Investment Adviser Registration Rules Under the Series 66

The Series 66 combines the content of the Series 63 (state securities law) with investment analysis and portfolio management concepts from the Series 65. One of the most consistently tested areas on the Series 66 is investment adviser registration: who must register, where they register, and what exemptions apply.

This post covers adviser registration in the depth the Series 66 requires.

The Two Levels of Registration

Investment advisers register at either the federal level (with the SEC) or the state level (with the state securities administrator), depending primarily on their assets under management.

SEC Registration (Federal Covered Advisers)

An investment adviser generally must register with the SEC if it manages $100 million or more in assets under management (AUM). Once registered with the SEC, the adviser is called a "federal covered adviser." Federal covered advisers are exempt from state registration requirements but must file a notice with each state where they have clients (typically just paying the state fee and submitting a copy of their SEC registration).

Advisers managing between $100 million and $110 million have a buffer zone. They may register with the SEC, or they may remain state-registered. Advisers with AUM under $100 million must generally register with the states in which they operate.

There are some additional situations where SEC registration is required regardless of AUM:

• Advisers to registered investment companies (mutual funds)
• Advisers with clients in 15 or more states (multi-state advisers)
• Internet advisers who maintain an interactive website and have clients nationwide

State Registration

Advisers with AUM under $100 million (or those who do not otherwise qualify for SEC registration) register at the state level. They must register in each state where they have a place of business and may need to register in states where they have clients above the de minimis threshold.

The de minimis exemption for state registration: An investment adviser with no place of business in a state and no more than 5 retail clients in that state during a 12-month period is not required to register in that state.

Investment Adviser Representatives (IARs)

An investment adviser representative is an individual who provides investment advice, manages accounts, or otherwise acts on behalf of a registered investment adviser. IARs of state-registered advisers must register at the state level, in any state where they conduct advisory activities.

IARs of federal covered advisers are not registered at the state level. The state may require a notice filing, but it cannot impose an IAR registration requirement on advisers who are federally covered.

For the Series 66, know these registration rules cold:

• IAR of a state-registered adviser: registers in the state
• IAR of a federal covered adviser: does not register with the state (states have limited authority over federal covered advisers and their reps)

The Investment Advisers Act of 1940

Federal registration of investment advisers is governed by the Investment Advisers Act of 1940. This Act requires registration, mandates disclosure to clients (Form ADV), and prohibits certain fraudulent practices.

Form ADV: Investment advisers (both federal and state) file Form ADV to register and update their information. Form ADV Part 2 (the brochure) must be delivered to clients and describes the adviser's services, fees, conflicts of interest, and disciplinary history. Part 2A covers the firm; Part 2B covers individual advisory personnel.

Delivery requirements: The brochure (Part 2A) must be delivered to new clients at or before the time of entering the advisory contract. If there are material changes, the adviser must deliver an updated brochure (or a summary of changes) annually.

The Three-Part Test for Investment Adviser Status

Under both federal and state law, a person is an investment adviser if they meet all three parts of the test:

1. For compensation: They receive some form of economic benefit (money, reduced fees, products) in connection with their advisory activities. Compensation does not have to be a direct fee. Referral fees, soft dollars, and embedded compensation can all qualify.

2. Regarding securities: The advice concerns securities. Advice about commodities, real estate, insurance, or currencies alone does not make someone an investment adviser.

3. As part of a regular business: The person provides advice regularly, not just occasionally. A one-time recommendation does not make someone an adviser.

All three elements must be present. The Series 66 tests the exclusions from adviser status under each element.

Exclusions from Investment Adviser Status

Certain persons are explicitly excluded from the definition of investment adviser even if they technically meet the three-part test:

Banks and bank holding companies: Not investment advisers under the Advisers Act (though bank employees who separately act as advisers may still need to register).

Lawyers, accountants, engineers, and teachers: Excluded if the advisory activity is incidental to their professional practice and they receive no separate compensation for the securities advice.

Broker-dealers: Excluded if the advice is incidental to their brokerage business and they receive no special compensation for the advice. This exclusion has limits. A broker-dealer who holds out as providing investment advisory services, charges separately for advice, or provides comprehensive planning is not excluded.

Publishers: Excluded if they publish general-circulation materials (newsletters, newspapers) containing impersonal advice not tailored to specific clients.

Government securities advisers: Excluded from the Advisers Act if they advise only on U.S. government securities (though they may be subject to other oversight).

Prohibited Practices Under the Advisers Act

Performance-based fees: Investment advisers generally cannot charge fees based on capital gains or capital appreciation unless the client is a "qualified client" (with at least $1.1 million in assets under management with the adviser or a net worth of at least $2.2 million). Performance fees that only benefit the adviser when the portfolio gains, but impose no clawback when it loses, are called asymmetric performance fees and are problematic.

Assignment of advisory contracts: An adviser cannot assign an advisory contract to another adviser without client consent. Assignment occurs when a controlling interest in the adviser changes hands.

Solicitor arrangements: An adviser can pay cash referral fees to solicitors who bring in clients, but must have a written agreement, and the solicitor must deliver a separate disclosure document explaining the referral arrangement and the compensation involved.

Custody rules: If an adviser has custody of client assets (physical possession or legal authority over the assets), enhanced safeguards apply including surprise annual audits by an independent accountant.

Brochure Supplements (Form ADV Part 2B)

Brochure supplements must be provided to clients for any supervised person (IAR) who provides advisory services directly to that client. The supplement covers the individual's educational background, business experience, disciplinary history, and outside business activities.

The Series 66 tests the brochure and supplement delivery requirements with some regularity. Know that the brochure goes to clients before they sign the contract, and supplements are provided for specific supervised persons who will work with that client.

Investment adviser registration is one of the most testable mechanical topics on the Series 66. Understand the AUM thresholds, the IAR registration rules, Form ADV requirements, and the three-part adviser definition, and this area becomes a reliable source of correct answers.