Investment advisers with their principal place of business in foreign jurisdictions have recently become subject to moratoriums on registration because the U.S. Securities and Exchange Commission (the “Commission” or the “SEC” ) and its Staff have concerns that these foreign applicants may be unable or unwilling to make their books and records available for inspection or examination due to local privacy laws. Israel is one of those countries. The United Kingdom was one of these jurisdictions until late 2020.
The SEC’s position, while well-intentioned, is not supported by the law. It also ignores the fact that (i) there are a number of registrants in these jurisdictions that have had their applications for registration deemed effective while local privacy laws were already in effect, and (ii) a number of registrants and exempt reporting advisers have clients, offices, or employees in jurisdictions subject to moratorium and the SEC and its Staff have never expressed concern over their compliance with local privacy laws.
This post walks through the law governing registration and approval as an investment adviser to show that the SEC is acting beyond its statutory authority. In doing so, it concludes that Section 203 of the Investment Advisers Act of 1940 (the “Advisers Act”) requires the SEC to approve otherwise valid applications and address the consequences of local privacy law through other means.
The Law and Issue
Section 203(a) of the Advisers Act states, “it shall be unlawful for any investment adviser, unless registered under this section, to make use of the mails or any means or instrumentality of interstate commerce in connection with his or its business as an investment adviser.”
Paragraph (c) goes on to provide the requirements for registration and the approval process. It reads:
Within forty-five days of the date of the filing of such application (or within such longer period as to which the applicant consents) the Commission shall—(A) by order grant such registration; or (B) institute proceedings to determine whether registration should be denied. Such proceedings shall include notice of the grounds for denial under consideration and opportunity for hearing and shall be concluded within one hundred twenty days of the date of the filing of the application for registration. At the conclusion of such proceedings the Commission, by order, shall grant or deny such registration. The Commission may extend the time for conclusion of such proceedings for up to ninety days if it finds good cause for such extension and publishes its reasons for so finding or for such longer period as to which the applicant consents.
The Commission shall grant such registration if the Commission finds that the requirements of [Section 203] are satisfied and that the applicant is not prohibited from registering as an investment adviser under section [203A]. The Commission shall deny such registration if it does not make such a finding or if it finds that if the applicant were so registered, its registration would be subject to suspension or revocation under subsection (e) of this section. [Emphasis added.]
The Staff is currently relying on subsection (e)(1) for denying these applications. That subsection permits denial if the applicant could be found to have “willfully made or caused to be made in any application for registration or report required to be filed with the Commission under this subchapter, or in any proceeding before the Commission with respect to registration, any statement which was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact, or has omitted to state in any such application or report any material fact which is required to be stated therein.”
As grounds for the moratoriums, the SEC Staff is relying on the affirmation on the Execution Page to Form ADV, which states: “I certify that the adviser’s books and records will be preserved and available for inspection as required by law.” The Staff believes that advisers in jurisdictions subject to moratorium have arguably made false or misleading statements in an application, granting them the authority to reject these applications, because the applicant might be in breach of local law if they comply with an examination request under Section 204. However, this position is too attenuated to survive scrutiny. The reference to “law” on the Execution Page is referencing the Investment Advisers Act and not foreign privacy laws. There is no hint in any proposing or adopting release concerning Form ADV that this reference means anything other than the Investment Advisers Act. There is no precedent for the SEC denying applications because an adviser might theoretically be in violation of local tax, zoning, or employment law.
These applicants have every reason to believe they are making these affirmations in good faith and can knowingly or unknowingly violate local privacy laws without causing their affirmations on Form ADV to be false or misleading.
In any event, every investment adviser registered with the SEC that has a client, employee, or office in Israel (or any other foreign jurisdiction subject to a moratorium) would be making the same alleged false or misleading statement. For this reason, the Staff’s position is simply unfair.
Personal Note
I spent a considerable amount of time debating whether to publish this post. I sought a lot of feedback from colleagues and friends. Lawyers–including myself–in this industry do not want to offend the SEC, any Commissioner, or its Staff. That was never my intention in publishing this article. However, I think we all need to be open to constructive criticism and acknowledge when our decisions are not based in the law, are arbitrary, or unfair.
It is also important to step back and understand that new applicants want to avoid litigating with the SEC to obtain registration. It doesn’t serve as a good introduction to regulated life in the United States. So new applicants are left either (i) avoiding business in the US, (ii) bringing their activities onshore, or (iii) trying to lobby their local governments to provide some sort of privacy relief. All of these solutions are less than ideal.
I believe the SEC should discontinue the practice of moratoriums immediately and work with Congress and foreign governments to seek assurances on local privacy law.