investment advisers that will
remain eligible for Commission registration after July
8, 1997. In some cases, a firm's registered
representatives form a large network of individually
registered investment advisers that use a broker-dealer
firm to effect certain securities transactions on
behalf of advisory clients. A broker-dealer firm's
compliance with the obligation to supervise both its
own trades and those that are effected through
unaffiliated broker-dealers may result in its control
of these registered advisers. Under the commenters'
suggested approach, this control, together with the
books and records the NASD requires, might qualify each
individually registered adviser for the exemption, even
though each such adviser has only a small, local
business and would not otherwise be eligible for
Commission registration.
<<64>> Of course, an adviser may choose to register its
affiliates under its registration as a single
registrant. If the adviser and its affiliates have
aggregate assets under management of $25 million or
more, the registrant would meet the threshold for
Commission registration, regardless of whether the
operations of the adviser and the affiliates are
integrated.
-----Start of Page 33
Under rule 203A-2(c) as adopted, an adviser that controls,
is controlled by, or is under common control with an adviser
eligible to register (and in fact registered) with the Commission
must register with the Commission if the two advisers have the
same principal office and place of business.<<65>> The
rule defines "control" as the power to direct or cause the
direction of the management or policies of an adviser, whether
through ownership of securities, by contract, or
otherwise.<<66>>
4. Investment Advisers With Reasonable Expectation of
Eligibility
The Commission proposed an exemption to permit a newly
formed adviser to register with the Commission at the time of its
formation if the adviser has a reasonable expectation that within
90 days it will become eligible for Commission
<<65>> 17 CFR 275.203A-2(c). The definition of principal
office and place of business in rule 203A-3(c) [17 CFR
275.203A-3(c)] applies to this rule. See infra section
II.E.2 of this Release. The Commission will consider a
Commission-registered adviser and an affiliated adviser
to have the same principal office and place of business
if the principal office of the affiliate is in the
proximate geographic area as the principal office of
the registered adviser.
<<66>> In the Proposing Release, the Commission explained that
by proposing rule 203A-2(c), it did not intend to
suggest that an advisory firm may reorganize its
operations in order to circumvent the requirements of
the Advisers Act. See Proposing Release at note 54.
Thus, for example, an adviser may not avoid application
of the Advisers Act by creating a state-registered
affiliate that is not separately and independently
organized.
-----Start of Page 34
registration.<<67>> All commenters addressing this
exemption supported it. Many, however, urged the Commission to
give newly formed advisers a longer period than 90 days to become
eligible for Commission registration. Some pointed out that even
if the start-up adviser has obtained commitments from prospective
clients for more than $25 million of assets, it may take more
than 90 days for clients (particularly institutional clients) to
transfer their assets to the adviser. To address this concern,
the rule as adopted allows for a period of 120 days.<<68>>
Under rule 203A-2(d), an adviser is exempt from the
prohibition on Commission registration if, at the time of
registration, it is not registered (or required to be registered)
with the Commission or any state and has a reasonable expectation
that it would be eligible for Commission registration within 120
days after the date its registration becomes
<<67>> See Proposing Release at section II.D.4.
<<68>> Rule 203A-2(d) [17 CFR 275.203A-2(d)]. Some commenters
also asked for clarification as to what constitutes a
"reasonable expectation." In proposing the exemption,
the Commission anticipated that it would be used
primarily by persons who start their own advisory firms
after having been employed by or affiliated with other
advisers, and that have received an indication from
clients with substantial assets that they will transfer
those assets to the management of the newly formed
adviser. In such a case, an adviser would have a
"reasonable expectation" that it would become eligible
for Commission registration in the prescribed time.
Other circumstances, however, also could support an
adviser's reasonable expectation of becoming eligible.
-----Start of Page 35
effective.<<69>> At the end of the 120-day period, the
adviser is required to file an amended Schedule I.<<70>>
If the adviser indicates on the amended Schedule I that it has
not become eligible to register with the Commission (e.g., it
does not have at least $25 million of assets under management),
the adviser is required to file a Form ADV-W concurrently with
the Schedule I, thereby withdrawing from registration with the
Commission.<<71>>
5. Advisers to ERISA Plans
Many investment advisers provide advice to employee benefit
plans governed by the Employee Retirement Income Security Act of
1974 ("ERISA"). ERISA protects a plan's named fiduciary from
liability for the individual decisions of an investment manager
<<69>> The requirement that the adviser not be registered or
required to be registered with the Commission or any
state is designed to ensure that the exemption is
available only to start-up advisers. This requirement
must be met at the time the adviser registers with the
Commission. Rule 203A-2(d)(1) [17 CFR 275.203A-
2(d)(1)]. A newly formed adviser that registers with
the Commission in reliance on this exemption, however,
subsequently may register with a state or states during
the 120-day period in anticipation of failing to become
eligible for Commission registration.
<<70>> Rule 203A-2(d)(3) [17 CFR 275.203A-2(d)(3)].
<<71>> Id. When registering with the Commission, an adviser
relying on this exemption must include on Schedule E to
Form ADV an undertaking to withdraw from registration
if, at the end of the 120-day period, the adviser would
be prohibited from registering with the Commission.
Rule 203A-2(d)(2) [17 CFR 275.203A-2(d)(2)]. An
adviser required by rule 203A-2(d)(3) to withdraw from
Commission registration at the end of the 120-day
period will not have available the additional 90-day
grace period provided by rule 203A-1(c) in which to
effect the appropriate state registrations.
-----Start of Page 36
appointed by the fiduciary to manage the plan's
assets.<<72>> The term investment manager is defined by
ERISA to include certain investment advisers registered under the
Advisers Act, as well as certain banks and insurance
companies.<<73>> Although the Coordination Act amended
ERISA to include state-registered investment advisers as
investment managers, that amendment expires two years after
enactment, on October 11, 1998.<<74>>
Several commenters urged the Commission to use its authority
under the Coordination Act to exempt advisers that manage
accounts subject to ERISA. These commenters expressed concern
that unless they were permitted to remain registered with the
Commission, they effectively would be denied the ability to
manage ERISA accounts and would be harmed competitively.
Although the Commission shares these commenters' concerns,
the Commission believes such an exemption would be inconsistent
with the purposes of the Coordination Act and outside the scope
of the Commission's authority. As described above, the grant of
exemptive authority in section 203A(c) was designed to permit
<<72>> Section 405(d)(1) of ERISA [29 USC 1105(d)(1)]. See 29
CFR 2509.75-8 (Department of Labor regulations
providing interpretative guidance on ability of plan
fiduciaries to delegate management and control of plan
assets to other persons under ERISA).
<<73>> Section 3(38) of ERISA [29 USC 1002(38)]. See 29 CFR
2509.75-5 (Department of Labor regulations providing
interpretative guidance on definition of "investment
manager" under ERISA).
<<74>> Section 308(b) of the Coordination Act.
-----Start of Page 37
Commission registration of advisers that are larger, national
firms, but do not have $25 million of assets under management.
An exemptive rule conditioned solely on the management of assets
of accounts subject to ERISA could exempt a large number of
small, locally operated advisers.<<75>> In the
Commission's view, in order for such a rule not to be anti-
competitive, the rule would have to exempt all advisers that
propose to serve clients regulated under ERISA. If not, the rule
would preclude advisers from entering that market. Thus, such an
exemption could result in most smaller advisers remaining
registered with the Commission -- completely frustrating a
principal purpose of the Coordination Act.<<76>>
On April 7, 1997, Chairman Levitt wrote to the leadership of
the Congressional committees with jurisdiction over ERISA, urging
that legislation be enacted eliminating the "sunset" provision in
the Coordination Act, thus making permanent the amendment of
ERISA that permits state-registered advisers to serve as
investment managers.<<77>>
<<75>> To reflect Congress' intent that the Commission
regulate only large, national advisers, the
Commission's exemption for pension consultants is
conditioned on the pension consultant's management of
over $50 million of plan assets. See supra note 60.
<<76>> The Commission also believes its authority to exempt
advisers to ERISA plans is circumscribed by the express
Congressional determination that the amendment to ERISA
provided in the Coordination Act expire after two
years.
<<77>> Letters from Arthur Levitt, Chairman, SEC (Apr. 7,
1997) to The Honorable James M. Jeffords, Chairman,
Committee on Labor and Human Resources, U.S. Senate,
-----Start of Page 38
E. Investment Advisers Not Regulated or Required to be
Regulated by States
Under section 203A(a)(1) of the Advisers Act, advisers that
are not regulated or required to be regulated as investment
advisers in the state in which they have their principal office
and place of business must register with the Commission
regardless of the amount of assets they have under
management.<<78>> This provision makes clear that the
Commission will retain regulatory responsibility for an adviser
with a principal office and place of business in a state that has
not enacted an investment adviser statute,<<79>> and for
foreign advisers doing business in the United States. The
Coordination Act, however, does not provide an explanation of
when an adviser is "regulated or required to be regulated" as an
investment adviser, nor does it define "principal office and
place of business."
and The Honorable William F. Goodling, Chairman,
Committee on Education and the Work Force, U.S. House
of Representatives (available in SEC File No. S7-31-
96).
<<78>> 15 USC 80b-3A(a)(1). The term "state" is defined in
section 202(a)(19) of the Advisers Act [15 USC 80b-
2(a)(19)] to include the District of Columbia, Puerto
Rico, the Virgin Islands, and any other possession of
the United States.
<<79>> As discussed supra note 7, Colorado, Iowa, Ohio, and
Wyoming currently do not have investment adviser
statutes.
-----Start of Page 39
1. "Regulated or Required to be Regulated"
Under the proposal, the Commission would have interpreted
the phrase "regulated or required to be regulated" in section
203A(a)(1) to mean "registered" with a state.<<80>> Under
this interpretation, an investment adviser exempt from
registration with the state in which it has its principal office
and place of business would be eligible for registration with the
Commission, even if it has less than $25 million of assets under
management.
Most commenters that addressed this issue, including several
state commenters, supported the Commission's proposed
interpretation. These commenters expressed concern that an
alternative interpretation under which an adviser would be deemed
"regulated" by a state if that state has in effect an investment
adviser statute would result in a regulatory "gap" that leaves
clients of advisers exempt from state registration and below the
threshold for Commission registration at risk. Two commenters,
however, objected to the proposed interpretation. One of these
commenters argued that the proposed interpretation would be
inconsistent with the goal of the Coordination Act, which was to
make the Commission primarily responsible for larger advisers
with national businesses and the state primarily responsible for
smaller advisers. This commenter also disagreed with the reading
of the legislative history of the Coordination Act reflected in
the Proposing Release. According to the commenter, the
<<80>> See Proposing Release at section II.E.1.
-----Start of Page 40
legislative history supports the view that all advisers with a
principal office in a state that has enacted a statute regulating
advisers are prohibited from registering with the Commission if
they do not meet the criteria for Commission registration.
These comments have caused the Commission to reconsider its
proposed interpretation. As discussed above, the legislative
history of the Coordination Act makes clear that Congress
intended the Coordination Act to result in the Commission
regulating larger advisers and the states regulating smaller
advisers.<<81>> The proposed interpretation, however,
would result in the Commission being responsible for a large
number of very small advisers that are not registered under state
law because they qualify for state de minimis exemptions. It
would be inconsistent with the purposes of the Coordination Act
for the Commission to retain responsibility for advisers whose
business activities states have determined are so limited that
they do not warrant their regulatory attention. The proposed
interpretation also would seem to frustrate the purpose of the
Coordination Act to limit significantly the number of advisers
registered with the Commission, since it would permit a
substantial number of very small advisers to remain registered
with the Commission.<<82>>
<<81>> See supra notes 4 and 5 and accompanying text.
<<82>> One commenter stated that it believes that there are
600 such advisers in New York alone. The proposed
interpretation also seems inconsistent with the goal of
the Coordination Act to reduce regulatory burdens,
since it could require a start-up adviser to first
-----Start of Page 41
The Commission believes a better interpretation of section
203A(a)(1) is that an adviser is "regulated or required to be
regulated" in the state in which it has its principal office and
place of business if that state has enacted an investment adviser
statute.<<83>> Such a state has asserted its interest in
regulating investment advisers. While a state may provide for
exemptions from its registration requirements or exceptions to
its definition of investment adviser, it does not thereby
delegate regulatory responsibility for such advisers to the
Commission.<<84>> Upon reconsideration, the Commission
believes the Coordination Act's legislative history supports this
position.<<85>>
register with the Commission, then move to state
registration as it outgrows the state de minimis
exemption, and later, if it continues to grow, return
to Commission registration.
<<83>> See supra note 7 and accompanying text.
<<84>> If a state repeals its investment adviser statute, the
Commission will assume regulatory responsibility for
all investment advisers with a principal office and
place of business in that state.
<<85>> The Senate Report explains that the Commission "will
continue to supervise all advisers that are based in a
state that does not register investment advisers."
Senate Report, supra note 4, at 4. The Proposing
Release and a number of commenters cited this sentence
for the proposition that an adviser is regulated by a
state if it is registered with that state. See
Proposing Release at note 59 and accompanying text. In
context, however, it appears that the sentence means
that the Commission will retain regulatory
responsibility for small advisers in states that do not
register any advisers.
-----Start of Page 42
State commenters supporting the Commission's proposed
interpretation argued that Congress intended to eliminate
regulatory overlap, not to create a regulatory "gap" in which
some advisers are left unregulated. Even under the proposed
interpretation, however, advisers that qualify for registration
exemptions under both federal and state law would continue to be
unregulated, and thus it is difficult to draw any conclusions
from the fact that some advisers will not be registered. To the
extent there is a "gap," the Commission believes that it is more
consistent with the Coordination Act for the gap be closed by the
states, which are given primary responsibility for regulating
advisers that are not eligible for Commission registration.
2. "Principal Office and Place of Business"
The Commission is adopting, as proposed, a new rule to
define the term "principal office and place of business" to mean
the "executive office of the investment adviser from which the
officers, partners, or managers of the investment adviser direct,
control, and coordinate the activities of the investment
adviser."<<86>>
F. Persons Who Act on Behalf of Investment Advisers
In addition to preempting state law with respect to
investment advisers registered with the Commission, the
Coordination Act preempts state law with respect to their
<<86>> Rule 203A-3(c).
-----Start of Page 43
"supervised persons."<<87>> A supervised person is defined
as any "partner, officer, director . . . , or employee of an
investment adviser, or other person who provides investment
advice on behalf of the investment adviser and is subject to the
supervision and control of the investment adviser."<<88>>
The Coordination Act preserves certain state laws with
respect to certain supervised persons of Commission-registered
advisers by providing that a "State may license, register, or
otherwise qualify any investment adviser representative who has a
place of business located within that State."<<89>> The
Coordination Act does not define "investment adviser
representative," nor does it describe what constitutes a "place
of business." In order to provide clarification, the Commission
is adopting definitions of these terms. The Commission also is
providing guidance as to the status of solicitors for
Commission-registered advisers.
1. "Investment Adviser Representative"
Rule 203A-3(a), as adopted, defines the term "investment
adviser representative" to mean a supervised person more than ten
percent of whose clients are natural persons.<<90>>
Natural persons who have at least $500,000 under management with
<<87>> Section 203A(b)(1)(A) of the Advisers Act [15 USC 80b-
3A(b)(1)(A)].
<<88>> Section 202(a)(25) of the Advisers Act [15 USC 80b-
2(a)(25)].
<<89>> Section 203A(b)(1)(A).
<<90>> 17 CFR 203A-3(a).
