Investment Advisor Act Of 1940 Assignment Management


General Information on the Regulation of Investment Advisers

March 11, 2011   [Update Currently in Progress]

Division of Investment Management

Introduction

The Securities and Exchange Commission (the "Commission" or "SEC") regulates investment advisers, primarily under the Investment Advisers Act of 1940 (the "Advisers Act"), and the rules adopted under that statute (the "rules"). One of the central elements of the regulatory program is the requirement that a person or firm meeting the definition of "investment adviser" under the Advisers Act register with the Commission, unless exempt or prohibited from registration.

Generally only larger advisers that have $25 million or more of assets under management or that provide advice to investment company clients are permitted to register with the Commission. Smaller advisers register under state law with state securities authorities. This document provides an overview of federal regulation, as applied to SEC-registered advisers. Many of the concepts discussed, however, also are relevant with respect to state-registered advisers.

The information in this document briefly summarizes some of the more important provisions of federal investment adviser regulation. Additional information on the mechanics of the registration process is contained in the document "How To Register as an Investment Adviser." The information in these documents should not be used as a substitute for the Advisers Act, rules, forms, and instructions to the forms (see "Requesting Copies of the Advisers Act, Rules, Forms, Letters, and Releases" for information on obtaining these documents) .

Sources of Regulation

The primary sources of federal investment adviser regulation are the Advisers Act, 15 U.S.C. 80b-1 et seq., and the rules thereunder, Title 17, Part 275 of the Code of Federal Regulations. In addition, the Commission and its Division of Investment Management (the "Division") provide interpretive guidance in: instructions to forms under the Advisers Act, "no-action letters," "interpretative letters," and "releases," all of which are publicly available. To request copies of the Advisers Act, rules, forms, no-action and interpretative letters, or releases, refer to the instructions at the end of this document under "Requesting Copies of the Advisers Act, Rules, Forms, Letters, and Releases." The copies of the Advisers Act, rules, and forms are current as of August 31, 1998.

Although state-registered advisers are governed primarily by state law, several provisions of the Advisers Act and Commission rules apply to such advisers. For more information on the provisions of federal law that apply to state-registered advisers, refer to the discussion below under "State-Registered Advisers."

Who Is Required To Register?

A person or firm is required to register with the Commission if he or it is:
  • an "investment adviser" under Section 202(a)(11) of the Advisers Act;
  • not excepted from the definition of investment adviser by Section 202(a)(11)(A) through (E) of the Advisers Act;
  • not exempt from Commission registration under Section 203(b) of the Advisers Act; and
  • not prohibited from Commission registration by Section 203A of the Advisers Act.

Each of these elements is addressed below.

Who Is an Investment Adviser?

Subject to certain limited exclusions discussed below, Section 202(a)(11) of the Advisers Act generally defines an "investment adviser" as any person or firm that: (1) for compensation; (2) is engaged in the business of; (3) providing advice, making recommendations, issuing reports, or furnishing analyses on securities, either directly or through publications. A person or firm must satisfy all three elements to be regulated under the Advisers Act.

The Division construes these elements broadly. For example, with respect to "compensation," the receipt of any economic benefit suffices. To be deemed compensation, a fee need not be separate from other fees charged, it need not be designated as an advisory fee, and it need not be received directly from a client. With respect to the "business" element, an investment advisory business need not be the person's or firm's sole or principal business activity. Rather, this element is satisfied under any of the following circumstances: the person or firm holds himself or itself out as an investment adviser or as providing investment advice; the person or firm receives separate or additional compensation for providing advice about securities; or the person or firm typically provides advice about specific securities or specific categories of securities. Finally, a person or firm satisfies the "advice about securities" element if the advice or reports relate to securities. The Division has stated that providing one or more of the following also could satisfy this element: advice about market trends; advice in the form of statistical or historical data (unless the data is no more than an objective report of facts on a non-selective basis); advice about the selection of an investment adviser; advice concerning the advantages of investing in securities instead of other types of investments; and a list of securities from which a client can choose, even if the adviser does not make specific recommendations from the list. An employee of an SEC-registered investment adviser does not need to register separately, so long as all of the employee's investment advisory activities are within the scope of his employment.

For additional guidance on the definition of "investment adviser" and the applicability of the Advisers Act to financial planners, pension consultants, and others, refer to Investment Advisers Act Release No. 1092 (October 8, 1987) (part of the Investment Adviser Registration Package; see below).

Exclusions From the Definition

Section 202(a)(11)(A)-(E) of the Advisers Act expressly excludes certain persons or firms from the definition of an investment adviser. These persons or firms need not register under, and generally are not regulated by, the Advisers Act. Excluded are:
  • Domestic banks (defined in Section 202(a)(2) of the Advisers Act) and bank holding companies (defined in the Bank Holding Company Act of 1956). Savings and loan institutions, federal savings banks, foreign banks, and credit unions do not fall within this exclusion.
  • Lawyers, accountants, engineers, and teachers if their performance of advisory services is solely incidental to their professions.
  • Brokers and dealers if their performance of advisory services is solely incidental to the conduct of their business as brokers and dealers, and they do not receive any special compensation for their advisory services. This exclusion is not available to a registered representative acting as a financial planner outside the scope of his employment with the broker employer.
  • Publishers of bona fide newspapers, news magazines, and business or financial publications of general and regular circulation. Under a decision of the United States Supreme Court, to enable a publisher to qualify for this exclusion, a publication must satisfy three elements: (1) the publication must offer only impersonal advice, i.e., advice not tailored to the individual needs of a specific client, group of clients, or portfolio; (2) the publication must be "bona fide," containing disinterested commentary and analysis rather than promotional material disseminated by someone touting particular securities, advertised lists of stocks "sure to go up," or information distributed as an incident to personalized investment services; and (3) the publication must be of general and regular circulation rather than issued from time to time in response to episodic market activity or events affecting the securities industry. See Lowe v. Securities and Exchange Commission, 472 U.S. 181 (1985).
  • Persons and firms whose advice, analyses, or reports are related only to securities that are direct obligations of, or obligations guaranteed by, the United States, or by certain U.S. government-sponsored corporations designated by the Secretary of the Treasury (e.g., FNMA, GNMA).

In addition to these exclusions, the Advisers Act gives the Commission the authority to exclude, by order, other persons and firms not within the intent of the definition of investment adviser. Any person or firm seeking such an order should refer to Rules 0-4 and 0-5 under the Advisers Act and Investment Advisers Act Release No. 969 (April 30, 1985).

Exemptions From Registration

A person or firm meeting the definition of investment adviser in Section 202(a)(11) does not need to register with the Commission if the person or firm qualifies for one of the exemptions from registration set forth in Section 203(b) of the Advisers Act. Investment advisers exempt from registration under Section 203(b) are still subject to certain anti-fraud provisions included in Section 206 of the Advisers Act. For more information on anti-fraud provisions, refer to the discussion below under "Anti-Fraud Provisions."

Section 203(b) of the Advisers Act provides five limited exemptions from registration. Section 203(b)(1) exempts any adviser (1) all of whose clients are within the same state as the adviser's principal business office, and (2) that does not provide advice or issue reports about securities listed on any national securities exchange. Section 203(b)(2) exempts advisers whose only clients are insurance companies. Section 203(b)(3) exempts any adviser that: (1) during the previous twelve months has had fewer than fifteen clients; (2) does not hold itself out generally to the public as an investment adviser; and (3) does not act as an investment adviser to a registered investment company or business development company. Rule 203(b)(3)-1 under the Advisers Act provides guidance on how to count clients when determining eligibility for this exemption. In determining if a person or firm holds himself or itself out as an investment adviser within the meaning of Section 203(b)(3), the Division looks at a number of factors, including, for example, whether the person or firm advertises; refers to himself or itself as an "investment adviser"; maintains a listing as an investment adviser in a telephone, business, building, or other directory; expresses a willingness to accept new advisory clients; or uses letterhead indicating any investment advisory activity. Section 203(b)(4) generally exempts any adviser that (1) is a charitable organization, or is employed by a charitable organization, and (2) provides advice, analyses, or reports only to charitable organizations, or to funds operated for charitable purposes. Section 203(b)(5) exempts advisers to church employee pension plans.

