In a few days, the Securities and Exchange Commission could issue new regulations that will have profound consequences for the investment adviser industry and investors that use it. At the heart of the current debate is the appropriate regulatory role of the states in regulating large investment advisers that do business on a national, or even international, basis.
If properly issued, the new regulations should help larger advisers and their institutional investor clients by decreasing the current costs, risks and burdens of dual and overlapping federal and state regulation. If not (or if the regulations are ignored by the states), advisers will continue to bear the costs and burdens of inefficient and duplicative regulation, as well as face decreased competitiveness, uncertainty and even litigation.
On Oct. 11, President Clinton signed into law the National Securities Markets Improvement Act, which included the most sweeping changes in the law governing investment advisers since the Investment Advisers Act of 1940. Title III of the law, the Investment Advisers Supervision Coordination Act, divides responsibility for investment advisers between federal and state governments. Subject to certain exceptions, the IASCA allocates primary regulatory authority over "larger" advisers (defined to be those that manage more than $25 million in client assets) to the SEC and authority over "smaller" advisers to the various state securities regulators.
This basic scheme makes abundant sense. By allocating and coordinating regulatory responsibility between the SEC and the states, Congress clearly sought to mitigate the problems of duplicative and inconsistent adviser regulations. As the SEC has noted: "Congress concluded that if the overlapping regulatory responsibilities of the Commission and the states were divided by making the states primarily responsible for smaller advisory firms and the Commission primarily responsible for larger firms, the regulatory resources of the Commission and the states could be put to better, more efficient use."
The IASCA proved to be the final - and ultimately the most contentious - piece of the 1996 securities law puzzle. Toward the end of the 1996 legislative session, the Senate and House appeared to be at an impasse in considering legislation dealing with investment advisers.
Based on bipartisan efforts led by Sen. Phil Gramm, R-Texas, and Sen. Christopher Dodd, D-Conn., - which were supported strongly by the Investment Counsel Association of America - the Senate earlier in the year had passed an advisers bill that pre-empted state registration, licensing and qualification laws for larger investment advisers. Sen. Gramm and his colleagues recognized everyone could win by coordinating efforts to regulate the investment adviser industry.
For larger advisers operating in interstate commerce - and, increasingly, in international markets - it makes sense to make the SEC their primary regulator. By shedding responsibility for several thousand smaller advisers, the SEC will be able to concentrate its resources on a more limited universe, thereby increasing investor protection and regulatory efficiency. And for smaller advisers, it makes sense to make states their principal regulator. As SEC Chairman Arthur Levitt Jr. has noted, "The 1996 Act provides the states with the paramount role in overseeing the small investment advisers . . . where it's clear that they can do a more effective job." Again, investors will be the biggest winners from coordinating specific responsibilities between the SEC and the states.
After the Senate passed its bill, it soon became apparent the situation on the other side of Capitol Hill was vastly different. The House had not passed any investment adviser bill and had resisted the notion of including any such legislation in the final conference report, in part because of opposition by state securities administrators. Thankfully, at the last minute, Sens. Gramm and Dodd proposed a compromise to the IASCA, which the House accepted. The final bill was enacted with overwhelming support.
As enacted, the IASCA retains the broad federal pre-emption of state registration, licensing and qualification requirements for larger advisers the original Senate bill contained. But the compromise bill also added the following exception from federal pre-emption: "except that a State may license, register or otherwise qualify any investment adviser representative who has a place of business located within that State."
The meaning of those 24 words is now the subject of an intense debate. The ICAA strongly believes they amount to a narrow and limited exception that allows states to register individuals of larger adviser firms based on uniquely local concerns - namely, where the adviser has an office in the state from which it does business and where a significant amount of the adviser's business consists of dealing with individual investors.
Unfortunately, the SEC's proposed regulations expand this narrow exception to the point that the basic purpose of the new law could be undermined. Instead of using the new law's "place of business" test, the SEC essentially has proposed a "doing business" test, so any employee of a large adviser firm who regularly travels to another state to provide advisory services could be subjected to state registration, licensing and qualification requirements. The proposed regulations even go so far as stating that a place of business could include "a hotel room, temporarily rented office space, or even the home of a client, if the adviser representative regularly provides advisory services or solicits, meets with, or communicates to the client at that location."
The ICAA believes this interpretation flies in the face of the normal meaning of "place of business" - i.e., an office or some other location from which the adviser provides advisory services, meets with, or communicates to clients. As Sen. Gramm noted recently, "When I think of place of business for an investment adviser representative, I certainly do not think of a restaurant, an automobile, an airport lobby or a phone booth, and I would consider it bizarre to think of an adviser's client as a place of business." If implemented, the proposal would negate the basic scheme envisioned under the IASCA, and actually could result in increased regulation and costs for larger advisers and their individual employees.
The SEC has received more than 100 written comment letters on its proposal and will meet shortly to consider final regulations. The proposed "place of business" definition has come under fire from nearly all corners. SEC Commissioner Isaac Hunt noted in a speech in April that "with one exception . . . every commenter who addressed the issue opposed the Commission's proposal."
The one exception to the maelstrom of opposition is the North American Securities Administrators Association, which essentially argues the federal government has no business telling the states how or whom they may regulate.
The ICAA hopes the SEC, upon reflection, will faithfully implement the law as envisioned: to coordinate regulatory responsibility for advisers between the SEC and the states. For larger advisers, this would mean the SEC would have primary regulatory authority over their activities, except the firm also would have to register investment adviser representatives (those who deal extensively with retail clients) in states where the firm has an office.
Even if the SEC properly implements the new law, a more serious threat might appear in the states. While it is too soon to predict the final outcome, some states already are considering legislation that directly contradicts provisions of the new law. These unfortunate actions apparently are being justified under the banner of states' rights. This type of confrontational approach, if pursued, could result in confusion, uncertainty and even litigation.
A far better approach would be for all states to work with the SEC, the Congress and the investment adviser industry to fulfill the letter and spirit of the new law - i.e., to coordinate regulation of the adviser industry.
Congress has taken a sensible step to ensure investor protection, increase regulatory efficiency and reduce overlapping and inconsistent regulation of large advisers. It would be highly unfortunate and counterproductive if states ignore such a common-sense approach and instead choose to go their separate ways.
The ICAA stands ready to work with the SEC, the states and the adviser industry to achieve the goal of sensible, uniform and more efficient regulation. The new law, if implemented properly by the SEC and the states, is a long overdue step toward this commendable goal. nDavid Tittsworth is executive director of the Investment Counsel Association of America, which comprises more than 200 investment advisory companies that manage more than $1 trillion in total.