Investment Adviser Guide

The following information is intended to be a brief overview concerning the investment adviser industry. Topics include definitions, characteristics of an investment adviser, regulators, application process, licensing periods, record keeping requirements, custody of client funds or securities, disclosure requirements, conflicts of interest, and regulator audits. This discussion does not purport to cover all aspects of the industry or all regulator requirements. You are urged to obtain and review the federal or state laws and rules that may apply to your activities.

  • Investment Adviser & Investment Adviser Representative Registration
  • Filings
  • Licensing Period
  • Recordkeeping
  • Custody
  • Disclosure
  • Fiduciary Duty
  • Audits
  • Conclusion
  • See also: IA FAQ

Investment Adviser and Investment Adviser Representative Registration
Investment advisers (“IA”) and investment adviser representatives (“IAR”) are persons who provide advice to others about investments for a fee and are required by most states to register or become licensed. Some states use the term “register” and others use the term “license.” For purposes of this Guide, the two have the same meaning.

Three essential elements that characterize an investment adviser are:

  • Provides advice or analysis about securities either by making direct or indirect recommendations to clients or by providing research or opinions on securities or securities markets.
  • Receives compensation in any form for the advice provided.
  • Engages in a regular business of providing advice about securities.

Advisers must register or become licensed with either state or federal securities regulators, based on the following:

State-registered Investment Advisers:

  • Have less than $100,000,000 in assets under management.
  • State investment adviser registrants also include investment advisers offering services that solely include financial planning or soliciting clients on behalf of other advisers.

Federally covered advisers:

  • Have $100,000,000 or more in client assets under regular and ongoing management and can also include:
    • Advisers to investment companies under the Investment Company Act of 1940; 
    • Advisers that providing services in 15 or more states;
    • Advisers that are pension consultants providing investment advice to employee benefit plans, governmental plans and/or church plans with respect to assets of plans having an aggregate value of at least $200 million.
    • Advisers that operate almost exclusively through an interactive web site (“internet advisers”).
  • Federally covered advisers must make a notice filing with the state if they have a place of business in the state or have six or more clients in that state in a twelve-month period, regardless of place of business. Certain employees of federally covered advisers may be required to register as investment adviser representatives. It is important to note that the investment adviser firm holds the registration/license but the investment adviser representatives is the individual who performs services on behalf of the registered/licensed investment adviser firm. Certain employees of federally covered advisers may be required to register as investment adviser representative . Some states include within the definition of an IAR a person (often called a solicitor) who regularly refers customers to an IA and who receives compensation for those referrals. Other states may have modified licensing requirements for solicitors.


Filings

An investment adviser and an investment adviser representative have a great deal of influence over the financial affairs of others – the clients. For that reason, state securities offices take an interest in how the investment adviser does its job. All states (except Wyoming), as well as the District of Columbia and Puerto Rico each have a registration or licensing requirement for investment advisers. State securities regulators may require:

  • State advisers to register or become licensed.
  • Federally covered advisers to make a notice filing of their Form ADV.
  • A passing score on a competency examination for each individual acting as an investment adviser representative or on behalf of a state-registered investment adviser firm.
  • Payment of a fee for processing the applications.
  • Certain disclosures to the state securities regulator and/or the public.
  • Registration of branch offices of the adviser.
  • A bond or minimum net capital.

Application for registration/licensing is made by:

  • Filing a complete Form ADV with the state in which one wants to offer services.
  • Providing any state-specific forms required.
  • Filing a Form U-4 application for each investment adviser representative who will provide services on behalf of the investment adviser.
  • Passing score on a competency examination or holding a qualified professional designation.
  • Remitting all required fees for the investment adviser and the investment adviser representative(s).
  • States require electronic filing via the Investment Adviser Registration Depository (IARD). See: How to Access IARD

A notice filing for a federal covered adviser is usually made by:

  • Filing a complete copy of its Form ADV as filed with the U.S. Securities and Exchange Commission.
  • Filing a Form U-4 application for each investment adviser representative who will provide services on behalf of the investment adviser.
  • Payment of any required notice filing fees.

The SEC requires electronic filing via the Investment Adviser Registration Depository (IARD).