Prohibition on Commission Registration

A person or firm that does not meet any of the criteria in Section 203A of the Advisers Act or Rule 203A-2 thereunder is prohibited from registering with the Commission.

Only the following types of advisers are permitted to register with the Commission (and therefore must register with the Commission, unless exempt under Section 203(b)):

  • advisers that have "assets under management" of $25 million or more;
  • advisers to registered investment companies;
  • advisers that have their principal office and place of business in a state that has not enacted an investment adviser statute (currently, only Wyoming), or that have their principal office and place of business outside the United States; or
  • advisers that are exempted from the prohibition by Commission rule or order. The Commission has adopted a rule exempting five categories of investment advisers:
  • nationally recognized statistical rating organizations ("NRSROs") (Rule 203A-2(a));
  • pension consultants that provide investment advice with respect to $50 million or more of plan assets (Rule 203A-2(b));
  • investment advisers sharing the same principal office and place of business with an affiliated investment adviser that is registered with the Commission (Rule 203A-2(c));
  • newly-formed investment advisers that have a reasonable expectation of being eligible for Commission registration within 120 days of formation (Rule 203A-2(d)); and
  • investment advisers that would otherwise be required to register as investment advisers with the securities authorities of 30 or more states (Rule 203A-2(e)).

Advisers are required to report their eligibility for Commission registration on Schedule I to Form ADV upon initial registration. Additionally, advisers are required to report their continuing eligibility for Commission registration annually by amending Schedule I to Form ADV within ninety days of the end of their fiscal year. For additional information on the prohibition on Commission registration, refer to Investment Advisers Act Release Nos. 1633 (May 15, 1997) and 1733 (July 20, 1998).

Successors to SEC-Registered Investment Advisers

An unregistered firm that is acquiring or assuming substantially all of the assets and liabilities of the investment advisory business of an SEC-registered investment adviser may rely on special registration provisions for "successors" to SEC-registered advisers. Specifically, if an unregistered successor files an application for registration as an investment adviser (on Form ADV) within thirty days following the succession, it may rely on the registration of its predecessor until its registration is declared effective by the Commission. If a new investment adviser is formed solely as a result of a change in an adviser's structure or legal status (e.g., form of organization or state of incorporation), and there is no practical change in control of the adviser, generally the adviser may amend its predecessor's Form ADV within thirty days following the transaction, rather than file a new application. In responding to Part I, Item 9 of Form ADV, a successor is not required to report successions previously reported. For further information on the registration of successors, refer to Investment Advisers Act Release No. 1357 (December 28, 1992). For more information on what constitutes a change of control, refer to the discussion below under "Prohibited Contractual and Fee Provisions, Assignment."

Anti-Fraud Provisions

Section 206 of the Advisers Act prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business. As a fiduciary, an investment adviser owes its clients undivided loyalty, and may not engage in activity that conflicts with a client's interest without the client's consent. In S.E.C. v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963), the United States Supreme Court held that, under Section 206, advisers have an affirmative obligation of utmost good faith and full and fair disclosure of all material facts to their clients, as well as a duty to avoid misleading them. Section 206 applies to all firms and persons meeting the Advisers Act's definition of investment adviser, whether registered with the Commission, a state securities authority, or not at all.

In addition to the general anti-fraud prohibition of Section 206, Rules 206(4)-1, 206(4)-2, 206(4)-3, and 206(4)-4 under the Advisers Act regulate, respectively: investment adviser advertising; custody or possession of client funds or securities; the payment of fees by advisers to third parties for client referrals; and disclosure of investment advisers' financial and disciplinary backgrounds. These rules are discussed in greater detail below.

Disclosure Obligations

The Brochure Rule

Rule 204-3 under the Advisers Act, commonly referred to as the "brochure rule," generally requires every SEC-registered investment adviser to deliver to each client or prospective client a Form ADV Part 2A (brochure) and Part 2B (brochure supplement) describing the adviser's business practices, conflicts of interest and background of the investment adviser and its advisory personnel. An adviser must deliver the brochure to a client before or at the time the adviser enters into an investment advisory contract with a client. The rule also requires an adviser, if there are material changes in the brochure since the adviser's last annual updating amendment, to deliver annually, without charge, to each client within 120 days after the end of the adviser's fiscal year either (i) a current brochure or (ii) a summary of material changes to the brochure as required by Item 2 of the brochure that offers to provide the adviser's current brochure without charge, accompanied by the Web site address (if available) and an e-mail address (if available) and telephone number by which a client may obtain the current brochure from the adviser, and the Web site address for obtaining information about the adviser through the Investment Adviser Public Disclosure system. An adviser must deliver to each client or prospective client a current brochure supplement for a supervised person before or at the time that supervised person begins to provide advisory services to the client.

SEC-registered advisers are not required to deliver a brochure to either (i) clients that are SEC-registered investment companies or business development companies; or (ii) clients who receive only impersonal investment advice from the adviser and who will pay the adviser less than $500 per year. An SEC-registered adviser is not required to deliver a brochure supplement to a client (i) to whom it is not required to deliver a brochure, (ii) who receives only impersonal investment advice, or (iii) certain officers, and employees of the adviser.

Other Disclosure Requirements

Rule 206(4)-4 under the Advisers Act requires every SEC-registered investment adviser that has custody or discretionary authority over client funds or securities, or that requires prepayment six months or more in advance of more than $500 of advisory fees, to disclose promptly to clients and prospective clients (collectively, "clients") any financial conditions of the adviser that are reasonably likely to impair the ability of the adviser to meet contractual commitments to clients. The rule also requires advisers (regardless of whether the adviser has custody or requires prepayment of fees) to disclose promptly to clients legal or disciplinary events that are material to an evaluation of the adviser's integrity or ability to meet its commitments to clients. The rule lists a number of legal and disciplinary events for which there is a rebuttable presumption of materiality for these purposes (although an event may still be material even if it is not on the list).

The Division takes the position that an investment adviser must disclose to clients all material information regarding its compensation, such as if the adviser's fee is higher than the fee typically charged by other advisers for similar services (in most cases, this disclosure is necessary if the annual fee is three percent of assets or higher). An investment adviser must disclose all potential conflicts of interest between the adviser and its clients, even if the adviser believes that a conflict has not affected and will not affect the adviser's recommendations to its clients. This obligation to disclose conflicts of interest includes the obligation to disclose any benefits the adviser may receive from third parties as a result of its recommendations to clients.

An investment adviser (even if unregistered) may be subject to disclosure obligations not only under the Advisers Act, but also under other federal statutes, including the Securities Exchange Act of 1934 (the "Exchange Act"). For example, Section 13(f) of the Exchange Act, and Rule 13f-1 thereunder, generally require an investment adviser exercising investment discretion, or sharing investment discretion with others, over equity securities (which would include convertible debt and options) having a fair market value in the aggregate of at least $100 million to file, on a quarterly basis, a Form 13F disclosing the holdings that it manages on its own behalf and on behalf of clients.

Books and Records To Be Retained

Section 204 of the Advisers Act and Rule 204-2 thereunder require that SEC-registered investment advisers maintain and preserve specified books and records, and make them available to Commission examiners for inspection. Rule 204-2 permits investment advisers, under certain conditions, to maintain books and records on microfilm and magnetic disk, tape, or other computer recordkeeping devices.

Rule 204-2 requires every SEC-registered investment adviser to retain copies of all advertisements and other communications (collectively, "advertisements") that the adviser has circulated, directly or indirectly, to ten or more persons (excluding persons connected with the adviser). Generally, the adviser also must create and retain all documents necessary to substantiate any performance information contained in advertisements. With respect to the advertisement of performance information for managed accounts, an adviser need retain only (1) all account statements, if they reflect all debits, credits, and other transactions in a client's account for the period of the statement, and (2) all worksheets necessary to demonstrate the calculation of the performance or rate of return of all managed accounts.

