Exemptions

Now that we’ve thoroughly discussed the registration process for investment advisers, let’s go through the circumstances that allow a person to avoid registration. The rules and regulations covered in the previous five chapters do not apply if an exemption or exclusion exists. Click the previous link if you need a full refresher, but here are the definitions:

The examples listed above relate to securities, but the same concept applies to investment advisers. Both exemptions and exclusions are exceptions to the rules, but for different reasons.

Exemptions

A person exempt from investment adviser registration technically meets the definition of an investment adviser. However, they’re not subject to registration requirements due to a specific mention in the Uniform Securities Act (USA) and/or North American Securities Administrators Association (NASAA) rules. These are the relevant exemptions to be aware of for the exam:

• Snowbird/vacation rule
• Institution rule
• De minimis rule
• Private fund advisers

Snowbird/vacation rule
If an adviser has no place of business in a state and only engages existing clients that are temporarily in that state (non-resident), no registration is required. We originally discussed this rule in a previous broker-dealer chapter, and the same applies to investment advisers*. Click the previous link if you need a full 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 engages institutions in that state, they are exempt from registration. This is another example of a rule discussed in a previous broker-dealer chapter that also applies to investment advisers. Click the previous link if you need a full refresher.

De minimis rule
Investment advisers can avoid registration in a state if these two conditions are met:

• No place of business in the state
• Maintains 5 or fewer retail clients in a 12-month period

Known as the de minimis rule*, this exemption allows an adviser to obtain a small group of retail clients (investors) in a state without registering in that state. As long as the adviser doesn’t maintain an office in the state and keeps the group to a maximum of five retail investors, the exemption applies. Keep in mind there’s no limit to the number of institutional clients, as discussed above.

*De minimis is Latin for “of minimal things.”

The de minimis rule is applicable 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 is generally only available to a small group of wealthy investors. Additionally, it’s private and not available to the general public. Hedge funds are very similar, and are even sometimes lumped into the category of private funds. The exam tends to avoid the specific characteristics of these funds, so don’t get too caught up in the details.

Prior to 2011, private fund advisers (investment advisers that manage private funds) largely avoided regulatory oversight, including registration. Securities regulators don’t pay too much concern to protecting larger and wealthier investors, even though these investment opportunities can be subject to high levels of risk. It’s assumed these investors have access to significant resources and are sophisticated enough to understand and withstand the risks of such investments.

We discussed the impact of the Dodd-Frank Wall Street Reform Act (usually referred to as Dodd-Frank) in a previous chapter. In addition to defining different types of investment advisers, Dodd-Frank removed a long-standing exemption for private fund advisers. Instead of virtually ignoring these advisers, federal regulations now subjected them to registration and disclosure requirements. Soon after the federal rules were updated, the North American Securities Administrators Association (NASAA) adopted their own version of the rule.

Private fund advisers overseeing less than $150 million of assets under management (AUM) still maintain a registration exemption, but are required to make periodic reports to the Securities and Exchange Commission (SEC). Those with $150 million or more of AUM must register with the SEC as a federal-covered adviser. Regardless of the situation, state registration is never involved. At the very most, a larger private fund adviser may be required to provide a notice filing to the state administrator (assuming they’re subject to registration as a federal-covered adviser). Therefore, it’s safe to say private fund advisers are 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.