VIOCO, LTD. Daniel G. Viola, J.D., Consultant (800) 931-3710 February 7, 1997 VIA E-MAIL Jonathan G. Katz Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Stop 6-9 Washington, D.C. 20549. SEC Release No. IA-1601File/ No. S7-31-96 Dear Mr. Katz: In response to the Commission’s request for comments enclosed herewith please find, in triplicate, my comments and suggestions on the proposed rules regarding investment advisors. In addition, in accordance with the Commission’s instructions, please note that I have submitted my comments electronically under the properly entitled subject line, “File No. S7-31-96.” The National Securities Markets Improvement Act of 1996, signed into law on October 11, 1996, has introduced some of the most important changes to the federal securities laws in the last quarter-century, including expanding the scope of private investment companies and dividing investment advisor supervision between the federal and state governments. As a former Senior Compliance Examiner with the SEC’s Northeast Regional Office, I am pleased to offer my comments and suggestions regarding the Commission’s proposed rules in connection with the amendments to the Investment Advisers Act of 1940, as amended (hereinafter the “Advisers Act”). As a practicing Consultant to investment advisors, I have had the opportunity to work closely with various types of investment advisors, including: hedge funds, financial planners, registered representatives also registered as RIAs and advisors dually registered as: broker-dealers, investment companies, and/or commodity operators. The proposed rules regarding the implementation of the Investment Advisers Supervision Coordination Act (hereinafter the "Coordination Act") are of particular interest to me and my clients. I. Introduction The purpose of my comments are to express my reservations with the SEC’s proposal which would prohibit certain advisors from registering with the Commission and mandating the withdrawal of certain existing registered advisors. It is my belief that the proposed plan contravenes the Congressional intent of the Coordination Act and the Advisers Act, as amended. To deny any advisor the opportunity to register with the SEC is unfair and a burden on interstate commerce. Moreover, to mandate that certain existing advisors withdraw their registrations with the SEC would be unconstitutional since it would comprise a taking of economic property, e.g., a $150 filing fee, without just compensation. In addition, mandating that certain advisors effectively de-register from the Commission would risk disrupting a client’s reliance on the representation that the advisor was registered with the SEC at the time such client began entrusting his or her money with such advisor. Finally, mandating that certain advisors effectively de-register and denying certain advisors the opportunity to register with the SEC would result in burdensome legislative conflicts. For example, investment advisors that currently advise ERISA clients must be registered under the Advisers Act according to the current definition of “investment manager.” Please consider my comments and suggestions as follows. A. Summary of the Coordination Act and the Application of the SEC’s proposals The primary purpose of the Coordination Act is to reallocate the regulatory responsibilities for investment advisors between the SEC and the states. The proposed rules establish the process by which certain advisors would withdraw from SEC registration, exempt certain advisors from the prohibition on SEC registration, and define certain terms, including “assets under management.” Please note that the Commission’s proposed rules are premised on de-registration. It is my contention that Congress intended the Commission to coordinate its resources regarding the mere supervision of advisors and not the registration process. It would be more effective for the Commission to maintain that all advisors initially register at the federal level if they “hold themselves out” as advisors or to maintain their federal registration status and to be supervised by either the applicable states or the SEC as described under the Commission’s proposal. In other words, the terms registration and supervision are not synonymous. The Coordination Act contemplates that federal and state authorities will work together in supervising the growing number of advisors. For example, under the Coordination Act, states may require SEC-registered advisors to file, for notice purposes only, documents filed with the SEC. Thus, for example, a state could require a SEC-registered advisor to file its Form ADV with the state, but could not require the advisor to provide any information on the state filing other than the information that is required by the Commission. Moreover, states may require SEC registered advisors to continue to pay state filing, registration, and licensing fees. B. Registration by Notification Based on the Congressional intent of the Coordination Act, I respectfully recommend that Advisors should register with the Commission for notification purposes and then be subject