Summary of Comments on Proposed Rule and Rule Amendment under the Investment Advisers Act of 1940 Addressing SEC-Registration of Internet Investment Advisers
September 25, 2002
List of Commenters
I. General Comments
On April 11, 2002, the Commission issued a release proposing new rule 203A-2(f) that would amend rule 203A-2 under the Investment Advisers Act of 1940 (Advisers Act). The proposal would exempt certain investment advisers that provide advisory services through the Internet (Internet Investment Advisers) from the prohibition on Commission registration set out in section 203A of the Advisers Act. The proposal would apply to investment advisers that provide substantially all of their investment advice through interactive websites where clients can enter their personal financial information and receive personalized investment advice based on computer algorithms. The comment period closed on June 6, 2002.
The Commission received 22 comment letters - ten from investment advisers; four from state securities administrators and one from NASAA; three from trade groups; and four from others.1 The majority of commenters generally supported the Commission's efforts to address the unique registration issues arising for investment advisory firms that provide investment advice through the Internet.2 Comments on the specifics of the Commission's proposal were mixed, with ten commenters suggesting the registration exemption be expanded to cover more forms of Internet investment advice,3 six commenters suggesting that the exemption be narrowed,4 and six asserting that the Commission should take no action.5
Comments from the trade groups were generally favorable. The ICAA and FPA were generally supportive of the proposal. The FPA commended the proposal's underlying concept of encouraging the availability of cost-efficient, automated and independent investment recommendations on a national scale to investors who may be unable to afford traditional advisory services. However, both commenters, out of concern that small traditional firms may rely on the proposal solely to avoid state registration, urged the Commission to slightly narrow the scope of the proposal.
State comments were mixed. Two state securities administrators and NASAA opposed the proposal and questioned the need for the exemption.6 These commenters argued that the proposal would frustrate the current allocation of regulatory responsibilities and resources between the Commission and the states under the National Securities Markets Improvement Act of 1996 (NSMIA). Two other state securities administrators were not opposed to the Commission's concept of a registration exemption dealing with the unique issues that arise when investment advisers provide advice exclusively through interactive websites.7 These two commenters, however, urged the Commission to narrow the proposal, out of concerns that the proposed rule would permit Internet Investment Advisers too much latitude to advise a portion of their clients through conventional means.
II. Specific Comments
A. Scope of Proposed Rule
1. Interactive Website
The proposed rule would require that an adviser eligible for the exemption provide substantially all of its advisory services through an interactive website. The proposed rule would define an "interactive website" as a website in which computer software-based models or applications provide investment advice to clients based on information each client supplies through the website. The Commission requested comment on whether the proposed rule adequately differentiates between advisers that merely use the Internet to market their business and those that conduct substantially all of their advisory business through the Internet.
The FPA and ICAA, as well as the CFP Board and two state securities administrators8 specifically supported the interactive website requirement. On the other hand, six commenters argued that the Commission should expand the scope of the proposed rule to cover investment advisers who provide advice to substantially all of their clients through any Internet-based means.9
a. Comments favoring the interactive website requirement
The commenters that supported the Commission's inclusion of the interactive website requirement emphasized the importance of the interactive website requirement in confining the scope of the rule to those advisers whose business models present the special issues meriting the exemption.10
b. Comments opposing the interactive website requirement
All eight comments opposing the interactive website requirement were from investment advisers urging the Commission to expand the registration exemption, to permit its use by advisers who communicate with their clients through a variety of electronic means, rather than by face-to-face contact.11
Some of these commenters stated that they are small investment advisory firms using the Internet for marketing purposes or to communicate with clients by e-mail.12 These commenters asserted that the costs of registering in multiple states prohibit them from accepting clients who would otherwise be available to them nationwide. Another firm asserted that, based on its experience maintaining registrations in 12 states, the scope of the rule should be expanded to cover investment advisers with national marketing strategies, without restriction to any interactive website criteria.13
c. Comment requesting clarification of the meaning of "interactive website"
One commenter expressed concern that the proposed rule's definition of "interactive website" was too broad and could inadvertently include businesses operating websites that aggregate and provide financial information in response to user requests.14 The commenter noted that these websites do not yield personalized advice because the user is not providing personal information, and any user who has access to the website and who requests the same information will receive the same response. This commenter recommended as a result of these considerations that we revise the definition for "interactive website" to require that clients supply personal information.
