Now that we’ve covered the registration process for investment advisers, let’s look at situations where a person can avoid registration. The rules and regulations from the previous chapters don’t apply when an exemption or exclusion applies. If you want a full refresher, use the link above. Here are the key definitions:
Those examples involve securities, but the same idea applies to investment advisers. Both exemptions and exclusions are exceptions to the rules, but they apply for different reasons.
A person who is exempt from investment adviser registration does meet the definition of an investment adviser. However, they aren’t required to register because the Uniform Securities Act (USA) and/or North American Securities Administrators Association (NASAA) rules specifically carve out an exemption.
These are the exemptions you’ll want to know for the exam:
Snowbird/vacation rule
If an adviser has no place of business in a state and only deals with existing clients who are temporarily in that state (non-residents), the adviser doesn’t have to register in that state. This rule was introduced earlier in a broker-dealer chapter, and it works the same way for investment advisers. Use the link if you want a refresher.
*The vacation rule and the institution rule (discussed below) were both referred to as exclusions for broker-dealers. Although the rules are essentially the same for investment advisers, it’s referred to as an exemption here. The difference is purely based on how the USA is written and is generally not an important test point.
Institution rule
If an adviser has no place of business in a state and only provides advisory services to institutions in that state, the adviser is exempt from registration in that state. This is another rule that also appeared in the earlier broker-dealer chapter.
De minimis rule
An investment adviser can avoid registration in a state if both of these conditions are met:
Known as the de minimis rule*, this exemption lets an adviser work with a small number of retail clients (investors) in a state without registering there. As long as the adviser doesn’t maintain an office in the state and keeps the number of retail clients to five or fewer in a 12-month period, the exemption applies.
There’s no limit on the number of institutional clients (as discussed under the institution rule).
*De minimis is Latin for “of minimal things.”
The de minimis rule applies to both investment advisers and investment adviser representatives (IARs), but not broker-dealers or agents. Even if a broker-dealer and/or agent has one retail client permanently located in a state, registration is required.
Private fund advisers
A private fund is similar to a mutual fund, but it’s generally offered only to a small group of wealthy investors. It’s also private, meaning it isn’t available to the general public. Hedge funds are closely related and are sometimes grouped under private funds. The exam usually doesn’t focus on the detailed characteristics of these funds, so the key is understanding how registration works for advisers to these funds.
Before 2011, private fund advisers (investment advisers that manage private funds) often avoided regulatory oversight, including registration. Regulators generally place less emphasis on protecting larger, wealthier investors, assuming they have the resources and sophistication to evaluate and tolerate the risks involved.
The Dodd-Frank Wall Street Reform Act (Dodd-Frank) was discussed in a previous chapter. Among other changes, Dodd-Frank removed a long-standing exemption for private fund advisers. Federal rules began requiring registration and disclosures for many of these advisers. Soon after, NASAA adopted its own version of the rule.
Private fund advisers with less than $150 million in assets under management (AUM) can still rely on a registration exemption, but they must file periodic reports with the Securities and Exchange Commission (SEC). Advisers with $150 million or more in AUM must register with the SEC as a federal-covered adviser.
In either case, state registration is not involved. At most, a larger private fund adviser may need to submit a notice filing to the state administrator (if the adviser is subject to SEC registration as a federal-covered adviser). For exam purposes, it’s fair to treat private fund advisers as generally exempt* from state registration.
*You’ll also see federal-covered advisers listed as an exclusion below. However, the private fund adviser exemption may result in an adviser being federal-covered. Federal-covered advisers are referred to as an exclusion in one rule, and an exemption in another. It seems like a contradiction, but this is how the law is written. Don’t worry about it, though! It’s not an important distinction for the exam.
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