-----Start of Page 44
the adviser representative's investment advisory firm immediately
after entering into the advisory contract with the firm, or who
the advisory firm reasonably believes have a net worth in excess
of $1 million (together with assets held jointly with a spouse)
immediately prior to entering into the advisory contract, are not
counted towards the ten percent threshold.<<91>>
Supervised persons who do not, on a regular basis, solicit, meet
with, or otherwise communicate with clients of the investment
adviser, or who provide only impersonal investment advice, are
excluded from the definition of investment adviser
representative.<<92>>
The Commission received extensive comment on the proposed
definition of investment adviser representative. Most investment
adviser commenters asserted that it was important for the
Commission to adopt a single definition of the term in order to
effect the purpose of Congress in creating a more uniform,
rational system of adviser regulation. NASAA and most of the
states opposed the adoption of any Commission definition, arguing
that (i) the Commission has no authority to define the term, (ii)
Congress intended for the states to define the term, and (iii)
the states have already defined the term.
There is no contemporaneous legislative history explaining
what Congress meant by the term investment adviser representative
<<91>> Rule 203A-3(a)(3)(i) [17 CFR 275.203A-3(a)(3)(i)]. See
infra notes 110 - 112 and accompanying text.
<<92>> Rule 203A-3(a)(2) [17 CFR 275.203A-3(a)(2)]. See infra
section II.F.1.c of this Release.
-----Start of Page 45
in section 203A(b)(1)(A).<<93>> The definition of
investment adviser representative varies substantially from state
to state.<<94>> As a result, the incorporation of state
<<93>> The House bill, H.R. 3005, 104th Cong., 2d Sess.
(1996), did not, in its original form, address the
regulation of investment advisers. The Senate bill,
which is the source of the Coordination Act, preempted
state qualification requirements with respect to
Commission-registered advisers and, as originally
introduced, their employees. See S. 1815, 104th Cong.,
2d Sess. section 103 (1996). The provision preserving
state authority over investment adviser representatives
was added by the conference committee. The "Joint
Explanatory Statement of the Committee of Conference,"
however, states only that "[t]he Managers agreed to
include certain amendments to the Investment Advisers
Act of 1940 to eliminate duplication, promote
efficiency, and protect investors." H.R. CONF. REP.
No. 864, 104th Cong., 2d Sess. 41 (1996), reprinted in
1996 U.S.C.C.A.N. 3920, 3922. The debates in Congress
that preceded final adoption of the bill reported by
the conference committee note only that the states were
given authority under the bill to continue to regulate
"investment adviser representatives." 142 Cong. Rec.
H12,047-01, H12,050 (daily ed. Sept. 28, 1996)
(statement of Rep. Markey) ("At the same time, we
agreed that the States should continue to have
authority to license the individual representatives of
investment advisers.").
<<94>> Although most states that require registration of
investment adviser representatives have patterned their
definition of investment adviser representative on the
NASAA model definition, see UNIF. SEC. ACT section
401(g) (1986), many have modified this definition, both
legislatively and administratively, to include, for
example, any person: who holds himself out as an
investment adviser (MD. CODE ANN., CORPS & ASS'NS
section 11-101(g)(vii) (1993)); who deals directly with
clients of the investment adviser (Arkansas Blue Sky
Rule 102.01); or who prepares reports or analyses
concerning securities (OKLA. STAT. ANN. tit. 71 section
2(l) (West Supp. 1997); VA. CODE ANN. section 13.1-
501(A) (1993); Definitions and Procedures for
Investment Advisor Representatives and Branch Offices
(Order of Deputy Commissioner of Securities, West
Virginia Securities Division, May 25, 1993, amended
eff. Oct. 11, 1995)).
-----Start of Page 46
law would conflict with one of the primary goals of the
Coordination Act, which is to promote uniformity of
regulation.<<95>> Likewise, the incorporation of state law
would be at odds with Congress' determination to preempt state
laws regulating the offering of mutual fund shares,<<96>>
as state investment adviser representative definitions generally
encompass persons who provide advisory services to mutual
funds.<<97>> Incorporation of state law also would be
inconsistent with Congress' intention to limit the application of
state law to at least some supervised persons. If a state
adopted a sufficiently broad definition of the term investment
adviser representative, the Coordination Act would have no
preemptive effect, since all supervised persons would be subject
<<95>> See Senate Report, supra note 4, at 4 ("Larger
advisers, with national businesses, should
be . . . subject to national rules.").
<<96>> See 1996 Act section 102 (amending section 18(b)(2) of
the Securities Act of 1933 [15 USC 77r(b)(2)] to
preempt state laws requiring registration of securities
issued by investment companies that are registered or
that have filed a registration statement with the
Commission); Senate Report, supra note 4, at 6-7; H.
REP. NO. 622, 104th Cong., 2d Sess. 30-31 (1996)
[hereinafter House Report].
<<97>> The NASAA model definition of investment adviser
representative includes any employee (except clerical
or ministerial personnel) of an investment adviser who
"manages accounts or portfolios of clients." See UNIF.
SEC. ACT section 401(g)(2) (1986). Most states that
define investment adviser representative include this
provision in their definitions. See, e.g., MD. CODE
ANN., CORPS. & ASS'NS, section 11-101(g)(1)(v) (1993);
MASS. GEN. LAWS ANN. ch. 110A, section 401(n) (West
Supp. 1996); NEV. REV. STAT. section 90.278(1)(d)
(Michie Supp. 1995).
-----Start of Page 47
to state licensing, registration, or qualification (hereinafter,
"state qualification requirements.")<<98>>
The Coordination Act does not contain any direction to
incorporate state law. In light of the many provisions in the
1996 Act designed to promote uniformity of regulation, the
decision of Congress to preempt state mutual fund regulation, and
the preemptive language used by Congress, the Commission does not
believe that Congress intended the definition of investment
adviser representative to incorporate state law. Rather, the
Commission believes that Congress left the term investment
adviser representative undefined with the expectation that the
Commission would use its rulemaking authority to define the term.
The Commission's authority to adopt a rule classifying
certain supervised persons as investment adviser representatives
is clear.<<99>> The ambiguities created by Congress' use
<<98>> Thus, such a definition would have the effect of
reading out of the Coordination Act the provision in
section 203A(b)(1)(A) preempting state qualification
requirements as to supervised persons of
Commission-registered advisers, violating the principle
of statutory interpretation that a statute is to be
construed so as to give effect to all of its language.
See, e.g., United States v. Menasche, 348 U.S. 528,
538-39 (1955).
<<99>> Section 211(a) of the Advisers Act [15 USC 80b-21(a)]
authorizes the Commission to adopt rules "as are
necessary or appropriate to the exercise of the
functions and powers conferred upon the Commission" in
the Advisers Act and to "classify persons and matters
within its jurisdiction and prescribe different
requirements for different classes of persons or
matters." Section 202(a)(17) of the Advisers Act [15
USC 80b-2(a)(17)] authorizes the Commission to adopt
-----Start of Page 48
of the undefined term investment adviser representative make it
important that the Commission, as the federal agency charged with
administering the Advisers Act, define the term so that the
substantial uncertainties and costly disputes likely to occur in
the absence of such a definition may be avoided.<<100>>
Only by adopting a uniform, national definition of investment
adviser representative can Congress' intent to "delineate more
clearly the securities law responsibilities of federal and state
governments" be achieved.<<101>>
a. Retail Clients
As discussed above, Congressional committee reports provide
no indication as to which persons providing investment advice on
behalf of Commission-registered advisers Congress intended states
to continue to register.<<102>> Therefore, in developing
rules that "classify, for the purposes of any portion.
. . of [the Advisers Act], persons, including employees
controlled by an investment adviser" (emphasis added).
<<100>> Even if the Commission did not have the explicit grants
of rulemaking authority discussed supra in note 99, the
Supreme Court has recognized that regulatory agencies
have authority to adopt rules to fill any gap left,
implicitly or explicitly, by Congress, see Chevron,
U.S.A., Inc. v. Natural Resources Defense Council,
Inc., 467 U.S. 837, 843-44 (1984), and that agency
rulemaking may preempt state law, see City of New York
v. Federal Communications Commission, 486 U.S. 57, 63-
64 (1988). The Commission notes that Congress
specifically anticipated that Commission rulemaking
would preempt state law. Section 203A(c) permits the
Commission to exempt advisers from the prohibition on
Commission registration, thereby preempting state law
with respect to the exempted advisers.
<<101>> See Senate Report, supra note 4, at 2.
<<102>> See supra note 93.
-----Start of Page 49
its proposed definition, the Commission examined testimony
Congress received in support of preserving state authority over
investment adviser representatives of Commission-registered
advisers.<<103>> Testimony offered by NASAA urged
Congress to permit states to establish qualification standards
for investment adviser representatives to protect "retail"
investors.<<104>> The Commission assumed that this
testimony persuaded Congress to preserve state authority over
such persons, and proposed to define the term investment adviser
representative in a manner consistent with the policy concerns
expressed in the testimony.<<105>>
Under the proposed definition, investment adviser
representative would mean a supervised person of an investment
adviser, if a substantial portion of the business of the
supervised person is providing investment advice to clients who
are natural persons. The proposed definition thus drew a
distinction between natural persons, whom the Commission
considered to be "retail investors," and investment companies,
businesses, educational institutions, charitable institutions,
and other types of clients. Under the proposed definition, most
<<103>> See Proposing Release at note 68 and accompanying text.
<<104>> See Senate Hearing, supra note 4, at 125 (testimony of
Dee R. Harris, President, NASAA). See also id. at 178
(statement of Steven M.H. Wallman, Commissioner, SEC
("My concern is with the treatment of associated
persons of [investment adviser] firms who provide
advice to retail customers." (emphasis in original))).
<<105>> See Proposing Release at section II.F.1.
-----Start of Page 50
investment adviser representatives who provide advice primarily
to natural persons would be subject to state qualification
requirements.
Commenters were divided over whether the definition should
distinguish between retail and other types of clients. Many
state commenters opposed this distinction, arguing there was no
basis in the Coordination Act or its legislative history for
limiting state oversight to adviser representatives that serve
retail clients.<<106>> Many of these commenters referred
to the example of an adviser representative who provides advisory
services to small businesses as the type of supervised person
that should be subject to state qualification requirements. In
contrast, many investment adviser commenters supported the
distinction, arguing that it was consistent with the legislative
history cited by the Commission in the Proposing Release.
Several of these commenters also urged the Commission to treat
certain "high net worth" clients as institutional clients.
The Commission continues to believe that it is consistent
with the intent of Congress as reflected in the structure and
purpose of the Coordination Act to distinguish between retail and
<<106>> Some of these commenters asserted that the Commission
mischaracterized the intent of NASAA in referring to
"retail" investors in its testimony. The Commission,
however, did not base the proposed rule on the intent
of NASAA in giving its testimony, but rather, on what
the members of the Senate committee receiving NASAA's
testimony (and the other members of Congress reviewing
the legislative record) are reasonably likely to have
believed NASAA's position was at the time of its
testimony.
-----Start of Page 51
other clients in defining the term investment adviser
representative. While there are other possible criteria for
distinguishing retail clients from other clients,<<107>>
the Commission believes that treating natural persons as retail
clients is consistent with the Coordination Act and has the
advantage of simplicity and ease of administration.<<108>>
Although small businesses may not be familiar with
investing, they must be familiar with selecting qualified service
providers, suppliers, and other parties with which they contract
as a part of their businesses. Small businesses will receive a
brochure setting forth the business and educational background of
prospective advisers and will have the opportunity to make an
<<107>> Dictionaries typically define "retail" as the sale in
small quantities to consumers. See, e.g., WEBSTER'S II
NEW RIVERSIDE UNIVERSITY DICTIONARY 1003 (1994). Such
a definition is not helpful in this context because,
depending on who is viewed as the "consumer" of the
advice, it leads to a conclusion either that all
businesses are retail clients (because they are
obtaining advice for their own portfolios), or that no
businesses are retail clients (because the ultimate
beneficiaries of the advice are the owners of the
businesses).
<<108>> Requiring adviser representatives to determine whether
a client is a "small business" would complicate the
definition and create uncertainty as to the
applicability of state qualification requirements. If
small businesses were treated as retail persons,
adviser representatives presumably would have to obtain
income statements and/or balance sheets from their
small business clients, and might be required to
determine whether the income or assets of a small
business client should be aggregated with the client's
parent or affiliate in order to determine whether state
qualification requirements apply.
-----Start of Page 52
informed decision whether the advisers are
qualified.<<109>> Because adviser representatives
providing advice to small businesses also typically provide
advice to individual investors, it is unlikely that the
Commission's decision to treat only natural persons as retail
clients will have a significant effect on the number of adviser
representatives subject to state qualification requirements.
As suggested by several commenters, the Commission is
modifying the rule to permit adviser representatives to exclude
certain "high net worth" individuals from treatment as natural
persons. Under the rule, high net worth individuals are those
with whom the Commission permits advisers to enter into a
"performance fee contract."<<110>> Because of their
wealth, financial knowledge, and experience, the Commission has
presumed that these individuals are less dependent on the
protections of the provisions of the Advisers Act that prohibit
such fee arrangements.<<111>> The Commission believes
<<109>> Rule 204-3 requires Commission-registered investment
advisers to provide existing and prospective clients
with a written disclosure statement describing the
adviser's services and fees, investment methods and
strategies, and education and business background, as
well as other information. See Part II of Form ADV.
<<110>> See rule 205-3 [17 CFR 275.205-3].
<<111>> See Investment Advisers Act Rel. No. 966 (Nov. 14,
1985) [50 FR 48556 (Nov. 26, 1985)] (adopting rule 205-
3). Rule 205-3 permits a registered investment adviser
to be compensated on the basis of a share of the
capital gains on or capital appreciation of client
assets. See infra section II.I.3 of this Release.
Compensation of this type is prohibited by section
205(a)(1) of the Advisers Act [15 USC 80b-5(a)(1)] with
-----Start of Page 53
that such individuals similarly do not need the protections of
state qualification requirements. Because of the historical
treatment of wealthy and sophisticated individuals under the
federal securities laws, Congress reasonably could have expected
these persons not to be considered retail
investors.<<112>>
b. Accommodation Clients
The Commission proposed to include in the definition of
investment adviser representative only those supervised persons a
"substantial portion" of whose business is providing advice to
natural persons.<<113>> A substantial portion of a
supervised person's business would be providing advice to natural
persons if, during the preceding twelve months, more than ten
percent of the supervised person's clients consisted of natural
persons, or more than ten percent of the assets under management
by the adviser attributable to the supervised person were assets
of clients who are natural persons (the "ten percent allowance").
Most commenters that addressed the proposed ten percent
allowance supported it. Some investment adviser commenters urged
the Commission to increase the allowance to 25 percent. The
certain limited exceptions.
<<112>> This conclusion is supported by the determination by
Congress in section 205(e) of the Advisers Act [15 USC
80b-5(e)] to broaden the authority of the Commission to
permit advisers to enter into performance fee contracts
with these persons.
<<113>> See Proposing Release at section II.F.1.
-----Start of Page 54
Commission is adopting the ten percent allowance substantially as
proposed. The Commission believes that increasing the allowance
to 25 percent could result in supervised persons accepting
natural person clients on more than just an accommodation basis.
The Commission notes, however, that the exclusion of certain high
net worth individuals from the ten percent allowance likely will
have the effect of expanding the number of accommodation clients
an adviser representative may accept.<<114>>
Under the proposed rule, the ten percent allowance would
have been measured either by reference to assets under management
attributable to the supervised person ("asset test") or by
reference to clients of the supervised person ("client test").
