An unusual pattern of regulation confronts anyone who wants to engage in the business of providing investment advisory services in New York State. As an aid to financial advisors who may want to commence or develop an investment advisory business in New York, this article will provide a framework for identifying the fault lines and arbitrary trigger points of investment advisory regulation within the state.

The Investment Advisers Act of 1940 imposes a bifurcated system, which requires investment advisers to be registered and regulated at either the federal or state level, subject to an overall exception that preserves independent federal and state authority for anti-fraud protection. The Advisers Act also divides regulatory authority between the states for advisers with multi-state operations and sets minimum thresholds for any state regulation. The unique features of New York State's regulatory scheme for investment advisers create a complex interplay between the federal and state requirements for advisers who offer their services in New York.

The following 9 questions and answers will help New York State advisers through an analysis of the regulatory restrictions that will apply to their proposed operations.

1. Will you be an "investment adviser" under federal law?

The Advisers Act governs the activities of those who come within the definition of "investment adviser," so an analysis of the application of investment adviser regulation to those who give financial advice must begin with the meaning of the term "investment adviser" under the Advisers Act.

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 and selling securities.

The term also includes anyone who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.

Generally, the Securities and Exchange Commission (SEC) broadly interprets the concept of "engaging in the business" of advising, and if an adviser gives advice on a basis that constitutes a business activity and provides the advice with some regularity, then the adviser is "engaging in the business." The frequency of the activity is viewed as a factor but is not determinative. The staff of the SEC has also determined that for the purpose of determining investment adviser status, the advice does not have to be about specific securities; it is sufficient if the adviser gives general advice about the value or securities.

References: Advisers Act section 202(a)(11); Investment Advisers Act Release No. 1092 (October 8, 1987).

2. If you are an investment adviser, will you nevertheless be exempted or excluded from federal investment adviser registration requirements?

In broad terms, the Advisers Act provides that unless an investment adviser is registered, or unless the adviser is exempted or excluded from registration, it is unlawful for the adviser to use any jurisdictional means in connection with its business as an investment adviser.

For advisers who provide investment advice on a limited basis, the principal exemption that may apply is the exemption for private investment advisers. Generally, any investment adviser that had fewer than 15 clients during the course of the preceding 12 months and that does not holds itself out to the public as an investment adviser is exempt from registration.

The principal exclusion from registration results from a provision of the Advisers Act that prohibits federal registration by any investment adviser that is regulated as an investment adviser in the state where its principal office and place of business is located unless the investment adviser has not less than $25 million of assets under management. It is notable that the threshold for the federal registration requirement has a "soft" border; that is, any investment adviser who has more than $25 million of assets under management may register federally, but any investment adviser who has more than $30 million of assets under management must register federally. The assets-under-management exclusion has the effect of dividing the regulatory requirements for investment advisers between the SEC, which registers larger investment advisers, and the individual States, which register smaller investment advisers.

For purposes of the assets under management exclusion, the SEC has adopted a special rule for investment advisers who provide investment advice exclusively through an interactive Internet website and have no more than 15 other clients; because advisers in this category are viewed as holding themselves out to the general public as investment advisers on a national basis, they must register with the SEC even though they may have less than $25 million under management.

The Advisers Act also provides exclusions from registration where the provision of investment advice is solely incidental to the performance of professional services by certain persons, such as lawyers, accountants, teachers, and brokers or dealers in securities. Generally, for investment advisory services to be considered solely incidental to these other activities, the provider may not charge a separate fee for the investment advisory services provided.

With regard to advisers who may be investment advisers because they publish analyses or reports regarding securities, there is an exclusion from the investment adviser definition for persons who are publishers of a bona fide newspaper, news magazine or business or financial publication of general and regular circulation. This exclusion has generally been interpreted to require that the publication provide only impersonalized advice, that it provide disinterested commentary (i.e. not promotional material), and that it be of general and regular circulation (i.e., not be selectively marketed or timed to activity in the securities market).

References: Advisers Act sections 2(a)(11), 203, and 203A; Rules 203(b)(3)-1 and 203A-2; Lowe v. SEC, 472 U.S. 181 (1985)

3. If you are subject to federal registration, what kinds of regulatory burdens will apply to your investment advisory activities?

If a financial advisor will act as an investment adviser and if it will not be exempted or excluded form registration, then it must register by filing a Form ADV with the SEC. Form ADV is filed over the Internet through the IARD electronic registration system. Form ADV requires information about the adviser's business, its business practices, the persons who own and control the adviser, its fees, and the potential conflicts of interest that the adviser may have with its clients. A description of the registration and filing process is available on the SEC's Internet website at www.sec.gov/divisions/investment/iard/register.html.

