Title IV of the Dodd-Frank Act includes many of the amendments to the Investment Advisers Act implemented by the Dodd-Frank Act. These amendments include provisions that reallocate responsibility for oversight of investment advisers by delegating generally to the states responsibility over certain mid-sized advisers, i.e., those that have between $25 and $100 million of assets under management. These provisions will require a significant number of advisers currently registered with the SEC to withdraw their registrations with the SEC and to switch to registration with one or more state securities authorities. An analysis of the SEC’s proposed rules (Release No. IA-3110) is set forth below.

Section 203A of the Investment Advisers Act generally prohibits an investment adviser regulated by the state in which it maintains its principal office and place of business from registering with the SEC unless it has at least $25 million of assets under management, and preempts certain state laws regulating advisers that are registered with the SEC. This provision, enacted in 1996 as part of the National Securities Markets Improvement Act, or NSMIA, eliminated the duplicative regulation of advisers by the SEC and state securities authorities, making the states the primary regulators of smaller advisers and the SEC the primary regulator of larger advisers.

Section 410 of the Dodd-Frank Act creates a new group of “mid-sized advisers” and shifts primary responsibility for their regulatory oversight to the state securities authorities. It does this by prohibiting from registering with the SEC an investment adviser that is registered as an investment adviser in the state in which it maintains its principal office and place of business and that has assets under management between $25 million and $100 million. Unlike a small adviser, a mid-sized adviser is not prohibited from registering with the SEC:

  • if the adviser is not required to be registered as an investment adviser with the securities commissioner (or any agency or office performing like functions) of the state in which it maintains its principal office and place of business;
  • if registered, the adviser would not be subject to examination as an investment adviser by that securities commissioner; or
  • if the adviser is required to register in 15 or more states.

Section 203A(c) of the Investment Advisers Act, which was not amended by the Dodd-Frank Act, permits the SEC to exempt advisers from the prohibition on SEC registration, including small and mid-sized advisers, if the application of the prohibition from registration would be “unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes” of section 203A. Under this authority, the SEC has adopted six exemptions from the prohibition on registration. As a consequence of section 410 of the Dodd-Frank Act, the SEC estimates that approximately 4,100 SEC-registered advisers will be required to withdraw their registrations and register with one or more state securities authorities.

Transition to State Registration

The SEC is proposing a new rule, rule 203A-5, which would require each investment adviser registered with the SEC on July 21, 2011 to file an amendment to its Form ADV no later than August 20, 2011, 30 days after the July 21, 2011 effective date of the amendments to section 203A, and to report the market value of its assets under management determined within 30 days of the filing. This filing would be the first step by which an adviser no longer eligible for SEC registration would transition to state registration. It would require each investment adviser to determine whether it meets the revised eligibility criteria for SEC registration, and would provide the SEC and the state regulatory authorities with information necessary to identify those advisers required to transition to state registration and to understand the reason for the transition or basis for continued SEC registration. An adviser no longer eligible for SEC registration would have to withdraw its SEC registration by filing Form ADV-W no later than October 19, 2011 (60 days after the required refiling of Form ADV). The SEC expects to cancel the registration of advisers that fail to file an amendment or withdraw their registrations in accordance with the rule. Finally, the proposed rule would permit the SEC to postpone the effectiveness of, and impose additional terms and conditions on, an adviser’s withdrawal from SEC registration if the SEC institutes certain proceedings before the adviser files Form ADV-W.

The SEC proposes to use its exemptive authority under section 203A(c) to provide for a transitional process with two “grace periods,” the first providing 30 days from the July 21, 2011 effective date of the Dodd-Frank Act for an adviser to determine whether it is eligible for SEC registration and to file an amended Form ADV, and the second providing an additional 60 days (following the end of the first 30-day period) for an adviser to register in the states and to arrange for its associated persons to qualify for investment adviser representative registration, which may include preparing for and passing an examination, before withdrawing from SEC registration. The SEC is proposing a 90-day transition process, which is shorter than the 180-day transition period that SEC rules currently provide for advisers switching from SEC to state registration, in order to promptly implement this Congressional mandate and accommodate the processing of renewals and fees for state registration and licensing via the IARD system, while allowing for an orderly transition.

Since the enactment of the Dodd-Frank Act, SEC staff have received inquiries from state-registered advisers and advisers registering for the first time expressing concern that they might be required to register with the SEC (because their assets under management are more than $30 million) only to have to withdraw their registration next year when the SEC implements section 410 of the Dodd-Frank Act (raising the threshold for SEC registration to $100 million of assets under management). To avoid such regulatory burdens, the SEC will not object if any state-registered or newly registering adviser is not registered with the SEC if, on or after January 1, 2011 until the end of the transition process (which would be October 19, 2011 under proposed rule 203A-5), the adviser reports on its Form ADV that it has between $30 million and $100 million of assets under management, provided that the adviser is registered as an investment adviser in the state in which it maintains its principal office and place of business, and it has a reasonable belief that it is required to be registered with, and is subject to examination as an investment adviser by, that state. Such advisers should remain registered with, or in the case of a newly registering adviser, apply for registration with, the state securities authorities.

