:By Barbara Mallon, partner at Mallon and Johnson in Chicago, 
e-mail at feedback@mallonandjohnson.com

The first major change concerns the registration requirements of investment advisors. Under the new Act, advisors managing less than $25 million in client assets, defined as securities portfolios over which the advisor provides continuous and regular supervision, will no longer be allowed to register with the SEC. They will be required, instead, to register with the states in which they maintain their principal place of business, and the states in which they do business. Advisors who manage $25 million or more in client assets, or who advise a mutual fund or small business investment company regardless of size, or are located in states not requiring advisors to register, will still have to register or remain registered with the SEC.

Conversely, those advisors fitting into one of the above categories of either managing over $25 million in assets or managing a mutual fund do not have to register with any of the states so long as they remain registered with the SEC. The new Act preempts state regulation of SEC-registered investment advisors and their supervised persons, as well as persons specifically exempted from the definition of investment advisor at the federal level.

A supervised person would include an employee or independent contractor of an investment advisor who provides investment advice on behalf of, and is supervised by, the investment advisor.

Moreover, the Act creates a national de minimus exception for those advisors who have six or fewer clients. Unless an advisor has a place of business within a state, no state can require it to register if the advisor has fewer than six clients in s where it would be unfair, or a burden on interstate commerce.

The advisory provisions of the new Act stem from Congress's concern for lack of oversight over the 22,500 investment advisors in the United States. According to the latest SEC statistics, with just 81 staffers to monitor 22,500 investment advisors, an advisor stands to be examined once every 44 years. With this in mind and recognizing the limited resources of the SEC, the Act seeks to place a greater burden of supervision upon the states in monitoring the practices of investment advisors.

So far advisors have mixed reactions to the reform legislation. The loss of SEC registration looms as a "stepsister" label among those advisors who do not maintain $25 million under management. Other advisors fear that small advisors will be at a marketing disadvantage in relation to larger firms because the small investment advisors would no longer be able to tout themselves as being SEC-registered.

The Consumer Federation of America (CFA) warns that advisor oversight could deteriorate with passage of this Act. The CFA charges that the increased responsibility from the Act would strain state regulators without sufficient resources to prevent fraud and abuse. "States are doing the best they can with grossly inadequate resources," CFA director Barbara Roper states. "In too many cases, however, their best still leaves investors dangerously vulnerable to fraud." Roper believes Act will present the worst of both worlds: States will be burdened with the entire job of overseeing smaller firms without any federal backup. On the other hand, the states will be prohibited from extending important state law provisions to the majority of individuals who deal directly with the public in the states. State regulators plan a nationwide effort to improve their oversight of investment advisors said Neal E. Sullivan, executive director of NASAA.

The impact of the registration change affects the examination process as well, the second area of change for investment advisors. First, fewer examinations will be conducted by the SEC. By some estimates, the new system will leave the states with primary responsibility for supervising 16,000 of the 22,500 registered investment advisors. The SEC would retain jurisdiction over the remaining 6,500 advisors, who manage approximately 95% of the $8 trillion under advisor management. However, both the SEC and states will still be able to bring anti-fraud actions against investment advisors regardless of whether they are registered with the SEC or the states.

Secondly, in the examinations conducted by the states, the focus will be away from the books and records or net capital requirements of the advisory firms. The new Act prohibits states from enforcing the books and records and financial responsibility standards other than those established by the state in which the investment advisor maintains its principal place of business. It is expected that this new regulation system will create greater uniformity of filing, reduce the burdens for investment advisors and allow for supervisory coordination between the states and the SEC.

The Act’s third change in relation to advisors is the creation of a statutory basis for an administrative proceeding against an investment advisor who has a conviction of any felony within the past ten years. Previously, the advisory laws only restricted access to registration if the advisor was convicted of certain crimes pertaining to fraud such as perjury, or theft. Now the conviction of any felony will be the basis for an administrative proceeding against an advisor to suspend or revoke its license.

Finally, the Act's fourth area of impact on advisors is the requirement that the SEC establish a telephonic or electronic data base so that investors can check the disciplinary histories of investment advisors and associated persons of investment advisors. This system appears to be similar to the National Association of Securities Dealers Central Registration Depository system in which investors can inquire and obtain that state within the preceding 12 month period. It is important to note that the states may still collect filing, registration, or licensing fees as in effect before the enactment of the new Act.

Advisors seeking to register with the state of their principal place of business should contact the State Securities Bureau and obtain the necessary forms for state registration. Generally, these forms include an application (previously, a copy of the Form ADV- whether the states will change the format is unknown), a consent to service of process, proof of passage of certain state examinations or a waiver therefrom.

The SEC’s exemptive authority may permit an advisor to register with the SEC even though it may not have the $25 million in assets or mutual fund affiliation. Legislative history of the new Act suggests that Congress intends the SEC to allow firms with a national or multi-state practice, when appropriate, to register with the SEC. The exemptive authority's policy directive appears limited to situatione disciplinary histories but not complaints.

In conclusion, advisors who meet the $25 million in client assets or manage a mutual fund will not do anything differently as far as registration with the SEC is concerned. However, for those with under $25 million in client assets, they must be registered with the state in which they have their principal place of business and do business by April 12, 1997, unless specific state exemptions apply. Accordingly, advisors in this category will no longer be examined by the SEC; just by the state(s). How the states will manage the increase of advisors under their oversight remains to be seen.