Prohibited Contractual and Fee Provisions

Assignment

Section 205(a)(2) of the Advisers Act requires each investment advisory contract entered into by an investment adviser (whether SEC-registered or not, unless exempt from registration under Section 203(b)) to provide that the contract may not be assigned without the client's consent. Section 202(a)(1) of the Advisers Act defines "assignment" generally to include any direct or indirect transfer of an investment advisory contract by an adviser or any transfer of a controlling block of an adviser's outstanding voting securities. Rule 202(a)(1)-1 under the Advisers Act, however, provides that a transaction that does not result in a change of actual control or management of the adviser (e.g., a reorganization for purposes of changing an adviser's state of incorporation) would not be deemed to be an assignment for these purposes. Section 205(a)(3) of the Advisers Act provides that if an investment adviser is organized as a partnership, each of its advisory contracts must provide that the adviser will notify the client of a change in its membership.

Performance Fees

Section 205(a)(1) of the Advisers Act prohibits an investment adviser (whether SEC-registered or not, unless exempt from registration under Section 203(b)) from receiving any type of advisory fee calculated as a percentage of capital gains or appreciation in the client's account ("performance fee arrangement"). The Advisers Act contains exceptions from this prohibition for contracts with: (1) registered investment companies and clients having more than $1 million in managed assets, if specific conditions are met; (2) private investment companies excepted from the Investment Company Act under Section 3(c)(7) of that Act; and (3) clients that are not U.S. residents. In addition Rule 205-3 under the Advisers Act permits investment advisers to charge performance fees to: (1) clients with at least $750,000 under management with the adviser or more than $1,500,000 of net worth; (2) clients who are "qualified purchasers" under section 2(a)(51)(A) of the Investment Company Act; and (3) certain knowledgeable employees of the investment adviser.

Advertising Restrictions

Rule 206(4)-1 under the Advisers Act prohibits SEC-registered investment advisers from using any advertisement that contains any untrue statement of material fact or that is otherwise misleading. The rule broadly defines "advertisement" to include any notice, circular, letter, or other written communication addressed to more than one person, or any notice or other announcement in any publication or by radio or television, that offers any investment advisory service.

In addition, an advertisement may not:

  • use or refer to testimonials (which include any statement of a client's experience or endorsement);
  • refer to past, specific recommendations made by the adviser that were profitable, unless the advertisement sets out a list of all recommendations made by the adviser within the preceding period of not less than one year, and complies with other, specified conditions;
  • represent that any graph, chart, formula, or other device can, in and of itself, be used to determine which securities to buy or sell, or when to buy or sell such securities, or can assist persons in making those decisions, unless the advertisement prominently discloses the limitations thereof and the difficulties regarding its use; and
  • represent that any report, analysis, or other service will be provided without charge unless the report, analysis, or other service will be provided without any obligation whatsoever.

The Division takes the position that an adviser may advertise its past performance (both actual performance and hypothetical or model results) only if the advertisement meets certain conditions and restrictions. An advertisement using performance data must disclose all material facts necessary to avoid any unwarranted inference. Among other things, an investment adviser may not advertise its performance data if the adviser: (1) fails to disclose the effect of material market or economic conditions on the results advertised; (2) fails to disclose whether and to what extent the advertised results reflect the reinvestment of dividends or other earnings; or (3) suggests or makes claims about the potential for profit without also disclosing the potential for loss.

In addition, generally an adviser may not advertise gross performance data (i.e., performance data that does not reflect the deduction of various fees, commissions, and expenses that a client would pay) unless the adviser also includes net performance information in an equally prominent manner. The staff has taken the position, however, that an adviser may provide gross performance information, accompanied by appropriate disclosure regarding the impact of fees and expenses, in certain limited circumstances that present minimal risk that the client will not understand the impact of fees and expenses, such as when the client is a sophisticated institution, and the adviser presents the information to the client "one-on-one." Neither the Commission nor the Division will pre-approve advertisements for compliance with the above requirements, although advertisements are subject to review during Commission inspections.

Suitability Requirements

As fiduciaries, investment advisers owe their clients a duty to provide only suitable investment advice. This duty generally requires an investment adviser to determine that the investment advice it gives to a client is suitable for the client, taking into consideration the client's financial situation, investment experience, and investment objectives. Investment Advisers Act Release No. 1406 (March 16, 1994).

Custody Requirements

Rule 206(4)-2 under the Advisers Act details how client funds and securities in the custody of the adviser must be held, and requires an SEC-registered adviser with "custody" to provide specified information to clients. An adviser will be deemed to have custody if it directly or indirectly holds client funds or securities, has any authority to obtain possession of them, or has the ability to appropriate them.

Restriction on Payment of Referral Fees

Rule 206(4)-3 under the Advisers Act generally prohibits an SEC-registered investment adviser from paying a cash fee, directly or indirectly, to a third party (a "solicitor") for referring clients to the adviser unless the arrangement complies with a number of conditions. Among other things, the rule requires that: (1)be a written agreement between the adviser and the solicitor (a copy of which the adviser must retain) detailing the referral arrangement; (2) at the time of any solicitation activities, the solicitor provide the prospective client with a copy of the investment adviser's brochure pursuant to Rule 204-3, and a separate, written disclosure document that discloses, among other things, that the solicitor is being compensated for referring or recommending the adviser, and the terms of the compensation (including any additional amounts the client will be charged by the adviser as a result of the referral arrangement); and (3) the adviser receives from the client, prior to, or at the time of, entering into any written or oral investment advisory agreement with the client, a signed and dated acknowledgment that the client received the investment adviser's brochure and the solicitor's written disclosure document. Solicitors generally will not be required to register separately as advisers with the Commission if they comply with the conditions of the rule. Failure to comply with these conditions, however, could result in liability to the adviser under the Advisers Act's anti-fraud provisions, and could result in the solicitor being deemed an unregistered investment adviser.

Wrap Fee Programs

Many advisers participate in wrap fee programs. Rule 204-3(f) under the Advisers Act requires a sponsor of a wrap fee program to prepare a "wrap fee brochure" that provides, in narrative form, a full explanation of the program and its sponsor, and to deliver the wrap fee brochure to wrap fee clients. A "wrap fee program" for purposes of the rule is a program under which investment advisory and brokerage execution services are provided for a single "wrapped" fee that is not based on the transactions in a client's account. An investment advisory program under which all clients pay traditional, transaction-based commissions is not a wrap fee program. Similarly, a program under which client assets are allocated among mutual funds is not a wrap fee program because normally there is no payment for brokerage execution.

Schedule H to Form ADV sets forth the information required in the wrap fee brochure. The wrap fee brochure must be prepared by the "sponsor" of the wrap fee program, i.e., the person that, for a portion of the fee, sponsors, organizes, or administers the program or recommends portfolio managers under the program. Some wrap fee programs will have more than one sponsor, in which case only one of the sponsors, as selected by the sponsors, needs to prepare the wrap fee brochure. An investment adviser providing portfolio management services to wrap fee clients is not a sponsor unless it performs other duties that would cause it to fall within the definition.

Wrap fee programs and other discretionary advisory programs that provide similar advice to a number of clients should be structured in a manner designed to avoid the creation of an unregistered investment company. The Commission has adopted Rule 3a-4 under the Investment Company Act of 1940 to provide a non-exclusive safe harbor from the definition of an investment company for advisory programs that meet certain requirements. See Investment Company Act Release No. 22579 (March 24, 1997).

Duty of Best Execution

As a fiduciary, an adviser has an obligation to obtain "best execution" of clients' transactions. In meeting this obligation, an adviser must execute securities transactions for clients in such a manner that the clients' total cost or proceeds in each transaction is the most favorable under the circumstances. In assessing whether this standard is met, an adviser should consider the full range and quality of a broker's services when placing brokerage, including, among other things, execution capability, commission rate, financial responsibility, responsiveness to the adviser, and the value of any research services provided. See Exchange Act Release No. 23170 (April 23, 1986).

