Regulation of Investment Advisors and Investment Advisor Representatives - Introduction

SEC Registered Investment Advisors

Who must register as a federal covered investment advisor?
The Investment Advisers Act of 1940 (a link to the entire Act can be found in Appendix B) was enacted to protect the public by requiring those who provide investment advice for compensation to register as advisors with the Securities and Exchange Commission (SEC). The provisions of the Act set out both required and prohibited behaviors for advisors who meet the following definition:

An investment advisor (IA) is an individual or entity 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."

Let's translate that definition into plain English and break it down to three main components:

  • Giving advice about securities
    • This includes references to securities in general, not just specific investment recommendations - for example, even advising a client to invest a set percentage in "stocks" is considered advice about securities.
       
  • Being in the business of giving that advice
    • This refers to presenting yourself as an investment advisor.
       
  • Being compensated for that advice
    • This includes receiving compensation of any kind, including fees, commissions, or a combination of the two - and the compensation does not have to be received directly from the client.

 

Exam Tips and Tricks
Many questions on the exam hinge on these components of the must be present to require registration as an investment advisor. For example, you might find a question where a professional such as an accountant or an attorney provides advice about asset allocation, but does not charge a separate fee for this service. In that case, he/she is not being compensated for the advice and so is not required to register.

 

Look Out!
As a rule of thumb, if a person gives specific advice related to investments - for a client\'s specific condition or portfolio - he/she is an investment advisor.

Exclusions
At first glance, it seems that virtually all financial planners, stockbrokers, money managers, pension consultants, etc. would be covered under this definition. However, a number of exclusions mayapply:

  • Banks, or bank holding companies
     
  • Professionals such as lawyers, accountants, teachers, etc. whose advice is incidental to their profession and who receive no special compensation for making recommendations
     
  • Publishers of bona-fide newspapers, magazines or financial publications of a general and regular circulation
     
  • Government securities advisors
     
  • Broker-dealers and their registered representatives whose advisory services are incidental to the securities business and who receive no special compensation for making recommendations

This last exception may seem illogical, since stockbrokers seem to be the major dispensers of investment advice. However, their job function is investment sales; therefore, the investment advice they give is considered incidental to that role. In addition, the Securities Exchange Act of 1934 regulates broker-dealers and their representatives.

Others who are exempt from registration:

  • IAs whose clients are all residents of the state of the IA's principal office and who do not provide advice on exchange-traded securities
     
  • IAs whose only clients are insurance companies
     
  • IAs who qualify for the private advisor exemption (less than 15 clients, do not hold themselves out to the public as investment advisors, and do not advise registered investment companies)

 

Exam Tips and Tricks
You can expect at least one question on the "out of state" clients. One of the options may be "IAs whose only clients are banks", but remember it is IAs whose only clients are insurance companies that are exempt, not those with other institutional clients.

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