Regulation of Investment Advisers

Investment adviser regulation is the regulatory framework for the profession of giving advice about securities for compensation. While this chapter weighs only 5% on the S63 outline, IA regulation is the heart of the S65/S66 exam and the core of every modern advisory practice. The three threshold questions are: who is an investment adviser, where do they register, and what documents and processes do they use to register and maintain that registration.

Section 1 covers the ABC test under USA §401(c) and Advisers Act §202(a)(11), exclusions from the definition, the solely-incidental and special-compensation traps, and exempt reporting advisers. Section 2 covers federal-vs-state allocation under NSMIA and Dodd-Frank, AUM thresholds, the multi-state rule, and notice filings. Section 3 covers Form ADV Parts 1, 2A, 2B, and CRS, the IARD filing system, brochure delivery requirements, and registration effective dates.

The statutory definition — Advisers Act §202(a)(11) and USA §401(c)

Both the federal Investment Advisers Act of 1940 and the model Uniform Securities Act define "investment adviser" using the same core elements. An investment adviser is any person who:

For compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.

This definition collapses into the ABC test:

• A — Advice about securities. The advice must be specifically about securities — not generic financial wellness, not insurance, not commodities, not real estate. The advice can be specific recommendations or general analysis, written or oral.
• B — In the business. The person must hold themselves out as in the business of giving such advice, OR provide such advice on a regular basis. Occasional or incidental advice does not satisfy this prong.
• C — For compensation. The person receives some form of compensation for the advice — cash fees, asset-based fees, commissions, hourly billing, or any other economic benefit. The compensation need not be direct or labeled as advisory fee.

All three prongs must be satisfied. If any one prong fails, the person is not an investment adviser under the statutory definition. The ABC test is the most heavily tested concept in this chapter.

All three prongs must be satisfied for a person to be an investment adviser. Miss any one and the person is not an IA.

Exclusions from the IA definition

USA §401(c) and Advisers Act §202(a)(11) enumerate categories of persons who are excluded from the IA definition even though their work involves some securities-related advice. The exclusions reflect a judgment that certain professionals are sufficiently regulated under other regimes that adding IA registration would be redundant.

Banks and bank holding companies. Banks are excluded from the federal IA definition under Advisers Act §202(a)(11)(A); state law parallels this. The exclusion covers the bank itself, not subsidiaries or affiliates that operate as separate advisory entities. A bank's trust department giving advice is generally excluded; a bank-affiliated registered investment adviser is not.

Lawyers, accountants, engineers, and teachers (the "LATE" exclusion). Members of these four professions are excluded if their advice is solely incidental to their profession AND they receive no special compensation for the advice. Both conditions must hold. A lawyer who casually advises an estate client about diversification is excluded. A lawyer who charges a separate hourly fee for portfolio review is NOT excluded.

Broker-dealers and their agents. BDs and agents are excluded from the IA definition if their advice is solely incidental to their brokerage business AND they receive no special compensation for the advice. The 2019 SEC Regulation Best Interest does not change this exclusion — commissions paid on securities transactions are not "special compensation" for advice. Separate advisory fees charged for advice ARE special compensation and defeat the exclusion.

Publishers of bona fide newspapers, news magazines, and business or financial publications of general and regular circulation. The publication must be of general circulation, not tailored to specific subscribers' circumstances, and the publisher must not provide individualized advice. A newsletter that offers individualized portfolio recommendations to subscribers is NOT excluded.

Federal covered advisers (excluded from state registration). Advisers registered with the SEC are excluded from state registration in any state where they have a place of business, but they may be required to notice-file. This is the federal-state allocation mechanism, covered in detail in Section 2.

Other narrower exclusions: family offices serving only family clients, advisers whose only clients are insurance companies, certain advisers to small business investment companies, and certain church plan advisers, among others.

The solely-incidental and special-compensation traps

Two phrases govern the LATE and BD exclusions, and the exam tests them relentlessly. Understanding them precisely is the difference between getting these questions right and wrong.

