Now that the registration process for investment advisers is clear, let’s look at when a person can avoid registration. The rules and regulations covered in the previous five chapters don’t apply if an exemption or exclusion exists. If you want the full refresher, use the link above. Here are the key definitions:
The examples above relate to securities, but the same idea applies to investment advisers. Both exemptions and exclusions are exceptions to the rules, but they apply 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 still meets the definition of an investment adviser. The adviser avoids registration only because the Investment Advisers Act of 1940 specifically provides an exemption.
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 concept at the state level that applies to institutions more broadly (not just insurance companies). The difference between the federal and state rules can show up as an exam point.
Intrastate advisers
Federal jurisdiction generally becomes more relevant when activity crosses state lines. A simple way to think about it is law enforcement: local or state police handle matters within a state, but crossing state lines often brings in federal involvement.
The same jurisdiction idea applies here. If an adviser operates only within one 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, the adviser must:
If the adviser provides advice on nationally listed securities, the intrastate exemption is no longer available, and SEC registration may be required (assuming no other exemption or exclusion 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 deals only 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 it works the same way for 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, 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 deals only with institutions in that state, the adviser is exempt from registration in that state.
This is another rule that also appeared in the earlier broker-dealer chapter. Use the link if you want a refresher.
Keep the federal/state distinction straight:
De minimis rule
Investment advisers can avoid registration in a state if both conditions are met:
Known as the de minimis rule*, this exemption lets an adviser have 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 keeps the number of retail investors at five or fewer, 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 one retail client permanently located in a state triggers registration for a broker-dealer and/or agent.
The de minimis rule also limits political contributions by investment advisers to prevent “pay-to-play” practices. 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 to the same candidate in the primary and again in the general election.
If contributions exceed the permitted amounts, the adviser causes 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 very similar and are sometimes grouped into the private fund category. The exam usually avoids detailed fund characteristics, so don’t get too focused on the fine points.
Before 2011, private fund advisers (investment advisers that manage private funds) largely avoided regulatory oversight, including registration. Regulators are generally less focused on protecting larger, wealthier investors, assuming these investors have the resources and sophistication to understand and withstand the risks.
The Dodd-Frank Wall Street Reform Act (Dodd-Frank), discussed in a previous chapter, removed a long-standing exemption for private fund advisers. Instead of largely ignoring these advisers, federal rules began subjecting them to 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 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 most, a larger private fund adviser may need to make a notice filing with the state administrator (assuming the adviser is a federal-covered adviser). So, private fund advisers are generally exempt* from state registration.
*You’ll also see federal-covered advisers listed as a ‘state-only 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.
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