Section 203A(b) of the Investment Advisers Act of 1940 (the “Advisers Act”) states:
(1) No law of any State or political subdivision thereof requiring the registration, licensing, or qualification as an investment adviser or supervised person of an investment adviser shall apply to any person—(A) that is registered under section 80b–3 of this title as an investment adviser, or that is a supervised person of such person, except that a State may license, register, or otherwise qualify any investment adviser representative who has a place of business located within that State; (emphasis added).
As such, the federal law preempts state regulation of “supervised persons” of investment advisers registered with the U.S. Securities and Exchange Commission (SEC), unless those supervised persons are also “investment adviser representatives”.
Whether a person who is responsible for business development and client introductions (i.e., a solicitor) on behalf of an investment adviser registered with the SEC is subject to state licensing turns on two issues:
- Whether the solicitor is a supervised person, and
- Whether he or she is an investment adviser representative.
A supervised person is defined in section 202(a)(25) of the Advisers Act as:
(i) any partner, officer, director (or other person occupying a similar status or performing similar functions), or employee of an investment adviser, or (ii) any other person who provides investment advice on behalf of the investment adviser and is subject to the supervision and control of the investment adviser. (emphasis added).
If an investment adviser registered with the SEC structures a relationship with a person responsible for business development and client introductions as an employee-employer relationship, then that person should be viewed as a supervised person. In this case, this employee would only be subject to state licensing if they meet the definition of investment adviser representative under rule 203A-3(a) under the Advisers Act. The term investment adviser representative generally means a supervised person of the investment adviser:
(i) who has more than five clients who are natural persons (other than excepted persons []); and
(ii) more than ten percent of whose clients are natural persons (other than excepted persons []).
For purposes of this definition, an “excepted person” is a natural person who is a “qualified client” under the Advisers Act. This definition includes (i) natural persons who have a net worth of more than $2,100,000 (excluding their primary residence), and (ii) natural persons who have $1,000,000 under the management of the investment adviser immediately after entering into their contract.
The SEC created this system in an effort to ensure that those providing investment advice primarily to retail investors as opposed to businesses, their retirement plans, educational institutions, charitable institutions and other type of sophisticated investors would remain subject to state licensing. In the adopting rule release accompanying rule 203A-3, the SEC staff made it clear that it drafted the definition to omit “high net worth individuals from treatment as natural persons…because of their wealth, financial knowledge, and experience…” and that these people “do not need the protections of state qualification requirements.” Therefore, by definition, a supervised person could have an infinite number of clients that are non-natural persons or that are high net worth individuals without becoming subject to state licensing (assuming that they do not have more than five natural person clients who are not excepted persons).
An issue that was also addressed in the adopting release for rule 203A-3 was whether a client of the investment adviser is a client of the supervised person for purposes of counting the five client limitation imposed by the definition of investment adviser representative. In the adopting release, the SEC staff noted that “some advisory firms consider each person to whom the firm provides advisory services to be a client only of the firm and not of any individual supervised person.” In response, the SEC staff noted that whether clients of an investment adviser will be considered those of a supervised person depends on whether the person “has substantial responsibilities with respect to the client’s account or communicated advice to the client. If more than one supervised person provides advice to a client, the client should be attributed to each supervised person.”
Therefore, if a supervised person of an investment adviser registered with the SEC is solely responsible for introducing clients to the firm, does not have substantial responsibilities for a client’s account, and does not communicate investment advice to the client, then they should not be subject to state licensing as “investment adviser representatives”.
This analysis does not turn on (i) where the employee is located, (ii) where the employee locates his or her clients, (iii) whether the employee receives incentive-based compensation[1], and (iv) whether the employee has other employers.
If a person
involved in business development or client introductions does not meet the
definition of “supervised person” or meets the definition of “investment
adviser representative”, an investment adviser would be required to analyze
state law to see whether that person is subject to licensing or qualification
as an “investment adviser” or “investment adviser representative”.
[1] However, the Employee Retirement Income Security Act of 1974 may impose limitations on the receipt of incentive-based compensation relating to employee benefit plans, which is outside the scope of this guidance.