"Solely incidental" means the advice arises only in the course of, and is reasonably related to, the primary professional activity. The advice is a byproduct of the primary work, not a separately-marketed service. Tests for this prong:

• Is the advice part of the natural flow of the professional engagement?
• Does the professional hold themselves out as an investment adviser in marketing materials, bios, or business cards?
• Does the professional maintain a separate advisory practice or department?
• Is the advice required to fulfill the underlying professional duty, or could the duty be discharged without the advice?

"No special compensation" means no separate fee or other economic benefit for the advice itself. The professional may receive compensation for the underlying primary service (legal fees, accounting fees, brokerage commissions), but not an additional, separately-identifiable fee for the advisory component. Tests:

• Is there an itemized advisory fee, hourly rate for advisory work, or asset-based fee?
• Does the bill list "investment advice" as a separate line item?
• Is the total fee higher because of the advisory component?
• Are there performance bonuses, success fees, or referral payments tied to investment outcomes?

If either test fails, the exclusion fails. A CPA who occasionally suggests asset allocation as part of tax planning, with no separate fee, is excluded. The moment that CPA starts a weekly investment newsletter for subscribers, opens a fee-based advisory practice, or charges separately for portfolio review, the exclusion collapses and IA registration is required.

Exempt Reporting Advisers (ERAs)

Beyond the categorical exclusions, two important exemptions allow certain advisers to operate as Exempt Reporting Advisers — they meet the IA definition but are exempt from full SEC registration. Instead, they file a limited Form ADV (Part 1A only) and remain subject to anti-fraud rules and certain reporting requirements.

Private fund adviser exemption (Advisers Act §203(m)):

• Adviser solely to private funds (3(c)(1) or 3(c)(7) funds under the Investment Company Act)
• U.S. private fund assets under management of less than $150 million
• Files Form ADV Part 1A with the SEC as an ERA
• Above $150M: must register fully as an investment adviser with the SEC

Venture capital fund adviser exemption (Advisers Act §203(l)):

• Adviser solely to qualifying venture capital funds as defined by SEC rule
• No AUM cap (unlike the private fund exemption)
• Files Form ADV Part 1A with the SEC as an ERA
• The fund must invest primarily in equity in qualifying portfolio companies, hold no significant leverage, and meet other criteria

What ERAs must still do:

• File Form ADV Part 1A annually with the SEC (and amend for material changes)
• Maintain books and records as the SEC requires
• Comply with anti-fraud rules under Advisers Act §206
• Submit to SEC examination authority

What ERAs do not have to do: File Form ADV Parts 2A, 2B, or CRS; deliver a brochure; comply with most operational rules (custody, advertising, books-and-records detail). The ERA exemption is genuinely lighter-touch than full registration, but it is not a complete bypass of the regulatory regime.

The federal-state allocation under NSMIA and Dodd-Frank

Before 1996, every investment adviser had to register with both the SEC and every state in which they did business — a duplicative burden that grew worse as advisers expanded geographically. The National Securities Markets Improvement Act of 1996 (NSMIA) divided IAs into two categories: federally-registered ("federal covered") advisers and state-registered advisers. The Dodd-Frank Act of 2010 raised the federal threshold and pushed mid-sized advisers down to the states.

The basic split:

• State-registered advisers register with each state where they have a place of business. The state has full regulatory authority — merit review of Form ADV, examinations, books-and-records review, and enforcement.
• Federal covered advisers register only with the SEC. States cannot impose substantive registration requirements but retain anti-fraud authority and may require notice filings.