2. The "Substantially All" Requirement
The proposal would permit an Internet Investment Adviser to register with the Commission if that adviser conducts "substantially all" of its advisory business through an interactive website. The proposed rule would define "substantially all" to mean "that at least 90 percent of the investment adviser's clients obtain their investment advice from the adviser exclusively through the interactive website." Proposed rule 203A-2(f)(2)(ii). The Commission requested comment on whether 90 percent is an appropriate percentage, and if not, whether a higher or lower percentage should be considered. The Commission also requested comment on whether the rule should require these clients to obtain their advice exclusively through the interactive website, and if not, how much advice they should be permitted to receive by other means.
Three commenters, including the ICAA, supported the Commission's proposal to define "substantially all" at the 90 percent level, although these commenters suggested other changes to the test, as described below.15 Four commenters asserted that the test should be more restrictive,16 and four contended that it should be less restrictive.17 Two argued for entirely different tests.18
a. Comments favoring the 90 percent level.
The ICAA commented that 90 percent was an appropriate minimum percentage to prevent abuse of the exemption, but further urged the Commission to narrow the substantially all test to clarify that the only clients who should count towards the 90 percent limit are those who have identified themselves and paid consideration to receive individualized advice based on personal information submitted through the interactive website.
Two other comments submitted by investment advisers expressed support for the 90 percent measure.19 However, these commenters also contented that the Commission should not condition availability of the rule upon these clients obtaining their advice exclusively from the interactive website, so long as the adviser could demonstrate the client originated from the website.
b. Comments favoring a more restrictive test
The FPA, CFP Board, and two state commenters20 urged the Commission to raise the percentage to 100 percent. These commenters argued that raising the percentage is necessary to discourage advisers from modifying their business models to avoid state regulation, and to limit the exemption to advisers that do not provide any face-to-face advice.21 The resulting effect, these commenters argued, would be to make the proposed rule compatible with the division of authority between the states and the Commission under NSMIA, and to prevent the rule from placing small, traditional firms at a competitive disadvantage. For the same reasons, these commenters agreed with the Commission's exclusivity requirement under the proposal, subject to the inclusion of a safe harbor provision that would permit de minimis personal contacts with interactive website clients based on exigent circumstances, such as a technology breakdown.
The FPA also urged the Commission to make the rule 203A-2(c) registration exemption unavailable to Internet Investment Advisers. This rule requires SEC registration for a firm that would otherwise be ineligible to register with the Commission if the firm controls, is controlled by, or is under common control with, another SEC-registered adviser with the same principal place of business. The FPA expressed concern that an Internet Investment Adviser with too many "traditional" clients, to meet the substantially all threshold, could split its traditional clients into a separate advisory firm under the control of the Internet Investment Adviser, and register the (otherwise ineligible) traditional firm under 203A-2(c).
c. Comments favoring a less restrictive test
Four comments from investment advisers asserted that the 90 percent test was too restrictive, and suggested tests ranging from less than 20 to 80 percent without regard to whether such clients received advice exclusively through an interactive website.22 These commenters argued that advisory firms must use a variety of delivery channels to provide investment advice to their clients, and that clients will obtain the most benefit if advisory firms are able to provide advice through whatever means best serves a particular client's needs.
d. Comments favoring a different test
One commenter suggested that the Commission base the definition of "substantially all" not on the number of clients, but on a percentage of services provided or client revenue generated.23 A second commenter suggested that the Commission add a requirement that the Internet Investment Adviser show it does business in multiple states.24 These commenters argued that these alternatives would help prevent traditional advisory firms from establishing rudimentary interactive websites solely to permit the firm to register under the exemption.
B. Other Suggested Revisions to the Proposed Rule
One commenter urged the Commission not to create a new exemption, but to modify its existing exemptive rules, such as by reducing the number of states necessary for the multi-state exemption or by lengthening the 120-day period of rule 203A-2(d) for newly-formed advisers who expect to meet the requirements for Commission registration.25
III. Demand for Services
The Commission requested comment on its expectation that demand for Internet Investment Advisers' services may grow in the next several years, perhaps as part of the growing demand for advice to pension plan participants.