Licensing Period
Investment advisers and investment adviser representatives must renew their registration/license annually. In many states, the term is from January 1 to December 31 of a given year. However, some states have different renewal dates. Check with the state securities office in each state where you intend to do business. If an adviser becomes registered/licensed in the middle of a year, the fee is usually not prorated.

States send out a notice to renew a registration or license some time in advance of the end of the year. Check with each state for specific details. The renewal process for investment advisers will be handled via IARD.

Recordkeeping

An adviser is required generally to maintain and keep current the records listed below. Additional recordkeeping requirements may also be set by the home state of the adviser. It will be necessary to check with the home state regulator.

Records generally required of all state-registered investment advisers pursuant to individual state securities statutes and regulations:

  • Receipts and Disbursements Journals
  • General Ledger
  • Order Memoranda
  • Bank Records
  • Bills and Statements
  • Financial Statements
  • Written Communications and Agreements (including electronic transmissions)
  • List of Discretionary Accounts
  • Advertising
  • Personal Transactions of Representatives and Principals
  • Client Records:
    • Powers Granted by Clients
    • Disclosure Statements
    • Solicitors’ Disclosure Statements
    • Performance Claims
    • Customer Information Forms and Suitability Information
    • Written Supervisory Procedures

Records required of advisers who have custody of client assets:

  • Journals of Securities Transactions and Movements
  • Separate Client Ledgers
  • Copies of Confirmations
  • Record by Security Showing Each Client’s Interest and Location Thereof

Records required of advisers that manage client assets:
(These records generally are required to be maintained in an easily accessible place for a period of five years from the end of the fiscal year during which the last entry was made and, for the first two years, the records must be maintained in the adviser’s principal office.)

  • Client Purchases and Sales History
  • Current Client Securities Position

Custody
If an adviser has direct or indirect access to client funds or securities, it is considered to have custody of client funds and is subject to additional scrutiny. State-registered investment advisers and applicants for state investment adviser registration should become familiar with the custody requirements in the state(s) in which they are registered or seeking registration.  States have either adopted the NASAA model custody rule or language similar to either the NASAA model custody rule or the SEC custody rule.  In September 2011, NASAA approved amendments to its custody model rule, aligning it closely to the SEC custody rule.  It is important to note that while there are two NASAA custody model rules (Model Rule 102(e)(1)-1 under the 1956 Uniform Securities Act and Model Rule USA 2002 411(f)-(1) under the 2002 Uniform Securities Act) the rules are identical: 1956 model custody rule, as amended  and 2002 model custody rule and known as the “NASAA model custody rule.”

As part of registration and audit/examination review, state securities regulators will require advisers to show how clients assets are handled by asking the following questions:

  • Has the adviser complied with the rules relating to safeguarding client assets in the adviser’s custody?
  • Does the Form ADV reflect that the adviser has custody?
  • Are these assets maintained in segregated accounts?
  • Does the adviser maintain the required records of client assets in its custody?
  • Does the client get an itemized statement at least every three months showing the assets in the adviser’s custody and the activity in the account?
  • Has a surprise audit of client assets has been conducted at least annually by an independent accountant?
  • If the adviser has discretionary authority over the client’s account, is there any evidence of excessive trading, self-dealing, preferential treatment, unsuitable recommendations, unauthorized transactions or incomplete disclosure?

Disclosure
The most important duty of an investment adviser is the disclosure of all information relating to the relationship between an adviser and a client. Advisers have great leeway in tailoring their client services as long as clients know up-front about such things as:

  • What kinds are services are available?
  • Who is providing those services?
  • What fees and other expenses will the client be subject to and are they negotiable?
  • Is the adviser being compensated from other sources?
  • Is the adviser affiliated with another adviser, a broker-dealer or an issuer of securities?
  • Can you implement a financial plan anywhere or do you only get to keep the plan if you implement it through the adviser?
  • What other potential conflicts of interest exist that might affect the adviser’s recommendations?