Generally, the SEC must either declare an investment adviser registration effective within 45 days after the Form ADV is filed, or it must take affirmative action to prevent the registration from becoming effective. The adviser may check through the IARD system to determine when the registration has become effective, and the SEC will deliver an Effective Order to the adviser by regular mail when registration is complete.

After the registration becomes effective, the adviser will be subject to a range of substantive regulatory requirements including requirements concerning amending and updating the Form ADV, advertising and referral fee limitations, providing disclosure documents to clients, using appropriate written investment advisory contracts with clients, maintenance of certain books and records, limitations on performance based fees, custody requirements, restrictions on trading in securities including principal and agency cross limitations, a code of ethics, privacy policies, and the establishment of a compliance program that includes written policies and procedures reasonably designed to prevent violations of the Advisers Act. A general overview of these requirements is provided by an SEC staff memorandum titled "Information for Newly-Registered Investment Advisers," which can be found at www.sec.gov/divisions/investment/adoverview.com.

The SEC undertakes periodic, special and other examinations of the books and records of federally registered investment advisers. The SEC's stated goal is to examine every investment adviser during the first year after it becomes registered and within every four-year period thereafter. Generally, the timing and frequency of inspections is related to the degree of risk associated with the kinds of operations the adviser engages in.

The Advisers Act preempts state registration of federally registered investment advisers by prohibiting any state or political subdivision of a state from requiring the registration, licensing, or qualification of an investment adviser or supervised person of an investment adviser that is registered with the SEC. The Advisers Act does permit the individual states to require notice filings, and where a federally registered investment adviser has more than 5 clients within the state, New York requires the adviser to file a notice copy of the federal Form ADV together with the payment of an annual fee. Filings are accomplished by adding New York as a notice filing state in the federal IARD filing and by submitting a paper copy of Part II and Schedule F of the Form ADV (which cannot be filed through the IARD system) to New York.

References: Advisers Act sections 203 and 203A; Rules 203-1, 203A-1; 13 NYCRR section 11.5.

4. If an advisory firm is subject to federal registration, what kinds of regulatory provisions will apply to the persons who act as its advisory representatives?

Although the Advisers Act generally preempts state registration, qualification, or licensing of the supervised persons of federally registered investment advisers, the states are permitted to regulate those persons who come within the definition of an "investment adviser representatives." Generally, an "investment adviser representative" is a supervised person of an investment adviser who has an office within the state if the representative has as clients more than 5 natural persons within the state, and if more than 10% of the representative's clients are natural persons (in each case, "excepted persons" -- natural persons who have at least $750,000 under management with the adviser or who have more than $1.5 in net worth -- are not counted). The SEC has excluded from investment adviser representative status those supervised persons who do not on a regular basis solicit, meet with, or otherwise communicate with clients of the investment adviser and those supervised persons who provide only impersonal investment advice.

  • Unlike many other states, New York does not impose separate qualification requirements for investment adviser representatives of federally registered investment advisers.

References: Advisers Act Section 203A and Rule 203A-3.13 NYCRR section 11.5.

5. If you are not subject to registration under federal investment adviser requirements, are you subject to registration by New York State?

As discussed above, the Advisers Act generally requires foreign investment advisers to register federally if they (a) have 15 or more clients within the U.S. during any 12-month period or if they hold themselves out to the public as offering investment advisory services, and (b) have more than $30 million of investments under management. The Adviser's Act also contains a "National De Minimis Standard," which prohibits the states from requiring investment advisers to register or comply with qualification or licensing requirements (other than provisions prohibiting fraudulent conduct) if they do not have a place of business within the state and if during the preceding 12-month period they had fewer than 6 clients who are residents of the state.

New York has filled the regulatory opening provided by the Advisors Act by requiring every investment adviser that is not registered federally and has sold investment advisory services to more than 5 persons residing in New York (exclusive of financial institutions and institutional buyers) to register as an investment adviser in New York.

References: Advisers Act sections 304(b)(3) and 222(d). National Securities Markets Improvements Act of 1996, Title III, Investment Advisers Supervision Coordination Act, section 307. New York General Business Law section 359-eee.

6. If you must register as an investment adviser in New York, what kinds of regulatory provisions will apply to your investment advisory activities?

Registration as an investment adviser in New York is accomplished by:

  • Filing a Form ADV with New York through the IARD system;
  • Mailing Part II and Schedule F of the Form ADV (which cannot be filed through IARD) to the state together with an income statement and a balance sheet that is either audited or certified by managment; and
  • Paying the required registration fee ($200).

Note that unlike the "soft" threshold for investment adviser registration under federal law (see question 2 above), the threshold for investment adviser regulation in New York is a "hard" threshold. That is, an investment adviser who has had fewer than 6 New York resident clients during the preceding 12 months is exempt, but as soon as an investment adviser has its sixth New York resident client within a twelve month period it must already be registered within the state or it will be in violation of the statute. In this regard, it should be noted that Form ADV, which New York requires to be filed in order to effect state registration, requires disclosure of the number of investment advisory clients the adviser had in its most recently completed fiscal year.