While comments from state securities administrators generally questioned whether there are a sufficient number of Internet Investment Advisers to support the proposed registration exemption, several industry commenters asserted that the demand for investment advice through the Internet would result in many new Internet-based investment advisers entering the sector.26
One industry commenter argued that the Internet "is the only practical means for providing quality, specific advice to self-directed pension plan participants with advice in an economical format," and that regulatory burden is hindering the development of the industry.27 Another industry commenter estimated the number of potential clients at 40 million.28 In contrast to these comments, state securities administrators generally commented that the Commission should address the needs of Internet Investment Advisers by exemptive orders rather than a rule,29 or that the Commission's existing exemption under rule 203A-2(e) for advisers required to register in 30 or more states is sufficient.30
In addition, AIMR commented that the growing demand for Internet investment advisory services should cause the Commission to exercise caution, lest the proposed registration exemption facilitate market entry by small businesses that may not be fully vested in making the types of commitments that are required of those in the advisory business. AIMR suggested that it would be premature for the Commission to adopt the proposed registration exemption during this developmental period.
IV. Similarly Situated Advisers
In connection with assessing the potential competitiveness effects of the proposal, the Commission requested comment on other types of investment advisers - without assets under management but operating in many states - that currently face burdens similar to Internet Investment Advisers. Specifically, the Commission requested information about the number of these advisers and the number of states in which they typically register. The Commission requested comment on whether it should also consider permitting them to register with the SEC.
Four industry commenters argued that their firms were, like Internet Investment Advisers, subject to unique burdens from multi-state registration because their firms advise (or would like to advise) clients in several states, yet do not have sufficient assets under management to meet the $25 million threshold for Commission registration under NSMIA.31 One other commenter contended that it was confronted with similar multi-state registration burdens in the service it provides in linking online consumers to advisers.32
The FPA conditioned its support for the proposal on the Commission making one change to address competitiveness concerns. As discussed above, the FPA urged the Commission to raise the "substantially all" threshold from 90 percent of clients to 100 percent, and to make the 203A-2(c) registration exemption unavailable to Internet Investment Advisers, lest some small traditional firms establish rudimentary websites solely to qualify for SEC registration. The FPA argued that, absent this change, traditional advisory firms would be at a competitive disadvantage because of image enhancement for Commission-registered Internet Investment Advisers and inequitable compliance costs. The ICAA, which also supported the proposal, acknowledged the possible effect on competition between Internet Investment Advisers and traditional firms, stating that the registration exemption might have the effect of encouraging firms to pursue the Internet business model.
Another commenter raised concerns that the proposed rule would result in disparate treatment of "online" and "offline" (or traditional) advisers based solely on the manner in which advisory services are delivered to their clients rather than on the firms' local or national focus, as intended by NSMIA.33
V. Cost Benefit Analysis
In the proposal, the Commission identified potential costs and benefits of the rule amendments, including relieving Internet Investment Advisers from the cost of registering in advance in 49 states and waiting until their registration obligations were triggered in 30 states, thereby making them eligible to register with the Commission under rule 203A-2(e). The Commission requested comment on the potential costs and benefits identified in the proposal, as well as any other costs or benefits that may result from the proposal. The Commission also encouraged commenters to identify, discuss, analyze, and supply relevant data regarding these or additional costs and benefits.
Five industry participants commented that the need to comply with registration requirements of multiple states impeded their ability to use the Internet to provide investment advice to clients in multiple states.34 These commenters did not quantify the cost of the impediment. Three, however, asserted that multi-state registration costs were so high as to be prohibitive for their small firms35 and one characterized them as an extreme hardship.36
One state commenter asserted that state registration requirements are sufficiently uniform to permit multi-state registration without unnecessary burden.37 On the other hand, one investment adviser registered in 12 states commented that differences in state requirements had led to significant expense, burden, and delay.38
Based on discussions with counsel familiar with state adviser registration and regulatory issues, the Commission estimated that the cost to an Internet Investment Adviser of complying with the registration and other regulatory requirements of 49 states would be approximately $50,000. NASAA and two other commenters disputed the
VI. Prospective Number of Internet Investment Advisers
The Commission requested comment on the number of Internet Investment Advisers likely to register with the Commission under the proposed rule.