Commenters believed that these tests were too complicated and
that the client test alone was sufficient. No commenters came
forth, as the Commission had requested, with suggestions for
making the asset test workable.<<115>> The Commission is
not adopting the asset test, but is concerned that, as a result,
an adviser representative who works on one or a few institutional
or business client accounts may not be able to accept any
accommodation clients because, if she did, more than 10 percent
of her clients would consist of natural persons. The Commission
directs the staff to work with investment advisers whose adviser
representatives may be so affected. If a workable method of
<<114>> See supra notes 110 - 112 and accompanying text.
<<115>> For example, an asset test would have to provide
guidance on how to attribute assets managed by the
adviser to a particular supervised person.
-----Start of Page 55
addressing this concern is developed, the Commission will revise
the definition of investment adviser representative.
The Commission also has revised the method of measuring the
ten percent allowance. As proposed, the allowance would have
been measured over the previous twelve month period. The
Commission believes that the proposed approach is too complicated
and would inappropriately delay the applicability of state
qualification requirements.<<116>> As adopted, therefore,
the rule requires a supervised person to determine compliance
with the ten percent allowance at all times, with respect to
current clients.<<117>>
<<116>> For example, a supervised person who previously
provided advisory services exclusively to institutional
clients and who is reassigned to retail clients could
not have been required, under the proposed rule, to
comply with state qualification requirements for up to
a year after being reassigned to retail clients,
because the supervised person would not have been
deemed to be an investment adviser representative until
retail clients represented 10 percent of his clientele
over a 12 month period. Conversely, an investment
adviser representative who previously provided advice
to retail clients and who is reassigned to
institutional clients could have been required to
continue to meet state qualification requirements even
though she no longer had retail clients, because under
the proposed rule, she would have continued to be an
investment adviser representative until retail clients
represented less than 10 percent of her clientele over
a 12 month period.
<<117>> Rule 203A-3(a)(1) [17 CFR 275.203A-3(a)(1)]. The
client test is measured with respect to all of an
adviser representative's clients nationwide.
Supervised persons may rely on the definition of
"client" in rule 203(b)(3)-1 [17 CFR 275.203(b)(3)-1]
for the purpose of counting clients, except that
supervised persons need not count clients that are not
U.S. residents. Rule 203A-3(a)(4) [17 CFR
275.203A-3(a)(4)].
-----Start of Page 56
The Commission recognizes that some advisory firms consider
each person to whom the firm provides advisory services to be a
client only of the firm and not of any individual supervised
person. The Commission believes that such an approach would be
inconsistent with the Coordination Act, and thus a client also
should be treated as a client of a supervised person if the
supervised person has substantial responsibilities with respect
to the client's account or communicates advice to the client. If
more than one supervised person provides advice to a client, the
client should be attributed to each supervised person.
c. Supervised Persons Providing Indirect or
Impersonal Advice
The Commission also is adopting an exception from the
definition of investment adviser representative for supervised
persons who provide advice to natural persons, but who do not "on
a regular basis solicit, meet with, or otherwise communicate with
clients."<<118>> This exception excludes from state
qualification requirements personnel of an adviser who may be
involved in the formulation of investment advice given to natural
persons, but who are not directly involved in providing advice to
(or soliciting) clients. In addition, the Commission is
excepting supervised persons who give only impersonal investment
advice.<<119>> This provision excludes personnel who may
be involved, for example, in preparing a newsletter, providing
<<118>> Rule 203A-3(a)(2)(i) [17 CFR 275.203A-3(a)(2)(i)].
<<119>> Rule 203A-3(a)(2)(ii) [17 CFR 275.203A-3(a)(2)(ii)].
-----Start of Page 57
general market timing advice, or preparing a list of recommended
purchases for inclusion on a web site. No commenters
specifically addressed these provisions, which are being adopted
substantially as proposed.
d. Dually Registered Investment Adviser
Representatives
The Proposing Release requested comment whether an
investment adviser representative that is dually registered as a
broker-dealer agent in a state should be excepted from the
definition of investment adviser representative.<<120>> A
number of investment adviser commenters expressed support for
such an exception, arguing that state investment adviser
representative registration of registered broker-dealer agents is
redundant. Many state and other commenters strongly opposed such
an exception, asserting that it would be inappropriate to treat
investment adviser representatives and broker-dealer agents the
same since they perform different functions, are subject to
different state examination requirements,<<121>> and are
governed by different regulations and fiduciary standards. The
<<120>> See Proposing Release at section II.F.1.
<<121>> The Commission notes, however, that many states accept
a person's receiving a passing grade on a broker-dealer
agent examination in lieu of an investment adviser
representative examination to satisfy state investment
adviser representative qualification requirements. For
example, many states accept passage of Series 63 (NASAA
Uniform State Law Exam) and Series 7 (General
Securities Representative Exam) in lieu of investment
adviser representative examinations. See, e.g., ALA.
ADMIN. CODE r. 830-X-3-.08(4); OR. ADMIN. R.
441-175-120(4) (1994).
-----Start of Page 58
Commission agrees, and the rule, as adopted, provides no
exception for dually registered broker-dealer agents.
e. Solicitors
In the Proposing Release, the Coordination Act was
interpreted as not generally preempting state regulation of
solicitors for Commission-registered advisers.<<122>>
Several commenters disagreed with this interpretation and
asserted that if a solicitor is an employee of the adviser for
which he or she solicits, the Coordination Act preempts state law
unless the solicitor is an investment adviser representative.
The Commission agrees, and is revising this interpretation.
Section 203A(b) preempts state regulation of "supervised
persons" of Commission-registered advisers, except those who are
investment adviser representatives. Whether a solicitor for a
Commission-registered adviser is subject to state qualification
requirements thus turns, first, on whether the solicitor is a
supervised person, and second, on whether he or she is an
investment adviser representative. A supervised person is
defined in section 202(a)(25) to be (i) any partner, officer,
director (or other person occupying a similar status or
performing similar functions), or employee of an investment
adviser, or (ii) any other person who provides investment advice
on behalf of the investment adviser and is subject to the
<<122>> See Proposing Release at section II.F.3. For a
description of solicitors' activities, see Investment
Advisers Act Rel. No. 688 (July 12, 1979) [44 FR 42126
(July 18, 1979)] (adopting rule 206(4)-3 [17 CFR
275.206(4)-3], the cash solicitation rule).
-----Start of Page 59
supervision and control of the investment adviser. Because
solicitation of clients may not involve providing investment
advice on behalf of the adviser, the status of a solicitor as a
supervised person will depend on the whether the solicitor is a
"partner, officer, director, or employee" of the adviser, or an
"other person."<<123>>
A solicitor who is a partner, officer, director, or employee
of a Commission-registered adviser is a supervised person, and is
subject to state qualification requirements only if the solicitor
is an investment adviser representative under rule 203A-3(a). A
third-party solicitor for a Commission-registered adviser (i.e.,
a solicitor who is not a partner, officer, director, or employee
of the adviser) is not a supervised person unless the solicitor
provides investment advice on behalf of the investment adviser
<<123>> In the Proposing Release, the Commission interpreted
the "provides investment advice on behalf of"
limitation in section 202(a)(25) as applying to all
categories of persons in the definition of supervised
persons. Upon reconsideration, the Commission believes
that this limitation should be applied only to "other
persons," and not to persons who are "partners,
officers, directors, or employees." As one commenter
pointed out, in a draft of the Coordination Act that
preceded the one in which the definition of "supervised
person" was added, state investment adviser regulations
would have been preempted as to all employees of a
Commission-registered adviser. The definition of
"supervised person" and the "other persons who provide
investment advice" language were added not to limit the
types of employees of Commission-registered advisers
exempted from state qualification requirements, but to
include persons who may not be employees but assume a
similar function (e.g., independent contractors). See
Senate Report, supra note 4, at 4.
-----Start of Page 60
and is subject to the supervision and control of the
adviser.<<124>> Thus, a third-party solicitor will be
subject to state qualification requirements to the extent state
investment adviser statutes apply to solicitors.<<125>>
In some cases, a solicitor may solicit on behalf of both a
state-registered adviser and a Commission-registered adviser.
The Commission believes that the Coordination Act does not
preempt states from subjecting such a solicitor to state
qualification requirements.
2. "Place of Business"
While section 203A(b)(1)(A) preserves the ability of a state
to license, register, or otherwise qualify investment adviser
representatives of Commission-registered advisers, the section
limits a state's authority to only those investment adviser
representatives who have a "place of business" within the state.
<<124>> Regardless of whether a solicitor is a "supervised
person," a solicitor is a "person associated with an
investment adviser" with respect to the adviser for
which he or she solicits. See section 202(a)(17). The
adviser, therefore, has an obligation to supervise its
solicitors with respect to activities performed on its
behalf. See Investment Advisers Act Rel. No. 688,
supra note 122. A solicitor for an adviser providing
solely impersonal advice is not necessarily a "person
associated with an investment adviser." See Investment
Advisers Act Rel. No. 688, supra note 122, at note 20.
<<125>> See, e.g., ALA. CODE section 8-6-2(19)(d) (1975); IDAHO
CODE section 30-1402(14)(d) (Michie Supp. 1995)
(defining investment adviser representative to include
certain persons associated with an investment adviser
that solicit for the sale of investment advisory
services). Rule 206(4)-3 will continue to govern cash
payments by a Commission-registered adviser to a
solicitor who is subject to state qualification
requirements.
-----Start of Page 61
The Commission proposed to clarify that, for purposes of section
203A(b)(1)(A), a place of business is any place or office from
which the investment adviser representative regularly provides
advisory services or otherwise solicits, meets with, or
communicates to clients.<<126>>
Most commenters, while supporting the adoption of a
Commission rule clarifying the term place of business, criticized
the proposed definition as too vague. Investment adviser
commenters were concerned with the uncertainty the use of the
term "regularly" would create. They also were concerned that, as
a result of the uncertainty, they would find it difficult to
ensure compliance by their supervised persons with state
qualification requirements. State commenters were concerned that
they would find it difficult to enforce state qualification
requirements because states would be required to prove that
advice had been given on a regular basis at a particular place.
The Commission has revised the definition of place of business to
address these concerns.
As adopted, rule 203A-3(b) defines a place of business of an
investment adviser representative to mean (i) an office at which
the investment adviser representative regularly provides
investment advisory services, solicits, meets with, or otherwise
communicates with clients, and (ii) any other location that is
held out to the general public as a location at which the
investment adviser representative provides investment advisory
<<126>> See Proposing Release at section II.F.2.
-----Start of Page 62
services, solicits, meets with, or otherwise communicates with
clients.<<127>> For the purposes of rule 203A-3(b), an
adviser representative would be considered to hold himself out to
the general public as having a location at which he conducts
advisory business by, for example, publishing information in a
professional directory or a telephone listing, or distributing
advertisements, business cards, stationery, or similar
communications that identify the location as one at which the
adviser representative is or will be available to meet or
communicate with clients.<<128>>
The definition encompasses permanent and temporary offices
as well as other locations at which an adviser representative may
<<127>> 17 CFR 275.203A-3(b). In response to a number of
comments, the Commission is not adopting the "itinerant
representative" provision contained in the proposed
definition that would have deemed the residence of each
client to be the place of business of an adviser
representative that did not regularly provide advisory
services in any location. That provision is
unnecessary under the revised rule.
<<128>> An adviser representative who sends a letter to certain
existing clients indicating, for example, that she will
be in their area and available for a meeting would not
have held out the location of the proposed meeting to
the general public for purposes of rule 203A-3(b)(2)
[17 CFR 275.203A-3(b)(2)]. Similarly, an adviser
representative that communicates to a defined group
under the terms of an advisory contract the location at
which she will be available would not be holding
herself out to the general public for purposes of rule
203A-3(b)(2). For example, in the case of a national
organization that engages an adviser to provide
advisory services to its members, an adviser
representative who communicates its availability at a
certain location to the members (even though those
individuals may not yet be clients) would not be
holding himself out to the general public.
-----Start of Page 63
provide advisory services, such as a hotel or
auditorium.<<129>> Whether an adviser representative will
be subject to the qualification requirements of a state in which
the hotel or auditorium is located will turn on whether the
adviser representative has let it generally be known that he or
she will conduct advisory business at the location, rather than
on the frequency with which the adviser representative conducts
advisory business there. This definition should provide a
clearer and more enforceable standard for determining when state
qualification requirements are triggered.
G. National De Minimis Standard
The Coordination Act amends the Advisers Act to add new
section 222(d), which makes state investment adviser statutes
<<129>> The following example discusses the application of the
rule to an investment adviser representative who
provides investment advisory services through an
Internet web site to clients in many states: an
adviser representative uses a computer at his home or
an office in State W where he prepares material to be
placed on the web site or distributed over the Internet
(but where he does not "regularly provide investment
advisory services, solicit, meet with, or otherwise
communicate with clients"). He also maintains an
office in State X where he evaluates the information
provided by clients and provides information in
response to clients. The adviser representative's web
site advertises the representative's physical office in
State Y where the representative meets clients. The
adviser representative e-mails its materials to a web
server in State Z for posting on the web and has a post
office box or an agent in State B to whom clients are
instructed to mail checks. Under the rule, the adviser
representative would have places of business in State X
(the state in which he has an office for purposes of
the rule) and State Y (the state in which he holds
himself out as conducting his advisory business), but
not in any other state.
-----Start of Page 64
inapplicable to advisers that do not have a place of business in
the state and have fewer than six clients who are residents of
that state (the "national de minimis standard").<<130>>
The Commission proposed a new rule to define the term "client"
for purposes of section 222(d).<<131>>
The proposed rule would treat as a single client a natural
person and (i) any relative, spouse, or relative of the spouse of
the natural person sharing the same principal residence, and (ii)
all accounts of which the natural person and such persons are the
sole primary beneficiaries. The proposed rule also would treat
as a single client a corporation, general partnership, limited
liability company, trust, or other legal organization (other than
a limited partnership) that receives investment advice based on
its investment objectives rather than the objectives of its
shareholders, partners, members, or beneficial owners. Under the
proposal, a limited partnership would be counted as a single
client if it would be counted as a single client under rule
203(b)(3)-1.<<132>>
Commenters stated the Commission's definition of the term
"client" would provide needed uniformity under the national de
<<130>> 15 USC 80b-18a(d).
<<131>> See Proposing Release at section II.G.
<<132>> At the time of the Proposing Release, rule 203(b)(3)-1
provided a safe harbor to count a limited partnership,
as opposed to each limited partner, as a client for
purposes of section 203(b)(3) of the Advisers Act [15
USC 80b-3(b)(3)]. As discussed infra, the Commission
is amending rule 203(b)(3)-1 to address additional
client relationships.
-----Start of Page 65
minimis standard. The Commission is adopting a rule defining the
term client, but is making several modifications from the
proposal.<<133>> As suggested by commenters, the final
rule also treats as a single client a natural person and (i) that
person's minor children (whether or not they share the natural
person's principal residence), and (ii) all trusts of which the
natural person and/or any relative or spouse of that person
sharing the same principal residence (or any minor children of
that person) are the only primary beneficiaries. The rule also
treats as a single client two or more corporations, partnerships,
or other legal organizations that each receive investment advice
based on the organization's investment objectives and have
identical shareholders, partners, or beneficiaries.<<134>>
<<133>> See rule 203(b)(3)-1. The Commission also is adopting
rule 222-1 [17 CFR 275.222-1], which defines other
terms used in section 222. Rule 222-1(a) [17 CFR
275.222-1(a)] defines place of business in the same
manner as rule 203A-3(b), except that the term is
applied to investment advisers rather than investment
adviser representatives. Rule 222-1(b) [17 CFR
275.222-1(b)] defines principal place of business in
the same manner that rule 203A-3(c) defines principal
office and place of business. See supra sections
II.F.2 and II.E.2 of this Release.
