E-mail 2/7/97 February 7, 1997 Jonathan G. Katz Secretary Securities and Exchange Commission 450 Fifth Street, NW Stop 6-9 Washington, DC 20549 RE: Rules Implementing Amendments to Investment Advisers Act of 1940 File No. 57-31-96 Dear Secretary: National Regulatory Services, Inc., (NRS) is pleased to have the opportunity to comment on the proposed new rules and rule amendments to implement the provisions of the Investment Advisers Supervision Coordination Act which reallocates regulatory and registration responsibilities for investment advisers between the SEC and the states. NRS, based in Lakeville, CT, offers registration, compliance consulting services and related products to investment advisers and broker-dealers. The NRS clientbase of over 4000 investment advisers and broker-dealers includes a wide range of firms from the small individual and start-up firms to the largest advisers, brokers-dealers, mutual fund complexes and other financial institutions. NRS commends the SEC for its efforts in addressing the requirements of the new legislation and its IA Release IA-1601 ("the Release") providing guidance to the industry which will assist in a more coordinated and, as we see it also, a less burdensome regulatory environment for the financial industry. NRS has closely followed the progress of the legislation and has carefully reviewed the legislation as passed and the Release concerning the new SEC rules and rule amendments under the Investment Advisers Act of 1940 ("Advisers Act"). NRS offers the following comments to assist in making the proposed rules, rule amendments, forms and new procedures clearer and able to be smoothly implemented by the industry where we believe further explanation and guidance is appropriate. Our comments are based on NRS' experience in assisting advisers in completing Form ADV and state applications. Our comments are focused on assisting advisers in more easily understanding the practical application of the new law to their practices. NRS comments on proposed Form ADV-T are as follows: COMMENT 1. FORM ADV-T PART I (I) The instruction for this question requests information as to the states where the adviser is already registered but does not request states in which an adviser may have an application pending. NRS points out that it may be useful to coordinate Form ADV-T filings with withdrawals of state registrations if pending state applications are also identified in this question. NRS recommends that ADV-T be coordinated with the states, or NASAA, and that the form request advisers to identify where the adviser is registered "2" or pending "1" as in Form ADV Part 1 Item 7. COMMENT 2. FORM ADV-T PART II (a) The instruction for item (a) states "After April 9, 1997, registrant will not be subject to having its SEC registration canceled." NRS suggests for clarity that this instruction be stated in the affirmative, e.g., "After April 9, 1997, registrant will be eligible to maintain its registration" rather than stating it in the negative as currently proposed. COMMENT 3. FORM ADV-T PART III (a) The instruction for Part III now states "Complete this worksheet if required by Part II." NRS suggests that the instructions would be clearer and more informative by stating the instruction as "Complete this worksheet if Part II a(i) is checked yes (X)." This would be a clearer and more specific instruction rather than the vague and general instruction referring to Part II. COMMENT 4. FORM ADV-T PART III (a) The current instruction for this Item (a) is "State the amount of registrant's assets under management: See Instruction 7." Instruction 7(d) requires the adviser to determine the amount of assets within 10 days prior to filing Form ADV-T. This 10 day requirement should be stated directly on the form in the Item (a) instruction for clarity. Also, the instructions give information about how to determine the value of securities portfolios for Form ADV-T purposes. These instructions may also apply to Form ADV-I. Currently, there are no instructions for calculating the amount of assets for purposes of Form ADV Part I Items 18.B and 19.B, except for distinguishing between discretionary and non- discretionary accounts. NRS foresees confusion and inconsistency by some advisers calculating and reporting assets on Form ADV-T and Form ADV Part I, Items 18 and 19. The amount of assets reported may differ because Form ADV Part I Items 18 and 19 report total assets as of the adviser's most recent fiscal year end. Please see our Comment 6, because NRS expects there may be significant differences between the different assets reported on Form ADV-T and Form ADV Part I Items 18 and 19. COMMENT 5. FORM ADV-T Instruction 7 Instruction 7 is long, confusing to follow and needs clearer distinctions between several of the categories of advisory services. The introduction to Instruction 7 can be clarified by combining subparagraph (e) with the first introductory paragraph to read: "In determining the amount of assets the registrant has under management, include the total value of securities portfolios with respect to which the registrant provides continuous and regular supervisory or management services within 10 days of filing this Form." In addition, for ease of reference, we have numbered the Commission's examples of accounts receiving continuous and regular supervisory and management services under subsection (c) as number 1 through 10 for discussion purposes. Based on NRS' experience in working with numerous advisers and the ever-expanding