The Commission estimated that perhaps as many as 20 firms would be currently eligible to register as Internet Investment Advisers under the proposed rule. Four commenters responded to this estimate.42 One of the four commenters considered the estimate too low, suggesting 50 instead of the estimated 20.43 Another of the four, on the other hand, thought that the estimate of 20 was too high.44 All four opined that the number of Internet Investment Advisers would likely grow in the future.
VII. Recordkeeping Requirements of the Proposed Rule
The proposed rule would require Internet Investment Advisers to maintain a record demonstrating that substantially all of their advisory business has been conducted through an interactive website. Although the Commission anticipates that most Internet Investment Advisers would generate the necessary records in the ordinary conduct of their Internet advisory business, the recordkeeping requirement of proposed rule 203A-2(f) may, however, impose a small additional burden on these advisers. The Commission estimated that this recordkeeping burden should not exceed an average of four hours annually per Internet Investment Adviser, for a total burden of 80 hours annually. The Commission requested comment on whether the estimate of the recordkeeping burden of the proposed rule is reasonable.
Only one commenter addressed our request for comment on the reasonableness of the proposed rule's recordkeeping burden. The commenter noted that the burden appeared reasonable and necessary.45
VIII. Miscellaneous Comments to the Proposed Rule
The FPA noted that the proposed rule makes no qualitative assessment of the advisory services to be provided on the interactive website, and would thus lead to small advisers intent on avoiding state registration establishing rudimentary interactive websites solely to qualify for SEC registration. In addition, one commenter recommended that the Commission consider exempting small introducing brokerage firms that may also be registered investment advisers.46
1 These four included the CFP Board, a professional association that establishes voluntary standards of professionalism for personal financial planners; two individuals; and a law firm.
2 CFP Board; Creative; FPA; Financial Engines; Fulk; ICAA; Lamaute Capital; Meier; Middleton; MyFinancial; Neal; Nebraska DBF; Pennsylvania Securities Commission; and The Timer.com.
3 Creative Financial; Financial Engines; Fulk; Lamaute Capital; Middleton; MyFinancial; Meier; Neal; Spear Capital; and The Timer.com.
4 FPA; CFP Board; ICAA; Pennsylvania Securities Commission; Nebraska DBF; and Taft.
5 AIMR; Connecticut Banking Commissioner; NASAA; Texas Board; SaveDaily.com; and Williams.
6 Connecticut Banking Commissioner; NASAA; and Texas Securities Board. These commenters contended that the Commission's existing registration exemptions - such as the exemption under rule 203A-2(e), which permits advisers obligated to register in 30 states to register with the Commission - are an adequate accommodation to any registration burdens faced by Internet Investment Advisers.
7 Nebraska DBF and Pennsylvania Securities Commission.
8 Nebraska DBF and Pennsylvania Securities Commission.
9 Creative; Financial Engines; Fulk; Meier; Neal; and Spear Capital.
10 FPA; CFP Board; ICAA; Nebraska DBF; and Pennsylvania Securities Commission. As discussed below, four of these commenters - the FPA, CFP Board, Pennsylvania Securities Commission, and Nebraska DBF - also urged the SEC to narrow the rule even further by requiring that 100 percent of an Internet Investment Adviser's clients (rather than the 90 percent proposed by the Commission) receive investment advice exclusively through the interactive website.
11 Creative; Lamaute Capital; Financial Engines; Fulk; Meier; Neal; MyFinancial; and Spear Capital.
12 Fulk; Meier; and Neal.
13 Spear Capital. Spear Capital proposed a different, two-part part test. The first part of the test would require that the adviser's business be substantially national in scope, which the commenter would define as (1) spending 90 percent of its marketing dollars on national media; (2) having its clients distributed nationally, in at least 10 states; (3) not conducting a greater amount of business in the state where its offices are located than it does in other similarly populated states; and (4) not normally conducting its business in a face-to-face manner in any local office. The second part of the test would require that the adviser have at least 100 clients or at least $10 million under management.
