61866 Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules

1Pub. L. No. 104–290, 110 Stat. 3416 (1996)

(codified in scattered sections of the United States

Code).

2Other amendments made by the 1996 Act to the

Advisers Act include revisions to (i) section 205 [15

U.S.C. 80b–5] to create additional exceptions to the

Advisers Act’s limitations on performance fee

arrangements, (ii) section 222 [15 U.S.C. 80b–18a]

to impose certain uniformity requirements on state

investment adviser laws, (iii) section 203(e) [15

U.S.C. 80b–3(e)] to permit the Commission to deny

or revoke the registration of any person convicted

of any felony (or any person associated with such

investment adviser), and (iv) section 203(b) [15

U.S.C. 80b–3(b)] to exempt from registration certain

advisers to church employee pension plans. See

sections 210, 304, 305(a), and 508(d) of the 1996

Act.

3 15 U.S.C. 80b–3a(a).

4The Commission has authority to deny

registration to any applicant that does not meet the

criteria for Commission registration and to cancel

the registration of any adviser that no longer meets

the registration criteria. Section 203(c) and (h) of

the Advisers Act [15 U.S.C. 80b–3(c) and (h)].

5 15 U.S.C. 80b–3a(b). In addition, state law is

preempted with respect to advisers that are

excepted from the definition of investment adviser

under section 202(a)(11) of the Advisers Act [15

U.S.C. 80b–2(a)(11)].

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Parts 275 and 279

[Release No. IA–1681, File No. S7–28–97]

RIN 3235–AH22

Exemption for Investment Advisers

Operating in Multiple States; Revisions

to Rules Implementing Amendments to

the Investment Advisers Act of 1940

AGENCY: Securities and Exchange

Commission.

ACTION: Proposed rules.

SUMMARY: The Commission is

publishing for comment under the

Investment Advisers Act of 1940 rule

amendments to exempt multi-state

investment advisers from the

prohibition on Commission registration

and two alternative amendments to

revise the definition of the term

‘‘investment adviser representative.’’

The Commission is proposing these

amendments to refine the rules

implementing the Investment Advisers

Supervision Coordination Act.

DATES: Comments must be received on

or before January 20, 1998.

ADDRESSES: Comments should be

submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Stop 6–9, Washington, D.C. 20549.

Comments also may be submitted

electronically at the following E-mail

address: rule-comments@sec.gov. All

comment letters should refer to File No.

S7–28–97; this file number should be

included on the subject line if E-mail is

used. Comment letters will be available

for public inspection and copying in the

Commission’s Public Reference Room,

450 Fifth Street, N.W., Washington, D.C.

20549. Electronically submitted

comment letters also will be posted on

the Commission’s Internet web site

(http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT:

Carolyn-Gail Gilheany, Attorney, or

Jennifer S. Choi, Special Counsel, at

(202) 942–0716, Task Force on

Investment Adviser Regulation, Division

of Investment Management, Stop 10–6,

Securities and Exchange Commission,

450 Fifth Street, N.W., Washington, D.C.

20549.

SUPPLEMENTARY INFORMATION: The

Commission is requesting public

comment on proposed amendments to

rule 203A–2 [17 CFR 275.203A–2], rule

203A–3 [17 CFR 275.203A–3], rule

206(4)–3 [17 CFR 275.206(4)–3] and

Schedule I to Form ADV [17 CFR 279.1]

under the Investment Advisers Act of

1940 [15 U.S.C. 80b–1 et seq.]

(‘‘Advisers Act’’). The Commission also

is proposing to withdraw rule 203A–5

[17 CFR 275.203A–5] and Form ADV–T

[17 CFR 279.3] under the Advisers Act.