<<134>> This provision codifies the Division's interpretative
position that trusts with identical beneficiaries could
be treated as a single client. See OSIRIS Management,
Inc. (pub. avail. Feb. 17, 1984). The final rule does
not require that the beneficial owners have identical
ownership interests in each legal organization. An
adviser could not avoid registration, however, by
arranging nominal common ownership. See section 208(d)
[15 USC 80b-8(d)] (which makes it unlawful generally
for any person to do indirectly any act which it would
be unlawful for that person to do directly under the
Advisers Act or rules thereunder).
-----Start of Page 66
Under the rule, any person for whom an investment adviser
provides investment advisory services without compensation is not
deemed to be a client.<<135>>
Section 203(b)(3), the federal de minimis provision, exempts
from registration with the Commission certain advisers having
fewer than fifteen clients during the preceding twelve months.
Rule 203(b)(3)-1 provides a safe harbor permitting the general
partner or other investment adviser to a limited partnership to
count the partnership, rather than each limited partner, as the
client for purposes of section 203(b)(3). The Proposing Release
requested comment whether the Commission should adopt one
definition of "client" for purposes of both section 222 and
section 203(b)(3) and if so, whether certain provisions of rule
<<135>> The adviser, however, has all of the fiduciary
obligations with respect to such a client that it has
with respect to a paying client. In addition, if the
assets of such an account are held in a securities
portfolio with respect to which the adviser provides
continuous and regular supervisory or management
services, those assets must be included in the
determination of the adviser's assets under management.
See infra section II.B.1 of this Release. The
Commission intends that the term "compensation," as
used in the rule, have the same meaning as the term
used in section 202(a)(11) of the Advisers Act [15 USC
80b-2(a)(11)]. See Applicability of the Investment
Advisers Act to Financial Planners, Pension
Consultants, and Other Persons Who Provide Investment
Advisory Services as a Component of Other Services,
Investment Advisers Act Rel. No. 1092 (Oct. 8, 1987)
[52 FR 38400 (Oct. 16, 1987)], in which the Division
explained that "compensation" includes any economic
benefit, whether or not in the form of an advisory fee,
and that it need not be paid directly, but can be
provided by a third party.
-----Start of Page 67
203(b)(3)-1 should be revised.<<136>> Commenters favored
the adoption of one definition of "client" to resolve open
questions and provide consistency under both sections.
The Commission agrees that one definition has advantages and
therefore is amending rule 203(b)(3)-1 to create one definition
of the term "client" for purposes of sections 203(b)(3) and
222(d).<<137>> In taking this action, the Commission has
modified certain provisions of rule 203(b)(3)-1 that were not
consistent with proposed rule 222-2's treatment of other legal
organizations.<<138>> The Commission does not expect
these changes to affect the scope of the relief that has been
provided by rule 203(b)(3)-1. The Commission also has modified
the proposed rule to incorporate the safe harbor approach of rule
203(b)(3)-1. As a safe harbor, the final rule is not intended to
specify the exclusive method for determining who may be treated
as a single client for purposes of sections 203(b)(3) and
222(d).<<139>> In addition, the final rule clarifies the
<<136>> See Proposing Release at note 96 and accompanying text.
<<137>> Rule 222-2 [17 CFR 275.222-2], as adopted, provides
that for purposes of section 222(d)(2) of the Act, an
adviser may rely upon the definition of client provided
by rule 203(b)(3)-1.
<<138>> Rule 203(b)(3)-1, as amended, no longer contains a
requirement that the limited partnership interests be
securities.
<<139>> Where a client relationship involving multiple persons
does not come within the rule, the question of whether
it may appropriately be treated as a single client must
be determined on the basis of the facts and
circumstances involved. In light of the inherently
factual nature of such determinations, the Commission
-----Start of Page 68
treatment of foreign clients for purposes of section
203(b)(3).<<140>>
Finally, the Commission wishes to emphasize that rules
203(b)(3)-1 and 222-2 define the term "client" only for purposes
of counting clients under sections 203(b)(3) and 222(d). Persons
that are grouped together for purposes of those sections may be
required to be treated as separate clients for other purposes
under the Advisers Act (and state investment adviser statutes).
H. Scope of State Authority Over Commission-Registered
Investment Advisers
1. Preemption of State Regulatory Authority
The Coordination Act gives the Commission primary
responsibility to regulate advisers that remain registered with
the Commission by preempting state regulation of those advisers.
New section 203A(b)(1) of the Advisers Act provides that "[n]o
law of any State . . . requiring the registration, licensing, or
qualification as an investment adviser shall apply to any
and its staff generally will not entertain requests for
interpretive advice with respect to client
relationships that do not come within rule 203(b)(3)-1.
<<140>> 17 CFR 275.203(b)(3)-1(b)(5). The rule provides that,
for purposes of section 203(b)(3), an adviser with its
principal office and place of business outside the
United States must count only clients that are United
States residents. An adviser with its principal office
and place of business in the United States must count
all clients, regardless of their place of residence.
See generally Vocor International Holding S.A. (pub.
avail. Apr. 9, 1990). Clients that are not United
States residents need not be counted for purposes of
section 222(d), since the availability of the national
de minimis standard turns on the number of clients who
are residents of the state in question.
-----Start of Page 69
[adviser registered with the Commission]. . . ."<<141>>
States retain authority over Commission-registered advisers under
state investment adviser statutes to investigate and bring
enforcement actions with respect to fraud or deceit against an
investment adviser or a person associated with an investment
adviser; to require filings, for notice purposes only, of
documents filed with the Commission; and to require payment of
state filing, registration, and licensing fees.<<142>>
The Proposing Release stated the Commission's view that
section 203A(b) preempts not only a state's specific
registration, licensing, or qualification requirements, but all
regulatory requirements imposed by state law on Commission-
registered advisers relating to their advisory activities or
services, except those provisions that are specifically preserved
by the Coordination Act.<<143>> As a result, the
Commission concluded that state regulatory provisions, such as
those that establish recordkeeping, disclosure, and capital
requirements, will no longer apply to advisers registered with
the Commission.<<144>>
The Commission received extensive comment on its
interpretation of the scope of state preemption. Investment
<<141>> 15 USC 80b-3A(b)(1).
<<142>> See section 203A(b)(2) of the Advisers Act [15 USC 80b-
3A(b)(2)]; section 307(a), (b) of the Coordination Act.
<<143>> See Proposing Release at note 20 and accompanying text.
<<144>> See Proposing Release at note 21 and accompanying text.
-----Start of Page 70
adviser commenters strongly favored the interpretation, while
NASAA and many of the state commenters argued that the
interpretation should be narrowed substantially. NASAA asserted
that because the Coordination Act preempts only state
registration requirements, only state regulatory requirements
that "flow from" state registration are preempted.<<145>>
The Commission continues to believe that the Coordination
Act broadly preempts state investment adviser statutes with
respect to Commission-registered advisers. While the language of
section 203A(b)(1) is not necessarily clear on its face and is
<<145>> Several state commenters asserted that, under the
Commission's interpretation of the preemption
provision, the Coordination Act would violate the Tenth
Amendment's command that powers not delegated to the
federal government by the Constitution are reserved to
the states. This argument appears to confuse the scope
of preemption (about which some of the commenters and
the Commission disagree) with the constitutional
authority of Congress (and the delegated authority of
the Commission) to exclusively regulate investment
advisers registered with the Commission. Section
203A(b) does nothing more than preempt certain state
laws regulating Commission-registered advisers. The
Supreme Court has made clear that the displacement of
state law under a federal regulatory scheme does not
violate the Tenth Amendment, provided that it is based
on a valid exercise of Congress' constitutional powers
such as those arising under the Commerce Clause.
"[T]he Federal Government may displace state regulation
even though this serves to 'curtail or prohibit the
States' prerogatives to make legislative choices
respecting subjects the States may consider
important.'" Federal Energy Regulatory Commission v.
Mississippi, 456 U.S. 742, 759 (1982) (quoting Hodel v.
Virginia Surface Mining & Reclamation Ass'n, Inc., 452
U.S. 264, 290 (1981)). No commenter suggested that
Congress exceeded its Commerce Clause authority in
passing the Coordination Act. See, e.g., section 201
of the Advisers Act [15 USC 80b-1] (express findings of
the effects of investment advisory activities on
interstate commerce).
-----Start of Page 71
susceptible to different readings,<<146>> in the
Commission's judgment the legislative history of the Coordination
Act strongly supports broad preemption. Congress intended that
Commission-registered advisers no longer be subject to
"overlapping" state and federal regulation,<<147>> but
instead be subject to uniform "national rules."<<148>>
Under NASAA's narrower interpretation, however, multiple, non-
uniform state regulation of Commission-registered advisers would
be preserved. Moreover, the effect of the preemption provisions
of the Coordination Act could be severely weakened, if not
nullified, if a state were to impose regulatory requirements on
advisers not subject to state registration, but who may be
transacting business in the state.<<149>>
<<146>> NASAA interprets the language "[n]o law of any State .
. . requiring the registration, licensing, or
qualification" as restrictive (i.e., meaning "no state
law that requires. . ."), while the Commission
interprets the same language as descriptive (i.e., "no
state law, which requires. . .").
<<147>> Senate Report, supra note 4, at 3-4.
<<148>> Id. at 4.
<<149>> This process could lead to Commission-registered
advisers being subject to a less uniform scheme of
regulation than state advisers, since states are
expressly precluded by section 222(b) and (c) of the
Advisers Act [15 USC 80b-18a(b), (c)] from enforcing
non-uniform books and records and financial
responsibility rules with respect to state-registered
advisers, but not with respect to Commission-registered
advisers.
In its comment letter, NASAA cited Cipollone v. Liggett
Group, Inc., 505 U.S. 504 (1992) for the proposition that
the historic police powers of the states are not to be
superseded by a federal statute unless that is the clear and
-----Start of Page 72
The structure and design of section 203A suggest Congress
intended to broadly preempt state investment adviser law. If
Congress simply preempted all state law with respect to
Commission-registered advisers, such a provision would have been
over inclusive.<<150>> If Congress preempted state
investment adviser law by itemizing specific regulations to be
preempted, such a provision would have been under inclusive and
would have led to confusion whether a particular state regulation
was included within a preempted category. Thus, the Commission
believes that section 203A(b)(1) was drafted to describe what
state investment adviser statutes typically require --
registration, licensing, and qualification -- in order to preempt
statutes containing these requirements with respect to
Commission-registered advisers. This view of section 203A(b)(1)
comports with the express intent of Congress to subject larger
advisers to a uniform, national regulatory regime. It also
explains why Congress believed it was necessary to preserve
certain state authority. If section 203A(b)(1) preempts only the
specific registration, licensing, and qualification requirements
of state investment adviser statutes, Congress would not have had
manifest purpose of Congress. As discussed in the text
above, the Commission believes that such clear and manifest
purpose is demonstrated by the language of the Coordination
Act and the intent of Congress as expressed in the
Coordination Act's legislative history.
<<150>> Such a provision, for example, would preempt areas of
state law such as labor and employment laws, commercial
codes, and even criminal law as it applies to
Commission-registered advisers.
-----Start of Page 73
to preserve the authority of states to investigate and enforce
fraud.<<151>>
2. Preservation of State Anti-Fraud Authority
Section 203A(b)(2) preserves state authority to investigate
and bring enforcement actions with respect to fraud or deceit
against a Commission-registered adviser or a person associated
with a Commission-registered adviser. In the Proposing Release,
the Commission interpreted section 203A(b)(2) as precluding a
state from indirectly regulating the activities of
Commission-registered advisers by applying state requirements
that define "dishonest" or "unethical" business practices unless
the prohibited practices would be fraudulent or deceptive absent
the requirements.<<152>>
NASAA and state commenters took strong exception to this
interpretation. Some argued states could continue to enforce
business practice rules as a means of enforcing anti-fraud rules.
The Commission does not believe that the Coordination Act can be
read to preserve such state regulatory authority over
Commission-registered advisers. Under the design of the
Coordination Act, Congress gave the responsibility of adopting
and enforcing prophylactic rules with respect to state-registered
<<151>> See supra note 142 and accompanying text.
<<152>> See Proposing Release at notes 23 and 24 and
accompanying text. The Commission, however, does not
view section 203A(b)(2) as preempting state private
civil liability laws or the authority of a state to
bring an action against a Commission-registered adviser
for failure to make notice filings or pay fees.
-----Start of Page 74
advisers to states, and with respect to Commission-registered
advisers to the Commission.<<153>> Both the states and
the Commission, however, retain anti-fraud authority with respect
to all advisers.<<154>> On its face, section 203A(b)(2)
preserves only a state's authority to investigate and bring
enforcement actions under its anti-fraud laws with respect to
Commission-registered advisers.<<155>> The Coordination
<<153>> Senate Report, supra note 4, at 4 ("The states should
play an important and logical role in regulating small
investment advisers whose activities are likely to be
concentrated in their home state. Larger advisers with
national businesses, should be registered with the
Commission and be subject to national rules." (emphasis
added)).
<<154>> Id. ("Both the Commission and the states will be able
to continue bringing anti-fraud actions against
investment advisers regardless of whether the
investment adviser is registered with the state or the
SEC.")
<<155>> While there is no legislative history addressing the
scope of section 203A(b)(2), Congress used similar
language to preserve state anti-fraud laws when it
preempted state regulation of securities offerings in
Title I of the 1996 Act. See section 18(c)(1) of the
Securities Act of 1933 [15 USC 77r(c)(1)] ("the [state]
securities commission[s] . . . shall retain
jurisdiction under the laws of such State[s] to
investigate and bring enforcement actions with respect
to fraud or deceit . . . ." (emphasis added)). The
House report discussing that section explained that
"[i]n preserving State laws against fraud and deceit .
. . the Committee intends to prevent the States from
indirectly doing what they have been prohibited from
doing directly. . . . The legislation preempts
authority that would allow the States to employ the
regulatory authority they retain to reconstruct in a
different form the regulatory regime . . . that Section
18 has preempted." House Report, supra note 96, at 34.
The Senate Report discusses a similar section in the
Senate bill, stating that "[t]he Committee clearly does
not intend for the "policing" authority to provide
states with a means to undo the state registration
-----Start of Page 75
Act does not limit state enforcement of laws prohibiting fraud.
Rather, states are denied the ability to reinstitute the system
of overlapping and duplicative regulation of investment advisers
that Congress sought to end.<<156>>
I. Other Amendments to Advisers Act Rules
The Commission proposed to amend several rules under the
Advisers Act to reflect changes made by the Coordination
Act.<<157>> The few commenters that addressed these
proposed amendments generally supported them, and the Commission
is adopting the amendments as proposed.
1. Amendments to Form ADV; Elimination of Form ADV-S
As proposed, the Commission is amending Form ADV to add a
new Schedule I, which is substantially the same as Form
ADV-T.<<158>> Schedule I will be used by the Commission
to screen applicants as to eligibility for Commission
registration. Schedule I is required to be included with all new
registrations filed on or after July 8, 1997. Additionally, the
Commission is adopting amendments to rule 204-1 to require an
preemptions." Senate Report, supra note 4, at 15.
<<156>> Although the Commission is subject to no similar
prohibition with regard to the application of its
prophylactic rules to state-registered advisers, the
Commission is making such rules inapplicable to
state-registered advisers in recognition of the clearly
stated purposes of Congress in passing the Coordination
Act. See infra section II.I of this Release.
<<157>> See generally Proposing Release at section II.H.
<<158>> See supra section II.C.1.a of this Release. Schedule I
is attached to this Release as Appendix B.
-----Start of Page 76
adviser to file an amended Schedule I annually within 90 days of
the end of the adviser's fiscal year.<<159>> The
Commission also is amending Items 18 and 19 to Part I of Form ADV
to require advisers to determine discretionary and non-
discretionary assets under management in the same manner as
required by Instruction 7 of Schedule I.
