Series 63 Study Guide
Post 3 of 7
- Module 1: Definitions from the Uniform Securities Act
- Module 2: Securities Act regulates broker-dealers and the agents
- Module 3: Investment Advisers and their representatives
- Module 4: Securities registration, exemptions, and their issuers
- Module 5: Administrative provisions and remedies
- Module 6 - Customer and prospects communication
- Module 7 - Obligations and ethical practices
Post 3 of 7 in the Series 63 Study Guide
In this section, we look at how the securities act regulates investment advisers and their representatives.
The provisions in this section and what we have already covered in the previous section are similar, but we will also look at what specifically applies to investment advisers and their representatives.
We can alert you to one difference from the start: investment advisers register with different entities than broker-dealers.
As we discussed earlier in this guide, broker-dealers must register with both the SEC and the state.
It’s either one or the other for an investment adviser.
They can be registered either with the state where they reside or with the SEC.
As for investment adviser representatives, they only need to register at the state level.
This is unlike an agent, who has to be registered with the SEC and the state if they represent FINRA member firms.
Who are and who aren’t classified as investment advisers?
Let’s recap what an investment adviser is.
The basic thing to remember is that an investment adviser will provide advice that’s related to securities.
So investment advisers will:
- Advise their clients about securities
- Regularly give this advice, as part of a business that has offices from which it provides its services
- Get compensated for the advice they provide
Investment adviser services could include portfolio management over and above providing investment advice for clients.
Those employed by an investment adviser firm are known as investment adviser representatives.
SEC Release IA-1092
According to SEC Release IA-1092, investment advisers also include:
- Pension consultants
- Financial planners
- Anyone, who as part of their financial practice, offers investment advice
Passing on investment advice to others
Here are the kinds of services that are offered by investment advisers.
- Financial planning
- Pension consulting
- Sport and entertainment advising
Employed by a business that gives investment advice
An investment adviser is subject to the regulations if they provide advice to clients and if:
- The advice they provide on a regular basis is considered a business activity. It’s the frequency the advice is given that determines whether they are an investment adviser or not, amongst other variables. That need not be the only task they carry out.
- Advertises their investment advisory services as an investment adviser or as someone who offers investment advice.
Is paid for their services
When a person gets paid in any form for giving advice about investments, they are deemed an investment adviser under the act.
Exclusions from the definition of investment adviser
Those excluded from the definition of an investment adviser will not be required to register.
The Uniform Securities Act provides us with instructions as to who doesn’t fall under this definition.
- Investment adviser representatives. Although the company they work for does fall under the definition.
- Trust companies
- Banks (although savings and loans associations, building and loan associations, or foreign banks do not fall under this specification)
- Savings institutions
- Accountants, engineers, teachers, and lawyers but only if they only give advice related to their profession.
- The brokerage firm’s investment advisory services are incidental to their primary business. This is only true if, when providing advice, they don’t receive extra payment for doing so.
- Publishers, columnists, employees, or TV station/network owners, operators, producers, or other staff providing financial news and updates. This is as long as general financial information is provided.
- Federal covered investment advisers registered with the SEC.
- Other individuals the state administrator specifies
We need to speak about federal covered advisers a little more.
The NSMIA, promulgated in 1996, made some changes to the registration of investment advisers.
The responsibilities for registration were divided between the SEC and securities departments of various states.
The biggest change came in terms of how advisers had to register.
While small investment adviser firms can register at the state level, larger firms need to register with the SEC but they would never need to register with both.
Federal covered advisers could only register with the SEC, however.
What is a federal covered adviser?
- They must be SEC-registered as an investment adviser and work with assets under management of $110 million (the current threshold).
- SEC registration is necessary as they are part of a contract under the Investment Company Act (1940) to manage an investment company.
We need to mention Dodd-Frank and assets under management.
According to the NSMIA, federal covered advisors do not need to register with the state based on the assets they manage.
There are various thresholds that cover this, created by Dodd-Frank.
They are for large, mid-sized, and small advisers.
- Large investment advisers
Large investment advisers with assets of over $110 million under their control, must be SEC-registered.
If they manage between $100 and $110 million in assets, it isn’t mandatory to register, but they can if they’d like and they think they will move past the threshold soon.
- Medium-size advisers
This group of advisers deals with assets between $25 million and $100 million.
They are not permitted to register with the SEC, so they register with the state where they operate.
There is one condition, however.
If they are advising an investment company registered under the Investment Company Act (1940), they must be registered with both the SEC and the state.
Firms classified as medium-sized can qualify for the SEC in other ways.
They cannot be stopped from registering with the SEC if:
-There is no requirement for investment advisers to be registered with the securities administrator of the state they operate in
-If the investment adviser was registered, the securities administrator would not require an examination
-The investment adviser must be registered in 15 or more states
-The investment adviser enjoys the advantage of a buffer.
