The Advisor's Professional Library

Recent Changes in the Regulatory Landscape

January 1, 2012

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June 22, 2011 marked a major shift in the regulatory environment. The SEC adopted rules for implementing the Dodd-Frank Act, yet they did not take these actions unilaterally. These necessary actions substantiate core provisions of the Dodd-Frank Act. According to SEC Chairperson Mary L. Schapiro, “These rules will fill a key gap in the regulatory landscape.”

Changes to the Investment Advisers Act

As was mentioned on several occasions in this book, rules are created to interpret legislation passed by Congress. The SEC’s new rules enforced Congress’ legislative intent in passing the Dodd-Frank Act. Many changes to the Investment Advisers Act were authorized by Title IV of the Dodd-Frank Act.

Among other changes, the new rules:

  • reallocated oversight of certain mid-sized advisors to state securities regulators;
  • made changes to Form ADV and its instructions;
  • repealed the private advisor exemption found in section 203(b)(3) of the Investment Advisers Act; and
  • provided a new definition of assets under management.

The new rules help the SEC to identify which RIAs must make the transition to state registration.

Impact of Dodd-Frank on Mid-Sized Advisors

The Dodd-Frank Act created a new RIA category referred to as “mid-sized advisors”, and it shifted primary responsibility for regulatory oversight of mid-sized advisors to the states. Mid-sized advisors are defined as those firms with assets under management that range from $25 million to $100 million.

The SEC adopted Rule 203A-5 to ease the transition from SEC to state registration. Mid-sized advisors registered with the SEC as of July 21, 2011, must remain registered with the Commission until January 1, 2012. All advisors registered with the SEC as of January 1, 2012, regardless of size, must file a one-time amendment to their Form ADV no later than March 30, 2012. This filing generally coincides with the advisor’s annual updating amendment filing if their fiscal year ends in December and will require them to update all of the items in Form ADV. Mid-sized advisors no longer eligible for SEC registration must switch to state oversight and withdraw their federal registrations by June 28, 2012. Since Wyoming does not regulate RIAs, an investment advisor with its principal place of business in that state, must be SEC-registered unless the firm is exempt from registration with the Commission.

Before switching from SEC to state registration, however, a mid-sized advisor should refer to the investment advisory laws for that state to determine if the firm is exempt from registration. If the mid-sized advisor is not required to register with the securities regulator of the state in which the firm maintains its place of business, it should remain SEC-registered. Mid-sized advisors should also remain SEC registered if the state in which the firm maintains its principal place of business does not subject advisors to an examination. For example, New York does not currently conduct examinations of advisors, so mid-sized RIAs domiciled in that state must be SEC-registered. It remains to be seen if other states will not be conducting examinations of RIAs.

Rule 203A-2 contains exemptions from the prohibition on SEC registration. The start-up exemption applies to advisory firms who expect to be eligible for SEC registration within 120 days of their registration approval date. There is a multi-state exemption for RIAs required to register in at least 15 states. RIAs in that category may choose to register or remain registered with the SEC.

Rule 203A-1 was adopted to prevent an RIA from being forced to frequently switch between SEC and state registration as the value of its assets under management change. The SEC has set up a buffer zone for mid-sized RIAs with assets under management which rise above or fall below the $100 million threshold. The new rule raised the threshold to $110 million, at which time the advisor must register with the SEC. If an advisor is already SEC-registered, the firm does not need to withdraw its registration until its assets under management fall beneath the $90 million threshold.

Mid-sized advisors eligible for a Rule 203A-2 exemption, along with advisors to a registered investment company or business development company under the Investment Company Act, may not rely on the buffer. Those entities are required to register with the SEC, regardless of the amount of their assets under management. In addition, those advisors that register with the SEC because they expect to have $100 million in assets under management within 120 days may not rely upon the buffer.

Multi-State Advisors

Under the new rules, the SEC amended the multi-state advisor exemption to align the rule with the Dodd-Frank requirements. This exemption now permits all investment advisors required to register as an investment advisor with fifteen or more states to register with the SEC. The previous requirement was that the advisor needed to be registered in at least thirty states.

An RIA relying on the multi-state advisor exemption must withdraw from SEC registration when it is no longer required to be registered in at least fifteen states. Advisors are only required to assess their eligibility for SEC registration annually.

As we saw in Differences Between State and SEC Regulation of Investment Advisors, NASAA launched a coordinated review program on November 29, 2011, easing the transition process for RIAs switching from SEC to state registration. The program is available to SEC-registered investment advisory firms who must switch to state registration in four to fourteen states.

Regulatory Assets under Management

The new Form ADV instructions refer to “regulatory assets under management,” instead of the traditional term, “assets under management.” Regulatory assets under management include securities portfolios for which RIAs provide continuous and regular supervisory or management services.

Assets must be included in the calculation, even if they are:

  • family or proprietary assets;
  • assets managed without compensation of any kind; or
  • assets of foreign clients.

Revised instructions to Form ADV require an RIA to calculate its regulatory assets under management on a gross basis. An RIA may not deduct any unpaid outstanding loans or other accrued liabilities. An RIA should not deduct securities purchased on margin when calculating regulatory assets under management. The SEC’s rationale is that it does not matter if a client has borrowed money for purchasing a portion of the regulatory assets under management.

