Tag: 202(a)(11)

Are you an Investment Adviser?

There has been a lot of focus on the effect of Dodd-Frank on private fund managers. Many had relied on the small adviser exception from registration. If you had fewer than 15 clients (funds) you were exempt from regulation. With the loss of that exclusion, the industry has been looking to other ways to fall outside the requirements of registration.

One may be to take another look at the definition of investment adviser and see if it really applies to what your fund does.

Section 202(a)(11) of the Advisers Act defines an “investment adviser” as

“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, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”

Let’s break it down into its three components:

  1. for compensation
  2. engaged in the business
  3. provide advice about securities

A person or firm must satisfy all three elements and not fall into one of the half dozen statutory exclusions to be regulated under the Advisers Act.

For fund managers, the “compensation” is easily satisfied. A fund manager is giving advice to its funds. Presumably, they are not doing it for free.

The term “securities” is very broadly defined in Section 202(a)(18) of the Investment Advisers Act.

Whether a person providing financially related services is an “investment adviser” is a facts and circumstances test. In  Release IA-1092 (.pdf) the SEC took a look at whether financial planners are investment advisers and provided some ways to look at whether you are in “engaged in the business” of “providing advice about securities.”

Here are some activities that the SEC believes falls into the category:

  • Giving advice about securities, even if it does not relate to specific securities
  • advise concerning the relative advantages and disadvantages of investing in securities in general as compared to other investments
  • in the course of developing a financial plan for a client, advises the client as to the desirability of investing in, purchasing or selling securities
  • a person who advises employee benefit plans on funding plan benefits by investing in, purchase, or selling securities, as opposed to, or in addition to, insurance products, real estate not involving securities, or other funding media
  • providing advice as to the selection or retention of an investment manager (under certain circumstances)

“Engaging in the business” of providing investment advice is a little trickier. Giving advice need not be the principal business activity. “The Giving of advice need only be done on such a basis that it constitutes a business activity occurring with some regularity. The frequency of the activity is a factor, but it is not determinative.”

It comes down to how often a fund manager gives advice to the fund about securities as part of the fund’s operations and investment process.

Sources:

Image is Have a Heart. by A. Golden / CC BY-NC-ND 2.0

Is a Fund Manager an Investment Adviser?

Yes, for private investment funds, the general partner is generally considered an investment adviser under the Investment Adviser Act.

Let’s start with the definition of an investment adviser from the Investment Advisers Act:

“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, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities…” [202(a)(11)]

You can parse three elements out of that definition:

  1. Compensation
  2. Advice concerning securities
  3. In the business

Compensation

The first one is the easiest. I don’t think you’re going to find a fund manager who is not getting paid. It may be a combination of management fees or carried interest, but it’s still compensation. You could look at some academic arguments about who would fall in and out of the definition, but those arguments are irrelevant to fund managers.

Advice concerning securities

If you are giving recommendations to buy or sell, then you are giving advice. In addition, if you are telling people when to switch between different investments or how to select investment advisers then you are giving advice. The fund manager is making the decision about what to buy, sell and finance so the fund manager is giving advice. [I’m writing about the “securities” side in another post.]

In the business

Lastly, you need to be “in the business” of giving advice. That’s going to rule out your shoeshine boy, but clearly fund managers are in the business of giving advice. Again, there are some academic questions that could make this prong of discussion interesting. But for a fund manager, it’s very straightforward.

Abrahamson

It’s not just me making this interpretation. The Second Circuit answered this question in 1978. [See: Abrahamson v. Fleschner, 568 F.2d 862 (2d Cir. 1977) , overruled in part on other grounds by Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979)] “These provisions reflect the fact that many investment advisers ‘advise’ their customers by exercising control over what purchases and sales are made with their clients’ funds.”

Exclusions

There are six exclusions in the definition of the “Investment Adviser” [202(a)(11)]but they are inapplicable to most fund managers:

  1. banks
  2. lawyers, accountants, teachers and engineers
  3. Certain broker/dealers
  4. publishers of bona fide newspapers and magazines in general circulation
  5. government securities advisers
  6. Nationally recognized statistical rating organization

Registration

That means fund managers are typically going to be considered to investment advisers. That also means that they may have to register with the SEC, unless there is an exemption from registration. Up until the Dodd-Frank Act, there was the 15 client exemption. That’s gone.