The Series 66 is a state-based exam primarily focused on the Uniform Securities Act (USA), but it also covers federal laws such as the Investment Advisers Act of 1940. Investment advisers are financial firms in the business of providing advice, and they’re 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 how broker-dealers operate). In some cases, state and federal rules conflicted, which created confusion about which regulator’s rules to follow. NSMIA addressed this by dividing investment advisers into two categories: 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 federal-covered adviser doesn’t register with the state administrator, it still must submit a notice filing in every state where it plans to do business. We’ll cover notice filings in the next chapter.
The main factor that determines whether an investment adviser is a federal-covered adviser (also called a “covered” adviser or an “SEC adviser”) 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 to be federal-covered.
Another law set specific AUM thresholds: the Dodd-Frank Wall Street Reform Act (usually called Dodd-Frank). Dodd-Frank defined three categories of investment advisers:
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 federal-covered adviser. If the firm exceeds $110 million of AUM, it must register with the SEC as a federal-covered adviser.
Many advisers choose to register as federal-covered as soon as 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 with the SEC (eligible, but not required). Advisers can grow AUM by adding new clients and through capital appreciation of the assets they manage. But AUM can also decline if clients leave or investments lose value.
Federal-covered advisers that qualify for SEC registration may keep their federal-covered status until AUM falls below $90 million. Once AUM is below $90 million, the adviser must withdraw federal registration and register with the relevant states.
Because AUM can change daily due to client inflows/outflows and market movement, the key question is when the threshold is measured. These AUM levels are generally 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. These firms typically register with the relevant state administrators. However, a mid-size adviser may be eligible for SEC registration as a federal-covered adviser in a few situations:
*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 advisers. 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 (listed above). 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 in which 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 deep detail on these securities here, but you should assume investment advisers are hired to manage these funds.
For example, many stock-based Vanguard funds are managed by a registered investment adviser called Vanguard Equity Index Group. That firm (a Vanguard subsidiary) is a federal-covered adviser, registered with and regulated by the SEC. The same concept applies to any investment adviser hired to manage a registered investment company.
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’ll be covered in more depth later in this unit. One exclusion, however, 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, the state administrator cannot require registration or impose regulation on a person whom the SEC and the IA40 exclude from registration. When federal law excludes a person or activity, states do not have the authority to regulate that person or activity as an investment adviser. Therefore, this 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 levels could claim 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 regulators, and it largely accomplished that goal. With a clearer division between state-registered and federal-covered advisers, it’s easier to determine 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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