Table of Contents

Executive Summary

I. Background

II. Discussion

A. Multi-State Investment Adviser

Exemption From Prohibition on

Registration With the Commission

B. Definition of Investment Adviser

Representative

1. Accommodation Clients

2. ‘‘High Net Worth’’ Clients

C. Other Amendments

1. Pension Consultants—Determining the

Value of Assets of Plans

2. Rule 206(4)–3—Cash Payments for

Client Solicitations

3. Schedule I to Form ADV

4. Transition Rule 203A–5 and Form

ADV–T

D. General Request for Comment

III. Cost-Benefit Analysis

IV. Paperwork Reduction Act

V. Summary of Regulatory Flexibility

Analysis

VI. Statutory Authority

Text of Proposed rule and Form

Amendments

Appendix A: Schedule I to Form ADV

Executive Summary

Section 203A of the Advisers Act

generally prohibits an investment

adviser from registering with the

Commission unless it has more than $25

million of assets under management or

is an adviser to a registered investment

company. Section 203A also preempts

most state regulatory requirements for

Commission-registered investment

advisers and their supervised persons

except for certain ‘‘investment adviser

representatives.’’ The Commission is

proposing an exemption from the

prohibition on Commission registration

for advisers required to register as an

investment adviser in 30 or more states.

The Commission also is proposing two

alternative amendments to the

definition of investment adviser

representative. Under the current

definition, supervised persons of

Commission-registered investment

advisers will not be subject to state

qualification requirements if no more

than ten percent of their clients are

natural persons (‘‘ten percent

allowance’’). The Commission is

proposing either (1) to add a provision

that would permit supervised persons to

have the greater of five natural person

clients or the number of natural person

clients permitted under the ten percent

allowance, or (2) to eliminate the ten

percent allowance and permit

supervised persons to have an unlimited

number of accommodation clients who

have certain business or familial

relationships with the supervised

person or the supervised person’s

business or institutional clients.

I. Background

Last year, Congress enacted the

National Securities Markets

Improvement Act of 1996 (‘‘1996

Act’’). 1 Title III of the 1996 Act, the

Investment Advisers Supervision

Coordination Act (‘‘Coordination Act’’),

amended the Advisers Act by

reallocating federal and state

responsibilities for regulation of

investment advisers. By limiting federal

registration and preempting certain state

laws, the Coordination Act divided

regulatory responsibilities for the

approximately 23,350 investment

advisers that were registered with the

Commission. 2 The Coordination Act

became effective on July 8, 1997.

Under new section 203A(a) of the

Advisers Act, 3 an investment adviser

that is regulated or required to be

regulated as an investment adviser in

the state in which it maintains its

principal office and place of business is

prohibited from registering with the

Commission unless the investment

adviser (i) has at least $25 million of

assets under management, or (ii) is an

investment adviser to an investment

company registered under the

Investment Company Act of 1940

(‘‘Investment Company Act’’). 4 Section

203A(b) of the Advisers Act generally

preempts state law with respect to

Commission-registered investment

advisers. 5

On May 15, 1997, the Commission

adopted new rules and rule
Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules 61867

6Rules Implementing Amendments to the

Investment Advisers Act of 1940, Investment

Advisers Act Release No. 1633 (May 15, 1997) [62

FR 28112 (May 22, 1997)] (‘‘Adopting Release’’).

7 Id. The Commission also amended several rules

under the Advisers Act to reflect the changes made

by the 1996 Act.

8Section 203A(a) and (b). Notwithstanding

section 203A(b), states retain authority over

Commission-registered advisers under state

investment adviser statutes to: (1) investigate and

bring enforcement actions with respect to fraud or

deceit against an investment adviser or a person

associated with an investment adviser; (2) require

filings, for notice purposes only, of documents filed

with the Commission; and (3) require payment of

state filing, registration, and licensing fees.

Moreover, section 203A(b) specifically preserves

state law with respect to investment adviser

representatives of Commission-registered advisers

who have a place of business in the state. See infra

section II.B of this Release.

9See S. Rep. No. 293, 104th Cong., 2d Sess. 3–

5 (1996) [hereinafter Senate Report].

10 Id. at 5.

11Section 203A(c) [15 U.S.C. 80b–3a(c)].

12 17 CFR 275.203A–2.

13See Arthur Andersen Financial Advisers,

Investment Advisers Act Release Nos. 1637 (June

16, 1997), 62 FR 33689 (Notice of Application),

1642 (July 8, 1997), 64 SEC Docket 2417 (Order);

Ernst & Young Investment Advisers LLP,

Investment Advisers Act Release Nos. 1638 (June

16, 1997), 62 FR 33692 (Notice of Application), and

1641 (July 8, 1997), 64 SEC Docket 2416 (Order);

and KPMG Investment Advisors, Investment

Advisers Act Release Nos. 1639 (June 17, 1997), 62

FR 33945 (Notice of Application), and 1643 (July 8,

1997), 64 SEC Docket 2418 (Order).

