Navigating the Process of Investment Adviser Registration
Increased Scrutiny Under Dodd-Frank
Sweeping regulatory changes made under the Dodd-Frank financial reform legislation expanded the scope and reach of the registration requirements under the Investment Advisers Act of 1940. Even as the process of registering under the Act appears to have become more thoroughly scrutinized and, as a result, more onerous, few would have expected this to be true.
Read this article to learn about:
- Regulatory Restructuring
- Rule 206(4)-7 -- The Compliance Rule
- Articulating the Registration Process
Among many other things, Dodd-Frank mandated that the threshold for SEC registration be raised from $30 million to $100 million in assets under management. The rationale for raising the bar for SEC registration by advisers was, in part, to free up the Commission’s limited resources to guarantee its capacity to fulfill the dual mandate of protecting U.S. markets and investors, which had been so sorely tested. The regulatory restructuring would require some 3,000 advisers registered with the Commission to register instead with appropriate state authorities and withdraw their registrations with the SEC, while theSEC would gain some 2,000 newly-registered private fund advisers. When proposed, critics questioned whether state regulators were any better equipped to shoulder the responsibility for effectively regulating these additional advisers, let alone the burden of providing an appropriate level of review to an increased number of registration applications for which they would now be responsible year after year. In fact, the states appear to have risen to the challenge… and then some. In 2012, 3,564 investment adviser registration applications submitted to the states were withdrawn during the review process - before an “approve/deny” decision could be reached—while another 736 were denied or revoked. During the switch from SEC to state registration, many advisers received deficiency letters, delays and requests for additional information, making it clear that the states were not only paying attention, but were judiciously scrutinizing applications to ensure compliance with expectations and the appropriate standard of care.
Not to be outdone, the SEC, which not only experienced a net loss of advisers for which it was responsible, but also added over 800 examiners since 2011, appears to have similarly stepped up its game. Increasingly, it has become imperative to provide clarifying information and disclosures, as appropriate, with SEC registration applications in order to avoid delays and ensure a seamless and timely approval of licensure. Even routine filings by existing registrants made through the IARD system (the electronic database established for receiving Form ADV, the basis for an adviser’s registration applicationand for client disclosure), which merely amends previously filed information, now often results in emailed inquiries and requests for clarification. Previously, this was not the case. Clearly, these filings are reaching the desks and conjecturing eyes of examiners.
Rule 206(4)-7— The Compliance Program Rule
Many first time registrants also fail to recognize the impact of Rule 206(4)-7, the Compliance Programs Rule, on the registration process. The Compliance Programs Rule was passed under the anti-fraud provisions of the Advisers Act in late 2003, effective in 2004. As such, any registered investment adviser that fails to meet its provisions can be cited for fraud, even if no client was harmed by the deficiency, and even if there was no intent to harm or commit fraud against any client or the Commission. Among other things, the Compliance Programs Rule requires that registered investment advisers adopt a comprehensive compliance program, including written policies and procedures fully tailored to the firm’sregulatory obligations, conflicts of interests and other risks arising by virtue of the firm’s unique practice, clientele (or anticipated clientele) and affiliations or the affiliations and outside business activities of the firm’s officers and employees from day one. If an adviser receives a letter of approval from the SEC and promptly begins to provide advice to clients for compensation without having implemented such a program, it can be liable for fraud under the Advisers Act. Therefore, any adviser seeking registration with the Commission must recognize that the process involves much more than establishing an IARD account, completing Form ADV, Part 1, preparing a Form ADV, Part 2, disclosure brochure in plain English, and navigating examiner scrutiny.
Articulating the Registration Process
While not as clearly defined or uniformly articulated in written regulations or otherwise, the states similarly impose a requirement that advisers implement a comprehensive compliance program from day one and may request detailed information regarding the firm’s policies, procedures and processes during the registration review process. Such requests from state regulators can be particularly troubling when there is no written regulation to provide specific requirements so that the adviser can understand precisely what the examiner is looking for to move the application forward. The right partner can help an adviser navigate the registration process, helping not only to ensure a timely registration approval, but also setting the firm up with a robust compliance program that will pay huge dividends during an initial regulatory exam.