Aggregation of Client Orders

In directing orders for the purchase or sale of securities to a broker-dealer for execution, an adviser may aggregate or "bunch" those orders on behalf of two or more of its accounts, so long as the bunching is done for purposes of achieving best execution, and no client is systematically advantaged or disadvantaged by the bunching. An adviser may include accounts in which it or its officers or employees have an interest in a bunched order. Advisers must have procedures in place that are designed to ensure that the trades are allocated in such a manner that all clients are treated fairly and equitably.

Principal Transactions and Agency Cross Transactions

Section 206(3) of the Advisers Act prohibits an adviser (whether SEC-registered or not), acting as principal for its own account, from knowingly selling any security to or purchasing any security from a client ("principal transaction"), without notifying the client in writing, and obtaining the client's consent before the completion of the transaction. Notification and consent for principal transactions must be obtained separately for each transaction. Rule 206(3)-2 under the Advisers Act permits an adviser to act as broker for both its advisory client and the party on the other side of the brokerage transaction ("agency cross transaction") without obtaining the client's prior consent to each transaction, provided that the adviser obtains a prior consent for these types of transactions from the client, and complies with other, enumerated conditions. The rule does not relieve advisers of their duties to obtain best execution and best price for any transaction. A principal or agency cross transaction executed by an affiliate of an adviser is deemed to have been executed by the adviser for purposes of Section 206(3) and Rule 206(3)-2.

Insider Trading Procedures and Duty of Supervision

Section 204A of the Advisers Act requires investment advisers (whether SEC-registered or not) to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by the investment adviser or any of its associated persons. Investment advisers also have a duty to supervise persons associated with the investment adviser with respect to activities performed on the adviser's behalf.

Withdrawal and Cancellation of Registration

As noted above, all SEC-registered investment advisers are required to report their continuing eligibility for Commission registration by amending Schedule I to Form ADV within ninety days of the end of the adviser's fiscal year. If an adviser reports on Schedule I that it is no longer eligible to maintain its Commission registration, it must withdraw its registration by filing a Form ADV-W Notice of Withdrawal from Registration within 180 days after the end of its fiscal year. Additionally, if an SEC-registered investment adviser ceases to conduct business as an investment adviser, the adviser must withdraw its registration by filing a Form ADV-W.

All information provided on Form ADV-W must be accurate and complete; failure to provide accurate and complete information could subject the adviser to liability under Section 207 of the Advisers Act. If the Commission finds that an SEC-registered investment adviser is no longer eligible to maintain its Commission registration or has ceased to conduct business as an investment adviser, the Commission will seek to cancel the adviser's registration. The Commission annually seeks to cancel the registrations of investment advisers that have failed to update Form ADV by amending Schedule I or that otherwise no longer appear to be engaged in business as an investment adviser.

State-Registered Advisers

Investment advisers that are prohibited from registering with the Commission (e.g. advisers that do not have assets under management of $25 million) generally must register with the state(s) in which they transact advisory business (e.g., have advisory clients or have a place of business), unless they are exempt from investment adviser regulation under state law. These advisers will be regulated primarily under state law administered by state securities authorities, rather than federal law administered by the SEC.

An adviser should check with each state in which it proposes to transact business, not just the state in which the adviser is located, for information about investment adviser regulation. The names and addresses of the appropriate regulating official for each state can be obtained by contacting the North American Securities Administrators Association, Inc., One Massachusetts Ave., N.W., Washington, D.C. 20001, telephone (202) 737-0900.

Most provisions of the Advisers Act and Commission rules apply solely to SEC-registered advisers, and therefore are not applicable to state-registered advisers. Thus, state-registered advisers are not required to file and amend Form ADV with the Commission under Rule 204-1; comply with the SEC's books and recordkeeping requirements under Rule 204-2; or deliver a brochure to clients under Rule 204-3. State investment adviser laws, however, may impose substantially the same requirements. For example, many state laws require advisers to register by filing Form ADV with the state.

State-registered advisers are subject to Section 206 of the Advisers Act, which prohibits fraudulent conduct. The Commission has authority to bring enforcement actions against state-registered advisers for fraud. Other provisions of the Advisers Act that apply to state-registered advisers include:

  • Section 204A, which requires advisers to establish, maintain, and enforce written procedures reasonably designed to prevent the misuse of material nonpublic information;
  • Section 205, which contains prohibitions on advisory contracts that (i) contain certain performance fee arrangements, (ii) permit an assignment of the advisory contract to be made without the consent of the client, and (iii) fail to require an adviser that is a partnership to notify clients of a change in the membership of the partnership. (The exemption provided in Rule 205-3 for certain performance fee arrangements, however, is available to all advisers, including state-registered advisers); and
  • Section 206(3), which makes it unlawful for any investment adviser acting as principal for its own account to knowingly sell any security to, or purchase any security from, a client, without disclosing to the client in writing before the completion of the transaction the capacity in which the adviser is acting and obtaining the client's consent. (The exemption provided in Rule 206(3)-2 from the prohibitions of Section 206(3), however, is available to all advisers, including state-registered advisers.)

Requesting Copies of the Advisers Act, Rules, Forms, Letters, and Releases 

Paper copies of the Advisers Act, the rules, the forms, no-action and interpretative letters, and releases may be obtained as follows:

  • The Advisers Act and the Forms.   Request a copy of the "Investment Advisers Act of 1940," Forms ADV (which includes Schedule I), Forms ADV-E and ADV-W, and additional copies of this Investment Adviser Registration Package, by calling the Publications Unit of the Commission at (202) 942-4046, or by sending a written request to: Publications Unit, U.S. Securities and Exchange Commission, 450 5th Street, N.W., Mail Stop C-11, Washington, D.C. 20549. There is no charge. When requesting Form ADV or the Investment Adviser Registration Package, advisers that are not U.S. residents should specifically ask for Forms 4-R, 5-R, 6-R, and 7-R concerning consent to service of process.
  • The Rules.   Request a copy of the "Code of Federal Regulations (CFR), Title 17, Part 240 to end," Stock No. 869-026-00056-5, by calling the Superintendent of Documents, Government Printing Office, at (202) 512-1800, or by faxing a request to (202) 512-2250. There is a charge. If requesting by telephone or fax, payment must be made by Visa or MasterCard. Copies of the rules also may be obtained by writing to the Superintendent of Documents, Government Printing Office, P.O. Box 371954, Pittsburgh, PA 15250-7954. When requesting by mail, payment may be made by Visa, MasterCard, personal check, or money order.
  • No-Action and Interpretative Letters and Releases.   Request a copy of a particular no-action or interpretative letter or release from the Office of Filings and Information Services, Public Reference Branch, by faxing a request to (202) 777-1030, by calling (202) 551-8090, or by writing to the Office of Filings and Information Services, Public Reference Branch, U.S. Securities and Exchange Commission, Room 1024, Mail Stop 1-2, 450 5th Street, N.W., Washington, D.C. 20549. There is a charge. Each request must provide the name and date of the letter, or the number and date of the release being requested, and include: the name and address to which the material is to be mailed (the Commission will not fax any material); the requester's telephone number; and a statement that the requester will be responsible for all charges. For additional information, please contact the Public Reference Branch of the Commission at (202) 551-8090.

In addition, electronic copies of the Advisers Act, the rules, and the forms are available.

 

http://www.sec.gov/divisions/investment/iaregulation/memoia.htm



Information for Newly-Registered Investment Advisers

November 23, 2010   [Update Currently in Progress]

Prepared by the Staff of the Securities and Exchange Commission’s Division of Investment Management and Office of Compliance Inspections and Examinations1

This information sheet contains general information about certain provisions of the Investment Advisers Act of 1940 (also called the “Advisers Act”) and selected rules under the Advisers Act. It is intended to assist newly-registered investment advisers in understanding their compliance obligations with respect to these provisions. This information sheet also provides information about the resources available to investment advisers from the SEC to help advisers understand and comply with these laws and rules.