Amendments to Form ADV

Item 2 of Part 1A of Form ADV requires each investment adviser applying for registration to indicate its basis for registration with the SEC and to report annually whether it is eligible to remain registered. Item 2 reflects the current statutory threshold for registration with the SEC as well as SEC current rules. The SEC proposes to revise Item 2 to reflect the new statutory threshold and the revisions the SEC proposes to make to related rules as a result of the Dodd-Frank Act. More specifically, the SEC proposes to amend Item 2 to require each adviser registered with the SEC (and each applicant for registration) to identify whether, under section 203A, as amended, it is eligible to register with the SEC because it:

  • is a large adviser (having $100 million or more of regulatory assets under management);
  • is a mid-sized adviser that does not meet the criteria for state registration and examination;
  • has its principal office and place of business in Wyoming (which does not regulate advisers) or outside the United States;
  • meets the requirements for one or more of the exemptive rules under section 203A of the Act (as proposed to be amended);
  • is an adviser (or subadviser) to a registered investment company;
  • is an adviser to a business development company and has at least $25 million of regulatory assets under management; or
  • has some other basis for registering with the SEC.

The SEC also expects to modify the IARD system, which is used to register investment advisers with applicable state or federal authorities, to prevent an applicant from registering with the SEC, and an adviser from continuing to be registered with the SEC, unless it represents that it meets the eligibility criteria set forth in the Investment Advisers Act and the SEC rules.

Assets Under Management

In most cases, the amount of assets an adviser has under management will determine whether the adviser must be registered with the SEC or the states. Section 203A(a)(2) of the Investment Advisers Act defines “assets under management” as the “securities portfolios” with respect to which an adviser provides “continuous and regular supervisory or management services.” Instructions to Form ADV provide advisers with guidance in applying this provision, including a list of certain types of assets that advisers may (but are not required to) include. The SEC is proposing revisions to these instructions in order to implement a uniform method to calculate assets under management that can be used under the Investment Advisers Act for purposes in addition to assessing whether an adviser is eligible to register with the SEC. The SEC also proposes to amend rule 203A-3 to continue to require that the calculation of “assets under management” for purposes of Section 203A be the calculation of the securities portfolios with respect to which an investment adviser provides continuous and regular supervisory or management services, as reported on the investment adviser’s Form ADV.

The SEC proposes to require all advisers to include in their regulatory assets under management securities portfolios for which they provide continuous and regular supervisory or management services, regardless of whether these assets are proprietary assets, assets managed without receiving compensation, or assets of foreign clients, all of which an adviser currently may (but is not required to) exclude. In addition, the SEC would not allow an adviser to subtract outstanding indebtedness and other accrued but unpaid liabilities, which remain in a client’s account and are managed by the adviser.

The SEC is proposing changes in order to preclude some advisers from excluding certain assets from their calculation and thus remaining below the new assets threshold for registration with the SEC. The changes would result in some advisers reporting greater assets under management than they do today, but the assets the SEC would require advisers to include in their assets under management are, in fact, assets managed by the adviser and allowing advisers to exclude such assets may have substantially more significant regulatory consequences than when the rules were first adopted. The SEC believes the management of such assets, for example, may suggest that the adviser’s activities are of national concern or have implications regarding the reporting for the assessment of systemic risk, a matter Congress considered important in enacting amendments to the Investment Advisers Act in the Dodd-Frank Act. The SEC, moreover, is proposing that advisers be required to include these assets so that the calculations would be more consistent among advisers. The SEC also believes that requiring that these assets be included in the calculation would better achieve the objective of the Dodd-Frank Act regarding which advisers must register with the SEC, which advisers must register with the states, and which advisers are exempt from SEC registration.

Switching Between State and SEC Registration

Rule 203A-1 currently contains two means of preventing an adviser from having to switch frequently between state and SEC registration as a result of changes in the value of its assets under management or the departure of one or more clients. First, the rule provides for a $5 million buffer that permits an investment adviser having between $25 million and $30 million of assets under management to remain registered with the states and does not subject the adviser to cancellation of its SEC registration until its assets under management fall below $25 million. Second, the rule permits an adviser to rely on the firm’s assets under management reported annually in the firm’s annual updating amendments for purposes of determining its eligibility to register with the SEC, allowing an adviser to avoid the need to change registration status based upon fluctuations that occur during the course of the year. If an adviser is no longer eligible for SEC registration, the rule provides a 180-day grace period from the adviser’s fiscal year end to allow it to switch to state registration.