- Small investment advisers
These investment advisers handle assets of $25 million or less.
SEC registration is only a necessity for advising investment companies registered under the Investment Company Act of 1940.
In the case of others that do not, SEC registration is not allowed; instead, they need to be registered in the state in which they operate unless state rules say something different.
One other scenario requires SEC registration.
Investment advisers operating in 15 or more states are subject to SEC regulation registration.
Here are some Dodd-Frank classifications exceptions:
- Pension consultants who manage more than $200 million
- Investing advisers with assets between $100 and $110 that are registered with the SEC
- Within 120 days of filing a Form ADV, those advisers anticipate being registered with the SEC
Notice filing: Federal covered investment advisors
Despite the fact that the Uniform Securities Act does not define them as investment advisers, state administrators may request information from investment adviser firms that operate in their jurisdiction.
Notice filing is the method used when this information is passed on to the state administrator.
What type of information is requested?
Usually, it’s documentation that the SEC has received from the investment adviser that the administrator wants copies of.
They may request that future documentation that is sent to the SEC be sent to them as well.
There’s a filing fee that will need to be paid by the adviser as well.
If they have a state-based office or if they have six or more retail clients over the period of a year from the state, they will need to file notice as well.
Exceptions to these requirements for notice filing should be noted too.
No notice filing for federal covered investment advisors is necessary if their base of operations is not located in the state and if their only state clients are:
- Investment companies
- Investment advisers
- Insurance companies
- Trust companies
- Employee benefit ($1 million or more asset)
- Savings institutions
- Government agencies
Registration exemptions for investment advisers
Some investment advisers won’t have to register in the state in which they operate, even when they fall under the definition of an investment adviser.
No place of business in this state is the first exemption to look at.
This is possible when an adviser has state registration elsewhere, has no office in another state but does have certain clients there.
In order for that to be the case, certain conditions regarding clients need to be met.
These can only be:
- Any broker-dealer registered under the Uniform Securities Act
- Investment advisers
- Employee benefit plans or other institutional investors (they must have assets of $1 million or more)
- Clients that are in the state temporarily (in other words, they are state residents)
- Other parties that are ruled exempted by rules or orders passed by the state administrator
There is also a de minimis exemption here.
If they do not have a physical location in the state and have fewer than five state-based retail clients within a 12-month period, they are not required to register.
Take note of the following as well.
The state considers an investment adviser or their representative to maintain a place of business if they advertise to the public that they can meet prospective clients there, even if they don’t have an office there.
When they do not advertise but instead contact existing clients beforehand, then they are not considered as having an office in the state.
The difference is that anyone can see advertising that an investment adviser might have taken out, but if they are only calling clients, they are dealing with one person at a time.
Moreover, the two target groups differ since one is prospective clients and the other is existing clients.
We move on to private fund advisor exceptions.
The NASAA’s Registration Exemption for Investment Advisers to Private Funds Model Rule shows how they can qualify for exemptions.
While investment advisors can provide advice to more than one qualified private fund, they are the only ones who can do so.
What are private funds?
The Investment Company Act says it is an “issuer that would be an investment company”.
So, therefore, only 100 persons or less beneficially own the issuer’s outstanding securities.
At the moment, the issuer has no plans to make a public offering of its securities in the future.
There are additional requirements for these private funds:
- Investments in them must be made by qualified investors (as per the definition).
- The SEC mandates that exempt reporting adviser reports (ERA reports) be filed with the state for public interest and to protect investors.
- Neither private fund advisers’ representatives nor the adviser themselves should have participated in any activity that would disqualify them as described in Regulation D Rule 506 (d)(1).
Registration/post-registration requirements: Investment advisers
Unless they are exempt from registration for any reason, persons that meet the definition of an investment adviser must register in the state in which they operate for the most part.
In this section, we’ll discuss what is required to register and what is needed after registering.
Registration: Form ADV
Registration as an investment advisor begins with a Form ADV.
This consists of four parts.
Let’s start with Form ADV part 1.
The information that needs to be filled in here has to do with the investment adviser.
It includes these details from Part 1A.
- Where their principal office is located
- If not found at their office, where their books and records are stored
- Business structure (a sole proprietorship, for example)
- The advisory services they provide (for example, individual portfolio management)
- Do they offer other business activities (for example, broker-dealer services)?
- Are they maintaining customer assets?
- Are customer accounts subject to discretionary control?
- Details of all officers, directors, partners, or other relevant control persons
- Disciplinary history
- States where the investment adviser is currently registered/where they will be registered
We move on to Form ADV part 2A, known as the investment adviser’s brochure.
