What is the Investment Advisers Act of 1940
The Investment Advisers Act of 1940 is a U.S. federal law that defines the role and responsibilities of an investment advisor/adviser. The Investment Advisers Act of 1940 was largely drafted as a response to the stock market crash 11 years earlier, as well as the subsequent Great Depression. The Act originated from a report on investment trusts and investment companies that the Securities and Exchange Commission (SEC) prepared for Congress in 1935. The SEC report warned of the dangers posed by certain investment counselors and advocated the regulation of those who provided investment advice. Based on this recommendation, Congress began work on the bill that eventually became the Investment Advisers Act of 1940.
Breaking Down Investment Advisers Act of 1940
The Investment Advisers Act of 1940 is the chief source of regulation for the SEC and provides the legal groundwork for monitoring those who advise pension funds, individuals and institutions on investing. It defines the nature of investment advice, who is an advisor and stipulates who must register with state and federal regulators. Its genesis can be seen in the Public Utility Holding Act of 1935, which allowed the SEC to examine investment trusts. That decision led to the passage of the Investment Company Act of 1940 and the Investment Advisers Act of 1940, which allowed further investigation into trusts and investment companies. The scrutiny found abusive or unsound practices and fees.
Establishing Advisor Criteria
The act addressed who is and isn't an advisor by applying three criteria: what kind of advice is offered, how the individual is paid for their advice/method of compensation, and whether or not the lion's share of the advisor's income is generated by providing investment advice (the primary professional function). Also, if an advisor leads a person to believe they are an investment advisor (via advertising, for example) they can be considered an advisor.
The act stipulates that anyone providing advice or making a recommendation on securities (as opposed to another type of investment) is considered an advisor. Individuals whose advice is merely incidental to their line of business may not be considered an advisor, however. Some financial planners and accountants may be considered advisors while some may not, for example.
Investment Advisers Act of 1940 Framework
Guidelines for the Investment Advisers Act of 1940 can be found in Title 15 section 80b-1 of the United States Code:
(1) their advice, counsel, publications, writings, analyses, and reports are furnished and distributed, and their contracts, subscription agreements, and other arrangements with clients are negotiated and performed, by the use of the mails and means and instrumentalities of interstate commerce;
(2) their advice, counsel, publications, writings, analyses, and reports customarily relate to the purchase and sale of securities traded on national securities exchanges and in interstate over-the-counter markets, securities issued by companies engaged in business in interstate commerce, and securities issued by national banks and member banks of the Federal Reserve System; and;
(3) the foregoing transactions occur in such volume as substantially to affect interstate commerce, national securities exchanges, and other securities markets, the national banking system and the national economy.15 U.S.C.
The Investment Advisers Act of 1940 and Registration
The Dodd-Frank Wall Street Reform Act of 2010 amended the act by stipulating that investment advisory firms or individuals with more than $110 million under management would be required to register with the SEC. Generally, though there are some exceptions and exemptions, all advisors with roughly $100 million can register with the SEC or their state regulator. Anything less than $25 million requires registration with the state only. The act also states the liability of investment advisors have and provides guidelines regarding the fees and commissions they can collect.