Supplemental Statement of Commissioner Steven M.H. Wallman Regarding Section 103 of S. 1815 Section 103 of S. 1815 addresses the regulation of both investment adviser firms, and investment adviser employees (i.e., associated persons). I agree with my colleagues' view that the preemption of state regulation of associated persons merits further study. However, unlike my colleagues, for the reasons discussed below, I cannot support the bill's current treatment of associated persons. The method chosen in the legislation for dividing regulatory responsibility between state and federal authorities for investment adviser firms has merit. Generally, smaller firms would be registered with the states, larger firms with the Commission. This scheme appropriately eliminates duplication and overlap, allows the federal and state governments to allocate efficiently scarce resources and, most importantly, maintains investor protection. My concern is with the treatment of associated persons of such firms who provide advice to retail customers. (I am not concerned with those employees who provide advice to registered investment companies or to sophisticated investors such as qualified purchasers, and I would support a preemptive provision to that extent.) As currently drafted, the states would be precluded from imposing any registration, educational, licensing, qualification or any other type of requirement on the employees of those larger firms that are registered as an investment adviser with the Commission. This approach at this time would not be consistent with maintaining a high level of investor protection. Moreover, this approach may inadvertently have adverse effects on small business and competition that should be considered. The changing demographics in this country are making the role of advisory professionals increasingly important. We have more self-direction of retirement funds than ever before, we have an aging work force, and we can no longer assume that government will take care of us in retirement. In short, we have a greater emphasis on individual responsibility for planning for the future. In this new climate we need to do everything we can to ensure that investment adviser employees who provide point of sale advice to retail customers meet the highest level of professionalism and satisfy appropriate testing, educational or other standards. The Commission itself has no such requirements. Substantive licensing and examination of professionals for other professions including securities and real estate brokers, as well as doctors, lawyers and accountants, has generally been the exclusive domain of the states, often working with private accreditation or self- regulatory organizations. The best answer is not yet known; it may be to implement a system similar to the state system for licensing accountants or it may be a federal testing, education or other standard. If we decided now to preclude the states, when there is no alternative standard, from involvement in this growing and important issue for employees of the largest firms, and from crafting a solution, investor protection may be harmed. The approach chosen in S. 1815 may also inadvertently harm small business. Associated persons of large firms will not be subject to any substantive registration, licensing or qualification requirements. Associated persons at smaller firms, however, will be subject to state regulation. The premise is that larger firms have good procedures for maintaining a quality workforce, while smaller firms do not. This determination is not supported by any evidence or theory, and may be interpreted to demean and harm the reputation of small businesses. It would also be like saying that lawyers, doctors and accountants dealing with the public do not need to pass qualifying exams merely because they work for a large law firm, HMO or accounting firm. This section of S. 1815 may also have unintended anti- competitive effects. Under Section 103, an associated person employed by a large firm who wants to change jobs and work with or start a smaller firm will have to comply with a new licensing scheme. This might well be a barrier to such a move. Moreover, larger firms will have an advantage in recruiting: individuals joining them do not have to satisfy any of the state requirements. If an individual wishes to join a smaller firm, he or she will have to comply with those requirements. I do not believe it can be good public policy to tie an individual's license or competence requirements to the size of his or her employer. It should be noted that many associated persons currently are registered at the state level as broker-dealer registered representatives. This supports the observation that these individuals perform functions ordinarily covered by state regulation. (Of course, overlap in the regulatory schemes for registered representatives and associated persons should be avoided, and the states should move toward a more uniform and streamlined approach to dual registration.) However, one unanticipated result from Section 103 of S. 1815 may be a migration out of the regulatory structure for many of these registered representatives, especially for those that have disciplinary or other problems. For example, some brokerage firms may establish large enough investment advisory groups so that individuals who were formerly registered representatives will now provide only investment advice and avoid any substantive state regulation. This kind of regulatory arbitrage should be avoided. Given the increasingly important role that investment adviser associated persons play in our society, I believe they need to be treated as the professionals that they are. Concerns about the state regulation and licensing process, many of which are justified, need to be answered by improvements at the state level or through a comprehensive federal scheme, not by preemption that may result in a windfall for the industry's larger players potentially at the expense of the investing public.