14 In tallying the number of states in which an

adviser is required to register, the investment

adviser would be required to exclude those states

in which it is not required to register because of

applicable state laws or the national de minimis

standard of section 222(d) of the Advisers Act. [15

U.S.C. 80b–18a] The Commission believes such an

exclusion is appropriate because it is the obligation

to register in a state, rather than the business

decision to register voluntarily, that demonstrates

that the adviser is subject to the type of burden

contemplated by the exemption.

15See Senate Report at 5 (Congress recognized

that the ‘‘definition of ‘assets under management’

* * * may, in some cases, exclude firms with a

national or multistate practice from being able to

register with the SEC’’).

16Proposed paragraph (e)(2) of rule 203A–2. At

the time of its application for registration with the

Commission, the investment adviser would be

required to include on Schedule E to Form ADV an

undertaking to withdraw from registration with the

Commission if it would no longer be required to

register in at least 25 states at the time of filing

Schedule I. The exemption would require an

investment adviser that indicates that it is no longer

required to register in at least 25 states to withdraw

from Commission registration by filing Form ADVW within 90 days of filing Schedule I. Proposed

paragraph (e)(3) of rule 203A–2.

17This representation must be attached to the

investment adviser’s annual amendment to Form

ADV revising Schedule I. Proposed paragraph (e)(2)

of rule 203A–2. Under the proposed multi-state

exemption, the investment adviser also would be

required to maintain a record of the states that the

adviser believes it would, but for the exemption, be

required to register. Proposed paragraph (e)(4) of

rule 203A–2.

18This ‘‘five-state difference’’ is similar to the ‘‘$5

million window,’’ which makes Commission

registration optional for an adviser having between

$25 and $30 million of assets under management.

See rule 203A–1(a), (b) [17 CFR 275.203A–1(a), (b)].

The Commission adopted the $5 million window to

avoid transient registration problems that could

occur because of a small decrease in the value of

client assets (as a result of a market decline) or the

departure of one or a few clients. See Rules

Implementing Amendments to the Investment

Advisers Act of 1940, Investment Advisers Act

Release No. 1601 (Dec. 20, 1996) [61 FR 68480 (Dec.

27, 1996)] (‘‘Proposing Release’’). Under the

proposed five-state difference, an investment

adviser registered with the Commission in reliance

upon the multi-state exemption would not be

required to de-register and then re-register with the

Commission frequently as a result of a change in

registration obligation in one or a few states.

amendments to implement the

Coordination Act. 6 These implementing

rules included rules that exempt four

types of investment advisers from the

statutory prohibition on Commission

registration and define certain terms

used in the Coordination Act. 7 In

adopting these rules, the Commission

anticipated that experience with the

new regulatory scheme might reveal the

need for additional rules or further

refinement of existing rules. Based on

its experience, the Commission is

proposing to exempt multi-state

investment advisers from the

prohibition on Commission registration,

to amend the definition of investment

adviser representative, and to clarify

certain other implementing rules.

II. Discussion

A. Multi-State Investment Adviser

Exemption from Prohibition on

Registration with the Commission

As discussed above, section 203A of

the Advisers Act limits registration with

the Commission, in most cases, to

investment advisers with at least $25

million of assets under management and

preempts state law with respect to these

investment advisers. 8 The $25 million

threshold was designed to allocate

regulatory responsibility to the

Commission for larger investment

advisers whose activities are likely to

affect national markets and to relieve

them of the burdens imposed by

multiple state regulation. 9 Congress

recognized, however, that there may be

investment advisers with less than $25

million of assets under management that

have national businesses and for which

multiple state registration would be

burdensome. 10 Therefore, the

Commission was given authority in

section 203A(c) of the Advisers Act to

exempt investment advisers, by rule or

order, from the prohibition on

Commission registration if the

prohibition would be ‘‘unfair, a burden

on interstate commerce, or otherwise

inconsistent with the purposes’’ of

section 203A. 11

Pursuant to its authority, the

Commission adopted rule 203A–2,

which permits Commission registration

for nationally recognized statistical

rating organizations and certain pension

consultants, affiliated investment

advisers, and newly formed investment

advisers with reasonable expectations

that they would soon become eligible

for Commission registration.12 The

Commission also, by order, has granted

exemptive relief to investment advisers

that do not have $25 million of assets

under management but have a national

or multi-state practice and conduct

advisory activities that require them to

register as investment advisers in 30 or

more states.13 The Commission is

proposing to amend rule 203A–2 to

codify the exemptions provided by

individual orders to investment advisers

required to be registered in multiple

states.