range of services available, NRS finds the examples overlapping and in need of clearer definitions. In example 1, NRS believes the term "traditional" portfolio management services may mean different things to different advisers. An expanded example would be helpful to distinguish this example from others. NRS also suggests examples 5 and 6 should be better distinguished from example 2. In particular, if example 5 and/or 6 are intended to cover "mutual fund allocation" programs, NRS believes that identifying such programs specifically by name, i.e., such as "discretionary or non- discretionary mutual fund allocation programs" will make these examples much clearer for advisers who must distinguish between these various categories of services for purposes of Form ADV-T and Form ADV-I. NRS believes example 4 could include mutual fund allocation programs and recommends the Commission further distinguish between providing services on a continuous basis (example 4) and providing advice which is on a periodic basis, no matter how frequent (example 6). Instruction 7 (a) and (b) are confusing in explaining how to determine a securities portfolio. Instruction 7(a) requests that cash and cash equivalents be excluded in the computation. Instruction 7(b) requires all securities, cash, etc. be included as part of the securities portfolio. This could be made clearer if sub-paragraph (b) was revised to: "(b) Include the entire value of each securities portfolio (securities, cash, cash equivalents and any non-securities position) for which registrant provides continuous and regular supervisory or management services." NRS suggests an example might clarify Instruction 7(a) as follows: A client's portfolio consists of the following: $ 4,000,000 stocks and bonds $ 4,000,000 cash/equivalents $ 2,000,000 non-securities $10,000,000 Total Assets For 7(a) purposes, cash/equivalents ($4,000,000) are excluded in determining whether this portfolio is a securities portfolio. The account is a securities portfolio because securities represent 66% of the account, ($4,000,000 of securities in a $6,000,000 portfolio). For Instruction 7(b), as a securities account, its entire value ($10,000,000) is to be included in the calculation of the adviser's total assets under management. COMMENT 6. FORM ADV-T PART III (b) The blank line in this item allows an adviser to insert amounts of assets managed. In contrast, Form ADV Part 1 Items 18 and 19 provide space for asset values with space and then "000.00" already printed. NRS is aware of numerous instances where advisers disregard the existing "000.00" and insert the total value of assets, thereby overstating their assets by millions. NRS suggests that when Form ADV is next revised, the "000.00" be deleted from Form ADV Part I, Items 18B and 19B. NRS also suggests that Instruction 7 be expanded to indicate that the Form ADV asks for the amount of assets as of the adviser's fiscal year end, and Form ADV-T requires the amount of adviser's assets managed as of a date within 10 days of filing Form ADV-T. Release IA-1601 states that if an adviser reports substantially more assets under management on Form ADV-T than on Form ADV, the adviser could be asked to explain the difference. This implies that the Commission expects the numbers reported to be similar. If so, NRS suggests that Item III(b) of Form ADV-T be expanded to indicate that an adviser could be asked to explain the difference. NRS points out there will be differences in the numbers reported. Factors contributing to this include: Form ADV requires reporting assets as of the adviser's last fiscal year end, but ADV-T requires assets within 10 days of filing. Therefore, for 83% of advisers (who have a 12/31 year end), assuming the ADV is correctly updated by March 31, there will be a 3 month gap in assets reported. The remaining advisers with other fiscal year ends may be correctly reporting assets from as much as 12 months before the ADV-T. Without the requirement of having to file the Form ADV-S, there may be many advisers who neglect to file these annual updating amendments, resulting in numbers in Form ADV Items 18 and 19 which are 15 months older than those reported in ADV-T and therefore perhaps substantially different amounts will be reported. The portfolios reported in Form ADV items 18 and 19 may not have been calculated according to the definition of Securities Portfolios to be used in Form ADV-T. The assets in Items 18 and 19 may include assets not under continuous and regular management. COMMENT 7. IA RELEASE 1601, II B.2 SECURITIES PORTFOLIOS Comment is requested as to the types of assets that should be excluded from determining the amount of assets under management. This relates to Form ADV-T instruction 7(d). NRS believes that it is beneficial to describe or identify at least types or categories of assets to be excluded for determining a securities portfolio to provide guidance for advisers. COMMENT 8. IA RELEASE 1601 II, E. 1. The Commission seeks comment on whether it should recommend that Congress amend Section 203(a)(1) to prohibit an adviser from registering with the Commission if it has a principal office and place of business in a state that has enacted an investment adviser statute (regardless of whether that statute requires the adviser to register). NRS has considered this and has analyzed state investment adviser information which points out this problem. As an example, New York State does have a statute which regulates investment advisers but due