Investment Advisers and Their Representatives

Who is an investment adviser

The three-part test: advice about securities, as a business, for compensation. All three must be present, and each is broader than it sounds.

Advice about securities includes advice about the value of securities, about the advisability of investing in, purchasing or selling them, and — under the Act's express language — includes financial planners and others who provide such advice as an integral component of other financially related services.

As a business does not require that advice be the person's only business, or even their primary one. Holding oneself out as providing advice is enough.

For compensation does not require a separate advisory fee. Any economic benefit received in connection with the advice counts.

The exclusions, which decide most questions:

A bank, savings institution or trust company.

A lawyer, accountant, engineer or teacher whose performance of these services is solely incidental to the practice of their profession — remembered as LATE.

A broker-dealer or its agent whose advice is solely incidental to the conduct of its brokerage business and who receives no special compensation for it.

A publisher of a bona fide newspaper, newsletter or financial publication that does not render advice based on the specific investment situation of each client.

A federal covered adviser, and an investment adviser representative.

The broker-dealer exclusion is the one an agent lives inside, and it has two conditions joined by 'and'. The advice must be solely incidental, and there must be no special compensation. Charge a separate fee for a financial plan and both conditions fail — the compensation is special, and the advice is no longer incidental. That is the boundary the exam is testing, and crossing it means the person or firm is an investment adviser and must be registered as one.

State or federal

The National Securities Markets Improvement Act divided adviser registration between the SEC and the states.

A federal covered adviser is one registered with the SEC under section 203 of the Investment Advisers Act of 1940. Broadly, advisers above an assets-under-management threshold, advisers to registered investment companies, and certain others register federally. Advisers below the threshold register with the states.

A federal covered adviser does not register with a state, but the state may require a notice filing — a copy of the documents filed with the SEC, a consent to service of process and a fee — and retains its anti-fraud authority. The Act's own notice filing provision says so directly.

State registration is required of an investment adviser transacting business in the state, with a de minimis exemption in section 201(c). A person need not register in a state if they have no place of business there and either their only clients in the state are institutional — investment companies, other advisers, federal covered advisers, broker-dealers, banks, trust companies, savings and loan associations, insurance companies, employee benefit plans with at least $1,000,000 in assets, and governmental agencies — or, during the preceding twelve months, they have had no more than five clients in the state other than those institutional ones.

So the two conditions again: no place of business in the state, plus either institutional-only clients or five or fewer other clients in twelve months. A place of business in the state defeats the exemption regardless of client count.

An adviser applies with an application and a consent to service of process — in practice the Form ADV — and registration becomes effective at noon of the thirtieth day, expiring December 31, exactly as for a broker-dealer.

Investment adviser representatives

An investment adviser representative is a partner, officer or director of, or an individual employed by or associated with, an investment adviser that is registered or required to be registered, or an individual with a place of business in the state who is associated with a federal covered adviser — and who does any of five things: makes recommendations or renders advice regarding securities; manages accounts or portfolios of clients; determines what recommendation or advice should be given; solicits, offers or negotiates for the sale of or sells investment advisory services; or supervises anyone who does any of those.

The fourth is the one people forget: a person who only sells the advisory service, without giving any advice themselves, is still a representative.

Section 201(d) makes it unlawful for a registered adviser to employ an unregistered representative, and a representative's registration is not effective while they are not employed by a registered adviser — the same non-portability rule that applies to agents.

Note the asymmetry between the two adviser categories. A state-registered adviser's representatives register in the state regardless of whether they have a place of business there. A federal covered adviser's representatives register in a state only if they have a place of business in that state. That distinction is a standing exam question.

When a representative begins or terminates employment, the notification obligation falls on the adviser in the state-registered case and on the representative in the federal covered case.

The NASAA model rules

The study guide names five NASAA model rules for advisers as testable. Each is a model — it has no legal force until a jurisdiction adopts it — and each addresses a specific conflict.

The Unethical Business Practices of Investment Advisers, Investment Adviser Representatives and Federal Covered Advisers Model Rule enumerates the practices treated as unethical, including recommending without reasonable grounds, exercising discretion without authority, misrepresenting qualifications or services, charging unreasonable fees, and failing to disclose conflicts.

The Recordkeeping Requirements for Investment Advisers Model Rule sets what records an adviser must make and keep.

The Contents of Investment Advisory Contract Model Rule requires an advisory contract to be in writing and to state the services, the term, the fee and how it is computed, whether the account is discretionary, and that the contract may not be assigned without the client's consent — and it prohibits performance-based compensation except in defined circumstances.

The Custody Requirements for Investment Advisers Model Rule sets the conditions under which an adviser may hold client funds or securities, including notice to the Administrator, segregation, an independent qualified custodian, account statements, and a surprise examination.

The assignment provision is worth stating on its own because it is counterintuitive and reliably tested: an advisory contract may not be assigned without the client's consent, which means an adviser cannot transfer client relationships in a sale of the business without asking each client. For a partnership, a change in a majority of the partners is treated as an assignment.

One more boundary for an agent to keep in view: an agent who begins charging a separate fee for planning, or who holds themselves out as a financial planner, has moved into this regime. The right response is to raise it with the firm's compliance department before it happens, not after.