Under the proposed exemption, an

investment adviser required to be

registered as an investment adviser with

30 or more state securities authorities

would be permitted to register with the

Commission.14 The Commission

believes that an investment adviser

whose activities trigger registration

requirements in 30 states is a national

firm and that the multiple state

registration requirements for such a firm

would constitute a burden on interstate

commerce. For that reason, the

Commission believes that such an

investment adviser would be the type of

firm for which Congress expected the

Commission to exercise its section

203A(c) exemptive authority and, as a

result, would have a single, national

regulator.15

Under the proposed rule

amendments, an adviser applying for

registration relying on the exemption

would be required to submit a

representation that the investment

adviser has reviewed its obligations

under state law and concluded that it is

required to register as an investment

adviser with the securities authorities of

at least 30 states.16 Once registered with

the Commission, the investment adviser

would continue to be eligible for the

exemption as long as it is annually able

to provide a representation that the

investment adviser has determined that,

but for the exemption, it would be

obligated to register in at least 25 states,

five fewer states than when it initially

registered.17 The Commission is

proposing this five-state difference to

prevent an investment adviser registered

with the Commission from losing the

exemption simply because, for example,

it lost a few clients in a small number

of states.18

Like other exemptions in rule 203A–

2, the proposed multi-state exemption
61868 Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules

19 17 CFR 275.203A–2(d).

20These requirements would be the result of the

conditions for the exemptions provided by rule

203A–2(d) and proposed paragraph (e) of rule

203A–2.

21The term supervised person is defined in the

Advisers Act as any ‘‘partner, officer, director . . .

or employee of an investment adviser, or other

person who provides investment advice on behalf

of the investment adviser and is subject to the

supervision and control of the investment adviser.’’

Section 202(a)(25) of the Advisers Act [15 U.S.C.

80b–2(a)(25)].

22Section 203A(b).

23 17 CFR 275.203A–3(a). The rule defines

‘‘excepted persons’’ as natural persons who have

$500,000 or more under management with the

representative’s investment advisory firm

immediately after entering into the advisory

contract with the firm, or who the advisory firm

reasonably believes immediately prior to entering

into the advisory contract have a net worth in

excess of $1 million (collectively ‘‘high net worth

individuals’’). Rule 203A–3(a)(3)(i) [17 CFR

275.203A–3(a)(3)(i)]. (The Commission is proposing

changes to the criteria for determining high net

worth individuals. See infra section II.B.2 of this

Release.) The Commission also excluded from the

term ‘‘investment adviser representative’’ those

supervised persons who do not on a regular basis

solicit, meet with, or otherwise communicate with

clients of the investment adviser or who provide

only impersonal investment advice. Rule 203A–

3(a)(2) [17 CFR 275.203A–3(a)(2)].

24Adopting Release, supra note 6, at nn.113–117

and accompanying text.

25As originally proposed, the ten percent

allowance would have been measured either by

reference to the assets under management

attributable to the supervised person or by reference

to clients of the supervised person. The

Commission adopted only the client test because

there did not appear to be any workable method of

attributing client assets to supervised persons. See

Adopting Release, supra note 6, at n.115 and

accompanying text.

26 Id.

27See, e.g., Unif. Sec. Act section 201(c) (1997);

Burns Ind. Code Ann. section 23–2–1–8(c)(3)

(1997); Md. Code Ann. section 11–401(b)(3)(ii)

(1997); Utah Code Ann. section 61–1–3(3)(c) (1997).

The first alternative is narrower than these state

exemptions because it would permit supervised

persons to have a total of five natural person clients

nationwide, rather than five natural person clients

per state as permitted by these states.

28The Investment Company Institute (‘‘ICI’’)

suggested that the Commission retain the ten

percent allowance and exclude from the term

natural persons certain clients who are ‘‘affiliated

with non-natural person clients.’’ See Letter from

Craig S. Tyle, Vice-President and Senior Counsel,

ICI, dated August 12, 1997 (available in File No.