to the supervision of either the state examiners or the SEC examiners. Thus, it would be feasible for an advisor to claim that it is an SEC registered advisor currently subject to exclusive state supervision. In light of the Coordination Act, the “small” advisor would then be responsible for notifying the SEC if and when it falls subject to federal supervision. The Form ADV-T, as proposed, would satisfy this notification (see infra). The process of federal registration by notification would be more beneficial to investors because an investor could call either the Commission or the Secretary of State in order to file a complaint or request information on the advisor. The ability for the Commission and the States to share information on advisors would also foster the Congressional intent of the Coordination Act because it would allow for a more effective communication between supervising regulators. Finally, the process of federal registration by notification would also be more beneficial to advisors because it would relieve advisors from the burden of having to frequently register and then de-register with the Commission as a result of changes in the amount of their assets under management. C. Supervision and the Procedures of Registration by Notification A new advisor would simply complete the Form ADV in triplicate and submit a check made payable to the SEC for $150, as usual. Advisors currently registered with the SEC would simply notify the SEC when they reach the “large advisor” status as defined under the Commission’s proposed rules. During the time that the advisor is subject to the state book and record rules, i.e., a “small advisor,” it would not be required to adhere to the corresponding rules under the SEC requirements as proposed. Hence, the purposes underlying the Coordination Act would be fostered in an orderly and fair manner. The Coordination Act eliminates the current system of duplicate federal and state regulation of investment advisors by dividing regulatory authority between the SEC and the states based primarily on the level of assets under management. Investment advisors with assets under management of $25 million or more and advisors to registered investment companies will fall exclusively under the supervisory jurisdiction of the Commission. Thus, the Commission would be able to conduct more frequent examinations of the larger investment advisors. All other investment advisors are placed under the supervisory jurisdiction of the states, except that the Commission may permit other investment advisors to register with it under certain circumstances where the purposes of the Act are contravened. Please note that I am in favor of more frequent examinations. It would appear that the existing registration requirements and my recommendations could streamline these efforts. Although states may have the exclusive supervisory jurisdiction over certain advisors, the Coordination Act limits the ability of a state regulator from imposing additional requirements on an advisor whose principal place of business is not in that state. The Coordination Act amends Section 222 of the Advisers Act to forbid a state from requiring an advisor to maintain any books and records in addition to those required under laws of the state in which such advisor maintains its principal place of business. The Coordination Act also imposes a national de minimis standard. Please note that I am in favor of the de minimis standard for state registration purposes. However, I believe states should be permitted to increase the standard, if warranted. D. Form ADV-T I understand that the purpose of the proposed rules and rule amendments is intended to clarify provisions of the Coordination Act and assist investment advisors in ascertaining their regulatory status. Again, it is my contention that registration is not synonymous with supervision. Under the SEC’s proposal, to help determine each investment advisor's status under the Coordination Act, and to provide for the mandatory withdrawal from SEC registration for advisors that are no longer eligible, the SEC is proposing a transition rule, rule 203A-5, and Form ADV-T. Under proposed rule 203A-5, all advisors registered with the SEC on April 9, 1997 would be required to file a completed Form ADV-T with the SEC no later than that date. Form ADV-T would enable an advisor to determine whether it meets the criteria set forth in the Coordination Act for SEC registration. Again, it is my contention that the proposed implementation of the proposed rules is well intended, but contravenes the intent of Congress. Form ADV-T would require each advisor to declare whether or not it remains eligible for SEC registration. For an advisor that declares itself not eligible for SEC registration, Form ADV-T would serve as the advisor's request for withdrawal from registration as of April 9, 1997. The proposed rule would also require every currently registered advisor to complete, sign, and return Form ADV-T by April 9, 1997. Failure to return the form would be a violation of an SEC rule. Advisors that do not return the form or that fail