Laws & Regulations

Investment Advisers Act of 1940

The Investment Advisers Act of 1940 is the primary federal statute governing investment advisers. It establishes the regulatory framework for the registration, conduct, and oversight of persons and firms that provide investment advice for compensation. This is one of the most heavily tested areas on the Series 65 exam, and you should have a thorough understanding of its key provisions.

Definition of Investment Adviser

Under Section 202(a)(11) of the Act, an investment adviser is any person or firm that:

1. Provides advice about securities (or issues reports or analyses concerning securities), AND
2. Is in the business of providing such advice (not just an occasional recommendation), AND
3. Receives compensation for such advice (does not need to be a separate fee; can be part of overall compensation).

All three elements must be present for a person to meet the definition. This is known as the "ABC test": Advice, Business, Compensation.

Exclusions from the Definition

Certain persons are excluded from the definition of investment adviser. Exclusions are built into the statute itself—these persons are simply NOT investment advisers. Key exclusions include:

• Banks and bank holding companies: Banks are excluded because they are already regulated by banking authorities. However, this exclusion does NOT extend to separately identifiable departments or divisions of banks that provide investment advice.
• Lawyers, accountants, engineers, and teachers: These professionals are excluded IF their investment advice is solely incidental to their primary profession and they receive no special compensation for the advice. A CPA who offers investment advice as a primary service (not incidental to accounting) would not qualify for this exclusion.
• Broker-dealers: Excluded IF their investment advice is solely incidental to their brokerage business and they receive no special compensation for the advice. A broker-dealer who charges a separate advisory fee or holds itself out as a financial adviser would NOT qualify for this exclusion.
• Publishers of general circulation: Newspapers, magazines, and financial publications of general and regular circulation are excluded. However, personalized investment advice (such as a newsletter tailored to individual subscribers) would not qualify. The key test is from Lowe v. SEC (1985): the publication must be of general and regular circulation and not provide personalized advice.
• Government securities advisers: Persons who advise exclusively on U.S. government securities.
• Nationally Recognized Statistical Rating Organizations (NRSROs): Credit rating agencies like S&P, Moody's, and Fitch.

Exemptions from Registration

Exemptions are different from exclusions. An exempt person IS an investment adviser but is exempt from the registration requirement. They are still subject to the anti-fraud provisions of the Act. Key federal exemptions include:

• Intrastate advisers: Advisers whose clients are all residents of the state where the adviser maintains its principal office, who do not advise on securities listed on a national exchange, and who do not advise investment companies.
• Advisers to insurance companies: Advisers whose only clients are insurance companies.
• Foreign private advisers: Advisers that have no place of business in the United States, fewer than 15 U.S. clients and investors in U.S. private funds, and less than $25 million in AUM attributable to U.S. clients.
• Private fund advisers: Advisers solely to private funds with less than $150 million in AUM in the United States.
• Venture capital fund advisers: Advisers solely to venture capital funds.

State Registration vs. SEC Registration

The National Securities Markets Improvement Act of 1996 (NSMIA) divided registration responsibilities between the SEC and state regulators based on assets under management (AUM). This prevents dual registration and streamlines the regulatory framework.

The AUM Threshold

• SEC registration required: Advisers with $100 million or more in AUM must register with the SEC. Advisers become eligible for SEC registration at $100 million and are required to register with the SEC at $110 million (this $100M-$110M range is a "buffer zone" to prevent frequent switching).
• State registration required: Advisers with less than $100 million in AUM generally must register with their state(s). They are prohibited from registering with the SEC unless they qualify under another provision.

Exceptions Permitting SEC Registration Below $100M

Certain advisers with less than $100 million in AUM may or must register with the SEC:

• Advisers to registered investment companies: Any adviser to a registered investment company (mutual fund) must register with the SEC regardless of AUM.
• Multi-state advisers: Advisers required to register in 15 or more states may choose SEC registration instead.
• Pension consultants: Advisers providing advice to ERISA plans with at least $200 million in plan assets.
• Internet advisers: Advisers who provide advice exclusively through an interactive website and have fewer than 15 non-internet clients in the preceding 12 months.
• Advisers located in states without registration requirements: If an adviser's home state does not have an IA registration statute, SEC registration is permitted.

