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Tips for Investors and Financial Professionals: What is an Investment Adviser?

George C. Miller,Esq. SHUSTAK REYNOLDS & PARTNERS, P.C. April 2013       

Introduction

The global financial crisis brought unprecedented change to the securities industry. Investment banks and brokerage firms once thought to be insulated from the ebbs and flows of the market failed outright or were brought to the brink of bankruptcy. Thousands of stockbrokers, investment advisers and others employed in the industry found themselves unemployed, sometimes overnight. Public sentiment for Wall Street fell to an all-time low.

At the same time, main street investors still needed investment advice and a place to invest their savings. More than ever, they sought unbiased, conservative advice to help avoid the risky products and investments that contributed to the financial crisis in the first place. Unlike stockbrokers, who sometimes are motivated to “sell” certain products to investors to generate enhanced commissions (usually the riskier or more exotic the product is, the higher the broker’s commission), investment advisers typically are compensated through annual advisory fees, ranging from .5-2% of total account value. As their compensation is not directly tied to the individual products they recommend to clients, there is, in theory, less of a chance their recommendations will be biased.

According to a study recently published by Fidelity Investments,2 most investors turned to investment advisers for advice following the financial crisis. In fact, more than 90% of investors surveyed ranked their adviser as being more helpful during the financial crisis than any other source. As the securities industry continues trending away from the traditional wirehouse model, however, it has become increasingly difficult for the public to differentiate between stockbrokers and investment advisers. This article expounds upon California’s definition of “investment adviser” and highlights some of the key differences between brokers and advisers.

“Investment Adviser” Defined

In California, an investment adviser is defined 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 a part of a regular business, publishes analyses or reports concerning securities.” Cal. Corp. Code §25009; see also Investment Adviser’s Act of 1940, codified, as amended, at 15 U.S.C. §§80b-1, et seq., at §80b-2(a)(11). Most state “blue sky” securities laws define “investment adviser” similarly. In short, anyone who gives investment advice to another for compensation is considered an investment adviser in California, subject to the licensing and registration requirements discussed below.

Moreover, anyone who engages in any of the following activities also may be deemed an investment adviser under California law: (1) recommending securities; (2) managing accounts or portfolios of clients; (3) soliciting, offering or negotiating for the sale of investment advisory services; and (4) supervising employees who perform any of the foregoing acts. Commissioner’s Opinion, 2010 WL 4222049 (Cal. Dept. Corp. 2010); see also In the Matter of the Desist and Refrain Order Against Robert T. Reese, et al., 2009 WL 6769332 (Cal. Dept. Corp. 2009) (issuing cease and desist order against unlicensed individual who received compensation for providing investment advice to a prospective investor).

A stockbroker, by contrast, is one who is “engaged in the business of effecting transactions in securities for the account of others…”. Cal. Corp. Code §25004. In short, investment advisers give advice for compensation while brokers effect securities transactions for commissions. Dually registered individuals-e.g., investment advisers who also are licensed and registered with a brokerage firm to act as a broker-may give investment advice andprocess securities trades. Unless an exception applies, and there are many, anyone who gives investment advice for compensation must be licensed and registered either with the SEC or the state securities regulator as an investment adviser.

Exceptions to the Registration Requirement

While the definition of “investment adviser” is very broad, there are a number of exceptions to the licensing and registration requirements. Stockbrokers, lawyers, accountants and other professionals whose rendering of advisory services is “merely incidental” to the conduct of their business are exempt. See 15 U.S.C. §80b-2(a)(11)(D). In addition, investment advisers whose only clien ts are insurance companies or who operate as a foreign private adviser, charitable organization or business development company (i.e., a private equity firm) generally need not be registered. See 15 U.S.C. §80b-3(b)(1)-(7). In California, a narrow “de minimis” registration exception also applies to advisers who do not maintain an office within California and have fewer than six clients within the state. See Cal. Corp Code §25230.1. Other states have similar exceptions.