Like Form ADV-T, Schedule I requires an adviser to indicate
whether it remains eligible for Commission registration. Unlike
Form ADV-T, however, Schedule I does not operate as a request for
withdrawal of the adviser's registration from the Commission;
rather, an adviser that indicates that it is not eligible for
Commission registration on Schedule I is required to withdraw
from Commission registration by filing Form ADV-W.<<160>>
The Commission no longer has any regulatory need for
advisers to file Form ADV-S, the annual report for advisers
registered under the Advisers Act, and therefore is eliminating
the requirement to file Form ADV-S, amending rule 204-1 to delete
references to Form ADV-S, and amending rule 279.3 to refer to
Form ADV-T.
<<159>> 17 CFR 275.204-1(a)(1).
<<160>> Instruction 6 to Schedule I. A separate Form ADV-W
continues to be required in order to assure that the
Commission staff is able to act promptly on the
withdrawal from registration. Subject to the grace
period under rule 203A-1(c), failure to file the
completed Form ADV-W will subject an adviser to the
commencement of proceedings to cancel its registration.
-----Start of Page 77
2. Rule 204-2 -- Books and Records
In light of the Congressional determination not to subject
advisers registered with the states to substantive federal
regulatory requirements after July 8, 1997, the Commission is
amending rule 204-2 to make the recordkeeping requirements of
that rule applicable only to advisers registered with the
Commission.<<161>> Additionally, the Commission is
amending rule 204-2 to require advisers that register with the
Commission after July 8, 1997 to preserve any books and records
the adviser was previously required to maintain under state
law.<<162>> These books and records are required to be
maintained in the same manner and for the same period of time as
the other books and records required to be maintained under rule
204-2(a).<<163>>
3. Rule 205-3 -- Performance Fee Arrangements
By its terms, section 205 prohibits all advisers, except
those exempt from registration under section 203(b), from
entering into advisory contracts in which the adviser would be
<<161>> Rule 204-2(a) [17 CFR 275.204-2(a)].
<<162>> Rule 204-2(k) [17 CFR 275.204-2(k)].
<<163>> Under rule 204-2(k), an adviser changing from state to
federal registration will count the period during which
the books and records were maintained under state law
toward compliance with the Commission's recordkeeping
requirement. For example, an adviser that was state-
registered for one year prior to registering with the
Commission will be required to maintain the books and
records required under state law for an additional four
years to fulfill the requirement of rule 204-2(e) [17
CFR 275.204-2(e)] that books and records be maintained
for five years.
-----Start of Page 78
compensated on the basis of performance of client
accounts.<<164>> Therefore, advisers prohibited from
registering with the Commission after July 8, 1997 will continue
to be subject to the limitations of section 205.<<165>>
Rule 205-3 provides an exemption from these limitations, but the
rule applies only to advisers registered with the Commission.
The Commission is amending rule 205-3 to make this exemption
available to all advisers, including those registered only under
state law after July 8, 1997.<<166>>
4. Rule 206(3)-2 -- Agency Cross Transactions
By its terms, section 206(3) of the Advisers Act prohibits
all advisers from engaging in agency cross
transactions.<<167>> Rule 206(3)-2 provides a
<<164>> Section 205(a)(1) [15 USC 80b-5(a)(1)]. Section
205(a)(1) provides that "[n]o investment adviser,
unless exempt from registration pursuant to section
203(b)" may enter into, extend, or renew any investment
advisory contract that provides for performance-based
compensation.
<<165>> State-registered advisers generally would not be
exempted from registration under section 203(b), but
rather, would be prohibited from registration under
section 203A(a).
<<166>> The extension of rule 205-3's safe harbor to
state-registered advisers does not preclude a state
from further restricting performance fee arrangements.
<<167>> Section 206(3) [15 USC 80b-6(3)]. Section 206(3) makes
it unlawful for any investment adviser acting as
principal for its own account to knowingly sell any
security to, or purchase any security from, a client,
without disclosing to the client in writing before the
completion of the transaction the capacity in which the
adviser is acting and obtaining the client's consent.
This limitation also applies if the adviser is acting
as a broker for a person other than the client in
-----Start of Page 79
non-exclusive safe harbor from this prohibition, but applies only
to certain advisers and broker-dealers registered with the
Commission.<<168>> Therefore, advisers prohibited from
registering with the Commission after July 8, 1997 will continue
to be subject to the limitations of section 206(3). The
Commission is amending rule 206(3)-2 to make this safe harbor
available to all advisers, including those registered only under
state law after July 8, 1997.<<169>>
effecting such a transaction.
<<168>> 17 CFR 275.206(3)-2.
<<169>> The amendment to rule 206(3)-2 was not proposed in the
Proposing Release, but the Commission believes that
good cause exists to adopt the amendment without the
notice and comment period required under section
553(b)(B) of the Administrative Procedure Act [5 USC
553(b)(B)]. In the Proposing Release, the Commission
proposed to amend several rules under the Advisers Act
to reflect changes made by the Coordination Act by
exempting state-registered advisers from Commission
regulation. In most cases, these amendments involved
modifying the scope of the rules to apply only to
Commission-registered advisers. See amendments to
rules 204-2, 206(4)-1, 206(4)-2, and 206(4)-4
(discussed in sections II.H.2 and II.H.4 of the
Proposing Release and sections II.I.2 and II.I.5 of
this Release). In another case, however, a rule was
proposed to be broadened in order to make an existing
exemption available to all advisers, including
state-registered advisers. See amendments to rule 205-
3 (discussed in section II.H.3 of the Proposing Release
and section II.I.3 of this Release). In preparing the
Proposing Release, the Commission staff surveyed the
rules under the Advisers Act to determine which rules
needed to be amended. The need to amend rule 206(3)-2,
however, was brought to the attention of the Commission
staff after the publication of the Proposing Release in
the Federal Register. The Commission believes good
cause exists to amend rule 206(3)-2 without notice and
comment. The decision to amend rule 206(3)-2 does not
reflect a specific policy decision, but rather, is part
of the technical amendment of all the rules under the
-----Start of Page 80
5. Rules 206(4)-1, 206(4)-2, and 206(4)-4 -- Anti-
Fraud Rules
The Commission has adopted four rules pursuant to its
authority under section 206(4) to "define, and prescribe means
reasonably designed to prevent . . . acts, practices, and courses
of business [that] are fraudulent, deceptive, or
manipulative."<<170>> These rules prohibit certain
abusive advertising practices, govern an adviser's custody of
client funds and securities, address the payment of cash to
persons soliciting on behalf of an adviser, and require certain
disclosure to clients regarding an adviser's financial condition
and disciplinary history.<<171>> Each of these rules,
other than the cash solicitation rule, applies to all advisers,
regardless of whether they are registered with the Commission.
The Commission is amending these rules to make them applicable
only to advisers registered (or required to be registered) with
the Commission. By excluding advisers not registered with the
Commission from these rules, the Commission is not suggesting
that the practices prohibited by these rules would not be
Advisers Act to reflect the changes of the Coordination
Act. The public effectively was on notice that the
Commission was undertaking such a technical revision to
the Advisers Act rules. See Proposing Release at
section II.H.1. ("The Commission is proposing
amendments to several rules under the Advisers Act to
reflect changes made by the Coordination Act.").
<<170>> 15 USC 80b-6(4).
<<171>> See rules 206(4)-1 to -4 [17 CFR 275.206(4)-1 to -4].
-----Start of Page 81
prohibited by section 206.<<172>> Rather, the Commission
recognizes that these rules contain prophylactic provisions, and
that after the effective date of the Coordination Act, the
application of these provisions to state-registered advisers is
more appropriately a matter for state law.<<173>>
III. EFFECTIVE DATES
The effective date of the Coordination Act is July 8, 1997.
With the exception of rule 203A-2, the rules and rule amendments
adopted in this Release will take effect on that same date, July
8, 1997.
Rule 203A-2, which provides four exemptions from the
prohibition on Commission registration,<<174>> will become
effective [insert date 60 days after publication in the Federal
Register]. The Office of Management and Budget has determined
that rule 203A-2 is a "major rule" under Chapter 8 of the
Administrative Procedure Act,<<175>> which was added by
the Small Business Regulatory Enforcement Fairness Act of 1996
<<172>> The anti-fraud provisions of the Advisers Act will
continue to apply to state-registered advisers after
July 8, 1997. See Proposing Release at note 108 and
accompanying text.
<<173>> The Commission also is amending rule 206(4)-3, the cash
solicitation rule, to correct cross-references that
were made incorrect by changes made to the Advisers Act
by the Coordination Act.
<<174>> See supra section II.D of this Release.
<<175>> 5 USC 801.
-----Start of Page 82
("SBREFA").<<176>> SBREFA requires all final agency rules
to be submitted to Congress for review and requires generally
that the effective date of a major rule be delayed for 60 days
pending Congressional review. A major rule may become effective
at the end of the 60-day review period, unless Congress passes a
joint resolution disapproving the rule.<<177>>
As discussed above, all investment advisers registered with
the Commission on July 8, 1997 are required to file a completed
Form ADV-T with the Commission no later than that
date.<<178>> Advisers that are eligible for an exemption
from the prohibition on Commission registration provided by rule
203A-2 must indicate that eligibility by checking the appropriate
box on Form ADV-T. Although the exemptive rule will not become
effective until [insert date 60 days after publication in the
Federal Register], the instructions to Form ADV-T require an
investment adviser to indicate eligibility for an exemption
assuming that rule 203A-2 will become effective.<<179>>
<<176>> Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996).
Under SBREFA, a rule is "major" if the rule is likely
to result in (i) an annual effect on the economy of
$100 million or more, (ii) a major increase in costs or
prices for consumers or individual industries, or (iii)
significant adverse effects on competition, investment,
or innovation. 5 USC 804(2).
<<177>> 5 USC 801(a)(3).
<<178>> See supra section II.A of this Release.
<<179>> See Instruction 5(a) to Form ADV-T. Likewise,
investment advisers registering with the Commission on
or after July 8, 1997, but before [insert date 60 days
after publication in the Federal Register] should
indicate eligibility for an exemption on Schedule I
-----Start of Page 83
Advisers that will be eligible for an exemption under rule 203A-2
will remain registered with the Commission between July 8, 1997
and the rule 203A-2 effective date, although the exemptive rule
will not be effective during that period. If Congress were to
pass a joint resolution during that time period disapproving rule
203A-2, the Commission would notify all such advisers that those
exemptions are not available.
IV. PAPERWORK REDUCTION ACT
Certain provisions of the rules and rule amendments contain
"collection of information" requirements within the meaning of
the Paperwork Reduction Act of 1995 (44 USC 3501 et seq.). The
Commission submitted them to the Office of Management and Budget
("OMB") for review and OMB has approved them in accordance with
44 USC 3507(d). The title for the collections of information and
their OMB control numbers are: "Form ADV" - 3235-0049, "Schedule
I" - 3235-0490, "Rule 203A-5 and Form ADV-T" - 3235-0483, and
"Rule 204-2" - 3235-0278, all under the Advisers Act. The
Commission did not receive any comments from the public in
response to its request for comments in the Paperwork Reduction
Act section of the Proposing Release. The final rules as adopted
do not include any changes that materially affect the collections
of information, including their requirements, purpose, use, or
necessity. In response to comments from OMB, the Commission
revised part of its Paperwork Reduction Act submission to OMB to
reflect one collection of information on Form ADV, as amended,
assuming that rule 203A-2 will become effective.
-----Start of Page 84
and another collection of information on new Schedule I to Form
ADV. As described below, this revision, as well as an updated
estimate regarding the number of respondents to the collections
of information, has resulted in a change to the burden estimates
for Form ADV and Schedule I. The collections of information
imposed by Form ADV, Schedule I, rule 203A-5 and Form ADV-T, and
rule 204-2 are in accordance with 44 USC 3507(d). An agency may
not conduct or sponsor, and a person is not required to respond
to, a collection of information unless it displays a currently
valid OMB control number.
Form ADV
Form ADV is required by rule 203-1 [17 CFR 275.203-1] to be
filed by every applicant for registration with the Commission as
an investment adviser. Rule 204-1 [17 CFR 275.204-1] sets forth
the circumstances requiring the filing of an amended Form ADV.
Registrants must file an amended Form ADV only when information
on the initial Form ADV filing has changed, either at the end of
the fiscal year or "promptly" for certain material changes. The
Commission amended rule 204-1 to require an adviser additionally
to file the cover page of Form ADV annually within 90 days after
the end of the adviser's fiscal year (along with a new Schedule
I, discussed below), regardless of whether other changes have
taken place during the year.
The Commission has revised its estimate of the overall
burden hours required by Form ADV as a result of a change in the
number of estimated respondents. The likely respondents to this
-----Start of Page 85
collection of information are all applicants for registration
with the Commission after July 8, 1997 as well as all currently-
registered advisers who will remain registered after July 8,
1997. The number of currently-registered advisers is 23,350, and
the Commission estimates that approximately 28 percent of these
advisers (6,538) will remain registered after July 8, 1997. The
Commission estimates that it will take currently-registered
advisers 1.0672 hours, on average, to fill out and file an
amended Form ADV, and that currently-registered advisers will, on
average, file Form ADV 1.5 times per year. The Commission also
estimates that it will take new applicants 9.0063 hours, on
average, to fill out and file their first Form ADV. The
Commission estimates that approximately 750 new applicants will
register with the Commission per year. Of the 750 new applicants
per year, 650 will amend Form ADV an average of 1 time annually.
The estimated 100 newly-formed investment advisers that will rely
on the exemption provided by 203A-2(d) will amend Form ADV an
average of 2 times annually (for purposes of updating their
Schedule I 120 days after initial registration). Accordingly,
the revised annual burden estimate is 18,128 total hours in the
aggregate for all respondents to Form ADV.
The collection of information required by Form ADV is
mandatory, and responses are not kept confidential. The
amendments to the instructions to Form ADV and rule 204-1 do not
affect the burden of filing Form ADV itself. The additional
-----Start of Page 86
burden of filing the Schedule I is included in the analysis of
Schedule I (below).
Schedule I
Schedule I is a new schedule to Form ADV. Schedule I
requires an adviser to declare whether it is eligible for
Commission registration. Schedule I, as part of Form ADV, is
required to be filed with an investment adviser's initial
application on Form ADV. The rules imposing this collection of
information are found at 17 CFR 275.203-1 and 17 CFR 279.1. The
Commission has not amended rule 203-1 or rule 279.1. Rule 204-1
[17 CFR 275.204-1] sets forth the circumstances requiring the
filing of an amended Form ADV. The Commission amended rule 204-1
to require an adviser to file an amended Schedule I annually
within 90 days after the end of the adviser's fiscal year. In
addition, an investment adviser relying on the "reasonable
expectation" exemption from the prohibition on Commission
registration provided by rule 203A-2(d) is required to file an
amended Schedule I to Form ADV at the end of 120 days after its
initial registration with the Commission. If the adviser
indicates on the amended Schedule I that it has not become
eligible to register with the Commission, the adviser is required
to file a Form ADV-W concurrently with the Schedule I, thereby
withdrawing its registration with the Commission.<<180>>
<<180>> Such an adviser also is required to file a short
written undertaking on Schedule E to Form ADV, simply
stating that the adviser "will withdraw from
registration" if on the 120th day after registering
with the Commission the adviser does not meet the
-----Start of Page 87
The collection of the information required by Schedule I is
mandatory and responses will not be kept confidential.