Uniform Securities Act (USA) Provisions for IAs

The Uniform Securities Act (USA) is a model state securities law that has been adopted (with variations) by most states. For investment advisers, the USA provides:

• State registration requirement: IAs that do not qualify for SEC registration must register with the state(s) where they maintain offices and/or have clients.
• De minimis exemption: An IA with no place of business in a state and having 5 or fewer clients in that state during the preceding 12 months is generally exempt from registering in that state (provided the adviser does not hold itself out to the general public as an IA in that state).
• Net worth and bonding requirements: States may impose minimum net worth or bonding requirements on advisers, particularly those with custody of client assets or who charge prepaid fees.
• Consent to service of process: Advisers registering in a state must file a consent to service of process, which appoints the state administrator to receive legal documents on the adviser's behalf.

Form ADV: Registration and Disclosure

Form ADV is the uniform form used by investment advisers to register with both the SEC and state securities authorities. It is filed electronically through the Investment Adviser Registration Depository (IARD) system. Form ADV has multiple parts, each serving a different purpose.

Form ADV Part 1

Part 1 contains administrative and organizational information about the advisory firm. It is filed with regulators (not delivered to clients) and includes:

• Item 1: Identifying information (name, address, CRD number, SEC file number).
• Item 2: SEC registration status.
• Item 3: Form of organization (corporation, LLC, partnership, sole proprietor).
• Item 4: Successions and changes in ownership.
• Item 5: Information about the advisory business (AUM, number of clients, types of clients, compensation arrangements).
• Item 6: Other business activities.
• Item 7: Financial industry affiliations and private fund reporting.
• Item 8: Participation in client transactions.
• Item 9: Custody information.
• Item 10: Control persons (owners with 25%+ interest).
• Item 11: Disciplinary history (DRPs — Disclosure Reporting Pages).

Form ADV Part 2A (Brochure)

Part 2A is the narrative brochure that must be delivered to clients. It provides detailed information about the firm's advisory services, fees, conflicts of interest, disciplinary history, and business practices. As discussed in Chapter 8, the brochure must be delivered before or at the time of entering into an advisory contract, and updated annually.

Form ADV Part 2B (Brochure Supplement)

Part 2B provides information about specific advisory personnel who provide advice to the client, including educational and business background, disciplinary information, other business activities, and compensation structure.

Wrap Fee Programs (Appendix 1)

Advisers who sponsor wrap fee programs must deliver a wrap fee program brochure (Form ADV Part 2A, Appendix 1) instead of the standard brochure. A wrap fee program bundles advisory services, brokerage execution, and custody into a single fee (usually a percentage of AUM). The wrap fee brochure must disclose the fee structure, the services included, the potential conflicts of interest (e.g., the adviser may have an incentive to trade less because doing so costs less), and how the program compares to paying separately for each service.

Recordkeeping Requirements

Rule 204-2 under the Investment Advisers Act specifies the books and records that SEC-registered investment advisers must create and maintain. These records must be kept in an easily accessible location and made available for SEC examination.

Required Records

Investment advisers must maintain the following records:

• Journals: Records of all cash receipts and disbursements.
• General and auxiliary ledgers: Including all asset, liability, reserve, capital, income, and expense accounts.
• Memoranda of orders: Records of all orders given for the purchase or sale of securities, including date, terms, and the person who recommended the trade.
• Bank records: Checkbooks, bank statements, cancelled checks, and cash reconciliations.
• Bills and statements: All bills or statements (paid or unpaid) relating to the business.
• Financial statements: Trial balances, financial statements, and internal audit working papers.
• Written communications: Originals of all communications received and copies of all communications sent by the adviser relating to recommendations, advice given, securities transactions, client accounts, and findings of the adviser's code of ethics review.
• Client records: A list of all accounts, powers of attorney, advisory contracts, and discretionary authority documentation.
• Advertising: All advertisements distributed, including performance claims and hypothetical illustrations.
• Solicitor records: Written agreements with solicitors and disclosure documents provided to prospects by solicitors.
• Code of Ethics records: The code itself, records of violations and actions taken, and personal securities reporting records.

Retention Periods

Most records must be maintained for 5 years from the end of the fiscal year in which the last entry was made. During the first 2 years of this period, the records must be kept in the adviser's principal office in an easily accessible place.

Important exceptions:

• Partnership articles and corporate documents: Must be maintained for at least 3 years after termination of the enterprise.
• Advisory contracts: Must be maintained for at least 5 years after the termination of the contract.
• Electronic storage: Records may be kept electronically if the storage system preserves the records accurately, provides easy access, and allows for easy reproduction.