The emphasis is primarily on customer-related information, including:
- Fees and commissions, hourly charges, and all other forms of compensation
- Client types
- Investment types the adviser recommends
- Investment strategies used
- Analysis methods
- Service of process consent
- Education and business background of the staff providing advice as well having discretionary control
- An audited balance sheet must be presented when the investment adviser retains custody or requests prepayment of fees
The investment adviser will need to create various supplements to the brochure for part 2b, with a particular focus on the supervised persons.
Next up is Form ADV Part 2B.
With regards to passing on investment advice, clients will deal with certain staff from the firm.
There are six categories of information about these staff in part 2B:
- Cover page: This identifies the supervisory person or persons that part 2B will be covering.
- Educational background, business experience
- Disciplinary information: Over the last 10 years. Any serious offense from more than 10 years ago must be disclosed too.
- Other business activities: For instance, if the supervised person receives commissions, bonuses, or fees for the sale of securities, it must be disclosed.
- Additional compensation
- Supervision: The supervised person’s supervision activities as well as all the details (title, name, contact numbers) of the supervisor will be listed under this heading.
The client must also receive a supplement for the following supervised persons:
- Those who work directly with the client and provide them with investment advice
- Those with discretionary authority over the client’s assets, even if they don’t have contact directly with them
If you’re taking the Series 63 exam, it is important to remember that the administrator can ask for documents that were filed with the SEC if the adviser has an office in their state.
Additionally, the exam could ask which sections of a Form ADV need to be submitted should they make that request:
- Federal covered investment adviser: Only submits Part 1A
- State-registered advisor: Submits Part 1A and 1B
We move on to Form ADV Part 3.
A Customer Relationship Survey (CRS) must be included in this section
This section, however, won’t have to be filled in by all advisers, only those who work with retail clients and are SEC-registered.
Updating a Form ADV
Within 90 days from the end of the fiscal year, an updating amendment must be filed for the Form ADV.
Probably the most critical factor here is the total amount of assets under management.
There are various amendments for material changes that can be made.
The investment adviser must amend the Form ADV if any of the following information changes or becomes inaccurate:
- The registrant’s name changes
- The business principal location changes
- The location where records and books are kept changes
- The person who prepares the Form ADV changes
- The organizational structure of the investment adviser changes, for example, it goes from a sole proprietorship to a partnership
- If the brochure’s information has become inaccurate for some reason
- There have been any changes regarding disciplinary actions taken against relevant staff
- Policy changes in relation to customer funds or securities
Financial requirements for investment advisers
Under the Uniform Securities Act, the administrator may establish minimum financial requirements for investment advisers in their state.
The administrator of a client’s account or the custodian of their funds may also require that they maintain a certain minimum net worth or post a surety bond.
When it comes to the custody of client funds, the requirements are usually higher than when discretion is given to the adviser.
A financial adviser with custody of client funds usually needs a net worth of $35,000, while those with discretionary authority will need a $10,000 net worth.
Taking both scenarios into consideration (custody and discretionary authority), their net worth must be $35,000.
As you prepare for the exam, you need to understand that the Uniform Securities Act provides only guidelines as to what these values can be.
State laws may require higher net worths for investment advisers who have custody of client funds, have discretion over their accounts, or both.
If an investment adviser is registered in multiple states, they only require bonding in the state where their principal office is located as that will be sufficient for the other states too.
Recordkeeping requirements for investment advisers
When it comes to general business records, investment advisers and broker-dealers have the same requirements.
Broker-dealers and investment advisers have different retention requirements, however.
- Broker-dealers: A period of three years is how long records must be kept. If requested, these records should be accessible for the first two years.
- Investment advisers: A period of five years is how long records must be kept. If requested, these records should be accessible for the first two years.
It is required to keep separate records for broker-dealers and investment advisers.
Investment adviser representative classification
Who is considered to be an investment adviser and who is not?
That’s what we will consider in this section.
The first step is that they are registered under the Uniform Securities Act.
This means persons who are in a similar position, perform similar functions, or who are partners, officers, or directors of the investment adviser.
In the case of those working for federally covered advisers, it is the registration requirements based on their having a business in the state in which they operate.
A person meets the definition of an investment adviser representative by doing the following on a state and federal level:
- Make recommendations
- Give advice around securities
- Handle client accounts
- Manage client portfolios
- Making recommendations to clients and giving advice to them regarding securities
- Selling their advisory services or using other techniques regarding sales (soliciting, offering, or negotiating)
- Supervise any person who offers any of the above actions
Individuals who are waiting for their registration to be approved cannot engage in any activity that requires registration.
While they are waiting, they may do research or clerical work.
We’ve mentioned the term “individual” here a few times and it’s an important one because the representative of an investment adviser can only be a natural person.
Investment adviser representative exclusion definitions
Despite working for an investment adviser, some employees may not be considered investment adviser representatives.