The Commission has revised its estimate of the overall
burden hours required by Schedule I as a result of a change in
the number of estimated respondents and by considering Schedule I
as a separate collection of information from Form ADV. The
likely respondents to this collection of information are all
applicants for registration with the Commission after July 8,
1997 as well as all currently-registered advisers who will remain
registered after July 8, 1997. As noted above, the Commission
estimates that approximately 6,538 advisers will remain
registered with the Commission after July 8, 1997. These
currently-registered advisers will file Schedule I once per year.
Of the 750 new applicants per year, 650 will file Schedule I once
per year. The Commission estimates that approximately 100 newly
registered advisers each year will rely on the "reasonable
expectation" exemption provided by rule 203A-2(d), and that these
advisers will file Schedule I twice per year. The Commission
estimates that it will take all advisers, whether currently-
registered or new applicants, 52.13 minutes, on average, to fill
out and file Schedule I. Accordingly, the revised annual burden
estimate is 6,419 total hours in the aggregate for all
respondents to Schedule I.
eligibility requirements for registration under section
203A of the Advisers Act and rules thereunder. This
requirement imposes only a nominal burden, subsumed
under the burden attributed to the Form ADV.
-----Start of Page 88
Rule 203A-5 and Form ADV-T
Providing the information required by Form ADV-T is
mandatory, and responses will not be kept confidential. Rule
203A-5 and Form ADV-T are being adopted substantially as
proposed, and the burden estimate has not changed.
Rule 204-2
Providing the information and keeping the books and records
required by rule 204-2 is mandatory, and responses generally are
kept confidential. The amendments to rule 204-2 were adopted
substantially as proposed, and the burden estimate has not
changed.
V. COST/BENEFIT ANALYSIS
In adopting these rules the Commission has given
consideration to their benefits as well as their costs. Certain
of the new rules and rule amendments, as well as Form ADV-T and
new Schedule I to Form ADV, are necessary to implement the
Coordination Act, both initially and on an on-going
basis.<<181>> They will establish the process by which
the Commission will identify those larger advisers that will
remain registered with the Commission and those smaller advisers
that are not eligible for Commission registration. This process
will implement Congress' determination that only larger advisers
be regulated by the Commission. In addition, by identifying
smaller advisers whose registration will be withdrawn, these
rules will work to prevent the preemption of state laws
<<181>> See rules 203A-5 and 204-1.
-----Start of Page 89
regulating those small advisers that Congress intended to be
regulated solely by the states. Although both of these benefits
are substantial, neither is quantifiable. These rules impose
some incidental preparation costs on investment advisers required
to file Form ADV-T and on those advisers that will, on an ongoing
basis, be required to file Schedule I. Without implementing
rules, however, the goals of the Coordination Act would not be
achieved.
Other rules related to the eligibility for and process of
Commission registration and de-registration are designed to
reduce costs on investment advisers.<<182>> These rules
(i) relieve advisers from the regulatory burden of frequently
having to register and then de-register with the Commission as a
result of changes in the amount of their assets under management,
(ii) provide guidance on how an adviser should determine its
assets under management, and (iii) provide a safe harbor for
advisers that register with state securities authorities based on
a reasonable belief that they are prohibited from registering
with the Commission because they have insufficient assets under
management. These rules are expected to provide investment
advisers with substantial benefits, and are not expected to
impose any significant costs on investment advisers or investors.
<<182>> See rule 203A-1, Instruction 8 to Form ADV-T, and rule
203A-4.
-----Start of Page 90
One rule exempts certain classes of advisers from the
prohibition on Commission registration, based on a finding by the
Commission that the prohibition on Commission registration would
be unfair, a burden on interstate commerce, or inconsistent with
the purposes of the Coordination Act.<<183>> This rule
should reduce regulatory burdens on investment advisers, without
significantly affecting compliance costs or imposing other
significant costs on investment advisers or the investing public.
Although the Commission will incur the incidental additional
costs associated with regulating the advisers that qualify for
these exemptive rules, the Commission has concluded that these
costs are appropriate in light of the purposes of the
Coordination Act and the exemptive authority provided to the
Commission therein.
The Commission is also adopting several definitional rules
to fill gaps left open by the Coordination Act. These rules are
intended to permit investment advisers to more readily ascertain
their regulatory status and that of their supervised persons.
Investment advisers generally are expected to benefit as a result
of this increased certainty. In particular, Commission-
registered advisers and their supervised persons may incur
substantial benefits as a result of the definitions of investment
adviser representative and place of business to the extent that
the failure of the Commission to define these terms could lead to
the application of significantly broader and non-uniform
<<183>> See rule 203A-2.
-----Start of Page 91
definitions by the states. Broader state definitions would
subject a greater number of supervised persons to state
qualification requirements than the Commission believes Congress
intended.<<184>> The Commission believes that
institutional and other non-retail clients do not need the
protections of state qualification requirements. The Commission
has concluded, therefore, that there are no substantial costs
associated with the narrower definitions the Commission is
adopting.
Finally, amendments to several existing rules under the
Advisers Act reflect the Coordination Act's reallocation of
regulatory responsibilities over investment advisers. These
amendments are not expected to provide substantial savings to
investment advisers or to impose significant costs on investment
advisers or the investing public. They will, however, have
important regulatory benefits, because in each case the rules
will either work to implement the Coordination Act's goal of
reallocating regulatory responsibility for advisers between the
Commission and the securities authorities of the states, or to
ensure that smaller, state-registered advisers are not unfairly
disadvantaged.
A complete cost-benefit analysis (including supporting data)
prepared by the Commission staff is available for public
inspection in File No. S7-31-96, and a copy may be obtained by
<<184>> See supra section II.F.
-----Start of Page 92
contacting Cynthia G. Pugh, Securities and Exchange Commission,
450 5th Street, N.W., Stop 10-2, Washington, D.C. 20549.
VI. SUMMARY OF REGULATORY FLEXIBILITY ANALYSIS
The Commission has prepared a Final Regulatory Flexibility
Analysis ("FRFA") in accordance with the provisions of the
Regulatory Flexibility Act ("Reg. Flex. Act") [5 USC 604] in
connection with the adoption of rule and form amendments
described in this Release. An Initial Regulatory Flexibility
Analysis ("IRFA") was prepared in accordance with 5 USC 603 in
conjunction with the Proposing Release and was made available to
the public. A summary of the IRFA was published in Investment
Advisers Act Release No. 1601 (Dec. 20, 1996) [61 FR 68480,
68491-92 (Dec. 27, 1996)]. As discussed further below, one
comment was received on the IRFA.
The FRFA explains both the need for, and the objectives of,
the rules adopted by the Commission. As set forth in greater
detail in the FRFA, the Coordination Act makes several amendments
to the Advisers Act, the most significant of which reallocates
federal and state responsibilities for the regulation of
investment advisers currently registered with the Commission by
limiting the application of federal law and preempting certain
state laws. The adopted rules and rule amendments implement
provisions of the Coordination Act that reallocate regulatory
responsibilities for investment advisers between the Commission
and the securities regulatory authorities of the states. The
adopted rules establish the process by which all investment
-----Start of Page 93
advisers that are currently registered with the Commission will
determine their eligibility for Commission registration as of
July 8, 1997, the effective date of the Coordination Act. The
adopted amendments to several rules under the Advisers Act
generally reflect the changes made by the Coordination Act.
The FRFA also (i) summarizes the significant issues raised
by public comments in response to the IRFA, (ii) summarizes the
Commission's assessment of such issues, and (iii) states any
changes made in the proposed rules as a result of such comments.
The Commission received one comment on the IRFA,<<185>>
which noted that the IRFA did not consider the potential impact
of the proposed rules on small advisers that manage funds
regulated under ERISA.<<186>> According to the commenter,
by failing to discuss such an exemption or other potential
alternatives that could minimize this impact on small ERISA
advisers,<<187>> the Commission overlooked an important
<<185>> See Letter from The Honorable Christopher S. Bond,
Chairman of the Senate Committee on Small Business
(Feb. 25, 1997) to Arthur Levitt, Chairman, SEC
(available in SEC File No. S7-31-96).
<<186>> See generally section II.D.5 of this Release. As
discussed in that section, ERISA protects a plan's
named fiduciary from liability for the individual
decisions of an investment manager appointed by the
fiduciary to manage the plan's assets. The term
investment manager is defined by ERISA to include
certain investment advisers that are registered under
the Advisers Act, as well as certain banks and
insurance companies. Although the Coordination Act
amended ERISA to include state-registered investment
advisers as investment managers, that amendment expires
two years after enactment, on October 11, 1998.
<<187>> 5 USC 603(c).
-----Start of Page 94
effect of the proposed rules. The Regulatory Flexibility Act
requires that an agency describe in the IRFA those significant
alternatives to the proposed rule that would further the stated
objectives of the applicable statutes and that would minimize the
significant economic impact of the proposed rule on small
entities.<<188>> In response to this comment, the FRFA
discusses the possibility of exempting these small advisers from
the prohibition on Commission registration, and explains the
Commission's conclusion that such an exemption would not be
consistent with the objectives of the Coordination Act.
The FRFA also provides a description of and an estimate of
the number of small entities to which the rules will apply. For
purposes of the Advisers Act and the Reg. Flex. Act, an
investment adviser generally is a small entity (i) if it manages
assets of $50 million or less, in discretionary or
non-discretionary accounts, as of the end of its most recent
fiscal year and (ii) if it renders other advisory services, has
$50,000 or less in assets related to its advisory
business.<<189>> The Commission estimates that up to
17,650 of approximately 23,350 investment advisers currently
registered with the Commission are small entities. The
Commission estimates that, after July 8, 1997, approximately 850
<<188>> See id.
<<189>> See rule 275.0-7 [17 CFR 275.0-7].
-----Start of Page 95
of these small-entity advisers will remain eligible for
registration with the Commission.<<190>>
As required by the Reg. Flex. Act, the FRFA describes the
projected reporting, recordkeeping and other compliance
requirements of the rules, and includes an estimate of the
classes of small entities that will be subject to the
requirements and the type of professional skills necessary for
preparation of the reports or records. Rule 203A-5 requires all
investment advisers registered with the Commission on July 8,
1997, to file new Form ADV-T no later than that date. The FRFA
notes, however, that the Commission anticipates that as a
consequence of this one-time filing, approximately 72 percent of
the investment advisers currently registered with the Commission
will no longer be subject to federal investment adviser
regulatory requirements, including reporting and recordkeeping
requirements. The incidental burden imposed by this one-time
filing requirement is necessary in order to implement the
Coordination Act. The FRFA explains that the Commission devised
<<190>> The Commission estimates that approximately 16,800 (72
percent) of the 23,350 advisers currently registered
with the Commission will be ineligible for Commission
registration after July 8, 1997. Most of those 16,800
advisers will be small entities. Certain small entity
advisers, however, will remain eligible for Commission
registration, including, for example, small entity
advisers in the four states that do not currently
regulate investment advisers. The IRFA estimated that
roughly 800 small entity advisers will remain eligible
for Commission registration after the effective date of
the Coordination Act. The estimate presented in the
IRFA has been increased to reflect the additional
advisers that have registered with the Commission.
-----Start of Page 96
Form ADV-T so that an individual familiar with the adviser's
services and operations may complete the form without legal or
other professional assistance, although in some cases an adviser
may need to seek outside assistance in connection with the
calculation of its assets under management.
The adopted amendments to Form ADV add new Schedule I, which
must be completed by every adviser registering with the
Commission after July 8, 1997, and revise Items 18 and 19 to Part
I of Form ADV to direct advisers to determine discretionary and
non-discretionary assets under management in the same manner as
required by Schedule I. Schedule I requires advisers to report
information similar to that required by Form ADV-T. The
Commission believes that the burden this new schedule imposes on
advisers is necessary in order to accomplish, on an ongoing
basis, the Coordination Act's reallocation of regulatory
responsibility for investment advisers. The FRFA notes that like
Form ADV-T, the Commission has designed Schedule I so that an
individual familiar with the adviser's services and operations
can complete this schedule without legal or other professional
assistance, although in some cases, an adviser may need to seek
outside assistance in connection with the calculation of its
assets under management. The FRFA explains that the annual
burden imposed on small entity advisers by the amendments to
Items 18 and 19 of Form ADV is expected to be negligible.
Rule 203A-2(d) permits a newly formed investment adviser
with a reasonable expectation that it will be eligible for
-----Start of Page 97
Commission registration within 120 days after such registration
becomes effective, to register with the Commission. The rule
requires the newly formed adviser (i) to include on Schedule E to
its Form ADV an undertaking to withdraw from Commission
registration if, on the 120th day after registering with the
Commission, it has not become eligible for Commission
registration, and (ii) to file an amended Schedule I to Form ADV
at the end of the 120-day period. If the amended Schedule I
indicates that the adviser has not become eligible for Commission
registration, the rule requires the adviser to file concurrently
a Form ADV-W, thereby withdrawing its Commission registration.
The FRFA notes that this burden on newly formed advisers that
choose to rely on this rule will be outweighed by the cost
savings and benefits provided by the rule.
The adopted amendments to rule 204-1 require all Commission-
registered investment advisers to update new Schedule I annually.
The FRFA explains that because the Commission has eliminated the
requirement that Commission-registered advisers annually file
Form ADV-S, this new annual reporting requirement should not be a
significant additional burden on the small-entity investment
advisers that remain eligible for Commission registration after
July 8, 1997.
The adopted amendments to rule 204-2 make the books and
recordkeeping requirements of that rule applicable only to
advisers registered with the Commission, and so eliminate these
recordkeeping requirements with respect to small entities and
-----Start of Page 98
other advisers that are not eligible for Commission registration
after July 8, 1997. The amendments to this rule also require
advisers that register with the Commission after July 8, 1997, to
preserve any books and records the adviser was previously
required to maintain under state law, but this requirement is not
expected to be a significant additional burden on advisers that
register with the Commission after July 8, 1997. The FRFA notes
that the adopted amendment does not have any impact on the type
of professional skills necessary for compliance with rule 204-2.
The FRFA also describes the steps the Commission has taken
to minimize the significant economic impact on small entities
consistent with the stated objectives of applicable statutes.
As discussed further in the FRFA, in connection with the
adopted rules, the Commission considered the following
alternatives to minimize the impact on small entities: (a) the
establishment of differing compliance or reporting requirements
or timetables that take into account the resources available to
small entities; (b) the clarification, consolidation, or
simplification of compliance and reporting requirements under the
rule for small entities; (c) the use of performance rather than
design standards; and (d) exemption from coverage of the rule, or
any part thereof, for small entities.<<191>> The
<<191>> The Commission also considered these alternatives in
connection with the proposed rules. See IRFA;
Investment Advisers Act Rel. No. 1601 (Dec. 20, 1996)
[61 FR 68480, 68491-92 (Dec. 27, 1996)] (summary of
IRFA).
-----Start of Page 99
Commission is easing the impact on small entities by increasing
the threshold for Commission registration from $25 to $30 million
of assets under management, and by providing an optional
exemption from Commission registration for advisers with assets
under management of between $25 and $30 million. The exemption
gives such advisers, including many small entities, the
flexibility to decide when it is best for them to transition from
state to Commission registration if their assets under management
increase to $25 million or more, and to transition from
Commission to state registration if their assets decrease to $30
million or less, and so should enable these advisers to avoid the
unnecessary costs and burdens associated with frequent
transitions between regulators. The Commission is also adopting
a second exemption from the prohibition on Commission
registration that permits Commission registration by newly formed
advisers that have a reasonable expectation of becoming eligible
for Commission registration within 120 days. This exemption will
help to ensure that newly formed advisers, including small entity
advisers, will not be required to register with numerous states,
only to de-register and re-register with the Commission shortly
thereafter once their assets under management increase to $25
million.