As an adviser registered with the SEC, you have an obligation to comply with all of the applicable provisions of the Advisers Act and the rules that have been adopted by the SEC. This information sheet does not provide a complete description of all of the obligations of SEC-registered advisers under the law. To access the Advisers Act and rules and other information, visit the SEC’s website at www.sec.gov (the Advisers Act and rules are available at http://www.sec.gov/divisions/investment.shtml).2

Investment Advisers Are Fiduciaries

As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests. You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations. You must employ reasonable care to avoid misleading clients and you must provide full and fair disclosure of all material facts to your clients and prospective clients. Generally, facts are “material” if a reasonable investor would consider them to be important. You must eliminate, or at least disclose, all conflicts of interest that might incline you — consciously or unconsciously — to render advice that is not disinterested. If you do not avoid a conflict of interest that could impact the impartiality of your advice, you must make full and frank disclosure of the conflict. You cannot use your clients’ assets for your own benefit or the benefit of other clients, at least without client consent. Departure from this fiduciary standard may constitute “fraud” upon your clients (under Section 206 of the Advisers Act).

Investment Advisers Must Have Compliance Programs

As a registered investment adviser, you are required to adopt and implement written policies and procedures that are reasonably designed to prevent violations of the Advisers Act. The Commission has said that it expects that these policies and procedures would be designed to prevent, detect, and correct violations of the Advisers Act. You must review those policies and procedures at least annually for their adequacy and the effectiveness of their implementation, and designate a chief compliance officer (“CCO”) to be responsible for administering your policies and procedures (under the “Compliance Rule” — Rule 206(4)-7).

We note that your policies and procedures are not required to contain specific elements. Rather, you should analyze your individual operations and identify conflicts and other compliance factors that create risks for your firm and then design policies and procedures that address those risks. The Commission has stated that it expects your policies and procedures, at a minimum, to address the following issues to the extent that they are relevant to your business:

  • Portfolio management processes, including allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, your disclosures to clients, and applicable regulatory restrictions;
     
  • The accuracy ofdisclosures made to investors, clients, and regulators, including account statements and advertisements;
     
  • Proprietary trading by you and the personal trading activities of your supervised persons;
     
  • Safeguardingof client assets from conversion or inappropriate use by your personnel;
     
  • The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
     
  • Safeguards for the privacy protection of client records and information;
     
  • Trading practices, including procedures by which you satisfy your best execution obligation, use client brokerage to obtain research and other services (referred to as “soft dollar arrangements”), and allocate aggregated trades among clients;
     
  • Marketing advisory services, including the use of solicitors;
     
  • Processes to value client holdings and assess fees based on those valuations; and
     
  • Business continuity plans.

Investment Advisers Are Required to Prepare Certain Reports and to File Certain Reports with the SEC

As a registered investment adviser, you are required to file an annual update of Part 1A of your registration form (Form ADV) through the Investment Advisers Registration Depository (IARD). You must file an annual updatingamendment to your Form ADV within 90 days after the end of your fiscal year. In addition to making annual filings, you must promptly file an amendment to your Form ADV whenever certain information contained in your Form ADV becomes inaccurate (the Form ADV filing requirements are contained in Rule 204-1 of the Advisers Act, and in the instructions to the Form).

  • Make sure your Form ADV is complete and current. Inaccurate, misleading, or omitted Form ADV disclosure is the most frequently cited finding from our examinations of investment advisers.
     
  • Please keep the e-mail address of your contact person current (Form ADV, Part 1A, Item 1J). We use this e-mail address to keep you apprised of important developments (including when it’s time to file an amendment to your Form ADV).
     
  • Accurately report the amount of assets that you have under management (Form ADV, Part 1A, Item 5F(2)). Advisers who have less than $25 million of assets under management, who are not otherwise eligible to maintain their registration with the SEC, or who stop doing business as an investment adviser, should file a Form ADV-W through IARD to withdraw their registration.

With respect to Part 2A of your Form ADV, you are required to file it electronically through IARD. As with Part 1A, you must update Part 2 annually within 90 days of the end of your fiscal year and whenever it becomes materially inaccurate. Part 2B brochure supplements, are not required to be uploaded to IARD.

You may also be subject to other reporting obligations. For example, an adviser that exercises investment discretion (or that shares investment discretion with others) over certain equity securities (including convertible debt and options), which have a fair market value in the aggregate of $100 million or more, must file a Form 13F each quarter that discloses these holdings. “Discretionary authority” means that you have the authority to decide which securities to purchase, sell, and/or retain for your clients.

You should also be aware that it is unlawful to make any untrue statement or omit any material facts in an application or a report filed with the SEC (under Section 207 of the Advisers Act), including in Form ADV and Form ADV-W.

Investment Advisers Must Provide Clients and Prospective Clients with a Written Disclosure Statement

Registered investment advisers are required to provide their advisory clients and prospective clients with a written disclosure document (these requirements, and a few exceptions, are set forth in Rule 204-3 under the Advisers Act). As a registered adviser, you comply with this requirement by providing advisory clients and prospective clients with Part 2 of your Form ADV. This written disclosure document should be delivered to your prospective clients before or at the time of entering into an advisory contract (under certain conditions, you may comply with the delivery requirements through electronic media).

Each year, you also need to deliver Part 2 or summary of material changes to each client, without charge. You are required to maintain a copy of each disclosure document and each amendment or revision to it that was given or sent to clients or prospective clients, along with a record reflecting the dates on which such disclosure was given or offered to be given to any client or prospective client who subsequently became a client (under Rule 204-2(a)(14)).

Investment Advisers Must Have a Code of Ethics Governing Their Employees and Enforce Certain Insider Trading Procedures

As a registered investment adviser, you are required to adopt a code of ethics (under the “Code of Ethics Rule” — Rule 204A-1 under the Advisers Act). Your code of ethics should set forth the standards of business conduct expected of your “supervised persons” (i.e., your employees, officers, directors and other people that you are required to supervise), and it must address personal securities trading by these people.

We note that you are not required to adopt a particular standard of business ethics. Rather, the standard that you choose should reflect your fiduciary obligations to your advisory clients and the fiduciary obligations of the people you supervise, and require compliance with the federal securities laws. In adopting a code of ethics, investment advisers may set higher ethical standards than the requirements under the law.

In order to prevent unlawful trading and promote ethical conduct by advisory employees, advisers’ codes of ethics should include certain provisions relating to personal securities trading by advisory personnel. Your code of ethics must include the following requirements:

  • Your “access persons” must report their personal securities transactions to your CCO or to another designated person each quarter. “Access persons” are any of your supervised persons who have access to non-public information regarding client transactions or holdings, make securities recommendations to clients or have access to such recommendations, and, for most advisers, all officers, directors and partners.
     
  • Your access persons must submit a complete report of the securities that they hold at the time they first become an access person, and then at least once each year after that.3 Your code of ethics must also require that your access persons obtain your approval prior to investing in initial public offerings or private placements or other limited offerings, including pooled investment vehicles (except if your firm has only one access person).
     
  • Your CCO or another person you designate in addition to your CCO must review these personal securities transaction reports.
     
  • Your supervised persons must promptly report violations of your code of ethics (i.e., including the federal securities laws) to the CCO or to another person you designate (provided your CCO also receives a report on such issues). You must also maintain a record of these breaches.

Also, as a registered investment adviser, you are required to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the misuse of material non-public information (under Section 204A of the Advisers Act). These policies and procedures must encompass your activities and those of your supervised persons. Advisers often include this prohibition on insider trading in their code of ethics.

Provide each of the people that you supervise with a copy of your code of ethics (and any amendments that you subsequently make to it), and also obtain a written acknowledgement from the supervised person that he/she has received it. In addition, you must describe your code of ethics in your Form ADV, Part 2, Item 11 and provide a copy to your advisory clients, if they request it.

Investment Advisers are Required to Maintain Certain Books and Records

As a registered adviser, you must make and keep true, accurate and current certain books and records relating to your investment advisory business (under “the Books and Records Rule” — Rule 204-2). The books and records that you must make and keep are quite specific, and are described below in part:

  • Advisory business financial and accounting records, including: cash receipts and disbursements journals; income and expense account ledgers; checkbooks; bank account statements; advisory business bills; and financial statements.
  • Records that pertain to providing investment advice and transactions in client accounts with respect to such advice, including: orders to trade in client accounts (referred to as “order memoranda”); trade confirmation statements received from broker-dealers; documentation of proxy vote decisions; written requests for withdrawals or documentation of deposits received from clients; and written correspondence you sent to or received from clients or potential clients discussing your recommendations or suggestions.
     
