"Implementing the Investment Advisers Supervision Coordination Act" Remarks By Isaac C. Hunt, Jr., Commissioner, U.S. Securities and Exchange Commission SEC/NASAA 19(c) Conference Washington, DC April 28, 1997 Good morning. It's my pleasure to be with you today. There are many important issues to discuss at this year's 19(c) conference. This morning, I thought I would discuss some of the more significant issues that the SEC is struggling with as we promulgate rules to implement the provisions of the new law that will affect investment advisers. I must tell you that the provisions of the Coordination Act that allocate federal/state jurisdiction of the adviser industry have stirred as much controversy as any matter I've considered during my tenure at the Commission. In fact, the SEC received over 100 comment letters concerning its investment adviser rule proposals. Each of these letters represents a different point of view. I have also personally met with many groups who have an interest in the SEC rulemaking: * I met with Neal Sullivan of NASAA. He was kind enough to stop by my office just before NASAA's comment letter was submitted. Neal told me that that NASAA's comments would be very tough in some areas, and indeed they were. * Later, I spoke to a group from the Investment Company Institute. Paul Stevens and Craig Tyle represented the ICI. They brought with them attorneys from American Express Financial Advisers, T. Rowe Price, and John Hancock. This group was also extremely forthright in its views. * Next, through my door to discuss the adviser rules was Duane Thompson of the Institute of Certified Financial Planners. Duane was accompanied by legal counsel and Susan Gordan Freed, who is the president of CFP. * Most recently, David Tittsworth and Karen Barr of the Investment Counsel Association of America dropped by 450 5th Street. David spent many years on Capital Hill, and he was more that happy to share his views on the "Congressional intent" of the new legislation. I was happy to talk to each of these groups. I firmly believe that the Commission should consider the rule proposals in a reasoned manner. And reading the comment letters and meeting with affected groups is an important part of this process. However, as we move forward to implement these new provisions our goal -- at the SEC -- is clear: The SEC must do its best to faithfully implement the Congressional intent of the new legislation. Within these parameters, we nevertheless face many difficult issues. Let's take a look of some of the more significant issues presented by the Adviser Act amendments. At first blush, the new provisions seem straightforward. The SEC will have primary responsibility for larger investment advisers -- that is, those advisers with more than $25 million under management or that advise mutual funds. Smaller advisers, such as most financial planners, will be prohibited from registering with the SEC and primarily will be regulated by the states. Of course, legal matters are never as straight forward as they seem. For SEC-registered advisers, the new legislation provides that a state may still license, register, or otherwise qualify any "investment adviser representative" who has a "place of business" located within that state. The Commission proposed to define these adviser reps as those whose business substantially consists of providing advice to clients who are natural persons. The objective here was to permit states to regulate those reps that service "retail clients." Most commentators strongly support this approach. Other commentators, however, argue that the Commission does not have the authority even to define the term. This latter group believes that Congress clearly intended for state law to prevail in this area. They believe that these adviser reps are within the primary jurisdiction of the states, and therefore it is important for the states to define who these reps are in order to carry our their oversight responsibility. A significant number of commentators thought we should broaden our approach. They argued that adviser reps should include those persons who provide advice to any client -- not just retail clients. This group suggests that although the thrust of the testimony to Congress was to protect individual or retail clients, Congress' regulatory concern was not limited to individuals. Some thought, for example, that small businesses should be included. There is also a substantial number of commentators who would narrow the SEC's proposal. Some stated that persons who provide advice to high net worth or sophisticated individuals should be excluded from the adviser rep definition. There also are different suggestions on how "high net worth individuals" should be defined. There were suggestions that we should refer to Reg D's treatment of accredited investors, while others want us to look to clients eligible to enter into performance fee arrangements under Rule 205-3 of the Advisers Act. Another letter suggested that we should use the "qualified purchaser" standard in newly enacted Section 3(c)(7) of the Investment Company Act of 1940, as recently amended. * * * Let's assume for a moment that the SEC can faithfully implement Congress' intent by adopting or not adopting a definition of "investment adviser rep." Each state will have qualification authority only concerning those reps who have "a place of business" located with their state. Currently, a state may assert jurisdiction over adviser reps having clients in the state, thus potentially subjecting the reps to registration in many states. The Commission's proposed definition sought to balance the concerns of the states and the industry, while being consistent with the statutory language of