The FRFA explains that in the proposing release, the
Commission also sought comment on other possible alternatives
that could meet the need for flexibility for small entities,
including whether the transition from state to Commission
-----Start of Page 100
registration should include a grace period, or whether a state-
registered adviser should only have to determine once annually
whether it is required to register with the Commission due to an
increase in its assets under management. In light of the
comments on these issues, the Commission is adopting rule 203A-
1(d), which permits (but does not require) a state-registered
adviser whose assets under management increase to $30 million to
postpone registering with the Commission until 90 days after it
has reported the increase in its assets under management in its
annual filing with its state regulator. This rule will provide
advisers, including small entity advisers, that have assets under
management of close to $30 million, additional flexibility in
determining if and when to transfer to Commission registration.
The FRFA also discusses the general concern expressed by
some commenters that the requirement that small advisers withdraw
from Commission registration by filing Form ADV-T will have an
adverse competitive effect on small advisers. The FRFA explains
that the Commission believes that this concern is too speculative
to be considered a significant economic impact on small advisers.
Although there is some evidence that smaller advisers believe
that holding themselves out as SEC-registered has marketing
advantages, the Commission is not aware of evidence that shows
the loss of such status would result in the loss of clients of
inhibit an adviser's ability to market itself to new clients.
Moreover, as detailed in the FRFA, the Commission believes that
an exemption from the prohibition on Commission registration for
-----Start of Page 101
small advisers that believe they would be put to a competitive
disadvantage if required to de-register would be inconsistent
with the purposes of the Coordination Act.
As detailed in the FRFA, the Commission considered exempting
small advisers that manage accounts subject to ERISA from the
prohibition on Commission registration. Several commenters
expressed concern that unless they were permitted to remain
registered with the Commission, they effectively would be denied
the ability to manage ERISA accounts and would be harmed
competitively. The FRFA explains that, although the Commission
shares these commenters' concerns,<<192>> the Commission
believes such an exemption would be inconsistent with the
purposes of the Coordination Act and outside the scope of the
Commission's authority. The grant of exemptive authority in
section 203A(c) was designed to permit Commission registration
for advisers that are larger, national firms, but do not have $25
million under management. On April 7, 1997, however, Chairman
Levitt wrote to the leadership of the Congressional committees
with jurisdiction over ERISA, urging that legislation be enacted
<<192>> For analytical purposes, the Commission assumes that
ERISA assets may make up as much as 30% (or $6.8
billion) of the total of approximately $22.7 billion of
discretionary assets managed by all advisers that
manage less than $25 million of discretionary assets.
Assuming that all of those assets would be transferred
from those smaller advisers, and that on average the
smaller advisers earned a 1% fee to manage those ERISA
assets, it is estimated that as much as $68 million in
fees could be foregone by small advisers that no longer
qualify as investment managers under ERISA. These fees
would probably be earned instead by larger advisers
that are registered with the Commission.
-----Start of Page 102
to make permanent the amendment of ERISA that would permit
state-registered advisers to serve as investment
managers.<<193>>
The FRFA is available for public inspection in File No. S7-
31-96, and a copy may be obtained by contacting Cynthia G. Pugh,
Securities and Exchange Commission, 450 Fifth Street, N.W., Mail
Stop 10-2, Washington, D.C. 20549.
VII. STATUTORY AUTHORITY
The Commission is adopting amendments to rule 203(b)(3)-1
pursuant to the authority set forth in section 206A of the
Investment Advisers Act of 1940 [15 USC 80b-6A].
The Commission is adopting new rule 203A-1 pursuant to the
authority set forth in section 203A(a)(1)(A) [15 USC
80b-3A(a)(1)(A)]; section 203A(c) [15 USC 80b-3A(c)]; and section
211(a) [15 USC 80b-11(a))] of the Investment Advisers Act of
1940.
The Commission is adopting new rule 203A-2 pursuant to the
authority set forth in section 203A(c) of the Investment Advisers
Act of 1940 [15 USC 80b-3A(c)].
The Commission is adopting new rule 203A-3 pursuant to the
authority set forth in section 202(a)(17) [15 USC 80b-2(a)(17)]
<<193>> Letters from Arthur Levitt, Chairman, SEC (Apr. 7,
1997) to The Honorable James M. Jeffords, Chairman,
Committee on Labor and Human Resources, U.S. Senate,
and The Honorable William F. Goodling, Chairman,
Committee on Education and the Work Force, U.S. House
of Representatives (available in SEC File No. S7-31-
96).
-----Start of Page 103
and section 211(a) [15 USC 80b-11(a)] of the Investment Advisers
Act of 1940.
The Commission is adopting new rule 203A-4 pursuant to the
authority set forth in section 211(a) of the Investment Advisers
Act of 1940 [15 USC 80b-11(a)].
The Commission is adopting new rule 203A-5 pursuant to the
authority set forth in sections 203(c)(1) and 204 of the
Investment Advisers Act of 1940 [15 USC 80b-3(c)(1) and 80b-4].
The Commission is adopting amendments to rule 204-1 pursuant
to the authority set forth in section 204 of the Investment
Advisers Act of 1940 [15 USC 80b-4].
The Commission is adopting amendments to rule 204-2 pursuant
to the authority set forth in sections 204 and 206(4) of the
Investment Advisers Act of 1940 [15 USC 80b-4 and 80b-6(4)].
The Commission is adopting amendments to rule 205-3 pursuant
to the authority set forth in section 206A of the Investment
Advisers Act of 1940 [15 USC 80b-6A].
The Commission is adopting amendments to rules 206(4)-1,
206(4)-2, and 206(4)-4 pursuant to the authority set forth in
section 206(4) of the Investment Advisers Act of 1940 [15 USC
80b-6(4)].
The Commission is adopting amendments to rule 206(4)-3
pursuant to the authority set forth in section 204, 206, and 211
of the Investment Advisers Act of 1940 [15 USC 80b-4, 80b-6, and
80b-11].
-----Start of Page 104
The Commission is adopting new rules 222-1 and 222-2
pursuant to the authority set forth in section 211(a) of the
Investment Advisers Act of 1940 [15 USC 80b-11(a)].
The Commission is adopting amendments to rule 279.3, new
Form ADV-T, and amendments to Form ADV pursuant to the authority
set forth in sections 203(c)(1) and 204 of the Investment
Advisers Act of 1940 [15 USC 80b-3(c)(1) and 80b-4].
TEXT OF RULES AND FORMS
List of Subjects in 17 CFR Parts 275 and 279.
Reporting and recordkeeping requirements, Securities
For the reasons set out in the preamble, Title 17, Chapter
II of the Code of Federal Regulations is amended as follows:
PART 275 - RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
1. The authority citation for Part 275 is revised to read
as follows:
AUTHORITY: 15 U.S.C. 80b-2(a)(17), 80b-3, 80b-4, 80b-6(4),
80b-6A, 80b-11, unless otherwise noted.
Section 275.203A-1 is also issued under 15 U.S.C. 80b-3A.
Section 275.203A-2 is also issued under 15 U.S.C. 80b-3A.
Section 275.204-2 is also issued under 15 U.S.C. 80b-6.
2. Section 275.203(b)(3)-1 is revised to read as follows:
275.203(b)(3)-1 Definition of "client" of an investment
adviser.
Preliminary Note to 203(b)(3)-1
-----Start of Page 105
This rule is a safe harbor and is not intended to specify
the exclusive method for determining who may be deemed a single
client for purposes of section 203(b)(3) of the Act.
(a) General. For purposes of section 203(b)(3) of the Act
[15 U.S.C. 80b-3(b)(3)], the following are deemed a single
client:
(1) A natural person, and:
(i) Any minor child of the natural person;
(ii) Any relative, spouse, or relative of the spouse of the
natural person who has the same principal residence;
(iii) All accounts of which the natural person and/or the
persons referred to in this paragraph (a)(1) are the only primary
beneficiaries; and
(iv) All trusts of which the natural person and/or the
persons referred to in this paragraph (a)(1) are the only primary
beneficiaries;
(2)(i) A corporation, general partnership, limited
partnership, limited liability company, trust (other than a trust
referred to in paragraph (a)(1)(iv) of this section), or other
legal organization (any of which are referred to hereinafter as a
"legal organization") that receives investment advice based on
its investment objectives rather than the individual investment
objectives of its shareholders, partners, limited partners,
members, or beneficiaries (any of which are referred to
hereinafter as an "owner"); and
-----Start of Page 106
(ii) Two or more legal organizations referred to in
paragraph (a)(2)(i) of this section that have identical owners.
(b) Special Rules. For purposes of this section:
(1) An owner must be counted as a client if the investment
adviser provides investment advisory services to the owner
separate and apart from the investment advisory services provided
to the legal organization, Provided, however, that the
determination that an owner is a client will not affect the
applicability of this section with regard to any other owner;
(2) An owner need not be counted as a client of an
investment adviser solely because the investment adviser, on
behalf of the legal organization, offers, promotes, or sells
interests in the legal organization to the owner, or reports
periodically to the owners as a group solely with respect to the
performance of or plans for the legal organization's assets or
similar matters;
(3) A limited partnership is a client of any general
partner or other person acting as investment adviser to the
partnership;
(4) Any person for whom an investment adviser provides
investment advisory services without compensation need not be
counted as a client; and
(5) An investment adviser that has its principal office and
place of business outside of the United States must count only
clients that are United States residents; an investment adviser
-----Start of Page 107
that has its principal office and place of business in the United
States must count all clients.
(c) Holding Out. Any investment adviser relying on this
section shall not be deemed to be holding itself out generally to
the public as an investment adviser, within the meaning of
section 203(b)(3) of the Act [15 U.S.C. 80b-3(b)(3)], solely
because such investment adviser participates in a non-public
offering of interests in a limited partnership under the
Securities Act of 1933.
3. Sections 275.203A-1 through 275.203A-5 are added to
read as follows:
275.203A-1 Eligibility for Commission registration.
(a) Threshold Increased to $30 Million of Assets Under
Management. No investment adviser that is registered or required
to be registered as an investment adviser in the State in which
it maintains its principal office and place of business shall
register with the Commission under section 203 of the Act [15
U.S.C. 80b-3], unless the investment adviser:
(1) Has assets under management of not less than
$30,000,000, as reported on the Form ADV [17 CFR 279.1] of the
investment adviser; or
(2) Is an investment adviser to an investment company
registered under the Investment Company Act of 1940 [15 U.S.C.
80a-1 et seq.].
(b) Exemption for Investment Advisers Having Between $25
and $30 Million of Assets Under Management. Notwithstanding
-----Start of Page 108
paragraph (a) of this section, an investment adviser that is
registered or required to be registered as an investment adviser
in the State in which it maintains its principal office and place
of business may register with the Commission if the investment
adviser has assets under management of not less than $25,000,000
but not more than $30,000,000, as reported on the Form ADV [17
CFR 279.1] of the investment adviser. This paragraph (b) shall
not apply to an investment adviser:
(1) To an investment company registered under the
Investment Company Act of 1940 [15 U.S.C. 80a-1 et seq.]; or
(2) That is exempted by 275.203A-2 from the prohibition
in section 203A(a) of the Act [15 U.S.C. 80b-3A(a)] on
registering with the Commission.
Note to paragraphs (a) and (b):
Paragraphs (a) and (b) together make registration with the
Commission optional for certain investment advisers that have
between $25 and $30 million of assets under management.
(c) Grace Period for Transition From Commission to State
Registration. An investment adviser registered with the
Commission, upon filing an amendment to Form ADV [17 CFR 279.1]
that indicates that it would be prohibited by section 203A(a) of
the Act [15 U.S.C. 80b-3A(a)] from registering with the
Commission, shall be subject to having its registration cancelled
pursuant to section 203(h) of the Act [15 U.S.C. 80b-3(h)],
Provided, That the Commission shall not commence any cancellation
proceeding on the basis of the amendment until the expiration of
-----Start of Page 109
a period of not less than 90 days from the date the investment
adviser was required by 275.204-1(a) to file the amendment.
(d) Transition From State to Commission Registration. An
investment adviser that is registered with a securities
commissioner (or any agency or officer performing like functions)
of any State that requires such investment adviser annually to
report to it the amount of assets under management pursuant to a
form or rule substantially similar to Schedule I to Form ADV [17
CFR 279.1] must register with the Commission within 90 days after
the date on which the investment adviser is required to report
assets under management of $30,000,000 or more to the state
securities commissioner, unless, at the time of registration with
the Commission, the investment adviser is prohibited by section
203A(a) of the Act [15 U.S.C. 80b-3A(a)] from registering with
the Commission.
Notes to paragraph (d):
1. An investment adviser may be prohibited by section
203A(a) from registering with the Commission if its assets under
management have decreased to an amount less than $25,000,000
during the 90-day period.
2. An investment adviser not eligible to rely on paragraph
(d) must register with the Commission promptly when no longer
prohibited by section 203A(a) from registering with the
Commission.
-----Start of Page 110
275.203A-2 Exemptions from prohibition on Commission
registration.
The prohibition of section 203A(a) of the Act [15 U.S.C.
80b-3A(a)] shall not apply to:
(a) Nationally Recognized Statistical Rating Organizations.
An investment adviser that is a nationally recognized statistical
rating organization, as that term is used in paragraphs
(c)(2)(vi)(E), (F), and (H) of 240.15c3-1 of this chapter.
(b)(1) Pension Consultants. An investment adviser that is
a "pension consultant," as defined in this section, with respect
to assets of plans having an aggregate value of at least
$50,000,000.
(2) An investment adviser is a pension consultant, for
purposes of paragraph (b) of this section, if the investment
adviser provides investment advice to:
(i) Any employee benefit plan described in section 3(3) of
the Employee Retirement Income Security Act of 1974 ("ERISA") [29
U.S.C. 1002(3)];
(ii) Any governmental plan described in section 3(32) of
ERISA [29 U.S.C. 1002(32)]; or
(iii) Any church plan described in section 3(33) of ERISA
[29 U.S.C. 1002(33)].
(3) In determining the aggregate value of assets of plans,
only that portion of a plan's assets for which the investment
adviser provided investment advice (including any advice with
respect to the selection of an investment adviser to manage such
-----Start of Page 111
assets) may be included. The value of assets shall be determined
as of the date during the investment adviser's most recent fiscal
year that the investment adviser was last employed or retained by
contract to provide investment advice to the plan with respect to
those assets.
(c) Investment Advisers Controlling, Controlled By, or
Under Common Control with an Investment Adviser Registered with
the Commission. An investment adviser that controls, is
controlled by, or is under common control with, an investment
adviser eligible to register, and registered with, the Commission
("registered adviser"), provided that the principal office and
place of business of the investment adviser is the same as that
of the registered adviser. For purposes of this paragraph,
control means the power to direct or cause the direction of the
management or policies of an investment adviser, whether through
ownership of securities, by contract, or otherwise. Any person
that directly or indirectly has the right to vote 25 percent or
more of the voting securities, or is entitled to 25 percent or
more of the profits, of an investment adviser is presumed to
control that investment adviser.
(d) Investment Advisers Expecting to Be Eligible for
Commission Registration Within 120 Days. An investment adviser
that:
(1) Immediately before it registers with the Commission, is
not registered or required to be registered with the Commission
or a securities commissioner (or any agency or officer performing
-----Start of Page 112
like functions) of any State and has a reasonable expectation
that it would be eligible to register with the Commission within
120 days after the date the investment adviser's registration
with the Commission becomes effective;
(2) Includes on Schedule E to its Form ADV [17 CFR 279.1]
an undertaking to withdraw from registration with the Commission
if, on the 120th day after the date the investment adviser's
registration with the Commission becomes effective, the
investment adviser would be prohibited by section 203A(a) of the
Act [15 U.S.C. 80b-3A(a)] from registering with the Commission;
and
(3) Within 120 days after the date the investment adviser's
registration with the Commission becomes effective, files an
amendment to Form ADV [17 CFR 279.1] revising Schedule I thereto
and, if the amendment indicates that the investment adviser would
be prohibited by section 203A(a) of the Act [15 U.S.C. 80b-3A(a)]
from registering with the Commission, the amendment is
accompanied by a completed Form ADV-W [17 CFR 279.2] whereby it
withdraws from registration with the Commission.