One of the most common exemptions from the regulatory scheme, however, applies to publishers of “bona fide newspaper[s], news magazine[s] or business or financial publication[s] of general and regular circulation.” See 15 U.S.C. §80b-2(a)(11)(D); accord Cal. Corp. Code §25009. As long as the publication does not give rise to a person-to-person relationship formed for the purpose of rendering financial advice, these publications are presumed to be excluded from the licensing and registration requirements. See Lowe v. S.E.C., 472 U.S. 181, 207-210 (1985) (“The dangers of fraud, deception, or overreaching that motivated the enactment of the statute are present in personalized communications but are not replicated in publications that are advertised and sold in an open market.”). This exception is based on First Amendment “commercial speech” protections.

While financial publications and pundits often skirt the line of engaging in conduct that falls within the definition of an “investment adviser”, their “recommendations” generally are carefully worded, expressed as opinions and not targeted toward any specific individuals. They also are not directly compensated for their investment advice, instead earning subscription or appearance fees. As a result, their conduct typically falls within the free speech exception to the regulatory framework.

Investment Adviser Regulation

Assuming no exception or exemption applies, all investment advisers must be licensed and registered with the SEC and/or the state securities regulator for the states in which they do business, depending on their total assets under management. Cal. Corp. Code §25230; N.R.S. 90.330; 15 U.S.C. §80b-3(a). Generally, the SEC regulates investment advisers with more than $100 million in assets under management, while advisers with less than $100 million are regulated by the state securities regulators of the states in which they do business. See SEC Rule 203A-1. All advisers must have passed the Series 65 securities license examination in effect as of January 1, 2000, or hold an older version of the Series 65 (or other combination of securities licenses) through a permissible “grandfathered” exception.3 See Cal. Code Regs. §260.236.

For dual registrants (e.g., individuals acting as both an investment adviser and stockbroker), the Series 65 license typically is registered with both the adviser’s broker-dealer of record and an investment advisory firm. Advisers who no longer wish to handle securities transactions or affiliate with a FINRA member firm may register their Series 65 license (or its equivalent) solely with a registered investment advisory firm. Prospective clients of an investment adviser may view the adviser’s licensing information and disciplinary history through the SEC’s Investment Adviser Public Disclosure (IAPD) website, at www.sec.gov/answers/iapd.htm.

Conclusion

The number of registered investment advisers has grown substantially in recent years.4 This trend is expected to continue as investors seek unbiased advice and clarity in what still is an uncertain economic environment. Investment advisers, and those interested in becoming advisers, should seek the advice of competent counsel to ensure they meet the numerous regulatory requirements governing the profession. And before entrusting their hard-earned savings to someone holding him or herself out as an “investment adviser”, public investors should confirm the individual is properly licensed and registered with the appropriate regulatory authorities.

Schedule a free initial consultation by calling Shustak Reynolds & Partners, P.C. toll free at 888-748-8748, or contact us online


1 Mr. Miller is an associate attorney based in the firm’s San Diego, California office. His practice focuses on securities arbitrations, including customer and “intra-industry” employment and promissory note disputes, business and corporate litigation, contractual disputes and judgment enforcement proceedings.

2 See http://www.fidelity.com/inside-fidelity/individual-investing/fidelity-study-finds-financial-crisis-was-wake-up-call-for-investors. The study describes the financial crisis as a “wake up call” for investors which caused permanent changes in their approach to handling finances, including expanded reliance on advice from financial professionals.

3 The Series 65 was developed by the North American Securities Administration Association (NASAA) and will qualify an individual to operate as an investment adviser representative in most states. The exam was substantially revised in early 2000 and currently is administered by FINRA. In California, advisers employed or engaged as an investment adviser prior to December 31, 1999, and advisers who have passed an older version of the Series 65 in addition to the Series 7, generally are exempt from re-taking the January 2000 version of the Series 65 examination. See Cal. Code Regs §260.236.

4 According to a research brief published by the RAND Corporation, a non-profit global policy think tank financed by the U.S. government and private endowments, the number of investment advisers has grown considerably in recent years. See http://www.rand.org/content/dam/rand/pubs/research_briefs/2008/RAND_RB9337.pdf.

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