Up to this point, we have focused on the firm itself, which is the Registered Investment Advisor (RIA). In this chapter, we will focus on the individuals who give advice on behalf of the firm. These individuals are Investment Advisor Representatives (IARs). In this book, the initials “RIA” will always refer to the firm and “IAR” always applies to the person giving advice.
The term, “advisor,” might apply to both the entity and the individual. For example, when a statement is made that advisors must act ethically, one really should not distinguish between the firm and the individuals. Stating that RIAs must act ethically might cause some readers to infer that IARs do not owe a similar duty.
Title III of NSMIA, which we discussed in Differences Between State and SEC Regulation of Investment Advisors, dictates that states may not require the registration, licensing, or qualification of SEC-registered investment advisory firms. States may, however, license, register, or otherwise qualify IARs who do business in that state. In addition, states retain the authority to investigate and bring enforcement actions in cases of fraud or deceit committed by SEC-registered firms and their associated persons.
In the case of state-registered investment advisory firms, there is a national de minimus standard. That standard prohibits any state from requiring the registration, licensing, or qualification of an RIA if the firm does not have a place of business located in the state and had five or fewer clients residing there during the prior twelve months.
As was mentioned in Differences Between State and SEC Regulation of Investment Advisors, only states, and not the SEC, register or license IARs. Members of both state and SEC registered firms may be required to register with the states in which they provide investment advice. According to the SEC’s study dealing with investment advisors and broker-dealers issued in January 2011, there were more than 275,000 IARs registered in various states as of September 30, 2010. Generally, IARs will not be required to register or become licensed in a state if their firms do not have a place of business there and have fewer than six clients residing in the state during the prior twelve months.
In almost every state, registration as an IAR is accomplished by filing a Form U4, which is the Uniform Application for Securities Industry Registration. Form U4 is filed on the Central Registration Depository (CRD) system. Individuals who are already registered representatives for broker-dealers will amend their U4s if they become IARs of an advisory firm. New York has its own version of Form U4, and Wyoming does not register IARs.
Most states require an IAR to pass the Series 65 exam—a difficult test, administered by FINRA that demonstrates whether someone has the basic knowledge needed to become an IAR. An individual usually has two years after passing the Series 65 exam to become licensed, and the exam remains valid for the entire time the person maintains his or her license. Alternatively, an IAR may pass the Series 66 and the Series 7 exams instead of taking the Series 65 exam.
Some states allow for the substitution of credentials, like the Certified Financial Planner (CFP) designation, in lieu of passing an exam. In Wisconsin, for example, individuals holding one of the following designations can claim a waiver from the exam requirement:
- CFP®--Certified Financial Planner
- ChFC®--Chartered Financial Consultant
- PFS--Personal Financial Specialist
- CFA--Chartered Financial Analyst
- CIC--Chartered Investment Counselor
Individuals must be members in good standing of the organization that awards the designation.
Aside from passing an exam or holding a particular designation, IARs may also be required to file an application, pay a fee, and undergo a background check. In some states, solicitors are required to be registered as IARs. A solicitor is any person who, directly or indirectly, solicits clients for, or refers clients to, an RIA. Insurance agents, bankers, accountants, and attorneys often act as solicitors.
Typical IAR Registration Requirements
Wisconsin’s requirements are typical of the rules requiring registration of IARs. This state’s securities law changed in 2009 and defines an IAR as anyone who is employed by or associated with an RIA who:
- makes recommendations or gives advice on securities;
- manages accounts of clients;
- holds himself or herself out as providing investment advice; or
- is compensated for soliciting clients for an investment adviser.
This definition does not include a clerical or ministerial employee.
As a general rule, Wisconsin considers any person providing advice on a specific client’s portfolio, whether directly or indirectly, or who discusses the performance of the portfolio or the RIA’s recommendations, to be acting as an IAR. A person who reviews a particular client’s account, makes recommendations to another RIA but never actually speaks with the client, must still register as an IAR. Because the advice is specific to a particular client’s needs and portfolio, the IAR is viewed as providing advice to a Wisconsin client.
In contrast, a member of an investment committee, which makes generic decisions on an RIA’s recommendations with no consideration given as to which clients hold or should hold such securities, is not transacting business or providing advice for Wisconsin clients. Therefore, that person does not need to be registered as an IAR.
In Wisconsin and in many other states, there is an exclusion from the definition of IAR if a supervised person does not have a place of business in Wisconsin and has no more than five clients who are natural persons—a legal term for human beings. IARs of SEC-registered RIAs that have no place of business in Wisconsin do not need to be registered, regardless of the number of clients. In contrast, IARs of state-registered advisory firms with no place of business in Wisconsin would be required to register there if they have more than five clients.
According to Wisconsin’s securities law, a solicitor may meet the definition of IAR if the person is a supervised employee of the RIA. As such, the solicitor must pass the same examinations as any other IAR.
A third party solicitor is a person who is not a partner, officer, director or employee of an RIA or a supervised person. Wisconsin’s statute stipulates that anyone who complies with Rule 206(4)-3 under the Investment Advisers Act and who solicits or refers fewer than ten Wisconsin residents to any one RIA within a calendar year, is not considered to be “soliciting.” Table 3-1 includes general principles for IAR registration in any state.
Table 3-1. General IAR State Registration Principles
The following general principles apply to registering as an IAR in all states. Note that the requirements for registration and maintaining the registration do vary from state to state.
Each state has the following requirements for IARs doing business in their state:
• Registration and/or licensure.
• Those who are federally covered advisers must make a notice filing of their Form ADV.
• Each individual acting as an investment adviser or investment adviser representative must achieve a passing score on a competency examination.
• Payment of fees for processing the applications.
• Certain disclosures to the securities agency and/or the public.
• Registration of branch offices of the adviser.
• A bond or minimum net capital.
The Big Picture
There are severe penalties imposed upon firms and individuals who dispense investment advice without properly registering. When individuals launch an advisory firm, they must avoid marketing themselves or the firm as investment advisors before they are approved and the registration process is completed
Among others, CPAs and attorneys should be especially careful that they are only providing investment advisory services that are incidental to their profession. Otherwise, they may be subject to investment advisors registration requirements. One accountant recently found himself in hot water with state securities regulators for allegedly providing more than just incidental investment advice. He had been providing similar advice for several decades.
In some states, applicants who are registering as IARs are automatically approved. If there are disciplinary items on their application, however, the state securities regulator will take a closer look and may require additional information regarding the disciplinary issue.
It is extremely important that RIAs keep detailed client lists that specify where each client resides. Otherwise, IARs may not realize that they are required to be registered in a particular state. Conversely, IARs may waste time and money if they register in states where they are exempted from registration.