What states can do with federal covered advisers:

• Require a notice filing — a copy of Form ADV plus any state-specific addendum, consent to service of process, and a filing fee
• Require notice filings for IARs employed by the federal covered adviser if they have a place of business in the state
• Enforce anti-fraud rules against the adviser, its IARs, and any conduct in connection with advisory services in the state
• Bring administrative or referred criminal action for any fraud or violation of state anti-fraud rules

What states cannot do with federal covered advisers:

• Impose substantive registration requirements on the firm beyond notice filing
• Impose net worth or capital requirements beyond federal levels
• Mandate state-specific record-keeping beyond federal levels
• Conduct merit review of the adviser's business model

AUM tiers under Dodd-Frank

Dodd-Frank revised the AUM thresholds that determine federal vs state registration. The current tiers, which appear constantly on the exam:

• Under $100 million AUM: Generally state-registered. The adviser registers with each state where they have a place of business. (The exception is the multi-state rule, below.)
• $100 million to $110 million AUM (the "buffer zone"): The adviser may remain state-registered or register with the SEC, at the adviser's option. The buffer prevents constant switching due to small AUM fluctuations. Once AUM crosses $110M, federal registration becomes mandatory.
• $110 million AUM and above: Mandatory federal (SEC) registration as a federal covered adviser. The adviser must withdraw from state registration and file Form ADV with the SEC.
• $90 million dropoff: A federally-registered adviser whose AUM falls below $90 million must withdraw from federal registration and re-register with the states at the next annual amendment.

The multi-state exemption (the "15+ rule"): An adviser with AUM between $25 million and $100 million may opt for SEC registration if they are registered — or required to register — as an investment adviser in 15 or more states. The rule exists to spare smaller advisers from the burden of managing 15+ separate state registrations.

Mid-sized advisers below the multi-state threshold: An adviser between $25M and $100M who registers in fewer than 15 states remains state-registered. This category, created by Dodd-Frank, transitioned roughly 3,000 mid-sized advisers from SEC to state oversight when the law took effect.

Other paths to federal registration regardless of AUM:

• Adviser to a registered investment company — must register with the SEC regardless of AUM
• Adviser eligible for the Internet Adviser exemption — advisers serving only through an interactive website may register with the SEC
• Adviser to a business development company with $25M+ AUM
• Pension consultants advising on $200M+ of plan assets

Place of business and the de minimis rule

The phrase "place of business" determines where a state-registered adviser must register and where a federal covered adviser must notice-file. Defined in NASAA model rules and adopted by reference in most state statutes, a place of business is any office or location from which the adviser conducts advisory business on a regular basis.

What counts as a place of business:

• The adviser's primary office or any branch office
• Any location where the adviser holds itself out as conducting business (e.g., listed on the website, business cards, or letterhead)
• Any location where the adviser regularly meets clients
• An IAR's home office if it is used to meet clients or is held out as the IAR's office

What does NOT count as a place of business:

• A vacation property where business is conducted only occasionally
• An itinerant location where no clients are met and no business is held out
• A hotel room or temporary office

De minimis exemption from state registration: An adviser with NO place of business in a state may have up to 5 retail clients in that state during the preceding 12-month period without triggering state registration. The 5-client exemption is widely tested and frequently confused:

• The exemption requires no place of business in the state
• The 5-client count is for non-institutional (retail) clients only — institutional clients (other IAs, BDs, banks, insurance companies, large pension plans) don't count
• If the adviser has any place of business in the state, the de minimis exemption does not apply and the adviser must register regardless of client count
• The exemption is parallel to the BD/agent "snowbird" rule that allowed unlimited existing-client follow-on contact (covered in Chapter 4-4)

Form ADV — the universal IA registration form

Form ADV is the single registration document used by both federal-covered and state-registered investment advisers. The same form is filed electronically through the Investment Adviser Registration Depository (IARD), the FINRA-operated system that also handles BD registrations through Web CRD.

