Study guide
This chapter covers the first two topics of the official NASAA Series 63 outline, worth a combined 10 percent of your exam (about 6 scored questions). Since the June 2023 update, the exam tests advisers mostly at the definitional level: who counts as an investment adviser or investment adviser representative, who is excluded, and which regulator each answers to.
What Makes Someone an Investment Adviser
The Uniform Securities Act defines an investment adviser using the same three-part test as federal law, often called the three-prong or ABC test. A person is an investment adviser if they (1) give Advice about securities, (2) do so as a regular part of a Business, and (3) receive Compensation for it. All three prongs must be present. Miss any one and the person is not an adviser at all. Advice about securities is read broadly: it includes recommendations to buy, sell, or hold specific securities, issuing reports or analyses about securities, and even advising on whether to invest in securities versus other assets. Advice limited to things that are not securities, such as rental real estate or gold coins, does not count. The business prong looks at regularity and whether the person holds themselves out as providing advice. The compensation prong is the broadest of all: any economic benefit satisfies it, whether an hourly fee, a flat planning fee, a subscription, or a single bundled charge that includes advice. The client does not have to pay directly, and the fee does not need to be labeled an advisory fee. Example: Maya charges clients 800 dollars for a written financial plan that recommends specific mutual funds. She advises on securities, does it as a business, and is compensated, so her firm is an investment adviser. Remember that under state law the term investment adviser generally refers to the firm; the individuals who work for the firm and give the advice are investment adviser representatives, covered later in this chapter.
Exclusions from the Definition and Exemptions from Registration
The act carves several persons out of the investment adviser definition entirely. Banks, savings institutions, and trust companies are excluded. So are professionals whose advice is solely incidental to their practice, remembered by the acronym LATE: Lawyers, Accountants, Teachers, and Engineers. The exclusion is lost if the professional charges a separate fee for advice or holds themselves out as an adviser; an accountant who advertises portfolio reviews for 300 dollars has become an adviser. Broker-dealers are excluded when their advice is incidental to their brokerage business and they receive no special compensation for it. Publishers of bona fide newspapers, magazines, or financial publications with regular, general, and paid circulation are excluded so long as the content is not tailored to individual clients. Investment adviser representatives are excluded because they are regulated separately, and federal covered advisers are excluded from the state definition because they answer to the SEC. Separate from the exclusions, some persons meet the definition but are exempt from state registration. A firm with no place of business in the state is exempt if its only clients there are institutions such as banks, insurance companies, other advisers, or broker-dealers. The national de minimis standard also exempts a firm with no place of business in the state that had five or fewer non-institutional clients there during the preceding twelve months. Keep one principle firm: exclusions and exemptions remove the registration duty, but the antifraud provisions of the act apply to anyone giving securities advice, registered or not.
State-Registered Versus Federal Covered Advisers
The National Securities Markets Improvement Act of 1996 (NSMIA) split adviser regulation between the SEC and the states, and the dividing line is assets under management, or AUM. An adviser with less than 100 million dollars in AUM generally registers with the state and is barred from SEC registration. Once AUM reaches 100 million dollars, the adviser may choose to register with the SEC, and once AUM hits 110 million dollars, SEC registration becomes mandatory. Going the other direction, an SEC-registered adviser does not have to switch back to state registration until AUM falls below 90 million dollars. These buffers exist so a firm hovering near the line does not bounce between regulators every quarter. Certain advisers are federal covered regardless of size, most notably advisers to registered investment companies such as mutual funds. A federal covered adviser does not register with any state Administrator. However, the state is not powerless: it may require a notice filing, which typically means submitting copies of the adviser's SEC filings (Form ADV) and paying a fee, and the state always retains authority to investigate and prosecute fraud committed within its borders. Example: Granite Peak Advisers manages 240 million dollars from its office in Denver. It is federal covered, registered only with the SEC, but Colorado may collect a notice filing fee, and if Granite Peak lies to a Colorado client, the Colorado Administrator can bring an enforcement action. Registration and renewal for advisers run through Form ADV filed on the IARD system.
Investment Adviser Representatives: Who Registers and Where
An investment adviser representative, or IAR, is an individual associated with an investment adviser who does any of the following: makes recommendations or otherwise renders advice about securities, manages client accounts or portfolios, determines which recommendations should be given, solicits or negotiates for the sale of advisory services, or supervises anyone who does these things. Notice that solicitors and supervisors are IARs even if they never personally construct a portfolio. Employees performing purely clerical or administrative work, such as scheduling or processing paperwork, are not IARs. Where an IAR must register depends on the type of firm. An IAR of a state-registered adviser registers in each state where the IAR has a place of business, and the de minimis standard offers relief in states where the IAR has no place of business and served five or fewer non-institutional clients in the past twelve months. An IAR of a federal covered adviser registers only in states where the IAR maintains a place of business; the number of clients in other states is irrelevant. Example: Jordan works for a federal covered adviser from a single office in Columbus and serves clients in eleven states. Jordan registers as an IAR only in Ohio. Two housekeeping points close the topic. First, an IAR's registration is not freestanding: it is effective only while the individual is associated with a registered or federal covered adviser. Second, the same individual can be dually registered, for example as both an agent of a broker-dealer and an IAR, provided each registration is properly in place.
Key terms
- Investment adviser
- — A person (usually a firm) that, for compensation, engages in the business of advising others about securities.
- Three-prong (ABC) test
- — The definitional test requiring Advice about securities, as a Business, for Compensation; all three must be present.
- LATE exclusion
- — Lawyers, Accountants, Teachers, and Engineers are excluded from the adviser definition when their advice is solely incidental to their profession.
- Federal covered adviser
- — An adviser registered with the SEC (or excepted from SEC registration), which therefore does not register with any state.
- NSMIA
- — The 1996 federal law that divided adviser regulation between the SEC and the states, largely by assets under management.
- Assets under management (AUM)
- — The value of client portfolios an adviser manages, used to determine whether the adviser registers with the state or the SEC.
- Notice filing
- — A state's collection of documents and fees from a federal covered adviser (or federal covered security) without actual state registration.
- De minimis exemption
- — No state registration is required for an adviser or IAR with no place of business in the state and five or fewer non-institutional clients there in twelve months.
- Investment adviser representative (IAR)
- — An individual associated with an adviser who gives advice, manages accounts, solicits advisory business, or supervises those who do.
- Place of business
- — An office or other location where an IAR regularly provides advisory services or holds themselves out as doing so; it determines where the IAR registers.
- Form ADV
- — The uniform registration form advisers file, through the IARD system, with the SEC or state Administrators.
Exam tips
- Compensation is read broadly: a single bundled fee, a commission, or any economic benefit satisfies the third prong, even if no separate advisory fee is charged.
- The classic trap on the LATE exclusion is the word incidental. The moment a lawyer or accountant charges separately for investment advice or advertises it, the exclusion is gone.
- Match the IAR to the firm type: IARs of federal covered advisers register only where they have a place of business; client counts in other states do not matter for them.
- Memorize the AUM buffers as three numbers: may register with the SEC at 100 million, must register at 110 million, and must leave SEC registration below 90 million.
- Exempt or excluded never means immune from fraud rules. If a question asks whether the Administrator can act against an unregistered person who defrauded state residents, the answer is yes.