The Series 65 is a state-based exam that primarily focuses on the Uniform Securities Act (USA), but it also covers federal laws such as the Investment Advisers Act of 1940. Investment advisers - financial firms in the business of providing advice - are regulated at either the federal level or the state level.
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 often had to register with both the SEC and each relevant state administrator (similar to broker-dealers). That created situations where state and federal rules conflicted, leaving advisers unsure which regulator’s rules to follow. NSMIA addressed this by drawing a clearer line between two categories of advisers: state-registered and federal-covered.
NSMIA created the term federal-covered adviser, meaning an investment adviser that is subject to SEC registration and regulation and is excluded from state registration and regulation. Even though a federally covered adviser doesn’t register with the state administrator, it still must submit a notice filing in each state where it plans to do business. We’ll cover notice filings in the next chapter.
A key factor in whether an adviser is federally covered is assets under management (AUM) - the total value of client assets the adviser manages. In general, the higher the AUM, the more likely the adviser is to be federally covered.
The Dodd-Frank Wall Street Reform Act (usually called Dodd-Frank) set specific AUM thresholds and grouped advisers into three categories:
Advisory firms with at least $100 million of AUM are considered large investment advisers. Once a firm reaches $100 million of AUM, it is eligible to register with the SEC as a federally covered adviser. If the firm exceeds $110 million of AUM, it must register with the SEC as a federally covered adviser.
Many advisers choose to register with the SEC once they reach $100 million of AUM. Dodd-Frank also allows an adviser that expects to reach at least $100 million of AUM within 120 days to register as a federal-covered adviser (meaning it’s eligible, but not required).
AUM can rise as an adviser adds clients or as the market value of managed assets increases. But AUM can also fall if clients leave or investments lose value.
A federally covered adviser that qualifies for SEC registration may keep its federal-covered status until its AUM falls below $90 million. Once it drops below $90 million, the adviser must withdraw its federal registration and register with the appropriate states.
Because AUM can change daily due to client inflows/outflows and market movement, the rules don’t treat every short-term dip as a registration trigger. Instead, AUM is evaluated once per year. At the end of the adviser’s fiscal year, the adviser files annual updating paperwork (covered in the next chapter) and reports its current AUM at that time.
You may see exam questions about how quickly an adviser must change registration status:
Advisory firms with at least $25 million of AUM, up to $100 million of AUM, are considered mid-size investment advisers. Firms in this range 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.
Advisory firms with less than $25 million of AUM are considered small investment advisers. Like mid-size advisers, small advisers are typically state-registered.
However, a small adviser can still be federal-covered under the multi-state adviser rule. If the adviser operates in 15 or more states, it qualifies for SEC registration as a federal-covered adviser.
In addition to AUM size, NSMIA identified two other situations where an adviser is considered federal-covered:
As covered in a previous chapter, there are several types of investment companies:
Investment companies are registered and regulated under the Investment Company Act of 1940, a federal law enforced by the SEC. You don’t need many details about these securities here - just assume that investment companies hire investment advisers to manage their portfolios.
For example, many stock-based Vanguard funds are managed by a registered investment adviser called Vanguard Equity Index Group. This firm (a Vanguard subsidiary) is a federal-covered adviser registered with and regulated by the SEC. The same is true for other investment advisers hired to manage registered investment companies.
The IA40 explicitly excludes certain persons, in specific circumstances, from the definition of an investment adviser. Many of these exclusions overlap with state law, and they’re covered later in this unit. One exclusion is unique at the federal level and does not appear in the USA.
A person who provides advice solely on US Government securities is excluded from the definition of an investment adviser under federal law. The USA does not mention this exclusion.
Even so, a state administrator cannot require registration or impose regulation on a person whom the SEC and IA40 exclude from registration. When federal law excludes a person or activity, states cannot override that exclusion. As a result, this federal exclusion effectively applies at the state level as well.
This outcome ties back to NSMIA. One part of NSMIA provides that federal rules and regulations supersede state rules and regulations when both could apply. That’s 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 of NSMIA’s goals was to reduce conflicts between federal and state regulation, and it largely accomplishes that. 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 the IA40.
The following video summarizes the key points from this chapter:
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