Form ADV has four parts, each serving a distinct disclosure and operational purpose:

• Part 1A and 1B — structured-data sections about the adviser's business: ownership, control affiliates, clients, AUM, disciplinary history, custodial arrangements. Filed with the regulator (SEC or state).
• Part 2A — the "Brochure" — narrative plain-English disclosure document covering services, fees, conflicts, disciplinary history, financial condition, and operational details. Delivered to clients.
• Part 2B — the "Brochure Supplement" — narrative disclosure about the specific IARs servicing the client's account: education, work history, professional designations, disciplinary events. Delivered to clients.
• Part 3 / Form CRS — the "Client Relationship Summary" — a 2-page plain-language summary for retail investors comparing the firm's services, fees, conflicts, disciplinary history, and questions to ask. Delivered at relationship start.

Filing mechanics:

• All parts are filed electronically through the IARD system
• Initial filing fee is paid to the IARD; state registration fees are paid in addition
• Amendments to Form ADV Part 1 are filed annually (within 90 days after fiscal year end) and promptly upon material changes to specified items
• Amendments to Part 2A are filed annually and promptly when information becomes materially inaccurate

Form ADV is one form with four parts. Each part has its own filing target (regulator vs client) and delivery rules.

Form ADV Parts — detail and delivery rules

Part 1A (filed with SEC) and Part 1B (filed with state): Structured-data sections requiring the adviser to report specific information about its business. Part 1A is required of all federally-registered advisers and most state-registered advisers; Part 1B contains state-specific information required only of state-registered advisers. Filed information includes:

• Identity of the adviser, principal office location, contact information
• Direct and indirect owners (5%+ ownership stakes), control affiliates, executive officers
• Clients: number, type, AUM by client category
• Advisory activities: financial planning, portfolio management, pension consulting, etc.
• Affiliated activities: broker-dealer, insurance, other financial businesses
• Custodial arrangements and physical custody of client assets
• Disciplinary history of the firm and its control persons

Part 2A — the Brochure (Delivered to Clients): A plain-English narrative document, organized in 18 standardized items, covering:

• Advisory services and fees
• Performance-based fees and side-by-side management
• Types of clients and account requirements
• Methods of analysis, investment strategies, and risk of loss
• Disciplinary information and other financial industry affiliations
• Code of ethics, participation or interest in client transactions, personal trading
• Brokerage practices, including soft-dollar arrangements
• Custody, including any practices that constitute custody under the rule

Delivery rules for Part 2A: Must be delivered to a prospective client at or before entering an advisory contract. Existing clients must be offered — in writing, annually — a copy of the updated brochure (the "annual offer to deliver"); if there has been a material change, the updated brochure must be promptly delivered, with a summary of material changes within 120 days of the adviser's fiscal year end.

Part 2B — the Brochure Supplement: A separate disclosure for each IAR providing advice to a specific client, covering the IAR's education, work history, professional designations, disciplinary events, and any side businesses. Must be delivered before or with the start of the advisory relationship with that IAR.

Form CRS — Client Relationship Summary

Form CRS (also known as Part 3 of Form ADV when filed by an IA, and as a separate form when filed by a BD) is a 2-page plain-language summary designed for retail investors. Adopted by the SEC in 2020 as part of Regulation Best Interest, Form CRS uses standardized language and headings to allow retail investors to compare service offerings across advisers and broker-dealers.

Content of Form CRS:

• Introduction — firm name, the fact that firm is registered with SEC, the type of services offered (advisory, brokerage, dual-registered)
• Relationships and Services — what investment services the firm offers, account monitoring, principal investments, account minimums
• Fees, Costs, Conflicts, and Standard of Conduct — how the firm is compensated, conflicts of interest, the standard of conduct that applies (fiduciary for IAs, best-interest for BDs)
• Disciplinary History — whether the firm or its financial professionals have any legal or disciplinary history
• Key Questions to Ask — standardized prompts the retail investor can use to learn more, including questions about the financial professional's qualifications, conflicts, and conduct standards

Delivery and update rules:

• Initial delivery: at or before the firm enters into an advisory contract with a retail investor, or recommends an account type/transaction
• For retail clients only — not required for institutional clients
• Updates: amended within 30 days of any material change; updated form delivered to existing retail clients within 60 days
• Must be posted on the firm's public website if the firm has one
• Required for both SEC-registered and state-registered advisers, though the state version may have minor variations

