Now that the registration process for investment advisers is clear, the next step is understanding when a person can avoid registration. The rules and regulations covered in the previous five chapters don’t apply when an exemption or exclusion applies. If you need 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 - just for different reasons.
This chapter covers exemptions and exclusions for persons who might otherwise be required to register with the Securities and Exchange Commission (SEC) or a state administrator.
A person who qualifies for a federal exemption does meet the definition of an investment adviser. However, they aren’t subject to SEC registration because the Investment Advisers Act of 1940 specifically exempts them.
These exemptions apply only to advisers who would otherwise be required to register as federal-covered advisers:
Only providing services to insurance companies
Investment advisers that provide advisory services only to insurance companies are exempt from SEC registration.
Later, when we cover state-based exemptions, you’ll see a similar state rule that applies to institutions more broadly (not just insurance companies). Keep the difference straight - this contrast can show up on the exam.
Intrastate advisers
Federal jurisdiction generally becomes more relevant when activity crosses state lines. A simple way to think about it: local or state authorities handle issues that stay within one state, while federal authorities often become involved when someone crosses state lines.
That same idea shows up here. If an adviser operates only within a single state, the adviser is exempt from SEC registration. To be required to register as a federal-covered adviser, the firm’s operations must take place in more than one state.
To use the intrastate exemption, it’s not enough to advise only clients within one state. The adviser also may not provide advice on securities listed on a national exchange (e.g., the NYSE, NASDAQ). If the adviser does, this federal exemption is no longer available, and SEC registration may be required (assuming no other exclusion or exemption applies and the adviser is otherwise required to register as a federal-covered adviser).
As noted above, a person who qualifies for an exemption still meets the definition of an investment adviser. Here, the focus is on state exemptions found in the Uniform Securities Act (USA) and/or North American Securities Administrators Association (NASAA) rules.
These exemptions apply only to advisers subject to state registration.
These are the relevant exemptions to know for the exam:
Snowbird/vacation rule
If an adviser has no place of business in a state and only works 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 the same concept applies to 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, they’re referred to as exemptions here. This difference comes from 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 works with institutions in that state, the adviser is exempt from registration in that state.
This is another rule discussed in the earlier broker-dealer chapter that also applies to investment advisers.
Keep the state rule and the federal rule separate:
De minimis rule
Investment advisers 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 stays at five or fewer retail investors in a 12-month period, the exemption applies.
There’s no limit on the number of institutional clients, as discussed above.
*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.
The de minimis rule also creates a limited exception for political contributions under “pay-to-play” restrictions. If a covered associate of an investment adviser is eligible to vote for a candidate, the covered associate may contribute up to $350 per election. If the covered associate is not eligible to vote for the candidate, the limit is $150.
For example, if an investment adviser isn’t eligible to vote for a mayor, the adviser can still contribute $150 to the mayor’s initial campaign and another $150 to the same mayor’s re-election, because those are separate elections. Primary and general elections are also treated as separate elections, so a person can typically contribute the de minimis amount for the primary and then again for the general election.
If contributions exceed the permitted amounts, the adviser triggers a two-year ban on receiving advisory compensation from that government entity.
Private fund advisers
A private fund is similar to a mutual fund, but it’s generally available only to a small group of wealthy investors and isn’t offered to the general public. Hedge funds are closely related and are sometimes grouped with private funds. The exam usually avoids detailed fund characteristics, so focus on the registration implications.
Before 2011, private fund advisers (investment advisers that manage private funds) largely avoided regulatory oversight, including registration. Regulators generally place less emphasis on protecting larger, wealthier investors, on the assumption that these investors have significant resources and enough sophistication to evaluate and bear the risks.
The Dodd-Frank Wall Street Reform Act (Dodd-Frank) was covered in a previous chapter. Among other changes, Dodd-Frank removed a long-standing exemption for private fund advisers. Instead of being largely ignored, these advisers became subject to federal registration and disclosure requirements. Soon after, NASAA adopted its own version of the rule.
Private fund advisers with less than $150 million in assets under management (AUM) still have a registration exemption, but they must file periodic reports with the Securities and Exchange Commission (SEC). Those 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 make a notice filing with the state administrator (if the adviser is a federal-covered adviser). As a result, private fund advisers are generally exempt* from state registration.
*You’ll also see federal-covered advisers listed as a “state only exclusion” below. The private fund adviser exemption can result in an adviser being federal-covered. In one rule, federal-covered status is treated as an exclusion; in another, it’s treated as an exemption. That’s a drafting issue in the law and generally isn’t an important exam distinction.
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