15 ICAA, Lamaute Capital and Middleton.
16 CFP Board; FPA; Nebraska DBF; and Pennsylvania Securities Commission.
17 Creative; Financial Engines; Meier and MyFinancial.
18 Nebraska DBF and SaveDaily.com.
19 Lamaute Capital and Middleton.
20 Nebraska DBF and Pennsylvania Securities Commission.
21 For example, the CFP Board posited that "[a] n investment advisory firm could establish an inexpensive and very basic interactive Internet based advisory program to `run up' their client totals enough to achieve Commission registration through the Internet Investment Adviser exemption, yet maintain a limited number of clients with whom it works in a traditional manner and receives the vast majority of its revenue."
22 Creative; Financial Engines; Meier; and MyFinancial.
23 Nebraska DBF.
26 Connecticut Banking Commissioner; NASAA; Nebraska DBF; and Texas Board each questioned the need for the proposed exemption, while Creative; Financial Engines; Middleton; and MyFinancial expressed expectations that a growing number of firms will be established to provide investment advice through the Internet. In addition, the CFP Board specifically supported the proposed rule as an innovation that would foster an environment of increased access to financial advice.
28 Financial Engines.
29 NASAA and Texas Board.
30 Connecticut Banking Commissioner; NASAA; and Texas Board.
31 Fulk (website would present a choice of model portfolios from which a client would select, and firm personnel would then manage client's assets according to the chosen model); Meier (adviser works by e-mail, for or through other advisers nationwide whose clients hold concentrations of a single stock, to research whether the clients should sell, hold, or hedge the investment); Neal (provides traditional flat-fee or hourly-fee financial planning services to middle-income clients through the Internet, telephone, and postal mail); and Spear Capital (firm with $9 million under management and 80 clients generated by a national newsletter and nationwide marketing efforts, rendering advice through a website, e-mail, telephone, and postal mail).
32 MyFinancial (developing Internet site permitting consumers to search for investment advisers by type, verify an adviser's credentials, evaluate the adviser's fees and services, determine whether the adviser is available by phone, e-mail, or instant message, engage the adviser, and pay for the advice received on a per-use basis).
34 Fulk; Meier; MyFinancial; Neal; and The Timer.com.
35 Fulk; MyFinancial; and Neal. MyFinancial pointed out that advisers who would otherwise link to consumers through services of its website would be prohibited from doing so because of the costs to the advisers of registering in multiple states.
37 Texas Board. As noted above, Nebraska DBF and Pennsylvania Securities Commission made the same point in the context of questioning the need for a specific exemption for Internet Investment Advisers. All three commenters noted that state application forms are largely uniform, that most states permit filing through the Investment Adviser Registration Depository and that NSMIA prohibits states from imposing recordkeeping or financial statement requirements that conflict with those imposed by the state of the adviser's principal place of business.
38 Spear Capital.
39 AIMR; NASAA; and Texas Board.
40 NASAA estimated that the total of state registration fees for all states would be approximately $8,000 to $10,000. However, as stated in the proposing release, registration fees were not included in the Commission's cost estimates. State registration fees were intentionally excluded because states impose notice filing requirements upon Commission-registered advisers doing business in their states, with associated fees approximately equivalent to state registration fees. None of the commenters provided estimates of the time or costs required to perform such tasks as obtaining legal review of 49 states' registration and regulatory requirements, preparing necessary documents, responding to state regulators' comments on registration applications, etc.
41 NASAA argued the cost estimate was flawed because it was based on the cost of registering with all 49 state securities administrators. NASAA asserted an Internet Investment Adviser only would be required to register with 29 states, since the multi-state adviser exemption would become available upon the Internet Investment Adviser's obligation to register in a 30th state. NASAA, however, did not explain how an Internet Investment Adviser would know which 29 states to register with, since, as noted by the Commission in the proposing release, an Internet Investment Adviser's clients can come instantaneously from any place, at any time.
42 Creative; Financial Engines; Middleton; and MyFinancial.
44 Financial Engines.
45 Creative. Creative also encouraged the Commission to use technology to monitor the activities of Internet Investment Advisers in real time.
46 Lamaute Capital.