Registration process and effective dates

State registration (USA §201/§202): A state-registered investment adviser files Form ADV (Parts 1A, 1B, 2A, 2B, and CRS where applicable) through the IARD system, pays the state fee, and submits any state-specific addenda. The registration becomes effective:

• Automatically on the 30th day after filing a complete application, unless the administrator denies, suspends, or stops the application during that window
• The administrator may shorten the period and grant early effectiveness, or may extend the period if additional information is needed
• A deficient or incomplete filing does not start the 30-day clock until the deficiency is cured

Federal registration: A federal covered investment adviser files Form ADV with the SEC through IARD. The SEC has up to 45 days to grant effectiveness, with the option to delay if additional information is required or if disciplinary or examination concerns warrant.

Books and records retention — the 5/2 rule:

• Required books and records must be retained for 5 years total from the date of last entry
• The first 2 years must be kept in the adviser's principal office (or otherwise immediately accessible)
• The remaining 3 years may be archived but must remain available for SEC or state examination
• Records include client account documents, billing records, advertising files, performance records, code-of-ethics documentation, and personal trading reports of access persons

Ongoing maintenance obligations:

• Annual amendment of Form ADV Part 1 (within 90 days of fiscal year end) and Part 2A (within 90 days, including a summary of material changes)
• Other-than-annual amendments must be filed promptly upon material changes to specified items
• Annual offer to deliver an updated brochure to existing clients
• Continuing education requirements for IARs (NASAA model rule, covered in next chapter)
• Maintenance of registration of each IAR with the state(s) where they have a place of business

Definition of Investment Adviser

Under the Uniform Securities Act and the Investment Advisers Act of 1940, a person is an investment adviser if they meet the ABC test:

• A — Advice: Provides advice about securities
• B — Business: In the business of providing advice (not just occasional or incidental)
• C — Compensation: Receives compensation for the advice

All three elements must be present. Exempt Reporting Advisers (ERAs) include advisers to private funds or venture capital funds who are exempt from full registration but must still file reports with the SEC.

State vs. Federal Registration

• State-registered: Advisers with AUM under $100 million generally register with the state(s) where they have a place of business
• Federal-covered: Advisers with AUM of $100 million+ register with the SEC. Notice-filing with states may still be required.

Registration and Post-Registration Requirements

• Books and records: Must maintain records for at least 5 years (2 years in the principal office)
• Uniform forms: Form ADV (Parts 1, 2A, 2B, 3) filed through IARD
• Registration maintenance: Annual updates, fee payments, continuing education for IARs
• IAR supervision: Investment advisers must supervise their representatives and maintain written supervisory procedures

Who Is Excluded from the IA Definition?

Certain persons are excluded from the investment adviser definition under both the Uniform Securities Act and the Investment Advisers Act of 1940. These exclusions are heavily tested:

• Banks and bank holding companies (but not bank subsidiaries or affiliates that act as advisers)
• Lawyers, accountants, engineers, teachers — IF advice is solely incidental to their profession AND they receive no special compensation for the advice
• Broker-dealers — IF advice is solely incidental to their brokerage business AND they receive no special compensation
• Publishers — IF the publication is of general and regular circulation (not tailored to individual subscribers)
• Federal covered advisers — excluded from state registration (but may still need to notice-file)

Critical distinction: "Solely incidental" and "no special compensation" must BOTH be true for the exclusion to apply. If a lawyer charges a separate fee for investment advice, they lose the exclusion and must register.

State vs. Federal Registration Thresholds

Notice filing: Even federal covered advisers must file copies of their Form ADV with states where they maintain a place of business. States may also require a consent to service of process and state-specific fees. States cannot impose additional substantive requirements on federal covered advisers beyond notice filing.

Form ADV — What's in Each Part