S7–28–97). Under the current rule, the ten percent

allowance is designed as a proxy for

accommodation clients and assumes that a

supervised person who has a small number of

could be used by a newly formed

investment adviser in conjunction with

the ‘‘start-up adviser’’ exemption in

paragraph (d) of the rule.19 A newly

formed investment adviser not

registered in any state could register

with the Commission if it reasonably

expected that it would be required to

register in 30 or more states within 120

days. After the 120-day period, the

investment adviser would be required to

file an amendment to Form ADV

revising Schedule I and attach a

representation that, but for the proposed

multi-state exemption, the investment

adviser would be required to register in

at least 25 states.20

Comment is requested whether the 30

state threshold should be increased or

decreased and whether the five-state

difference is sufficient to prevent

transient registration problems. Because

determining the obligations to register

under state law requires a legal analysis,

should the Commission require

investment advisers to represent that

counsel has reviewed the applicable

state and federal laws and has

concluded that the investment adviser

qualifies for the proposed multi-state

exemption? Should the Commission

prohibit a newly formed investment

adviser from using this exemption in

conjunction with the reasonable

expectation exemption?

B. Definition of Investment Adviser

Representative

The Coordination Act preempts most

state regulatory requirements for

Commission-registered investment

advisers and their supervised persons,21

but permits states to continue to license,

register, or otherwise qualify an

‘‘investment adviser representative’’

who has a place of business in the

state.22 In rule 203A–3(a), the

Commission defined investment adviser

representative as a supervised person

more than ten percent of whose clients

are natural persons other than excepted

persons.23

1. Accommodation Clients

The ‘‘ten percent allowance’’ in the

definition of investment adviser

representative was designed to permit

supervised persons who provide

advisory services principally to clients

other than natural persons to continue

to accept so-called ‘‘accommodation

clients’’ without being subject to state

qualification requirements.24 In

adopting the ten percent allowance, the

Commission acknowledged that the

allowance may pose a problem for

supervised persons with one or a few

institutional clients who would not be

able to have any accommodation

clients.25 To have one accommodation

client, a supervised person would need

to have at least ten clients that are not

natural persons. Therefore, the

Commission directed the staff to work

with investment advisers whose

supervised persons would be affected by

the definition to develop a workable

method of addressing this concern and

indicated that it may propose revisions

to the definition.26 The Commission

staff has consulted with members of the

industry for their views and has

recommended proposals to the

Commission to resolve this issue.

The Commission is now proposing

two alternative amendments to the

definition of investment adviser

representative to allow supervised

persons who provide services to one or

a few institutional or business client

accounts to continue to have

accommodation clients without being

subject to state qualification

requirements. Under the first

alternative, the Commission proposes to

retain the ten percent allowance and

add a provision that would permit

supervised persons to have up to five

natural person clients. Supervised

persons could have under the first

alternative the greater of five natural

person clients or the number of natural

person clients permitted under the ten

percent allowance without being subject

to state qualification requirements.

The first alternative would allow

supervised persons with one or a few

institutional or business clients to

accept at least five natural person

clients and would address the problem

with the current rule. Moreover, this

alternative would provide a simple,

bright-line test for supervised persons to

determine when they are subject to state

qualification requirements. The

disadvantage of this alternative,

however, is that the five clients may not

necessarily be limited to those clients

who the supervised person advises on

an accommodation basis; the proposed

five natural person minimum could

include natural persons who have no

relationship to an investment adviser’s

institutional or business clients.

Furthermore, the five natural person

minimum would permit supervised

persons who have only retail clients

(i.e., natural person clients) to avoid

state qualification requirements until

they obtained their sixth client. The

provision, however, likely would have a

small effect on the number of

supervised persons who would not be

subject to state qualification

requirements because many states do

not require supervised persons to

register in the state until they have more

than five clients in their respective

state.27

Under the second alternative,

supervised persons who have natural

person clients would be excluded from

the definition of investment adviser

representative if the natural person

clients either are ‘‘high net worth’’

clients or have a familial or business

relationship with the supervised person

or his business or institutional clients.28
Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules 61869

natural person clients does so on the basis of an

accommodation to her institutional clients. The ICI

proposal would permit the supervised person to

have a defined group of accommodation clients in

addition to a group of natural persons (up to ten

percent of the supervised person’s clients) who are

unrelated to her institutional clients without being

subject to the state qualification requirements. The

Commission is proposing a narrower version of the

ICI’s recommendation to limit the rule’s exception

to clients who are or may reasonably be presumed

to be accommodation clients.

