Introduction to Investment Adviser Regulation and ABC Test

An Introduction to An Introduction to Investment Adviser Investment Adviser Regulation Regulation Presented by, Max L. Schatzow, Esq.

Introduction Introduction

12,659 IAs registered with the U.S. SEC with $72 trillion in AUM managing 36 million client accounts 17,635 IAs registered with state securities regulator 3,587 IAs that are exempt reporting advisers Iprovide counsel to these IAs as it relates to registration, regulation, examinations, enforcement and litigation. I also provide counsel on transactional and employment matters. Over the last couple of years, I have started providing outsourced compliance services.

Definition of Definition of Investment Investment Adviser Adviser ABC TEST ABC TEST

Section 202(a)(11) Section 202(a)(11) of the Investment of the Investment Advisers Act of 1940 Advisers Act of 1940 (the Advisers Act ) (the Advisers Act )

Defines an investment adviser as any person or firm that: for compensation; is engaged in the business of; providing advice to others or issuing reports or analyses regarding securities.

Compensation Compensation Advisory fee (AUM- based, hourly or retainer) Financial planning fees Commissions Carried Interest or Profit Distribution

Engaged in Engaged in the Business the Business Not required to be primary or exclusive business Holding Out test Receipt of compensation Frequency and specificity of the investment advice

Advice about Advice about Securities Securities Stocks, bonds, mutual funds, partnership interests and commodity pools? Yes Real estate, coins, or commodities? No Advice about market trends? Yes Selection of other advisers? Yes Asset allocation? Yes

Who does this Who does this definition cover? definition cover? Financial Planners? Pension Consultants? Financial Adviser? Wealth Manager? Family Offices? Hedge Fund and Private Equity Fund Managers?

Specific Specific Exclusions Found Exclusions Found in the Definition in the Definition

For example: Banks and bank holding companies Lawyers, accountants, engineers and teachers as long as the advice is incidental to the practice of their professions Brokers and Dealers Publishers Family office

Registration Registration

Section 203(a) of the Advisers Act An investment adviser must register unless: Prohibited, or Exempt from registration

State vs. Federal Registration Small Advisers - < $25mm of assets under management Regulated by the state where principal office and place of business is located (unless an exemption is available) Examples of state exemptions: New Jersey Uniform Securities Law N.J.S.A 49:3-56 Exemption from Registration The person has a place of business in this State and during any period of 12 consecutive months that person does not have more than five clients, who are residents of this State Pennsylvania Securities Act of 1972 Section 102(j) Exclusion - A person who has a place of business in this State and during the preceding twelve-month period has had not more than five clients in or out of this State and does not hold himself out generally to the public as an investment adviser

Mid-Sized Advisers Between $25mm and $100mm Regulated by the state where principal office and place of business is located (unless an exemption is available); and Subject to examination by the state securities authority New York is only state that does not conduct examinations, so SEC registration is required Large Advisers - > $100mm

Small and Mid-Sized Advisers are prohibited from registering with the SEC Several exceptions to the prohibition Investment Company advisers Related Advisers Certain Newly Formed Advisers Multi-state Advisers Internet Advisers State IAs still subject to Section 206 of the Advisers Act (Anti- fraud provision) SEC IAs still subject to certain state laws Anti-fraud statutes Notice filings Investment Adviser Representative licensing

A Few A Few Relevant Relevant Exemptions Exemptions

Foreign Private Advisers Charitable Organizations Private Fund Advisers Venture Capital Advisers

The Registration The Registration Process Process (with the SEC) (with the SEC)

Form Form ADV ADV

Currently 2 Parts (Rules proposed in April 2018 now require a 3rd Part) Form ADV Part 1 Q&A or Check the Box Information about the business, ownership, clients, employees, disclosure events Form ADV Part 2 Narrative Brochures Business practices, investment strategies, risk disclosures, fees and conflicts of interests Form ADV Part 3 Form CRS or Client Relationship Summary containing information for retail investors Timeline SEC must grant registration or institute an administrative proceeding within 45 days

Five Overarching Five Overarching Regulatory Regulatory Aspects for Aspects for Investment Investment Advisers Advisers

1. Fiduciary Duty Duty of Care Duty to act and provide advice in the best interest of the client Duty to seek best execution of client transactions where the adviser has the responsibility to select broker- dealers to execute client trades Duty of Loyalty Duty to place client s interest first Avoid conflicts or make full and fair disclosure of material conflicts

2. Substantive Provisions of the Advisers Act Section 206(3) Transactional Provisions (principal and agency transactions) Section 206(4) Unlawful to engage in any act, practice or course of business which is fraudulent, deceptive or manipulative. Rule 206(4)-1 Advertisements Rule 206(4)-2 Custody of Client Cash or Securities Rule 206(4)-3 Use of Solicitors Rule 206(4)-5 Pay to Play Prohibitions Rule 206(4)-6 Voting Client Proxies Rule 206(4)-7 Compliance Procedures and Supervision Rule 204A-1 Code of Ethics

3. Contractual Requirements No requirement to have written advisory contract Prohibition on performance-based fees Qualified Clients $1 million under management Net worth test Knowledgeable employees Anti-Assignment Provisions Advisers Act requires contracts to include a provision prohibiting the assignment of the contract. Transactions that do not result in change of actual control or management are not deemed assignments Prohibition on Hedge Clauses No Termination Penalties

4. Recordkeeping Requirements Rule 204-2 Books and Records 5. Regular examination of IAs Notification of completed examination with no findings Deficiency letter Referral to the Division of Enforcement

Thank You Thank You