  • Records that document your authority to conduct business in client accounts, including: a list of accounts in which you have discretionary authority; documentation granting you discretionary authority; and written agreements with clients, such as advisory contracts.
     
  • Advertising and performance records, including: newsletters; articles; and computational worksheets demonstrating performance returns.
     
  • Records related to the Code of Ethics Rule, including those addressing personal securities transaction reporting by access persons.
     
  • Records regarding the maintenance and delivery of your written disclosure document and disclosure documents provided by certain solicitors who seek clients on your behalf.
     
  • Policies and procedures adopted and implemented under the Compliance Rule, including any documentation prepared in the course of your annual review.

Some advisers are required to maintain additional records. For example, advisers that have custody and possession of clients’ funds and/or securities must make and keep additional records that are described in the Books and Records Rule (Rule 204-2, paragraph (b)), and advisers who provide investment supervisory or management services to any client must also make and keep specific additional records (which are described in Rule 204-2, paragraph (c)).

You must keep these records for specified periods of time. Generally, most books and records must be kept for five years from the last day of the fiscal year in which the last entry was made on the document or the document was disseminated. You may be required to keep certain records for longer periods, such as records that support performance calculations used in advertisements (as described in Rule 204-2, paragraph (e)).

You are required to keep your records in an easily accessible location. In addition, for the first two of these years, you must keep your records in your office(s). If you maintain some of your original books and records somewhere other than your principal office and place of business, you must note this practice and identify the alternative location on your Form ADV (in Section 1K of Schedule D). Many advisers store duplicate copies of their advisory records in a location separate from their principal office in order to ensure the continuity of their business in the case of a disaster.

You may store your original books and records by using either micrographic media or electronic media. These media generally include microfilm or digital formats (e.g., electronic text, digital images, proprietary and off-the-shelf software, and email). If you use email or instant messaging to make and keep the records that are required under the Advisers Act, you should keep the email, including all attachments that are required records, as examiners may request a copy of the complete record. In dealing with electronic records, you must also take precautions to ensure that they are secure from unauthorized access and theft or unintended destruction (similar safeguarding provisions regarding client information obtained by you is required by Regulation S-P under the Gramm-Leach-Bliley Act). In general, you should be able to promptly (generally within 24 hours) produce required electronic records that may be requested by the SEC staff, including email. In order to do so, the Advisers Act requires that you arrange and index required electronic records in a way that permits easy location, access, and retrieval of any particular electronic record.

Investment Advisers Must Seek to Obtain the Best Price and Execution for Their Clients’ Securities Transactions

As a fiduciary, you are required to act in the best interests of your advisory clients, and to seek to obtain the best price and execution for their securities transactions. The term “best execution” means seeking the best price for a security in the marketplace as well as ensuring that, in executing client transactions, clients do not incur unnecessary brokerage costs and charges. You are not obligated to get the lowest possible commission cost, but rather, you should determine whether the transaction represents the best qualitative execution for your clients. In addition, whenever trading may create a conflicting interest between you and your clients, you have an obligation, before engaging in the activity, to obtain the informed consent from your clients after providing full and fair disclosure of all material facts. The Commission has described the requirement for advisers to seek best execution in various situations.

In selecting a broker-dealer, you should consider the full range and quality of the services offered by the broker-dealer, including the value of the research provided, the execution capability, the commission rate charged, the broker-dealer’s financial responsibility, and its responsiveness to you. To seek to ensure that you are obtaining the best execution for your clients’ securities trades, you must periodically evaluate the execution performance of the broker-dealers you use to execute clients’ transactions.

You may determine that it is reasonable for your clients to pay commission rates that are higher than the lowest commission rate available in order to obtain certain products or services from a broker-dealer (i.e., soft dollar arrangement). To qualify for a “safe harbor” from possible charges that you have breached your fiduciary duty by causing your clients to pay more than the lowest commission rate, you must use clients’ brokerage commissions to pay for certain defined “brokerage or research” products and services, use such products and services in making investment decisions, make a good faith determination that the commissions that clients will pay are reasonable in relation to the value of the products and services received, and disclose these arrangements.

The SEC staff has stated that, in directing orders for the purchase or sale of securities, you may aggregate or “bunch” orders on behalf of two or more client accounts, so long as the bunching is done for the purpose of achieving best execution, and no client is systematically advantaged or disadvantaged by the bunching. The SEC staff has also said that, if you decide not to aggregate orders for client accounts, you should disclose to your clients that you will not aggregate and the potential consequences of not aggregating orders.

If your clients impose limitations on how you will execute securities transactions on their behalf, such as by directing you to exclusively use a specific broker-dealer to execute their securities transactions, you have an obligation to fully disclose the effects of these limitations to the client. For example, if you negotiate volume commission discounts on bunched orders, a client that has directed you to use a specific broker should be informed that he/she will forego any benefit from savings on execution costs that you might obtain for your other clients through this practice.

You should also seek to obtain the best price and execution when you enter into transactions for clients on a “principal” or “agency cross” basis. If you have acted as a principal for your own account by buying securities from, or selling securities to, a client, you must disclose the arrangement and the conflicts of interest in this practice (in writing) and also obtain the client’s consent for each transaction prior to the time that the trade settles. There are also explicit conditions under which you may cross your advisory clients’ transactions in securities with securities transactions of others on an agency basis (under Rule 206(3)-2). For example, you must obtain advance written authorization from the client to execute such transactions, and also provide clients with specific written disclosures. Compliance with Rule 206(3)-2 is generally not required for transactions internally crossed or effected between two or more clients you advise and for which you receive no additional compensation (i.e., commissions or transaction-based compensation); however, full disclosure regarding this practice should be made to your clients.

Requirements for Investment Advisers’ Contracts with Clients

As a registered investment adviser, your contracts with your advisory clients must include some specific provisions (which are set forth in Section 205 of the Advisers Act). Your advisory contracts (whether oral or written) must convey that the advisory services that you provide to the client may not be assigned by you to any other person without the prior consent of the client. With limited exceptions, contracts cannot include provisions providing for your compensation to be based on the performance of the client’s account. In addition, the SEC staff has stated that an adviser should not enter into contracts with clients, except with certain sophisticated clients, that contain terms or clauses commonly referred to as a “hedge clause” because such clauses or provisions are likely to lead other clients to believe that they have waived their rights of legal action, whether under the federal securities laws or common law.

Investment Advisers May be Examined by the SEC Staff

As a registered investment adviser, your books and records are subject to compliance examinations by the SEC staff (under Section 204 of the Advisers Act). The purpose of SEC examinations is to protect investors by determining whether registered firms are complying with the law, adhering to the disclosures that they have provided to their clients, and maintaining appropriate compliance programs to ensure compliance with the law. If you are examined, you are required to provide examiners with access to all requested advisory records that you maintain (under certain conditions, documents may remain private under the attorney-client privilege).

More information about examinations by the SEC and the examination process is provided in the brochure, “Examination Information for Broker-Dealers, Transfer Agents, Clearing Agencies, Investment Advisers and Investment Companies,” which is available on the SEC’s website at http://www.sec.gov/about/offices/ocie/ocie_exambrochure.pdf.

Requirements for Investment Advisers that Vote Proxies of Clients’ Securities

As a registered investment adviser, if you have voting authority over proxies for clients’ securities, you must adopt policies and procedures reasonably designed to ensure that you: vote proxies in the best interests of clients; disclose information to clients about those policies and procedures; and describe to clients how they may obtain information about how you have voted their proxies (these requirements are in Rule 206(4)-6 under the Advisers Act).