29 17 CFR 275.205–3.

30See Adopting Release, supra note 6, at nn. 110–

112 and accompanying text.

31See Investment Advisers Release No. 1682

(November 13, 1997). In the companion release, the

Commission also is proposing to add a third

alternative test of sophistication.

32See rule 203A–2(b) [17 CFR 275.203A–2(b)];

Adopting Release, supra note 6, at nn. 58–61 and

accompanying text.

33 17 CFR 275.203A–2(b)(3).

34Conversely, if the value of the assets of plans

was above $50 million as of the adviser’s last fiscal

year, but decreased to below $50 million before

Schedule I is filed, under the current rule, the

adviser would be eligible to rely on the pension

consultant exemption.

35An adviser seeking to rely on the pension

consultant exemption would be required to

aggregate: (i) the value of plan assets for which it

provided advisory services at the end of the 12-

month period, and (ii) the value of any other plan

assets for which it provided advisory services at the

end of its employment or contract (if terminated

before the end of the 12-month period).

During the interim period before the proposed

rule is adopted, the Commission would not object

if pension consultants chose to value plan assets

under the method being proposed rather than under

the method provided by the current rule.

Under this alternative, the Commission

would eliminate the current ten percent

allowance, and a supervised person

could have an unrestricted number of

clients who are natural persons without

being subject to state qualification

requirements. These clients would be

limited, however, to either (i) high net

worth clients (as currently permitted by

the rule), or (ii) persons who are (A)

partners, officers, or directors of the

investment adviser for whom the

supervised person works or of a

business or institutional client of the

investment adviser for whom the

supervised person works, (B) relatives,

spouses, or relatives of spouses of such

partners, officers or directors, or (C)

relatives or spouses, or relatives of

spouses of the supervised person.

The advantage of this approach is that

it extends the provision of the rule for

accommodation clients to supervised

persons with one or a few clients while

more closely tying the accommodation

client exception to the purpose for

which it was adopted. Instead of

presuming that the natural person

clients of a supervised person having

primarily business clients are

accommodation clients, the rule would

(with the exception of high net worth

clients) require there be the type of

relationship between the supervised

person and the client that customarily

results in the client being considered an

accommodation client. This approach,

however, could greatly increase or

decrease the number of natural person

clients supervised persons are permitted

to have by the rule before they are

subject to state qualification

requirements. Moreover, it would make

the rule somewhat more complex and,

perhaps, the status of a supervised

person as an investment adviser

representative less transparent to a state

securities commissioner seeking to

enforce state law. Comment is requested

on the scope of the accommodation

client exception under this alternative.

Are there additional relationships

between the investment adviser,

supervised person, and client that

suggest the client is an accommodation

client?

Comment is requested on the

advantages and disadvantages of the two

approaches. Comment is requested on

whether additional approaches could be

used to permit a supervised person with

one or a few institutional or business

clients to accept a small number of

natural person clients on an

accommodation basis without being

subject to state qualification

requirements. Commenters suggesting

an additional approach should address

whether the approach limits the scope

of the exception to its original purpose

(i.e., to permit accommodation clients),

any additional complexity it adds to the

rule, and the ease with which

supervised persons can determine

whether they are subject to state

qualification requirements.

2. ‘‘High Net Worth’’ Clients

Under the current rule, certain ‘‘high

net worth’’ individuals are excepted

persons for purposes of the definition of

investment adviser representative and

are not counted towards the ten percent

allowance. The criteria for determining

high net worth individuals are based on

the criteria in rule 205–3 under the

Advisers Act for determining those

clients with whom investment advisers

may enter into a performance fee

contract under that exemptive rule.29

The Commission excluded these high

net worth individuals from the

definition of investment adviser

representative because the Commission

presumed that these individuals, who

are less dependent on the protections of

the performance fee prohibition, do not

need the protections of state

qualification requirements.30

In a companion release, the

Commission is proposing to revise the

high net worth criteria in rule 205–3 to

reflect, among other things, the effects of

inflation since the standards were

adopted in 1985.31 The criteria for

determining which individuals qualify

as high net worth individuals in the

definition of investment adviser

representative would be revised to

reflect the changes being proposed in

the companion release. Therefore, the

threshold levels for high net worth

individuals would increase from

$500,000 under management and

$1,000,000 net worth to $750,000 and

$1,500,000, respectively.