The SEC proposal would amend rule 203A-1 to eliminate the $5 million buffer for advisers having between $25 million and $30 million of assets under management, but to retain the ability of an adviser to avoid the need to change registration status based upon intra-year fluctuations in its assets under management for purposes of determining its eligibility to register with the SEC. The SEC believes the current buffer seems unnecessary in light of Congress’s determination generally to require most advisers having between $30 million and $100 million of assets under management to be registered with the states. Moreover, at this time, the SEC believes it is not necessary to increase the $100 million threshold in order to provide a similar buffer for advisers crossing that threshold and becoming registered with the SEC under the amended statutory provisions. The SEC believes that the requirement that advisers only assess their eligibility for registration annually and the grace periods provided to switch to and from state registration will be sufficient to address the concern that an investment adviser with assets under management approaching $100 million or affected by changes in other eligibility requirements will frequently have to switch between state and federal registration.

Exemptions from the Prohibition on Registration with the SEC

Section 203A(c) of the Investment Advisers Act provides the SEC with the authority to permit investment advisers to register with the SEC even though they would be prohibited from doing so otherwise. Under this authority, the SEC has adopted six exemptions in rule 203A-2 from the prohibition on registration. The SEC believes its authority under this provision was unchanged by the Dodd-Frank Act and therefore extends to the new mid-sized adviser category in section 203A(a)(2) of the Act, as amended. As a result, as currently drafted, each of these exemptions would, by its terms, apply to mid-sized advisers–exempting them from the prohibition on registering with the SEC if they meet the requirements of rule 203A-2. The SEC is proposing amendments to three of the exemptions to reflect developments since their adoption, including the enactment of the Dodd-Frank Act.

NRSROs. The SEC proposes an amendment to eliminate the exemption in rule 203A-2(a) from the prohibition on SEC registration for nationally recognized statistical rating organizations, or NRSROs. Since the SEC adopted this exemption, Congress amended the Investment Advisers Act to exclude NRSROs from the Investment Advisers Act and provided for a separate regulatory regime for NRSROs under the Securities Exchange Act of 1934, or Exchange Act. Only one NRSRO remains registered as an investment adviser under the Act and reports that it has more than $100 million of assets under management and thus would not rely on the exemption.

Pension Consultants. The SEC proposes to amend the exemption available to pension consultants in rule 203A-2(b) to increase the minimum value of plan assets from $50 million to $200 million. Pension consultants typically do not have “assets under management,” but the SEC has required these advisers to register with it because their activities have a direct effect on the management of large amounts of pension plan assets. The SEC had the threshold at $50 million of plan assets for these advisers to ensure that, in order to register with the SEC, a pension consultant’s activities are significant enough to have an effect on national markets. The SEC proposes to increase this threshold to $200 million in light of Congress’s determination to increase from $25 million to $100 million the amount of “assets under management” that requires all advisers to register with the SEC. This threshold would maintain a ratio to the statutory threshold that is the same as the ratio of the $50 million plan asset threshold and $25 million assets under management threshold currently in place. As a result, advisers currently relying on the pension consultant exemption advising plan assets of less than $200 million may be required to register with one or more states.

Multi-state Advisers. The SEC proposes to amend the multi-state adviser exemption to align the rule with the multi-state exemption Congress built into the mid-sized adviser provision under section 410 of the Dodd-Frank Act. Under rule 203A-2(e), the prohibition on registration with the SEC does not apply to an investment adviser that is required to register in 30 or more states. Once registered with the SEC, the adviser remains eligible for SEC registration as long as it would be obligated, absent the exemption, to register in at least 25 states. The Dodd- Frank Act provides that a mid-sized adviser that otherwise would be prohibited may register with the SEC if it would be required to register with 15 or more states.

The SEC believes that this provision of the Dodd-Frank Act reflects a Congressional view on the number of states with which an adviser must be required to be registered before the regulatory burdens associated with such regulation warrant registration solely with the SEC and application of the preemption provision. Thus, the SEC is reconsidering the threshold of its multi-state exemption, and proposes to amend rule 203A-2(e) to permit all investment advisers required to register as an investment adviser with 15 or more states to register with the SEC. The SEC also proposes to eliminate the provision in the rule that permits advisers to remain registered until the number of states in which they must register falls below 25 states, and it is not proposing a similar cushion for the 15-state threshold. The Dodd-Frank Act contains no such cushion for mid-sized advisers. The SEC also believes that the requirement that advisers only assess their eligibility for registration annually and the grace periods provided to switch to and from state registration may be sufficient to address the concern that an investment adviser required to register in 15 states would frequently have to switch between state and federal registration.