The SEC’s intent was to provide a uniform method for calculating assets under management to maintain consistency for registration purposes and risk assessment. Using a uniform method for calculating assets under management prevents RIAs from excluding assets in order to avoid registration or to remain state registered. In addition, the uniform method is intended to prevent inconsistent application of the Investment Advisers Act to RIAs managing the same amount of assets.

When the SEC implemented its new rules, they also revised the Form ADV instructions. RIAs must now provide the specific number of employees who are IARs or licensed insurance agents, whereas in the past, Form ADV required RIAs to select from a range of numbers. RIAs must also report the number and types of clients receiving advisory services. An approximate number of clients is acceptable if the firm has over 100 clients, and the approximate number of clients who are not United States persons must be reported.

There are new categories for business development companies, other investment advisers, and insurance companies. The RIA must answer questions regarding the types of clients it advises, specify the percentage each client type comprises in relation to the total number of clients, and report the approximate percentage of regulatory assets under management attributed to each client type.

Registration Changes

As a result of the SEC’s new rules, pension consultants may be forced to transition from SEC to state registration. Only pension consultants providing investment advice to plans with assets exceeding $200 million may remain SEC-registered. Until now, a pension consultant was permitted to be SEC-registered if it provided investment advice to plans with $50 million or more in assets.

Family offices are entities established by affluent families for wealth-management and other services to members of the family. Historically, family offices were not required to register with the SEC, because there was an exemption provided to investment advisors with fewer than fifteen clients. This fifteen client exemption was repealed, so that the SEC could regulate hedge fund and other private advisors. Under the new rules, however, certain family offices still do not need to be registered as investment advisors.

A family office will be excluded from registration under the Investment Advisers Act if it:

  • is wholly owned by family clients and is exclusively controlled by family members and/or family entities;
  • does not hold itself out as an investment advisor to the public; and
  • only provides investment advice to “family clients” as defined by the rule.

Generally, the term “family members” includes all lineal descendants of a common ancestor who are no more than ten generations removed from the youngest generation of family members. Lineal descendants include adopted children, stepchildren, foster children of a common ancestor, and descendants’ spouses or spousal equivalents. The family office is also permitted to advise key employees, charities, and certain family trusts, without losing its exemption from registration.

Those family offices not qualifying for the exclusion must register with either the SEC or the appropriate state securities regulator by March 30, 2012.

Hedge Funds and Private Equity Funds

As previously noted, advisors to hedge funds and private equity funds were entitled to a registration exemption if they had fewer than fifteen clients or funds and did not hold themselves out as investment advisers. These formerly-exempt advisors have until March 30, 2012, to register with the SEC, and the application must be filed by February 14, 2012, allowing forty-five days to review it.

The SEC also revised Form ADV instructions guiding advisors of private funds in determining their regulatory assets under management. The following steps must be taken by the advisor.

  • The firm must include the value of any private fund over which it exercises continuous and regular supervisory or management services.
  • The firm must include the amount of any uncalled capital commitments made to a private fund managed by the adviser.
  • The firm must utilize the market value of private fund assets or the fair value of private fund assets where market value is unavailable.

This third instruction prevents an investment advisor from electing to value its assets based on their cost, which is likely to be lower than valuing assets based on their market value. As previously mentioned, the advisor must use the fair value of fund assets where market value is not available.

Amendments to Form ADV are intended to gather detailed information from advisors of private funds. This information includes conflicts of interest and identification of key service providers.

There were three new exemptions from registration created for advisors of private funds. These exemptions apply to:

  1. advisors solely to venture capital funds;
  2. advisors that only give advice to private funds with less than $150 million in assets under management; and
  3. certain foreign advisors that have no place of business in the U.S.

The first two groups in this list are referred to as exempt reporting advisors. Even though they are not required to register with the SEC, exempt reporting advisors are subject to strict reporting, recordkeeping, and other compliance obligations. Although exempt reporting advisors file the same Form ADV as RIAs, they only need to respond to certain items and questions. Exempt reporting advisors must file their first Form ADV between January 1, 2012 and March 30, 2012.

The Big Picture

Cost of compliance plays a major role in decisions made by advisory firms. In situations where an RIA has the ability to choose between state or SEC registration, the firm may try to anticipate which regulatory oversight will be less burdensome. For example, some state securities regulators are conducting examinations of RIAs registered in that state, but do not have an office there. Historically, the state where an RIA has its principal place of business conducts any examinations that occur. If an RIA may be subject to examinations by some or all of the states in which it is registered, the firm may choose SEC registration if it qualifies for the multi-state advisor exemption.

Conversely, if regulatory oversight of SEC-registered investment advisors becomes oppressive, a firm might choose to remain state registered for as long as possible. It might even turn down clients if their assets will make the difference between state and SEC registration.

Les Abromovitz

Les Abromovitz

Les Abromovitz is the author of The Investment Advisor’s Compliance Guide, published by The National Underwriter Company/ALM Media.

An attorney and member of the Pennsylvania bar, Les has handled hundreds of consulting and publishing projects for National Compliance Services,, a leading compliance and regulatory services firm. He has conducted a number of seminars and training sessions dealing with compliance subjects. Les is also the author of several white papers that analyze compliance issues impacting Registered Investment Advisors (RIAs)‎.

To contact Mr. Abromovitz, email or call 561-330-7645 Ext. 213‎.