June 6, 2002
Via U.S. Mail and Electronic Filing
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W. Mailstop 6-9
Washington, DC 20549
Re: Exemption for Certain Investment Advisers Operating Through the Internet, Release No. IA-2028; File No. S7-10-02
Dear Mr. Katz:
The Investment Counsel Association of America1 appreciates the opportunity to submit comments regarding the Securities and Exchange Commission's proposed rules relating to an exemption for certain investment advisers operating through the Internet. The rule proposal would permit certain Internet advisers to register with the Commission instead of with state securities authorities. Because the ICAA's membership consists of SEC-registered investment advisers with at least $25 million in assets under management, the Commission's proposal for Internet advisers would not directly apply to our members. However, the ICAA takes this opportunity to comment on the rule proposal as it may affect the division of jurisdiction between the Commission and the states established by the National Securities Markets Improvement Act of 1996 (NSMIA).
Under NSMIA, Congress divided the responsibility for regulating investment advisers between federal and state regulators. State securities authorities regulate smaller advisory firms that are essentially local businesses and have assets under management of less than $25 million. The Commission is responsible for regulation of larger advisers, defined by NSMIA to include those with assets under management over $25 million and advisers to registered investment companies.2 The assets under management test was designed by Congress to distinguish between advisers with a national presence and those that are local businesses.
Under NSMIA, the SEC may permit some advisers to be regulated at the federal level, even though they do not meet the $25 million assets under management test, if the prohibition on SEC registration would be "unfair," a burden on interstate commerce, or otherwise inconsistent with the purposes of Section 203A of the Advisers Act.3 The Commission proposes to use this exemptive authority to permit Internet advisers to register with the SEC. Most Internet advisers currently are not eligible to register with the SEC because they do not meet the $25 million in assets under management test.4 Further, most of these advisers do not initially qualify to use the SEC's multi-state advisory exemption which permits an adviser that does not meet the statutory thresholds to register with the SEC if it would otherwise have to register with the securities authorities of at least 30 states.5 Internet advisers typically cannot determine when their state registration obligations are triggered and therefore would most likely be required to register in advance with all 50 states. The Commission observed that the cost of registering in all state jurisdictions acts as an impediment to launching these businesses and that requiring these advisers to register in multiple states would appear to be unfair and a burden on interstate commerce.
Proposed Rule 203A-2(f) would exempt an adviser from the prohibition on Commission regulation if the adviser conducts substantially all of its advisory business through an interactive website on the Internet. "Substantially all" would be defined to mean that at least 90 percent of the investment adviser's clients obtain advice exclusively through the interactive website. An "interactive website" is defined as a website in which computer-based models or algorithms provide investment advice to clients based on information that each client supplies through the website. This condition is intended to exclude advisers that simply have a website for marketing or client servicing purposes from registering with the SEC.
The Commission notes that Internet advisers, which were not in existence when NSMIA was enacted in 1996, appear to be the type of advisory business with a national presence contemplated by Congress. The Commission notes that the adviser's business is not confined to one or a few states because Internet advisers do not have a physical presence in any particular state and clients of Internet advisers have little or no direct contact with Internet advisers. Additionally, the Commission notes that Internet advisers appear to be the type of advisers that should qualify for an exemption from the prohibition on Commission regulation because the cost of registering in multiple states may be unfair and a burden on interstate commerce.
While we do not object to the intent or substance of the proposal, we are concerned that the allocation of responsibility between the states and the SEC forged by NSMIA not be unduly altered to the detriment of both advisers and investors. One of the principal purposes of NSMIA was to deploy limited regulatory resources more efficiently. The SEC has indicated that it is experiencing a significant shortage of personnel at this time.6 In recent speeches, staff of the SEC's Office of Compliance, Inspections and Examinations have noted that the five-year inspection cycle may be strained as the number of advisers increases.7 Under numerous existing exemptions, the SEC currently has regulatory authority over approximately 800-1,000 advisers that do not have at least $25 million in assets under management or serve as an adviser to a mutual fund.8 If comments or other information indicate that the proposed exemption would cover more than the 20 advisers estimated by the SEC, the Commission should seriously reconsider the prudence of this proposal.
We urge a narrow interpretation of the rule proposal - one that provides an exemption only for a small group of advisers that genuinely conduct substantially all of their advisory business through the Internet. The Commission notes that the rule proposal 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. Those who have websites as marketing tools or that use Internet vehicles such as e-mail, chat rooms, bulletin boards, webcasts or other electronic media to communicate to clients would not be eligible for the exemption. The ICAA strongly supports this conclusion. Any expansion of the rule proposal to cover other small advisers would dilute the limited resources of the SEC and would be contrary to the spirit and intent of NSMIA. It is possible that the proposed exemption could provide an incentive for state-registered advisers to set up interactive websites as a means to avoid state regulation.9 Accordingly, the Commission should be mindful of such a development and should continue to monitor on an ongoing basis any abuse of the exemptive relief granted under the rule proposal.