275.203A-3 Definitions.
For purposes of section 203A of the Act [15 U.S.C. 80b-3A]
and the rules thereunder:
(a)(1) Investment Adviser Representative. "Investment
adviser representative" of an investment adviser means a
supervised person of the investment adviser more than ten percent
-----Start of Page 113
of whose clients are natural persons other than excepted persons
described in paragraph (a)(3)(i).
(2) Notwithstanding paragraph (a)(1) of this section, a
supervised person is not an investment adviser representative if
the supervised person:
(i) Does not on a regular basis solicit, meet with, or
otherwise communicate with clients of the investment adviser; or
(ii) Provides only impersonal investment advice.
(3) For purposes of this section:
(i) "Excepted person" means a natural person who:
(A) Immediately after entering into the investment advisory
contract with the investment adviser has at least $500,000 under
management with the investment adviser, or
(B) The investment adviser reasonably believes, immediately
prior to entering into the advisory contract, has a net worth
(together with assets held jointly with a spouse) at the time the
contract is entered into of more than $1,000,000.
(ii) "Impersonal investment advice" means investment
advisory services provided by means of written material or oral
statements that do not purport to meet the objectives or needs of
specific individuals or accounts.
(4) Supervised persons may rely on the definition of
"client" in 275.203(b)(3)-1 to identify clients for purposes of
paragraph (a)(1) of this section, except that supervised persons
need not count clients that are not residents of the United
States.
-----Start of Page 114
(b) Place of Business. "Place of business" of an
investment adviser representative means:
(1) An office at which the investment adviser
representative regularly provides investment advisory services,
solicits, meets with, or otherwise communicates with clients; and
(2) Any other location that is held out to the general
public as a location at which the investment adviser
representative provides investment advisory services, solicits,
meets with, or otherwise communicates with clients.
(c) Principal Office and Place of Business. "Principal
office and place of business" of an investment adviser means the
executive office of the investment adviser from which the
officers, partners, or managers of the investment adviser direct,
control, and coordinate the activities of the investment adviser.
275.203A-4 Investment advisers registered with a State
securities commission.
The Commission shall not assert a violation of section 203
of the Act [15 U.S.C. 80b-3] (or any provision of the Act to
which an investment adviser becomes subject upon registration
under section 203 of the Act [15 USC 80b-3]) for the failure of
an investment adviser registered with the securities commission
(or any agency or office performing like functions) in the State
in which it has its principal office and place of business to
register with the Commission if the investment adviser reasonably
believes that it does not have assets under management of at
-----Start of Page 115
least $30,000,000 and is therefore not required to register with
the Commission.
275.203A-5 Transition rules.
(a) Every investment adviser registered with the Commission
on July 8, 1997 shall file a completed Form ADV-T [17 CFR 279.3]
no later than July 8, 1997.
(b) If an investment adviser registered with the Commission
on July 8, 1997 would be prohibited from registering with the
Commission under section 203A(a) of the Act [15 U.S.C. 80b-
3A(a)], and is not otherwise exempted by 275.203A-2 from such
prohibition, such investment adviser shall withdraw from
registration with the Commission on Form ADV-T [17 CFR 279.3].
(c)(1) Except as provided in paragraph (c)(2) of this
section, an investment adviser that indicates on Form ADV-T [17
CFR 279.3] that the investment adviser withdraws from
registration with the Commission shall be deemed to have
withdrawn from registration as of the later of:
(i) July 8, 1997; or
(ii) The date the investment adviser first files with the
Commission Form ADV-T [17 CFR 279.3] or any amendment to Form
ADV-T [17 CFR 279.3] that indicates that the investment adviser
withdraws from registration with the Commission.
(2) If, prior to the effective date of the withdrawal from
registration of an investment adviser on Form ADV-T [17 CFR
279.3], the Commission has instituted a proceeding pursuant to
section 203(e) of the Act [15 U.S.C. 80b-3(e)] to suspend or
-----Start of Page 116
revoke registration, or a proceeding pursuant to section 203(h)
of the Act [15 U.S.C. 80b-3(h)] to impose terms or conditions
upon withdrawal, the withdrawal from registration shall not
become effective except at such time and upon such terms and
conditions as the Commission deems necessary or appropriate in
the public interest or for the protection of investors.
4. Section 275.204-1 is revised to read as follows:
275.204-1 Amendments to application for registration.
(a) Every investment adviser whose registration with the
Commission is effective on the last day of its fiscal year shall,
within 90 days of the end of its fiscal year, unless its
registration has been withdrawn, cancelled, or revoked prior to
that day, file:
(1) Schedule I to Form ADV [17 CFR 279.1];
(2) A balance sheet if the balance sheet is required by
Item 14 of Part II of Form ADV [17 CFR 279.1]; and
(3) An executed page one of Part I of Form ADV [17 CFR
279.1].
(b)(1) If the information contained in the response to
Items 1, 2, 3, 4, 5, 8, 11, 13A, 13B, 14A and 14B of Part I of
any application for registration as an investment adviser, or in
any amendment thereto, becomes inaccurate for any reason, or if
the information contained in response to any question in Items 9
and 10 of Part I, all of Part II (except Item 14), and all of
Schedule H of any application for registration as an investment
adviser, or in any amendment thereto, becomes inaccurate in a
-----Start of Page 117
material manner, the investment adviser shall promptly file an
amendment on Form ADV [17 CFR 279.1] correcting the information.
(2) For all other changes not designated in paragraph
(b)(1) of this section, the investment adviser shall file an
amendment on Form ADV [17 CFR 279.1] updating the information
together with the amendments required by paragraph (a) of this
section.
5. Section 275.204-2 is amended by revising the
introductory text of paragraph (a) and adding paragraph (k) to
read as follows:
275.204-2 Books and records to be maintained by investment
advisers.
(a) Every investment adviser registered or required to be
registered under section 203 of the Act [15 U.S.C. 80b-3] shall
make and keep true, accurate and current the following books and
records relating to its investment advisory business:
* * * * *
(k) Every investment adviser that registers under section
203 of the Act [15 U.S.C. 80b-3] after July 8, 1997 shall be
required to preserve in accordance with this section the books
and records the investment adviser had been required to maintain
by the State in which the investment adviser had its principal
office and place of business prior to registering with the
Commission.
6. Section 275.205-3 is amended by revising the section
heading and paragraph (a) to read as follows:
-----Start of Page 118
275.205-3 Exemption from the compensation prohibition of
section 205(a)(1) for registered investment advisers.
(a) General. The provisions of section 205(a)(1) of the
Act [15 U.S.C. 80b-5(a)(1)] shall not prohibit any investment
adviser from entering into, performing, renewing or extending an
investment advisory contract that provides for compensation to
the investment adviser on the basis of a share of the capital
gains upon, or the capital appreciation of, the funds, or any
portion of the funds, of a client, Provided, That all the
conditions in this section are satisfied.
* * * * *
7. Section 275.206(3)-2 is amended by revising the
introductory text of paragraph (a) to read as follows:
275.206(3)-2 Agency cross transactions for advisory clients.
(a) An investment adviser, or a person registered as a
broker-dealer under section 15 of the Securities Exchange Act of
1934 [15 U.S.C. 78o] and controlling, controlled by, or under
common control with an investment adviser, shall be deemed in
compliance with the provisions of sections 206(3) of the Act [15
U.S.C. 80b-6(3)] in effecting an agency cross transaction for an
advisory client, if:
* * * * *
8. Section 275.206(4)-1 is amended by revising the
introductory text of paragraph (a) to read as follows:
275.206(4)-1 Advertisements by investment advisers.
(a) It shall constitute a fraudulent, deceptive, or
manipulative act, practice, or course of business within the
-----Start of Page 119
meaning of section 206(4) of the Act [15 U.S.C. 80b-6(4)] for any
investment adviser registered or required to be registered under
section 203 of the Act [15 U.S.C. 80b-3], directly or indirectly,
to publish, circulate, or distribute any advertisement:
* * * * *
9. Section 275.206(4)-2 is amended by revising the
introductory text of paragraph (a) to read as follows:
275.206(4)-2 Custody or possession of funds or securities of
clients.
(a) It shall constitute a fraudulent, deceptive, or
manipulative act, practice or course of business within the
meaning of section 206(4) of the Act [15 U.S.C. 80b-6(4)] for any
investment adviser registered or required to be registered under
section 203 of the Act [15 U.S.C. 80b-3] who has custody or
possession of any funds or securities in which any client has any
beneficial interest, to do any act or take any action, directly
or indirectly, with respect to any such funds or securities,
unless:
* * * * *
10. In 275.206(4)-3, paragraph (a)(1)(ii)(C) is amended
by revising the cite "paragraphs (1), (4) or (5)" to read
"paragraphs (1), (5) or (6)".
11. Section 275.206(4)-4 is amended by revising the
introductory text of paragraph (a) to read as follows:
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275.206(4)-4 Financial and disciplinary information that
investment advisers must disclose to clients.
(a) It shall constitute a fraudulent, deceptive, or
manipulative act, practice, or course of business within the
meaning of section 206(4) of the Act [15 U.S.C. 80b-6(4)] for any
investment adviser registered or required to be registered under
section 203 of the Act [15 U.S.C. 80b-3] to fail to disclose to
any client or prospective client all material facts with respect
to:
* * * * *
12. Sections 275.222-1 and 222-2 are added to read as
follows:
275.222-1 Definitions.
For purposes of section 222 [15 U.S.C. 80b-18a] of the Act:
(a) Place of Business. "Place of business" of an
investment adviser means:
(1) An office at which the investment adviser regularly
provides investment advisory services, solicits, meets with, or
otherwise communicates with clients; and
(2) Any other location that is held out to the general
public as a location at which the investment adviser provides
investment advisory services, solicits, meets with, or otherwise
communicates with clients.
(b) Principal Place of Business. "Principal place of
business" of an investment adviser means the executive office of
the investment adviser from which the officers, partners, or
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managers of the investment adviser direct, control, and
coordinate the activities of the investment adviser.
275.222-2 Definition of "client" for purposes of the national
de minimis standard.
For purposes of section 222(d)(2) of the Act [15 U.S.C. 80b-
18a(d)(2)], an investment adviser may rely upon the definition of
"client" provided by 275.203(b)(3)-1. PART 279 - FORMS
PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 1940
13. The authority citation for Part 279 continues to read
as follows:
AUTHORITY: The Investment Advisers Act of 1940, 15 U.S.C.
80b-1, et seq.
14. By revising Instructions 2 and 7 of Form ADV
(referenced in 279.1), and by adding Instruction 10 to read as
follows:
Note: The text of Form ADV does not and the amendments will not
appear in the Code of Federal Regulations.
Form ADV
* * * * *
Form ADV Instructions
* * * * * *
2. Organization
This Form contains two parts. Parts I and II are filed with
the SEC and the jurisdictions; Part II generally can be given to
clients to satisfy the brochure rule. The Form also contains the
following schedules:
-- Schedule A - for corporations;
-----Start of Page 122
-- Schedule B - for partnerships;
-- Schedule C - for entities that are not sole
proprietorships, partnerships or corporations (e.g.,
limited liability companies and limited liability
partnerships);
-- Schedule D - for reporting information about
individuals under Part I Item 12;
-- Schedule E - for continuing responses to Part I items;
-- Schedule F - for continuing responses to Part II items;
-- Schedule G - for the balance sheet required by Part II
Item 14;
-- Schedule H - for satisfaction of the brochure rule by
sponsors of wrap fee programs; and
-- Schedule I - for reporting information related to
eligibility for SEC registration.
* * * * *
7. SEC Filings
* Submit filings in triplicate to the Securities and
Exchange Commission, Washington D.C. 20549. There is no fee for
registration or amendments.
* Non-residents -- Rule 0-2 under the Investment Advisers
Act of 1940 [17 CFR 275.0-2] covers those non-resident persons
named anywhere in Form ADV that must file a consent to service of
process and a power of attorney. Rule 204-2(j) under the
Investment Advisers Act of 1940 [17 CFR 275.204-2(j)] covers the
-----Start of Page 123
notice of undertaking on books and records non-residents must
file with Form ADV.
* Federal Information Law and Requirements -- Investment
Advisers Act of 1940 Sections 203(c), 204, 206, and 211(a)
authorize the SEC to collect the information on this Form from
applicants for investment adviser registration. The information
is used for regulatory purposes, including deciding whether to
grant registration. The SEC maintains files of the information
on this Form and makes it publicly available. Only the Social
Security Number, which aids in identifying the applicant, is
voluntary. The SEC may return as unacceptable Forms that do not
include all other information. By accepting this Form, however,
the SEC does not make a finding that it has been filled out or
submitted correctly. Intentional misstatements or omissions
constitute Federal criminal violations under 18 U.S.C. 1001 and
15 U.S.C. 80b-17.
* * * * *
10. Updating
Amendments to this form should be filed:
-- promptly for any changes in:
Part I -- Items 1, 2, 3, 4, 5, 8, 11, 13A, 13B,
14A, and 14B;
-- promptly for material changes in:
Part I - Items 9, 10, all items of Part II except
Item 14, and all Items of Schedule H;
-----Start of Page 124
-- within 90 days of the end of the fiscal year for the
filing of Schedule I and any other changes.
Note: Every investment adviser is required to
file Schedule I no later than 90 days after the
end of its fiscal year.
* * * * *
15. By revising Items 18 and 19 of Form ADV (referenced in
279.1) to read as follows:
Note: The text of Form ADV does not and the amendments will not
appear in the Code of Federal Regulations.
* * * * *
[THE TEXT OF ITEMS 18 AND 19 DOES NOT APPEAR ON THE WORLD WIDE
WEB. TO OBTAIN A COPY OF ITEMS 18 AND 19, CALL THE COMMISSION'S
PUBLIC REFERENCE ROOM AT (202) 942-8090.]
* * * * *
16. By adding Schedule I to Form ADV [ 279.1].
Note: The text of Schedule I will not appear in the Code of
Federal Regulations. Schedule I is attached as Appendix B to
this Release.
[THE TEXT OF SCHEDULE I DOES NOT APPEAR ON THE WORLD WIDE WEB.
TO OBTAIN A COPY OF SCHEDULE I, CALL THE COMMISSION'S PUBLIC
REFERENCE ROOM AT (202) 942-8090.]
17. Section 279.3 and Form ADV-S are revised to read as
follows:
-----Start of Page 125
279.3 Form ADV-T, transition form for determining eligibility
for Commission registration.
Note: The text of Form ADV-T will not appear in the Code of
Federal Regulations. Form ADV-T is attached as Appendix A to
this Release.
This form shall be filed pursuant to 275.203A-5(a) of this
chapter by every investment adviser registered with the
Commission on July 8, 1997.
By the Commission.
Jonathan G. Katz
Secretary
May 15, 1997
-----Start of Page 126
APPENDIX A: FORM ADV-T
-----Start of Page 127
APPENDIX B: SCHEDULE I
[THE TEXT OF SCHEDULE I DOES NOT APPEAR ON THE WORLD WIDE WEB.
TO OBTAIN A COPY OF SCHEDULE I, CALL THE COMMISSION'S PUBLIC
REFERENCE ROOM AT (202) 942-8090.]