These employees generally fill clerical positions, for example.
Whenever they perform a task that is reserved for representatives of investment advisers, they must register as such.
The Series 65 or Series 66 exam is a requirement for those wishing to become investment adviser representatives.
Uniform Securities Act exemptions from requirements to register as an investment adviser representative
There are a few exemptions to the requirement to register as an investment adviser representative under the act
Several of these are similar to those covered already when looking at what an investment advisor is defined as.
Due to this, we will discuss something that often arises in the Series 63 exam.
That’s no place of business in the state and it only applies to investment adviser representatives.
Individuals are exempt from registration:
- Their place of business is in the state and they are licensed under the securities act of the state
- Clients that are already in the state but are not residents of the state
This is sometimes referred to as the snowbird exception.
An additional exclusion is if someone represents a federal covered investment advisor.
A special rule applies in this regard as per the Investment Advisers Act (Section 203A).
Those working for a federal covered adviser are only required to register in the state where their business is located.
But what is defined as a place of business?
- Their office, from which they operate and provide the various services they provide
- Public locations where they regularly provide the services they offer
Even if a firm has 500 clients in a state, registration of its representatives would not be required as long as they don’t have an office base there.
Federal covered advisers representatives are also covered in a similar manner too.
Additionally, know that the de minimis rule doesn’t apply to anyone affiliated with them.
Investment adviser representatives and their registration requirements
Investment advisers are breaking the law if they are state-registered but employ an unregistered representative.
When an investment adviser representative is registered as required, should they not work in the employment of an investment adviser, their registration isn’t in effect until they do so.
This same rule is for federal covered adviser representatives as well.
So how does registration work?
Well, a form U4 must be completed but there are other ways.
For example, a Form U10 can be used too.
Partners, officers, directors, and anyone else performing a similar function will need to be registered as well.
Once the registration process is complete, it takes 30 days to become effective.
What about independent financial planners used as contractors by firms and not seen as employees?
Well, it doesn’t mean they cannot be registered if they are in the role of a representative.
As part of the registration process, a financial planner must also complete a Form U4 and consent to service of process.
Registration for a representative is only ever with the state and that’s something asked on the exam often.
For those who work for federally covered advisers, this is also true.
Also, in a sole proprietorship, an individual can act as an advisor as well as a representative.
They will not be considered an investment adviser if they act only as a representative, however.
Next, we cover termination procedures related to investment adviser representatives.
Representatives may be required to give notice if they wish to terminate their contract with an investment adviser, depending on how the adviser is registered.
It is the firm’s responsibility to inform the administrator if the investment adviser is registered with the state.
In the case of a federal covered advisor, the representative leaving must inform the state administrator, not the firm.
When a representative moves from one investment adviser firm to the next, both will have to advise the state administrator.
What about the financial requirements of investment adviser representatives?
There aren’t any at all, unlike those imposed on investment advisers.
But, it’s important to note that if a representative goes bankrupt, their registration can be rescinded.
And continuing education requirements for investment adviser representatives?
NASAA’s Model Rule on Investment Adviser Representative Continuing Education went into effect in 2020.
This lays out some directives in terms of continuing education:
- Ethics and professional responsibility: Six credits are required for this aspect of continuing education.
- Products and practice requirements: Six credits are required for this aspect of continuing education.
In addition, we need to consider representatives registered with FINRA.
If they meet FINRA continuing education requirements that meet certain NASAA criteria, that’s fine.
- Continuous education content focused on compliance, regulatory, ethical, and sales practice standards
- The continuing education content comes from state and federal investment advisory statutes, securities industry rules and regulations, and financial services industry standards and practices.
- The participants demonstrate proficiency in the subject matter of the educational materials as required by the continuing education content
Representatives are tasked with reporting their completed continuing education is reported as necessary by the authorized adviser.
This differs from FINRA requirements where the firm is required to report all completed continuing education.
Securities professionals summary
It is crucial that you understand the difference between a broker-dealer, an agent, an investment adviser, and a representative if you hope to pass the Series 63 exam.
Let’s recap with a brief summary.
- A major part of their business revolves around securities and executing trades in them
- They are compensated by markups (markdowns) and commissions
- A broker-dealer’s agents are responsible for buying and selling securities in accordance with customer orders.
- Despite the fact that they can work in a large company doing both tasks, they do have separate responsibilities when compared to investment advisers
Third, investment advisers.
- They mainly provide advice to their clients, for example, investment advice
- An investment advisor is compensated through fees and other charges that depend on the size of the assets they manage
Fourth, investment adviser representatives.
- Mostly, they provide investment advice to clients of the adviser.
- After a client has received investment advice, the investment adviser representative will then issue a buy/sell order to an agent at the broker-dealer where the client holds a brokerage account