To Be or Not To Be…an RIA

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New York, NY – Based on research conducted by Integrity Research Associates, a relatively small percentage of all U.S.-based alternative or independent research firms are also “registered investment advisors”.  Most independent research firms have traditionally claimed that they need not register as RIA’s due to the “publisher’s exemption”.  However, it is not obvious that this exemption actually applies to all independent research providers.  Today’s article discusses this topic in more detail.


What is an Investment Advisor?

According to Section 202(a)(11) of the Investment Adviser’s Act of 1940, an “investment adviser” is any person or firm that is engaged in the business of making recommendations; issuing reports, or furnishing analyses on investment securities either directly or through publications; and that receives compensation for these services.  A firm or individual must satisfy all three criteria to be deemed an investment adviser.

It is important to note that the SEC defines these three criteria broadly.  For example, the receipt of any economic benefit would be deemed compensation.  In addition, the fees received for advice do not need to be separate from other fees received, nor do they need to be designated as “advisory fees”.  As far as the “business of making recommendations”, the investment advisory component does not need to be the sole or even principal business activity of the individual or firm.

Exclusions

The Advisers Act also excludes certain persons or firms from the definition of an investment adviser.  These excluded persons or firms need not register, and are generally not regulated by, the Investment Advisers Act.  These excluded entities, include:

  1. Domestic banks and bank holding companies.
  2. A variety of professionals or firms if their performance or provision of advisory services is incidental to their core professions or businesses.  This includes lawyers, accountants, engineers, and teachers.  Broker-dealers are also excluded if their performance of advisory services is solely incidental to the conduct of their business as brokers and dealers, and they do not receive any special compensation for their advisory services.
  3. Publishers of newspapers, news magazines, and business or financial publications of general and regular circulation. Under a decision of the United States Supreme Court, a publisher may qualify for this exclusion under three conditions: (1) the publication must offer only impersonal advice (the advice may not customized to the individual needs of a specific client, group of clients, or portfolio); (2) the publication must be “bona fide,” in other word’s it must include objective commentary and analysis rather than promotional material or advertising particular securities, and (3) the publication must be of general and regular circulation rather than issued from time to time in response to specific market activity or periodic events affecting the securities industry.
  4. Persons and firms whose advice, analyses, or reports are related only to securities that are direct obligations of, or obligations guaranteed by the United States or by certain U.S. government-sponsored corporations designated by the Secretary of the Treasury.


Exemptions

Even if a person or firm meets the definition of an “investment advisor”, they might not need to register with the SEC if they meet one of the criteria established in Section 203(b) of the Investment Advisers Act.  These exemptions include any advisor:

  1. Whose entire client base is within the same state as the adviser’s principal business office;
  2. That does not provide advice or issue reports about securities listed on any national securities exchange;
  3. That (a) during the previous twelve months has had fewer than fifteen clients; (b) does not hold itself out generally to the public as an investment adviser; and (c) does not act as an investment adviser to a registered investment company or business development company;
  4. That is a charitable organization, is employed by a charitable organization, or provides advice, analyses, or reports only to charitable organizations, or to funds operated for charitable purposes;
  5. That provides advisory services to church employee pension plans.

Whether a firm should be registered as an investment advisor with the SEC or a state is typically determined by the amount of assets under management. In order for a firm to register with the SEC, the firm must have over $25 million of AUM at the time of registration or within 120 days of the effective date of the investment advisor registration. If a firm has less than $25 million of AUM and doesn’t anticipate having $25 or more within 120 days of the effective date of the investment advisor registration, then it must register with the individual state(s) as an investment advisor.  If a firm has $30 million or more of AUM, then it must register with the SEC.  Firms with more than $25 million and less than $30 million of AUM can be registered with either the state securities regulator or SEC.


Requirements for Investment Advisers

While there are many requirements associated with becoming a Registered Investment Adviser (including examination requirements, books and record retention, and state or federal regulation), one of the most important responsibilities of an investment adviser is the ongoing fiduciary duty an RIA has to clients.  As a fiduciary, an investment adviser has a duty of care, loyalty, honesty, and good faith to always act in the best interest of its clients.  Some of the duties associated with being a fiduciary include:

  1. To place the interest of clients first at all times;
  2. To have a reasonable basis for its investment advice;
  3. To seek best execution for clients’ securities transactions where the adviser directs such transactions;
  4. To make investment decisions consistent with any mutually agreed upon client objectives, strategies, policies, guidelines, and restrictions;
  5. To treat clients fairly;
  6. To make full and fair disclosure to clients of all material facts about the advisory relationship, particularly regarding conflicts of interest; and
  7. To respect the confidentiality of client information.


What this means for research providers?

In our experience, some independent research providers actually perform the act of being “investment advisers” due to the specific investment advice they provide clients, the periodic nature of their reports and/or recommendations, etc.  As a result, these research providers might not be eligible to claim the “publishers’ exemption” or one of the other exemptions that might apply.

However, a number of these firms don’t register as investment advisers, nor do they fulfill the requirements associated with being one.  While the team at Integrity Research Associates is not qualified to make informed judgments whether a specific research firm should be registered as an adviser or not, it is clear to us that most research firms should consider addressing this potential regulatory risk by reviewing their business practices with competent legal professionals to determine if they should be registered as an Investment Adviser with either a state or the SEC.

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