Additionally, the ICAA provides the following responses with respect to certain comments identified in Section II of the Release:
The ICAA believes the rule proposal makes an appropriate distinction in this regard. As discussed above, the ICAA agrees that advisers that simply maintain websites as marketing tools or for client servicing purposes should not be afforded exemptive relief under the rule proposal. However, we recommend that the Commission continue to monitor the types of advisers that register under the proposed exemption as future trends in technology affect the investment adviser business.
The ICAA believes that the "substantially all" test appropriately limits use of the rule to those advisers that the SEC intends to cover. The rule proposal defines substantially all to mean that at least 90 percent of the investment adviser's clients obtain advice exclusively through the interactive website. The 90 percent limitation is the minimum appropriate percentage. However, in order to prevent abuse of the exemption, the Commission should require that the 90 percent limitation apply only to certain clients of the investment adviser - which the rule should specifically define as an identifiable class of clients that, in return for compensation, receive tailored investment advice based on personal information supplied to the adviser through an interactive website. For example, an anonymous user that pays no compensation to the adviser should not be considered a countable "client" under the proposed rule.10 Otherwise, an intrastate adviser with 10 traditional clients would be transformed into a federally registered adviser when the 100th person "hits" the adviser's interactive website. Numerous websites of financial services providers generate basic asset allocation strategies and other financial guidance in response to a few basic questions entered by members of the public. Some of these types of websites may be "hit" hundreds of times a day.11 Thus, Internet advisers should not be permitted to factor anonymous users of interactive websites into the 90 percent client limitation. Moreover, a rule proposal that distinguishes between identified and anonymous clients coincides with the intent of the SEC to grant an exemption only to a narrow class of advisers that are burdened by multiple-state regulation. Finally, a requirement that an Internet adviser provide advice to an identifiable set of clients is consistent with the adviser's fiduciary duty to know the customer and provide suitable investment advice.
The Commission should require that these clients obtain all of their advice from the adviser exclusively through the interactive website. As discussed above, the intent of the rule proposal is to grant an exemption only in narrow circumstances. The fundamental difference between Internet advisers and traditional advisers is that Internet advisers have no direct contact with clients. A rule proposal that allows for direct contact with clients or that allows Internet advisers to provide in-person advice would blur the line between Internet advisers and traditional advisers and would create an incentive for small traditional advisers to escape state regulation.
The Commission should maintain the "exclusive" standard but remind Internet advisers of the importance of providing advice through other means if appropriate in the course of fulfilling their fiduciary duties. Internet advisers, as well as all other advisers, must fulfill their obligations to provide suitable advice to their clients. Advisers providing on-line advice therefore must ensure that they receive sufficient information to enable them to fulfill this obligation. Similarly, investors should be provided adequate means to communicate their investment objectives. There may be some situations in which direct contact between investor and adviser may be required to fulfill suitability requirements. In such circumstances, the Internet adviser cannot factor these types of clients into the 90 percent limitation required under the proposed rule.
Thank you for considering our comments on the proposed rule. Please do not hesitate to contact the undersigned if we may provide any additional information.
cc: The Honorable Cynthia A. Glassman
The Honorable Isaac C. Hunt, Jr.
Paul F. Roye, Esq.
Cynthia M. Fornelli, Esq.
Robert E. Plaze, Esq.
|1||The ICAA is a not-for-profit association that exclusively represents the interests of SEC-registered investment advisers. Founded in 1937, the Association's membership today consists of approximately 300 investment advisory firms that collectively manage in excess of $3 trillion for a wide variety of institutional and individual clients. For additional information, please consult our web site at www.icaa.org.|
|2||Investment Advisers Act of 1940 (Advisers Act), Section 203A(a)(1).|
|3||Advisers Act, Section 203A(c).|
|4||Advisers exclusively using interactive websites generally do not exercise discretionary or continuous supervision over assets.|
|5||Advisers Act, Rule 275.203A-2(e).|
|6||See, e.g., Testimony Concerning Appropriations for Fiscal 2003, by Harvey Pitt, SEC Chairman, before the Commerce, Justice, State, and the Judiciary, Committee on Appropriations, United States House of Representatives (April 17, 2002).|
|7||See, e.g., OCIE Considering Certification Policy, IA Week (April 15, 2002); ShopTalk: OCIE Speaks, IA Week (March 4, 2002).|
|8||This information is based on data derived from investment adviser filings on the Investment Adviser Registration Depository as of April 29, 2002, by analyzing aggregate adviser responses to questions in Form ADV, Part 1. The SEC, other regulators, and the public could more effectively use the information provided in Item 2A of Form ADV Part 1 if registrants were explicitly required to check all boxes that apply. We strongly recommend that the Commission take this opportunity to amend its Form ADV instructions in this respect. For example, requiring registrants to check all applicable boxes would assist in ascertaining the precise number of Internet advisers going forward.|
|9||Indeed, permitting Internet advisers to register with the SEC may give such advisers a competitive advantage over state-registered advisers with a more traditional business model. In considering this proposal, the Commission should make a conscious decision whether to encourage the Internet business model as a matter of policy.|
|10||Cf. Advisers Act, Rule 203(b)(3)-1 (advisers may exclude from client count nonpaying clients).|
|11||See Vanguard and T.Rowe Price websites for examples of websites that offer interactive investment tools and generate investment guidance to anonymous users.|