to its 40 client de minimis, there are many advisers unregistered in New York State. NRS' database of Form ADV filings indicates that of approximately 2600 Commission registered investment advisers located in New York State, 600 of those advisers are not registered with New York. As another example, firms that are dually registered as a broker-dealer and an investment adviser with under $25 million in assets may rely on certain states' broker-dealer exemption from registration. These are firms that are not registered as advisers per se by the state. NRS recommends to the SEC that if a state has enacted an investment adviser statute, a small adviser with a principal place of business in that state should not be regulated by the Commission, even though the adviser might be exempt from state registration. To require otherwise would result in the Commission registering and regulating small or other advisers that a state chooses not to regulate, thereby complicating the regulatory framework by having the Commission register/regulate advisers intended to be regulated by the states. The complexity of determining all states' various exemptions and exclusions, and then subjecting such firms to Commission oversight, is not in the spirit or intent of the legislation. COMMENT 9. IA RELEASE 1601 II C.2 TRANSITION FROM COMMISSION TO STATE REGISTRATION Comment is requested as to whether a 90 day grace period would allow sufficient time for an adviser to register with the states. Based upon NRS' extensive experience and many years of registering advisory and brokerage firms with the states and regulatory bodies, 90 days is an insufficient amount of time. While many state registrations are completed in that period, there are numerous delays in the processing and approval process which may be caused by examination requirements, documentation, bonding requirements that must be completed, in addition to state backlogs and an anticipated increased workload upon state securities divisions due to the new legislation. NRS recommends that the grace period be increased to 120 days. COMMENT 10. IA RELEASE 1601 II 2.0.4. INVESTMENT ADVISERS WITH REASONABLE EXPECTATION OF ELIGIBILITY This section and its procedures allow for a newly formed adviser to apply for registration with the Commission based upon its reasonable expectation that it will be eligible to register within a short time (90 days). After 90 days, the adviser is to be required to file an amended Form ADV-I. If not eligible to be registered with the Commission at that time, an ADV-W must be filed. NRS recommends the instructions should stress that if an adviser does not meet the minimum amount of assets in the 90 day period, the adviser's SEC registration will be withdrawn, and the adviser will need at that time to be state registered wherever required. Therefore, such advisers should be sure of meeting the $25 million threshold within 90 days. COMMENT 11. IA Release 1601 II F. 1. INVESTMENT ADVISER REPRESENTATIVE Comment is requested as to whether the proposed definition of "investment adviser representative," and exclusions, are appropriate. The proposed definition of investment adviser representative does not simplify the regulatory framework. NRS points out it may be difficult and costly to monitor and track when a supervised person exceeds the 10% test and must register as an investment adviser representative. Firms could easily fall out of compliance by the addition or termination of a client or by an increase in the value of the client's assets. Also, while recognizing that the Commission does not have authority to regulate individuals associated with an investment adviser who are not "supervised persons," NRS points out that it is counterintuitive that a solicitor would be required to take multiple state-required qualifying examinations which exceed those required of persons providing portfolio management services. COMMENT 12. IA-RELEASE 1601 II G NATIONAL De MINIMIS STANDARD Comment is requested on the definition of "client" for purposes of identifying and counting clients. NRS supports the Commission's proposed definition of client and believes each entity should be counted as a single client. COMMENT 13. IA RELEASE 1601 II.G NATIONAL DE MINIMIS STANDARD Comment is requested about whether the Commission should adopt a single rule regarding the counting of clients under section 203(b)(3) and 222(d). NRS supports a single rule for the counting of clients for uniformity of regulation and purpose. In particular, the Commission has previously addressed the treatment of limited partnerships under rule 203(b)(3)-1 and NRS does not see a need to reconsider such existing provisions. COMMENT 14. IA RELEASE 1601 II. G. NATIONAL DE MINIMIS This Release defines "place of business" in Section II F Persons Who Act on Behalf of Investment Advisers. The National De Minimis section does not specifically define place of business. Guidance or additional explanation should be included so it is clear whether the definition of a place of business for purposes of identifying investment adviser representatives also applies for National De Minimis purposes. CONCLUSION NRS appreciates the opportunity to be able to assist and comment on the proposed new rules and rule amendments which will aid in the transition to the new federal and state regulatory framework. If we may assist further or provide additional information or background on our comments, please let us know. Very truly yours, Jacqueline H. Hallihan President