New York-Those of you in alternative research who have been reading with schadenfreude our previous posts about the securities industry’s struggles with the U.S. Investment Advisors Act, take care. There is a big dog behind you ready to bite you in the rear. Alternative research providers are also subject to the Advisors Act.
The Publishers Exemption
As we discussed previously, the definition of an investment advisor is sufficiently broad to encompass most investment research. You meet the test if you give advice about securities, whether stocks, bonds, mutual funds, limited partnerships or commodity pools. Advice on real estate, precious metals or commodities is not deemed advice on securities, but advice on market trends or asset allocation is.
Most alternative research providers rely on the so-called publishers’ exemption which exempts from registration under the Advisor Act “the publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation.” Let’s look more carefully at this exemption.
Lowe v SEC
The US Supreme Court examined the publishers exemption in a suit brought by the SEC against newsletter publisher Christopher Lowe. In interpreting the exclusion, the Supreme Court first read the term “bona fide” to mean a “genuine” publication “in the sense that it would contain disinterested commentary and analysis as opposed to promotional material disseminated by a “‘tout.'” Most investment research will pass this test, although it is possible that research produced as part of an IR program could be an issue.
The Court then found that “[t]he Act was designed to apply to those persons engaged in the investment-advisory profession-those who provide personalized advice attuned to a client’s concerns, whether by written or verbal communication.” Accordingly the Court held that Lowe was not an investment adviser as defined by the Act since the newsletters did “not offer individualized advice attuned to any specific portfolio or to any client’s particular needs.” A key phrase here is ‘personalized advice attuned to a client’s concerns’. If an alternative research provider offers access to analysts or custom research, this could trigger the personalized advice provision, nullifying the publisher’s exemption.
There’s more. The SEC also looks to the regularity of the research in determining if the publisher’s exemption applies. Research is exempt if it “is of general or regular circulation rather than issued from time to time in response to episodic market activity.” You can debate whether most fundamental research is regular or episodic. To our knowledge, the issue has not been tested…yet.
In the Matter of Weiss Research Inc
In June 2006, the SEC brought action against Weiss Research (not to be confused with Weiss Ratings which is now part of theStreet.com) for failing to meet the publishers’ exemption to the Advisors Act. Between 2001 and 2005, Weiss had established “auto-trading” accounts with selected brokers. Under this “auto-trading”, the brokers would automatically execute the trades recommended in the Weiss Research newsletters.
As of December 2003 there was $30 million in subscriber assets in these auto-trading accounts. According to the SEC, Weiss made false statements about the track records of these auto-trading accounts, highlighting profitable trades and omitting mention of unprofitable trades. Weiss also provided assistance to subscribers to determine which premium service would be suitable for them.
The SEC decided that Weiss Research was an investment advisor because it provided advice on securities. The SEC ruled that Weiss Research failed to meet the publishers’ exemption because it engaged in personalized communication with investors regarding its investment advice and because Weiss effectively had discretionary control over the auto-trading accounts. Weiss Research had to pay about $2 million in various penalties.
It is not clear how effective the publishers’ exemption will be for alternative research providers. First, it is questionable whether most investment research meets the “general or regular circulation” test. Second, the SEC seems to have a broad definition of what constitutes personalized advice, including analyst contact. While it does not appear that the SEC is planning a “sweep” of alternative research providers, the potential for trouble is there. If the SEC finds anything amiss with an alternative research provider, the publishers’ exemption may prove a weak reed of support.