Advertising Rules

The SEC's Marketing Rule (Rule 206(4)-1, adopted in 2020 and effective November 2022) replaced the prior advertising and solicitation rules under the Investment Advisers Act. The new rule modernized the regulatory framework for adviser advertising, including the use of testimonials, endorsements, and performance presentations.

General Prohibitions

Under the Marketing Rule, an advertisement may NOT include:

• Untrue statements of material fact: Any false or misleading claim.
• Unsubstantiated material claims: Material claims that cannot be substantiated at the time the advertisement is disseminated.
• Untrue or misleading implications: Statements that are technically true but create a misleading impression.
• Omission of material facts: Leaving out information that would be necessary to make the advertisement not misleading.
• Cherry-picked performance: Presenting certain profitable trades or time periods while omitting others to create a misleading picture of the adviser's track record.
• Material claims without a reasonable basis: The adviser must have a reasonable basis for believing it will be able to substantiate any material claim.

Testimonials and Endorsements

Under the previous rule, testimonials were strictly prohibited in advertisements. The new Marketing Rule permits testimonials and endorsements with specific conditions:

• Clear and prominent disclosure: The advertisement must disclose whether the person providing the testimonial or endorsement is a client, whether they were compensated, and any material conflicts of interest.
• Written agreement: For compensated endorsers (including solicitors), a written agreement is required.
• Oversight: The adviser must have a reasonable basis for believing the testimonial or endorsement complies with the rule.
• Disqualification: Persons subject to certain disciplinary events are barred from serving as endorsers.

Performance Presentation

The Marketing Rule establishes specific requirements for presenting investment performance in advertisements:

• Net performance: If gross performance is shown, net performance must also be shown with at least equal prominence.
• Time periods: Performance must be shown for 1-year, 5-year, and 10-year periods (or since inception if shorter), each ending at the most recent practicable date.
• No cherry-picking: Performance cannot be presented for a selected time period that creates a misleading impression.
• Hypothetical performance: May be shown only if the adviser adopts policies and procedures reasonably designed to ensure the performance is relevant to the likely financial situation and investment objectives of the intended audience. Hypothetical performance may NOT be included in advertisements distributed to a mass audience.
• Predecessor performance: An adviser may show predecessor performance if there is sufficient continuity of personnel and investment processes.

Political Contributions, Cybersecurity, and Business Continuity

Political Contributions (Pay-to-Play Rule)

The SEC's Rule 206(4)-5 (the "pay-to-play rule") is designed to prevent investment advisers from obtaining advisory contracts with government entities (such as public pension funds) through political contributions. The rule includes:

• Two-year "time out": If a covered associate of an adviser makes a political contribution to an official who can influence the selection of an adviser for a government entity, the adviser is prohibited from receiving compensation for advisory services from that government entity for two years from the date of the contribution.
• De minimis exception: Covered associates may contribute up to $350 per election to officials for whom they can vote and $150 per election to other officials without triggering the two-year time-out.
• Covered associates: The rule applies to the adviser's executives, employees who solicit government entities, and anyone who supervises such solicitors.
• Third-party solicitation restrictions: Advisers cannot use third parties (placement agents) to solicit government entities unless the third party is a registered broker-dealer or investment adviser and is itself subject to a pay-to-play rule.

Cybersecurity

While there is no single comprehensive federal cybersecurity rule for investment advisers, the SEC has increasingly emphasized cybersecurity through guidance, enforcement actions, and examination priorities. Advisers are expected to:

• Conduct risk assessments: Identify and assess cybersecurity risks to client data and advisory operations.
• Implement policies and procedures: Adopt written cybersecurity policies addressing access controls, data encryption, incident response, vendor management, and employee training.
• Protect client data: Under Regulation S-P and Regulation S-ID (Identity Theft Red Flags), advisers must safeguard nonpublic personal information and have identity theft prevention programs.
• Incident response: Have plans for responding to cybersecurity breaches, including client notification procedures.

Business Continuity Planning

Investment advisers are expected to maintain business continuity plans (BCPs) that address how the firm will continue to operate and serve clients during disruptions such as natural disasters, pandemics, cyberattacks, or other emergencies. While there is no specific Advisers Act rule mandating BCPs, the SEC views business continuity planning as part of an adviser's fiduciary duty and compliance obligations.

Key elements of a BCP include:

• Identification of critical business functions and systems
• Backup and recovery procedures for data and records
• Alternative communication methods with clients and employees
• Succession planning for key personnel
• Regular testing and updating of the plan