If you vote proxies on behalf of your clients, you must also retain certain records. You must keep: your proxy voting policies and procedures; the proxy statements you received regarding your client’s securities (the Rule provides some alternative arrangements); records of the votes you cast on behalf of your clients; records of client requests for proxy voting information; and any documents that you prepared that were material to making a decision as to how to vote or that memorialized the basis for your decision (these requirements are described in Advisers Act Rule 204-2(c)(2)).

Requirements for Investment Advisers that Advertise their Services

To protect investors, the SEC prohibits certain types of advertising practices by advisers. An “advertisement” includes any communication addressed to more than one person that offers any investment advisory service with regard to securities (under “the Advertising Rule” — Rule 206(4)-1). An advertisement could include both a written publication (such as a website, newsletter or marketing brochure) as well as oral communications (such as an announcement made on radio or television).

Advertising must not be false or misleading and must not contain any untrue statement of a material fact. Advertising, like all statements made to advisory clients and prospective clients, is subject to the general prohibition on fraud (Section 206 as well as other anti-fraud provisions under the federal securities laws). Specifically prohibited are: testimonials; the use of past specific recommendations that were profitable, unless the adviser includes a list of all recommendations made during the past year; a representation that any graph, chart, or formula can in and of itself be used to determine which securities to buy or sell; and advertisements stating that any report, analysis, or service is free, unless it really is free.

The SEC staff has said that, if you advertise your past investment performance record, you should disclose all material facts necessary to avoid any unwarranted inference. For example, SEC staff has indicated that it may view performance data to be misleading if it:

  • does not disclose prominently that the results portrayed relate only to a select group of the adviser’s clients, the basis on which the selection was made, and the effect of this practice on the results portrayed, if material;
     
  • does not disclose the effect of material market or economic conditions on the results portrayed (e.g., an advertisement stating that the accounts of the adviser’s clients appreciated in value 25% without disclosing that the market generally appreciated 40% during the same period);
     
  • does not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that accounts would have or actually paid;
     
  • does not disclose whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings;
     
  • suggests or makes claims about the potential for profit without also disclosing the possibility of loss;
     
  • compares model or actual results to an index without disclosing all material facts relevant to the comparison (e.g., an advertisement that compares model results to an index without disclosing that the volatility of the index is materially different from that of the model portfolio); and
     
  • does not disclose any material conditions, objectives, or investment strategies used to obtain the results portrayed (e.g., the model portfolio contains equity stocks that are managed with a view towards capital appreciation).

In addition, as a registered adviser, you may not imply that the SEC or another agency has sponsored, recommended or approved you, based upon your registration (under Section 208 of the Advisers Act). You should not use the term “registered investment adviser” unless you are registered, and you should not use this term to imply that as a registered adviser, you have a level of professional competence, education or special training. For example, the SEC staff has stated that advisers should not use the term “RIA” after a person’s name because using initials after a name usually indicates a degree or a licensed professional position for which there are certain qualifications; however, there are no federal qualifications for becoming an SEC-registered adviser.

Requirements for Investment Advisers that Pay Others to Solicit New Clients

Registered investment advisers may pay cash compensation to others to seek out new clients on their behalf, commonly called “solicitors” or “finders,” if they meet certain conditions (under Rule 206(4)-3 of the Advisers Act):

  • The solicitor is not subject to certain disciplinary actions.
     
  • The fee is paid pursuant to a written agreement to which you are a party and (with limited exceptions) the agreement must: describe the solicitor’s activities and compensation arrangement; require that the solicitor perform the duties you assign and in compliance with the Advisers Act; require the solicitor to provide clients with a current copy of your disclosure document; and, if seeking clients for personalized advisory services, require the solicitor to provide clients with a separate written disclosure document containing specific information.
     
  • You receive from the solicited client, prior to or at the time you enter into an agreement, a signed and dated notice confirming that he/she was provided with your disclosure document and, if required, the solicitor’s disclosure document.
     
  • You have a reasonable basis for believing that the solicitor has complied with the terms of your agreement.

Requirements for Investment Advisers that have Custody or Possession of Clients' Funds or Securities

Registered investment advisers that have “custody” or “possession” of client assets must take specific measures to protect client assets from loss or theft (under “the Custody Rule” — Rule 206(4)-2 under the Advisers Act).

The first step is to determine whether you have custody or possession of client assets. “Custody” is defined as “holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them.” This includes situations in which you:

  • have physical possession of client funds or securities, even temporarily;
     
  • enter into arrangements (including a general power of attorney) authorizing you to withdraw funds or securities from the client’s account (note that if you are authorized to deduct your advisory fees or other expenses directly from clients’ accounts, you have custody); and
     
  • serve in a capacity that gives you or a supervised person legal ownership or access to client funds or securities (note that if you are a general partner to a privately-offered pooled investment vehicle, you have custody).
     
  • If you are a trustee, you may have custody.

If you have custody, with limited exceptions, you must maintain these client funds and securities at a “qualified custodian.” Generally, qualified custodians include most banks and insured savings associations, SEC-registered broker-dealers, Commodity Exchange Act-registered futures commission merchants, and certain foreign financial institutions. With a limited exception, for client accounts over which you have custody, you must have a reasonable basis, after due inquiry, for believing that the client (or a designated representative) receives periodic reports directly from the custodian that contain specific information with respect to the funds and securities in custody. With respect to pooled investment vehicles over which you have custody, the qualified custodian must send account statements for the pooled vehicle directly to each investor.

If you have custody of client funds or securities that are held at an unrelated, independent qualified custodian, then you must have a "surprise verification" by an independent public accountant. The independent public accountant must verify the funds and securities in your custody or possession at least once each calendar year, and must then promptly file a “certificate of accounting” with Form ADV-E electronically through IARD.4

If you have custody of client funds or securities that you or a related person maintains as a qualified custodian, then you must also have an internal control report completed by an independent public accountant registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board.

Staff answers to frequently asked questions regarding the custody rule may be found at http://www.sec.gov/divisions/investment/custody_faq_030510.htm.

Requirements for Investment Advisers to Disclose Certain Financial and Disciplinary Information

Registered investment advisers may be required to disclose certain financial and disciplinary information (under Rule 206(4)-4 under the Advisers Act). These requirements are described below.

Registered advisers that have custody or discretionary authority over client funds or securities, or that require prepayment six months or more in advance of more than $1,200 in advisory fees, must promptly disclose to clients and any prospective clients any financial conditions that are reasonably likely to impair their ability to meet their contractual commitments to their clients.

All registered advisers must also promptly disclose any legal or disciplinary events that would be material to a client’s or a prospective client’s evaluation of the adviser’s integrity or its ability to meet its commitments to clients (regardless of whether the adviser has custody or requires prepayment of fees). The types of legal and disciplinary events that may be material include:

  • Criminal or civil actions, where the adviser or a management person of the adviser was convicted, pleaded guilty or “no contest,” or was subject to certain disciplinary actions with respect to conduct involving investment-related businesses, statutes, regulations, or activities; fraud, false statements, or omissions; wrongful taking of property; or bribery, forgery, counterfeiting, or extortion.
     
  • Administrative proceedings before the SEC, other federal regulatory agencies, or any state agency where the adviser’s or a management person’s activities were found to have caused an investment-related business to lose its authorization to do business or where such person was involved in a violation of an investment-related statute or regulation and was the subject of specific disciplinary actions taken by the agency.
     
  • Self-regulatory organization (SRO) proceedings in which the adviser or a management person was found to have caused an investment-related business to lose its authorization to do business; or was found to have been involved in a violation of the SRO’s rules and was the subject of specific disciplinary actions taken by the organization.

Informational Resources Available From the SEC

The SEC provides a great deal of helpful information about the compliance obligations of investment advisers on the SEC’s website at https://www.sec.gov/investment. This information includes links to relevant laws and rules, staff guidance and studies, enforcement cases, and staff no-action and interpretive letters (generally from 2001 — present). In addition, the SEC’s website contains a list of the source materials that were used in preparing this information sheet.

