A person excluded from a legal definition of an investment adviser is not subject to registration, rules, or regulations typically applicable to advisory firms. The USA explicitly mentions the following investment adviser exclusions:
Investment adviser representatives (IARs)
We learned how agents are excluded from the definition of a broker-dealer in a previous chapter. Agents are the registered employees of a broker-dealer, not the broker-dealer themselves. The same concept applies here. IARs are not the firms (investment advisers) they work for. A natural person (human being) representing a business is not the business itself!
Certain professionals providing incidental advice
This is the specific language from the USA regarding this exclusion:
A lawyer, accountant, engineer, or teacher whose performance of these services is solely incidental to the practice of his profession [is excluded from the definition of an investment adviser]
When the USA was written, there were four distinct professions named for this exclusion. Most test takers remember this as the LATE exclusion - Lawyers, Accountants, Teachers, and Engineers. These professionals can give “incidental” investment advice and still avoid being considered an investment adviser. What exactly is incidental? Let’s first start with the dictionary definition:
Let’s assume a lawyer is hired to file suit against another party and wins the lawsuit, resulting in their client receiving a significant sum of money. They advise their client to invest that money into a safe, short-term security until they find some long-term use for it.
On the surface, it certainly seems the lawyer meets the definition of an investment adviser. They gave advice related to securities while being compensated by their client. However, is the client hiring them for their investment advice or for their legal expertise? If the argument can be made the securities advice is “on the side” and not what the client is paying for, this exclusion can be applied (only to LATE professionals).
It is absolutely possible a lawyer, accountant, teacher, or engineer could be considered as an investment adviser. If the securities advice isn’t incidental, they meet the definition. For example, what if the lawyer we discussed above started offering financial plans involving securities as a separate service? If the client is paying directly for investment advice, the product or service is no longer incidental.
Broker-dealers and agents
A similar exclusion to the LATE rule exists for broker-dealers and agents. According to the USA:
A broker-dealer or its agent whose performance of these services is solely incidental to the conduct of its business as a broker-dealer and who receives no special compensation for them [is excluded from the definition of an investment adviser].
It’s not uncommon for advice to be provided while executing securities transactions. For example, assume a customer calls their registered agent to buy a security. They mention a specific stock and ask the agent if the investment should be made given their financial situation. The agent states the security is suitable and recommends the trade. The customer buys the stock through the agent and pays a commission.
This should feel familiar - the agent is providing investment advice while being compensated by the client. But, what exactly is a commission? It’s payment for executing a transaction. Commissions typically exist regardless of whether the trade was based on a recommendation (known as a solicited trade) or not (known as an unsolicited trade). It’s considered the cost of fulfilling a transaction request, not payment for securities advice.
This doesn’t mean broker-dealers and/or agents are never considered investment advisers. If an advisory fee is charged on top of the commission, the exclusion doesn’t apply. To be legally compliant in this scenario, the broker-dealer and agent should be dual-registered as an investment adviser and IAR (respectively).
Media programs
According to the USA:
A publisher of any bona fide newspaper, news column, newsletter, news magazine, or business or financial publication or service, whether communicated in hard copy form, or by electronic means, or otherwise, that does not consist of the rendering of advice on the basis of the specific investment situation of each client [is excluded from the definition of an investment adviser]
A number of media programs that discuss securities exist today, especially in the digital age. This could include everything from a newspaper to a financial blog. The USA further adds “radio, television programs, or other electronic communications” to the same exclusion, which additionally includes everything from TV and radio shows to YouTube and TikTok channels. As long as the advice provided on the media program is general in nature, the distributor and/or author are not considered investment advisers.
What exactly does ‘general in nature’ mean? In basic terms, the advice provided is not specific to a particular client’s situation. For example:
“I recommend senior citizens invest a significant amount of their portfolio in Treasury bonds”
While there’s mention of a specific security, a specific client is not involved. The media program exclusion can be applied when generalizations (e.g. senior citizens) are used. However, the following would not qualify:
“I’m speaking with Jade today, who is 40 years old and has two children. She works full time, and makes a combined annual income of $125,000 with her spouse. Her current portfolio is invested entirely in very safe debt securities, and I recommend she invest 50% of her portfolio in the Fidelity Large Cap Stock Fund.”
Do you see the difference? The more specific the recommendation, the more likely the exclusion no longer applies*.
*You’ve probably seen some real-world examples that seem to contradict this. For example, Dave Ramsey and Suze Orman provide financial advice (many times involving securities) to specific people. Neither is currently registered; Ramsey has no history of registration and Orman hasn’t been registered since 1991. Try to separate the “real world” from the exam. There are a lot of “gray areas” the exam doesn’t cover that may apply to these types of media programs.
Federal-covered advisers
In a previous chapter, we discussed the difference between state-registered and federal-covered advisers. When an adviser is registered with the Securities and Exchange Commission (SEC), they are excluded from the definition of an adviser according to state laws. Federal-covered advisers are still subject to some state-specific rules and obligations, including notice filing requirements and investigations related to fraud. Regardless, they are not required to register with the administrator and largely avoid regulation at the state level.
Banks and savings institutions
Generally speaking, banks and savings institutions are excluded from most securities laws and regulations. The USA makes it clear the bank must be US-based, resulting in the exclusion not being applicable to foreign banks. Generally speaking, if it sounds like a US-based bank, it’s probably excluded. However, this exclusion does not apply to bank holding companies, (as we discussed in a previous chapter). If you need a refresher on this topic, follow the previous link.
Any person designated by the administrator
The USA gives state administrators broad powers when enforcing securities laws. Several times throughout the law, language like this appears:
“Such other persons not within the intent of this subsection as the [Administrator] may by rule or order designate.”
This legal language loosely translates to “the state administrator can do what they want.” If they want to recognize an entity as being excluded from the definition of an investment adviser, they have the power to do so (even if the entity isn’t mentioned anywhere in the USA). The same concept applies to institutional investors; the state administrator may recognize any person as an institution.
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