to voluntarily withdraw from SEC registration despite no longer being eligible would be subject to a cancellation proceeding under section 203(h) of the Advisers Act, as amended. The SEC has requested that industry comments regarding its proposed rules be submitted by February 10, 1997. The SEC intends to review and publish all the formal comments pertaining to the proposed Form ADV-T and proposed rule 203A-5. Under the current SEC implementation scheme, the time pressures for investment advisors to obtain, review and complete the Form ADV-T may prove too burdensome a task. Given the Congressional intent of the new legislation, the SEC should consider allowing any investment advisor (who holds themselves out as an investment advisor) to initially register or maintain their existing federal registration and to subsequently file a transition form at such time the advisor is deemed to fall under the supervisory jurisdiction of the SEC. This suggested filing requirement would be similar to the effective filing requirements established under section 13(f) under the Securities Exchange Act of 1934. For example, section 13(f) mandates that an institutional investment manager, exercising investment discretion over accounts having an aggregate fair market value of at least $100 million or more in certain equity securities, (on the last trading day of any month) must notify the Commission by filing a Form 13F within 45 days of the end of each quarter. In the alternative, because I believe that the time for implementation is insufficient for effective compliance, I respectfully recommend that the Commission provide a 180 day extension from the current date of April 9, 1997. An extension is warranted in order to provide sufficient opportunity to for advisors to inform certain client’s and/or their insurance carriers of their registration status. In addition, under the Commission’s proposal, advisors must also ascertain their state registration requirements prior to withdrawing their status on the federal level. Without a sufficient extension, the SEC may cause investment advisors to inadvertently violate certain state advisory laws. II. Conclusion In sum, it is possible for the registration process to remain the same and for the Advisers Act, as amended to have limited application to certain investment advisors. This has always been the case under the Advisers Act, as amended. For example, the anti-fraud provisions contained in the Advisers Act are applicable to all investment advisors. Likewise, under the Coordination Act, the Commission is proposing to amend rule 205-3 regarding performance based fee arrangements. The SEC’s proposal would make the safe harbor requirements set forth under rule 205-3 rule available to all advisors after April 9, 1997, including those registered only under state law. I am pleased to offer my comments and suggestion to the SEC. I respect the Commission’s efforts in this matter and would be honored to entertain any additional requests. If you have any questions or comments, please do not hesitate to call me directly at (800) 931-3710 or (914) 242-0500. Respectfully submitted, /s/ Daniel G. Viola, J.D., Consultant to HedgeWare, Inc. President and Consultant of VIOCO, Ltd. cc: Chairman Arthur Levitt, U.S. Securities and Exchange Commission National Securities Markets Improvement Act of 1996, Pub. L. No. 104-290, 110 Stat. 3416 (1996) (to be codified in sections of 15 USC). 15 USC 80b-1 et seq. Section 3(38)(B) of ERISA (pending amendment). Senate Report No. 293, 104th Cong., 2d Sess. 3-4 (1996) (The reallocation of regulatory responsibilities primarily grew out of Congress' concern that the SEC's resources are inadequate to supervise the activities of the growing number of investment advisors registered with the Commission, many of which are small, locally operated, financial planning firms. Congress concluded that if the overlapping regulatory responsibilities of the Commission and the states were divided by making the states primarily responsible for smaller advisory firms and the Commission primarily responsible for larger firms, the regulatory resources of the Commission and the states could be put to better, more efficient use.). Coordination Act section 307(a). Coordination Act section 307(b). See also, H.R. REP. NO. 622, 104th Cong., 2d Sess. 34 (1996). The Coordination Act, in part, requires advisors with $25 million or more of assets under management to register with the Commission; advisors with less than $25 million of assets under management that are registered with a state may not register with the Commission. The Coordination Act also precludes a state from requiring a advisor to maintain a higher bond or net capital amount than would be required by the state in which it maintains its principal place of business and complies with bonding and capital requirements. 15 U.S.C. 78m(f). 15 USC 80b-6. (By its terms, section 206 applies to all persons who meet the definition of "investment adviser" in section 202(a)(11) of the Advisers Act [15 USC 80b-2(a)(11)], regardless of whether they are registered with the Commission.).