To assist chief compliance officers of investment advisers and investment companies in meeting their compliance responsibilities and to help enhance compliance in the securities industry, the SEC has established the “CCOutreach Program.” This program includes regional and national seminars on compliance issues of concern to CCOs. Information about CCOutreach and any scheduled events is available at http://edgarfeed.sec.gov/info/complianceoutreach.htm.

Finally, the SEC staff regularly receive calls and correspondence concerning the application of the federal securities laws, and advisers and other registrants are encouraged to communicate any questions or issues to SEC staff. To ensure that you reach the right person at the SEC, the SEC’s website lists the names and contact information for SEC staff in the Division of Investment Management who are responsible for responding to communication from the public about specific topics (https://www.sec.gov/investment/contact/divisions-investment-imcontacthtm.html). With respect to issues or questions that arise in the context of a compliance examination by the SEC, advisers are encouraged to raise any questions or issues directly with the SEC examination team, or with examination supervisors in their local SEC office (contact information for senior examination staff is available at http://www.sec.gov/about/offices/ocie/ocie_org.htm).


Additional Information: Reference Materials

The following informational sources may be helpful.

Investment Advisers Are Fiduciaries

Investment Advisers Must Have Compliance Programs

Investment Advisers Are Required to Prepare Certain Reports and to File Certain Reports with the SEC

Investment Advisers Must Provide Clients and Prospective Clients with a Written Disclosure Statement

  • Rule 204-3 under the Advisers Act.
     
  • Use Of Electronic Media By Broker-Dealers, Transfer Agents, and Investment Advisers for Delivery of Information; Additional Examples Under The Securities Act Of 1933, Securities Exchange Act Of 1934, And Investment Company Act, Advisers Act Release No. 1562 (May 9, 1996), available on the SEC’s website at http://www.sec.gov/rules/interp/33-7288.txt.

Investment Advisers Must Have a Code of Ethics Governing Their Employees and Enforce Certain Insider Trading Procedures

  • Section 204A and Rule 204A-1 of the Advisers Act.
     
  • Investment Adviser Codes of Ethics, Advisers Act Release No. 2256 (July 2, 2004), available on the SEC’s website at http://www.sec.gov/rules/final/ia-2256.htm.
     
  • SEC staff no-action letter, Kleinwort Benson Investment Management Limited (pub. avail. Dec. 15, 1993), available on the SEC’s website at http://www.sec.gov/divisions/investment/noaction/kleinwort121593.htm.
     
  • SEC staff no-action letter, Corinne E. Wood (Herbert-Simon Co.) (pub. avail. April 17, 1986), available on the SEC’s website at http://www.sec.gov/divisions/investment/noaction/herbert-simon031886.htm.

Investment Advisers are Required to Maintain Certain Books and Records

  • Rule 204-2 under the Advisers Act and Regulation S-P, privacy rules promulgated under Section 504 of the Gramm-Leach-Bliley Act.
     
  • Privacy of Consumer Financial Information (Regulation S-P), Advisers Act Release No. 1883 (June 22, 2000), which is available on the SEC's website at http://www.sec.gov/rules/final/34-42974.htm.
     
  • Electronic Recordkeeping by Investment Companies and Investment Advisers, Advisers Act Release No. 1945 (May 24, 2001), which is available on the SEC�s website at http://www.sec.gov/rules/final/ic-24991.htm.

Investment Advisers Must Seek to Obtain the Best Price and Execution for Their Clients’ Securities Transactions

  • Section 206 of the Advisers Act.
     
  • Interpretive Release Concerning Scope of Section 28(e) of the Securities Exchange Act of 1934 and Related Matters, Exchange Act Release No. 23170 (Apr. 23, 1986), available on the SEC’s website at http://www.sec.gov/rules/interp/34-23170.pdf.
     
  • Interpretation of Section 206(3) of the Investment Advisers Act of 1940, Advisers Act Release No. 1732 (July 17, 1998), available on the SEC’s website at http://www.sec.gov/rules/interp/ia-1732.htm.
     
  • Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934, Exchange Act Release No. 54165 (July 18, 2006), available on the SEC’s website at http://www.sec.gov/rules/interp/2006/34-54165.pdf.
     
  • In re Thompson and McKinnon, Exchange Act Release No. 8310 (May 8, 1968), available on the SEC’s website at http://www.sec.gov/litigation/opinions/34-8310.pdf.
     
  • In re Mark Bailey and Co., Advisers Act Release No. 1105 (Feb. 24, 1988), available on the SEC’s website at http://www.sec.gov/litigation/admin/ia-1105.pdf.
     
  • In re Kingsley, Jennison, McNulty & Morse, Inc., Advisers Act Release No. 1396 (Dec. 23, 1993), available on the SEC’s website at http://www.sec.gov/litigation/opinions/ia-1396.pdf.
     
  • In re Marvin & Palmer Associates, Inc., Advisers Act Release No. 1841 (Sept. 30, 1999), available on the SEC’s website at http://www.sec.gov/litigation/admin/ia-1841.htm.
     
  • SEC staff no-action letter, United Missouri Bank of Kansas City, N.A. (pub. avail. May 11, 1990), available on the SEC’s website at http://www.sec.gov/investment/noaction/unitedmissouribank012395.htm.
     
  • SEC staff no-action letter, SMC Capital, Inc. (pub. avail. Sept. 5, 1995), available on the SEC’s website at http://www.sec.gov/divisions/investment/noaction/smccapital090595.htm.
     
  • SEC staff no-action letter, Pretzel & Stouffer (Dec. 1, 1995), available on the SEC’s website at http://www.sec.gov/divisions/investment/noaction/pretzelstouffer120195.htm.

Requirements for Investment Advisers’ Contracts with Clients

Investment Advisers May be Examined by the SEC Staff

Requirements for Investment Advisers that Vote Proxies of Clients’ Securities

Requirements for Investment Advisers that Advertise their Services

  • Section 206 and Rule 206(4)-1 under the Advisers Act.
     
  • SEC staff no-action letter, Clover Capital Management, Inc. (pub. avail. Oct. 28, 1986), available on the SEC’s website at http://www.sec.gov/divisions/investment/noaction/clovercapital102886.htm.
     
  • SEC staff no-action letter, Investment Company Institute, (pub. avail. Sept. 23, 1988), available on the SEC’s website at http://www.sec.gov/divisions/investment/noaction/ici092388.htm.
     
  • SEC staff no-action letter, Mandell Financial Group. (pub. avail. May 21, 1997), available on the SEC’s website at http://www.sec.gov/divisions/investment/noaction/mandell052197.htm.

Requirements for Investment Advisers that Pay Others Cash to Solicit New Clients

Requirements for Investment Advisers that have Custody or Possession of Clients' Funds or Securities

Requirements for Investment Advisers to Disclose Certain Financial and Disciplinary Information


1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any publication or statement by any of its employees. The views expressed herein are those of the staff and do not necessarily reflect the views of the Commission or the other staff members of the SEC.

2 This information sheet contains descriptions of the Advisers Act, rules, Commission releases, court decisions, Commission orders and opinions, which impose or explain legal obligations. It also contains staff interpretations and no-action letters that have been issued by the Division of Investment Management. Staff interpretations and no-action letters provide informal interpretative and advisory assistance and represent the views of persons who are continuously working with the provisions of the Advisers Act. Opinions expressed by the staff, however, are not an official expression of the Commission’s views and they do not have the force of law. You may wish to speak with an attorney or a compliance professional about specific provisions and how they apply to your firm. This information is current as of June 2007.

3 A complete report contains: the title and type of security; the exchange ticker symbol or CUSIP number; the number of shares, and principal amount of the security; the name of any broker, dealer or bank where the access person has an account that holds securities for the access person's direct or indirect benefit; and the date the access person submits the report.

4 There are exceptions to this requirement. For example, an adviser is not required to provide regular account statements with respect to a registered investment company or a limited partnership (or another type of pooled investment vehicle) that is subject to an audit at least annually and that distributes its audited financial statements prepared in accordance with generally accepted accounting principles (GAAP) to all investors, generally within 120 days of the end of its fiscal year (under Rule 206(4)-2).

 

http://www.sec.gov/divisions/investment/advoverview.htm


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