The Series 63 is a state-based exam primarily focused on the Uniform Securities Act (USA). Most of the test covers state laws, rules, and regulations. However, you’ll also see questions on certain federal laws.
We’ve already touched on some federal concepts with broker-dealers. Broker-dealers must register with both the Securities and Exchange Commission (SEC) and each relevant state administrator.
Investment advisers (firms in the business of providing investment advice) work differently. To understand how they register, you first need the federal law that governs SEC-registered advisers.
The Investment Advisers Act of 1940 (IA40) was enacted to regulate entities that provide investment advice in a professional capacity. IA40 is a federal law, and it applies to investment advisers that register directly with the SEC.
In the mid-1990s, the National Securities Market Improvement Act of 1996 (NSMIA) was enacted to reduce over-regulation and promote efficiency in the securities markets. Before NSMIA, investment advisers generally had to register with both the SEC and each relevant state administrator (similar to broker-dealers). That created a practical problem: state and federal rules could conflict, leaving advisers unsure which regulator to follow.
NSMIA addressed this by drawing a clearer line between state and federal oversight. It effectively divided investment advisers into two categories: state-registered and federal-covered.
NSMIA created the term federal-covered adviser. A federal-covered adviser is an investment adviser that:
Even though federal-covered advisers don’t register with the state administrator, they still must make a notice filing in each state where they plan to do business. We’ll cover notice filings in the next chapter.
A key factor in whether an adviser is federal-covered is assets under management (AUM). AUM measures the value of the assets an adviser manages on behalf of clients. In general, the higher the AUM, the more likely the adviser is SEC-registered (and therefore federal-covered).
The Dodd-Frank Wall Street Reform Act (usually called Dodd-Frank) set specific AUM thresholds and defined three categories of investment advisers:
Large investment advisers
Advisory firms with at least $100 million of AUM are considered large investment advisers.
In practice, many advisers choose to register with the SEC once they reach $100 million AUM. Dodd-Frank also allows an adviser to register with the SEC if it reasonably expects to reach at least $100 million of AUM within 120 days (eligible, but not required).
AUM can rise and fall as clients add or withdraw assets and as markets move. So what happens if a federal-covered adviser’s AUM declines?
A federal-covered adviser may keep its SEC registration until its AUM falls below $90 million. Once it falls below $90 million, the adviser must withdraw its federal registration and register with the appropriate states.
Because AUM fluctuates daily, the rules don’t treat a one-day dip the same as a sustained change. These thresholds are generally evaluated once per year, when the adviser files its annual updating amendment (covered in the next chapter). At that time, the adviser reports its current AUM.
You may see exam questions about how quickly an adviser must change its registration status:
Mid-size investment advisers
Advisory firms with at least $25 million of AUM, up to $100 million AUM, are considered mid-size investment advisers. These firms typically register with the relevant state administrators.
In a few situations, a mid-size adviser becomes eligible for SEC registration as a federal-covered adviser:
*Don’t worry about the specifics here. The language quoted above comes directly from SEC rules and refers to uncommon situations. The key point is that advisers in these situations may be treated as federal-covered. Don’t worry about the context.
Small investment advisers
Advisory firms with less than $25 million of AUM are considered small investment advisers. Like mid-size advisers, small advisers are typically state-registered.
A small adviser can still qualify as federal-covered under the multi-state adviser rule. If it operates in 15 or more states, it is eligible for SEC registration as a federal-covered adviser.
In addition to AUM size, NSMIA identifies two other situations where an adviser is considered federal-covered:
Investment companies offer various types of investment products. You’ve probably heard of a mutual fund, which is one type of investment company. Investors buy shares of the fund, pooling their money with other investors. A professional manager then invests that pool according to a stated investment objective.
For example, the Vanguard 500 Index Fund aims to provide investors a return that matches the S&P 500.
Most investment companies follow this general structure. You don’t need detailed product characteristics here, but you do need to recognize an investment company when you see one. The categories and subcategories of investment companies are:
Investment companies are registered and regulated under the Investment Company Act of 1940, a federal law enforced by the SEC. For Series 63 purposes, assume investment companies hire investment advisers to manage their portfolios.
For example, the Vanguard fund above is managed by a registered investment adviser known as Vanguard Equity Index Group. This firm (a Vanguard subsidiary) is a federal-covered adviser registered with, and regulated by, the SEC. The same treatment applies to other investment advisers hired to manage registered investment companies.
IA40 explicitly excludes certain persons, in specific circumstances, from the definition of an investment adviser. Many of these exclusions overlap with the USA, and we’ll cover them in depth later in this unit. One exclusion, however, is unique to federal law.
Under federal law, a person who provides advice solely on US Government securities is excluded from the definition of an investment adviser. The USA does not mention this exclusion. Even so, a state administrator can’t require registration or impose regulation on a person that the SEC and IA40 exclude from registration. When federal law excludes a person or activity, states can’t override that exclusion.
Here are the most commonly referenced US Government securities:
You don’t need to know the detailed characteristics of these securities for the Series 63 exam. The key points are that they’re considered safe, they’re backed by the US Government, and a person who only provides advice on these securities is excluded from the federal definition of an investment adviser.
This “federal over state” concept is tied to NSMIA. One part of NSMIA provides that federal rules and regulations supersede state rules and regulations when both could apply. If there’s common jurisdiction, federal law prevails. This is why state administrators can’t enforce higher financial requirements on broker-dealers than the SEC.
Investment advisers are different because they register with either the SEC or the states (not both). One purpose of NSMIA was to reduce conflicts between federal and state regulation, and it largely does so. With a clearer division between state-registered and federal-covered advisers, it’s easier to identify which rules apply: state-registered advisers generally follow the USA, while federal-covered advisers generally follow IA40.
The following video summarizes the key points from this chapter:
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