Federalism can be a real pain in the neck sometimes. While the duality of both state and federal government has endured and served our country well, it has made investment advisor registration at the state level a mix of hard-to-find statutes, non-intuitive exceptions and revenue grabs. The most notable of these state-by-state registration quirks is the infamous “de minimis” exemption from registering as an investment advisor in a particular state.
The National De Minimis Standard, as it is officially referred to, is contained in Section 222(d) of the Investment Advisers Act of 1940. It traces its roots back to 1997, the year that the National Securities Markets Improvement Act of 1996 (commonly referred to as “NSMIA”) became effective. Through NSMIA, the SEC channeled the Founding Fathers by adopting a coordinated regulatory balance between the SEC and the various state securities regulators.
Don’t get me wrong: NSMIA did clear up and parse out what was previously a complicated web of conflicting mandates. But it also left the door open just wide enough for states to assert their powers in several important ways.
But let’s back up a step and start with the de minimis standard in all its glory:
No law of any State or political subdivision thereof requiring the registration, licensing, or qualification as an investment adviser shall require an investment adviser to register with the securities commissioner of the State (or any agency or officer performing like functions) or to comply with such law (other than any provision thereof prohibiting fraudulent conduct) if the investment adviser—
(1) does not have a place of business located within the State; and
(2) during the preceding 12-month period, has had fewer than 6 clients who are residents of that State.
Translation: an investment advisor that does not have a place of business in Texas (for example) and does not have more than five clients in Texas may not be required by Texas to register or become licensed there. A place of business in Texas or more than five clients residing in Texas nullifies the de minimis exemption.
What this doesn’t mean is that Texas has no jurisdictional authority whatsoever over such an investment advisor. To the contrary – and this is the open door I referred to earlier – Texas actually retains quite a bit of authority to, among other things:
- Require notice filings in Texas
- Require fees to be paid to Texas
- Enforce Texas anti-fraud provisions
I used Texas in my example for a reason: Texas is one of a handful of states that requires an out-of-state investment advisor to file notice and pay fees even if the advisor has only one client residing in Texas. Check out the Texas State Securities Board’s FAQs for a helpful explanation, specifically question and answer 1.A.9:
So, you might ask, didn't NSMIA create a national de minimis exemption from investment advisor registration?
[…] If an investment adviser does not have a place of business (See FAQ 1.A.10) located in Texas and, during the preceding 12 month period, had no more than five clients (See FAQ 1.A.11) who are Texas residents, the investment adviser is not required to register with the Texas Securities Commissioner. See Rule 116.1(b)(2)(A)(iv). However, a notice filing and fee are required. See Rule 116.1(b)(2)(C) and FAQ 1.A.12…
Touché Texas, touché.
New Hampshire takes a slightly different approach by acknowledging the de minimis licensing exemption for state-registered investment advisors, but it does not acknowledge the same exemption for SEC-registered investment advisers (refer to its notice here):
[SEC-registered investment advisers] are not subject to the investment adviser licensing provisions of the State of New Hampshire. Every federal covered adviser doing business in New Hampshire must file a notice and pay a fee prior to conducting investment adviser business in New Hampshire. There is no "de minimis" exception from the notice filing requirement.
Most if not all other states take the simpler route and don’t bother with out-of-state advisors with five or fewer clients residing in their state. I vaguely used “most if not all” because I haven’t taken the time to pore over each and every state’s securities laws, lest I start bleeding directly from my eyes. Texas, Louisiana, and New Hampshire are the three most well-known de minimis oddities as far as I'm aware.
For transient or virtual advisors, it’s at least worth noting how the SEC defines “place of business” for purposes of Section 222(d):
(1) An office at which the investment adviser regularly provides investment advisory services, solicits, meets with, or otherwise communicates with clients; and
(2) Any other location that is held out to the general public as a location at which the investment adviser provides investment advisory services, solicits, meets with, or otherwise communicates with clients.
A Missouri-registered adviser that resides and primarily works out of his home in Missouri but occasionally meets with two Illinois clients in a pay-by-the-hour shared office in Illinois will squarely fall within the inevitable gray area of this definition. Like many definitions, whether the advisor has a “place of business” in Illinois will ultimately require a judgment call to determine if Illinois registration is required. In this hypothetical scenario, the frequency of such meetings will be the key.
NSMIA undoubtedly simplified the regulatory interplay between the SEC and the states, but the de minimis standard is but one example of how the states can and have asserted their independent authority.
Eat your heart out, James Madison.