the new legislation. Under the proposal, a place of business is any "place or office" from which the rep "regularly" provides advisory services. Most commentators acknowledged the need for a federal definition, but opposed the use of the term "regularly." Many states want an adviser rep to be deemed to have a place of business in any state in which the rep is physically present and providing advice. They are concerned that under the proposed definition they would not be able to enforce state registration requirements. On the other side of this issue are the investment advisers who want an adviser rep to be deemed to have a "place of business" only in those states in which the rep has a business office. Several commentators thought that it would be helpful if the SEC clarified what "regularly" means. Some expressed concern that adviser reps could avoid registration by defining the term themselves. One group suggested that place of business should be defined broadly to include any place where a rep "solicits or meets" with clients -- even if the contact is sporadic. On the other hand, one large investment adviser argued that place of business should be limited to locations where the rep spends at least 25% of his or her time. Our proposed rules also tried to deal with itinerant investment adviser reps. If a rep does not regularly provide advisory services at any place or office, the Commission's proposal would define place of business to be the residence of each client. This provision was designed to prevent itinerant reps from claiming they have no place of business. We thought that as a practical matter an adviser rep would designate at least one place or office in a state in which he or she regularly communicates to clients. This seemed like a good approach at the time. With only one exception, however, every commentator who addressed this issue opposed the Commission's proposal. The vast majority stated that the standard was too broad and would create a "doing business" standard. Several commentators argued that it was not necessary for the SEC to address the issue of itinerant reps because reps will have at least one office in the U.S. They also thought it highly unlikely that a rep would claim that he or she had no place of business. Now let's assume for the moment that the SEC can faithfully carry out Congressional intent and define or not define "place of business." * * * The next provision in the legislation provides that the states have the continued authority to investigate and bring enforcement actions with respect to "fraud and deceit" against any investment adviser -- big or small -- or persons associated with any investment adviser. The Commission, in the proposing release to implement the advisory provisions, commented that a state should not be able to indirectly regulate the activities of SEC-registered advisers by enforcing requirements that are defined as "dishonest" or "unethical" business practices -- unless the activities rise to the level of being "fraudulent." In comment letters, many states -- and NASAA in particular - - objected to this interpretation, arguing that it would limit the states' enforcement authority. Certain members of Congress also have raised objections to this aspect of the Commission's release. As you can imagine, the mutual fund industry generally wants the states' enforcement authority to be interpreted as narrowly as possible. * * * Well, we can say with certainty that each state has the authority to license or otherwise qualify investment adviser reps -- of SEC-registered advisers -- who have a place of business within that state. We also can say with certainty that the states may bring enforcement actions for fraud and deceit against SEC-registered advisers and their associated persons. Working out the details is going to be the tough part. The SEC's Division of Investment Management has been working tirelessly on this project. You'll be happy to know that last week the Division submitted its recommendation for the final rules to the Commission. I, along with the other Commissioners, are in the process of reviewing their recommendations. As I noted at the beginning of my remarks, the SEC will do its best to faithfully implement the Congressional intent of the new legislation. However we move forward, not everyone will be happy with the final rules. But you should be fully aware that the Commission will consider the issues before us with the utmost care. I know that the rules we promulgate will affect the lives of many persons: _ For the SEC-registered investment advisers, the new rules will likely determine the states in which their reps will have to register. This is a massive compliance concern for large advisers with reps spread throughout the country. _ For the reps of the SEC-registered advisers, the new rules will determine where they should be licensed. If, for example, a rep has an office in 1 state -- but clients in 5 states, will the rep need to be licensed in more than 1 state. Also, will there be a bright line test to determine the states that have licensing jurisdiction or will the rep need to hire a team of lawyers to render a reasoned legal opinion? _ For the states, the new rules will likely affect their jurisdictional reach concerning the activities of SEC-registered advisers. States have a legitimate interest in protecting their citizens, and it is much easier to oversee persons who are required to be licensed -- as opposed to sitting back and waiting for your citizens to be defrauded. Soon the ink will dry on the adviser rules. When this happens, let's move forward and work together. And -- most importantly -- let's continue to focus on what is best for investors. Thank you. # # #