The key document in making these disclosures is Part 2A of Form ADV, often referred to as the adviser’s brochure (note that FORM ADV Part 2A replaced FORM ADV Part II in 2011). This document should clearly spell out the details of the advisory relationship and other business interests of the adviser. This is the reference tool with which the client or potential client can compare advisory firms for cost of services and for compatibility with their needs. That is why investment advisory regulations require that Part 2A of Form ADV or the brochure be given to customers in advance or no later than the time of entering into a contract if rescission is permitted within a specifically allotted time. State securities regulators also require FORM ADV Part 2B filings (“the brochure supplement”) from individuals providing advice to customers.

Examiners will look for disclosure-related items not only in the disclosure document but in any material describing any facet of the adviser’s business that a client or potential client might see. This can include:

  • Advertising
  • Seminar materials
  • Web sites
  • Print, radio and TV ads
  • Bulk mailings
  • Contracts
  • Fee schedules
  • Portfolio reviews

Fiduciary Duty
The anti-fraud provisions of the Investment Advisers Act of 1940, the NASAA Model Rule on Unethical Business Practices of Investment Advisers, Investment Adviser Representatives, and Federally Covered Advisers (NASAA Model Rule 102(a)(4)-1), and most state laws impose a duty on investment advisers to act as fiduciaries in dealings with their clients. Many states impose these requirements as part of their unethical business practices rules, or through other rules or caselaw. Fiduciary duty requires the adviser to hold the client’s interest above its own in all matters. Conflicts of interest should be avoided at all costs. However, there are some conflicts that will inevitably occur, such as a person being licensed as a securities agent of a broker-dealer as well as an adviser. In these instances, the adviser must take great pains to clearly and accurately describe those conflicts and how the adviser will maintain impartiality in its recommendations to clients. The SEC has said that an adviser has a duty to:

  • Make reasonable investment recommendations independent of outside influences
  • Select broker-dealers based on their ability to provide the best execution of trades for accounts where the adviser has authority to select the broker-dealer.
  • Make recommendations based on a reasonable inquiry into a client’s investment objectives, financial situation and other factors
  • Always place client interests ahead of its own.

When examiners review advisory books and records, they will be on the lookout for undisclosed or misrepresented conflicts of interest and prohibited practices. Some are obvious and some not so obvious. Some examples of practices that advisers should avoid are:

  • Acting as an issuer or affiliate of an issuer of securities
  • Recommending unregistered, non-exempt securities or the use of unlicensed broker-dealers
  • Any activity that acts as a fraud or deceit on clients
  • Charging unreasonable fees
  • Failing to disclose to all customers the availability of fee discounts
  • Using contracts which seek to limit or avoid an adviser’s liability under the law (hedge clauses)
  • Limiting a client’s options with regard to the pursuit of a civil case or arbitration
  • Borrowing money from or lending money to clients
  • Other situations which require disclosure of the conflict include, but are not limited to:
    • The adviser or its employees are also acting as a broker-dealer and/or securities agent
    • The adviser is receiving transaction-based compensation, including 12b-1 or other marketing fees, related to securities recommended to its clients
    • The adviser receives any type of compensation from any source for soliciting or referring clients to another adviser or a broker- dealer.
    • Hidden fees in the form of undisclosed service charges, wrap fees or expenses reimbursed by other parties.

The examiner will view perceived conflicts from the point of view of the customer; was the disclosure or lack of disclosure a factor in the client’s decision to use an adviser’s services or ratify an adviser’s recommendations? Was the customer misled? Was the customer placed at a disadvantage or taken unfair advantage of as a result of the conflict and the adviser’s compliance with disclosure requirements? The burden of proof lies with the adviser.

Audits
IA firms are subject to periodic, sometimes unannounced, audits by regulators. The purpose of an audit is to determine compliance with the regulator’s licensing, books and records, and anti-fraud requirements.

A 2013 survey of state securities regulators has revealed the top five problems noted in audits and examinations:

1. Books and Records
2. Registration
3. Contracts
4. Privacy
5. Brochure delivery

Conclusion
As you can see from these materials, being involved in the investment adviser industry requires attention to detail and knowledge of your regulator’s laws and rules. Consult with the securities regulator in your state, or with the SEC if appropriate, to determine the exact requirements for you or your firm.