Elimination of Safe Harbor. Rule 203A-4 provides a safe harbor from SEC registration for an investment adviser that is registered with the state securities authority of the state in which it has its principal office and place of business, based on a reasonable belief that it is prohibited from registering with the SEC because it does not have sufficient assets under management. Investment advisers have not, in the SEC’s experience, asserted, as a defense, the availability of this safe harbor, which protects only against enforcement actions by the SEC and not any private actions, and the SEC is not proposing to extend it to the higher threshold established by the Dodd-Frank Act. This rule was designed for smaller advisory businesses with assets under management of less than $30 million, which may not employ the same tools or otherwise have a need to calculate assets as precisely as advisers with greater assets under management. The SEC views it as unlikely that an adviser would be reasonably unaware that it has more than $100 million of regulatory assets under management when it is required to report its regulatory assets under management on Form ADV.

Mid-Sized Advisers. Section 203A(a)(2) of the Investment Advisers Act, as amended by the Dodd-Frank Act, will prohibit mid-sized advisers from registering with the SEC, but only if:

  • the adviser is required to be registered as an investment adviser with the securities commissioner (or any agency or office performing like functions) of the state in which it maintains its principal office and place of business; and
  • if registered, the adviser would be subject to examination as an investment adviser by such commissioner, agency, or office.

Mid-Sized Advisers—Required to be Registered. The Dodd-Frank Act does not explain how to determine whether a mid-sized adviser is “required to be registered” or is “subject to examination” by a particular state securities authority. The SEC proposes to incorporate into Form ADV an explanation of how it construes these provisions. Under section 203A(a)(1) of the Investment Advisers Act, an adviser that is not regulated or required to be regulated as an investment adviser in the state in which it has its principal office and place of business must register with the SEC regardless of the amount of assets it has under management. The SEC has interpreted “regulated or required to be regulated” to mean that a state has enacted an investment adviser statute, regardless of whether the adviser is actually registered in that state. This interpretation has two relevant consequences. First, advisers with a principal office and place of business in Wyoming, or in foreign countries, must register with the SEC regardless of whether they have assets under management and would not otherwise be eligible for one of the SEC’s exemptive rules. Second, some smaller advisers exempt from state registration are not subject to registration with either the SEC or any of the states.

The SEC believes that Congress was concerned with the latter consequence when it passed this provision of the Dodd-Frank Act. The bills originally introduced and passed in the House and Senate increased up to $100 million the threshold for SEC registration under the “regulated or required to be regulated” standard that is used today in section 203A(a)(1). Accordingly, some advisers with a significant amount (more than $25 million) of assets under management could have escaped oversight by either the SEC or any of the states by taking advantage of state registration exemptions. Perhaps to avoid this possibility, the Conference Committee included a provision to prohibit a mid-sized adviser from registering with the SEC if, among other things, it is “required to be registered” as an adviser with the state securities authority where it maintains its principal office and place of business. A mid-sized adviser that can and does rely on an exemption under the law of the state in which it has its principal office and place of business such that it is “not required to be registered” with the state securities authority must register with the SEC, unless an exemption from registration with the SEC otherwise is available. An adviser not registered under a state adviser statute in contravention of the statute, however, would not be eligible for registration with the SEC.

The SEC is proposing changes to Form ADV to require a mid-sized adviser filing with the SEC to affirm, upon application and annually thereafter, that it is not required to be registered as an adviser with the state securities authority in the state where it maintains its principal office and place of business. An adviser reporting that it is no longer able to make such an affirmation thereafter would have 180 days from its fiscal year end to withdraw from SEC registration. Thus, the rule would operate to permit an adviser to rely on this affirmation reported in its annual updating amendments for purposes of determining its eligibility to register with the SEC.

Mid-Sized Advisers-Subject to Examination. Not all state securities authorities conduct compliance examinations of advisers registered with them. Congress therefore determined to require a mid-sized adviser to register with the SEC if the adviser is not subject to examination as an investment adviser by the state in which the adviser has its principal office and place of business.

The SEC does not intend either to review or evaluate each state’s investment adviser examination program. Instead, the SEC will correspond with each state securities commissioner (or official with similar authority) and request that each advise the SEC whether an investment adviser registered in the state would be subject to examination as an investment adviser by that state’s securities commissioner (or agency or office with similar authority). The SEC believes that the states, being most familiar with their own circumstances, are in the best position to determine whether advisers in their state are subject to examination. Using the responses that the SEC receives, the SEC will identify for advisers filing on IARD the states in which the securities commissioner did not certify that advisers are subject to examination and incorporate that list into IARD to ensure that only mid-sized advisers with their principal office and place of business in one of those states (or, as discussed above, mid-sized advisers that are not registered with the states where they maintain their principal office and place of business) will register with the SEC.

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