Beyond the applicable filing requirements (which require annual updates), New York applies relatively few substantive regulatory requirements to New York State registered investment advisers. New York requires its state registered investment advisers to maintain a variety of books and records concerning their advisory activities for a minimum of 5 years. New York also requires state registered investment advisors to submit copies of any advertising used in the state and copies of any investment advisory literature sold to clients in the state. New York also requires its registered investment advisers to annually send a statement to their New York clients indicating that they may obtain from the adviser upon request a copy of the adviser's Form ADV.

If an investment adviser is registered in the state in which it maintains its principal office, the National De Minimis Standard contained in the Advisers Act prevents any other state from imposing registration or qualification standards on the state registered adviser that are more restrictive than the requirements of the adviser's state of registration with respect to: the maintenance of books and records, net capital requirements, or bonding requirements. New York has no net capital or bonding requirements applicable to its state registered investment advisers.

Although the Advisers Act relegates to the states the primary responsibility for investment advisers who are not required to register federally, it nevertheless includes a number of provisions that apply to all investment advisers including those that are state registered. These provisions include:

  • Requirements for advisers to maintain procedures reasonably designed to prevent misuse of material non public information by the adviser and its associated persons in violation of the Securities Exchange Act;
  • Requirements governing the provisions contained in advisory contracts with clients relating to performance fees, assignment of the contract, and notification of change in the membership of the adviser if it is organized as a partnership;
  • Restrictions on the collection of performance fees; and
  • Prohibitions on fraud and restricting agency cross and principal transactions.

References: Advisers Act Section 222 and Rules 222-1 and 2; Section 204A; Section 205; Section 205(b)(1) and Rules 205-1, 2 and 3. 13 NYCRR sections 11.9, 10, 14, and 15.

7. If you must register as an investment adviser in New York, what kinds of regulatory provisions will apply to persons who act as your investment adviser representatives?

Under the Advisers Act, the individual states may impose licensing and qualification requirements on the investment adviser representatives (see question 4 above) of both federal and state registered investment advisers. New York does not apply any licensing or qualification requirements to the investment adviser representatives of federally registered investment advisers.

New York does require every investment adviser who is required to register in New York and who is an individual, and every individual who represents a state registered investment adviser in New York in doing any of the acts that make a person an investment adviser, to take and pass an examination or qualify for a waiver from the examination requirement. Those persons must:

  • Pass the Uniform Investment Adviser Law Exam (Series 65); or
  • Pass both the General Securities Representative Examination (Series 7) and the Uniform Combined State Law Examination (Series 66); or
  • Be exempt from the examination requirement by being a member of a recognized, credentialed professional organization such as a Certified Financial Planner (CFP), Chartered Investment Counselor (CIC), Chartered Financial Consultant (ChFC), Personal Financial Specialist (PFS), or Chartered Financial Analyst (CFA).

References: 13 NYCRR sections 11.6 and 11.7.

8. If you are not subject to registration under federal or New York State investment advisers laws, what regulations will apply to your investment advisory activities in New York?

In those situations where a state is preempted from imposing registration and qualification standards on investment advisers, the National De Minimis Standard contained in the Advisers Act nevertheless permits the state to prohibit fraudulent conflict. New York

empowers its attorney-general to investigate and prosecute fraudulent practices committed by investment advisers.

The Advisers Act also imposes certain requirements on all investment advisers, whether or not they are required to be registered or qualified by the SEC or any state. These requirements include:

  • Requirements for advisers to maintain procedures reasonably designed to prevent misuse of material non public information by the adviser and its associated persons in violation of the Securities Exchange Act;
  • Requirements governing the provisions contained in advisory contracts with clients relating to performance fees, assignment of the contract, and notification of change in the membership of the adviser if it is organized as a partnership;
  • Restrictions on the collection of performance fees; and
  • Prohibitions on fraud and restricting agency cross and principal transactions.

References: Advisers Act Section 222 and Rules 222-1 and 2; Section 204A; Section 205; Section 205(b)(1) and Rules 205-1, 2 and 3. New York General Business Law sections 352, 358, and 359-eee.

9. If you are considering the commencement of investment advisory activities in New York, what is the next step?

The foregoing discussion should enable an investment adviser to form a general understanding of the level of regulatory oversight that applies to investment advisers and to their supervised persons depending upon whether they will be required to register federally with the SEC, register with New York State, or operate below the threshold of the National De Minimus Standard. If the adviser determines to proceed with its proposed investment adviser activities, the next step would be to work with appropriate legal counsel to develop a comprehensive compliance program tailored to the specific operations that the adviser will undertake.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.