C. Other Amendments

1. Pension Consultants—Determining

the Value of Assets of Plans

The Commission adopted rule 203A–

2(b) to exempt certain pension

consultants from the prohibition on

Commission registration. Under the

rule, pension consultants that provide

investment advice to employee benefit

plans with respect to assets having an

aggregate value of at least $50 million

are required to register with the

Commission even if they do not

otherwise meet the criteria for

Commission registration.32 Rule 203A–

2(b)(3) requires investment advisers

relying on the exemption to value plan

assets as of the date during the

investment adviser’s most recent fiscal

year that the investment adviser was last

employed or retained by contract to

provide investment advice to the plan

with respect to those assets.33 Because

of the fiscal year requirement, an

investment adviser could not rely on the

pension consultant exemption when, in

fact, it provides investment advice to

over $50 million of assets of employee

benefit plans if the amount of assets

grew to more than $50 million after the

end of the investment adviser’s fiscal

year, but before it filed Schedule I.34

The Commission, therefore, is proposing

to amend the rule to permit investment

advisers to determine the aggregate

value of plan assets during a 12-month

period ending within 90 days before the

investment adviser files Schedule I.35

2. Rule 206(4)–3—Cash Payments for

Client Solicitations

The Coordination Act amended

section 203(e) of the Advisers Act by

adding new section 203(e)(3), which

provided the Commission with the

authority to deny or revoke the

registration of any investment adviser if

the investment adviser (or any person
61870 Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules

36See section 305 of the 1996 Act.

37Rule 206(4)–3 prohibits cash payments for

client solicitation under certain circumstances.

38 Instruction 5 would be revised to eliminate an

unnecessary reference to July 8, 1997, amend the

instruction with respect to the pension consultant

exemption consistent with the revision proposed in

this Release, and add an instruction with respect to

the proposed multi-state adviser exemption. In

addition, the Commission is proposing to delete

Instruction 8 and the unnecessary reference to the

date of the valuation of the assets under

management in Schedule I, Part II.

39See supra section II.A of this Release.

40Every investment adviser applying for

registration with the Commission is required to file

Form ADV with the Commission and to file an

amended Form ADV when information on the form

has changed. Form ADV requires information about

the states in which an investment adviser is

registered, but does not distinguish between states

where the registration is mandatory and where

registration is voluntary. Moreover, the Commission

no longer receives Form ADV information for stateregistered advisers.

41According to information obtained from the

one-time form, Form ADV–T, there are

approximately 21 advisers that are registered with

30 or more states and no longer registered with the

Commission. Although approximately 21

investment advisers are registered in more than 30

states, the Commission estimates that only about

half of these advisers are required to register in 30

or more states. Therefore, the Commission estimates

that there may be ten investment advisers that

would qualify for the proposed multi-state

exemption each year.

42The Coordination Act expressly preserved the

authority of the states to require Commissionregistered investment advisers to pay state filing,

registration, and licensing fees. Section 307(b) of

the Coordination Act.

43 In the Cost-Benefit Analysis of Rules

Implementing Amendments to the Investment

Advisers Act of 1940, the Commission estimated

that the cost for a mid-size adviser to comply with

state-law registration requirements could be as

much as $20,000. See Cost-Benefit Memorandum

(available in File No. S7–31–96) (‘‘Implementing

Amendments Cost-Benefit Analysis’’). The

Commission believes that, because advisers eligible

for the proposed multi-state exemption would

typically be required to register in more states than

the average adviser registered with the Commission

(i.e., at least 30 states), the cost would be at least

$30,000 per adviser. These dollar estimates were

based on discussions with law firms that provide

these kinds of services to investment advisers.

44The Commission requests comment from the

states on the costs of investment adviser

examinations and the frequency of such

examinations.

associated with the investment adviser)

is convicted of any felony, and

redesignating section 203(e)(3) as

section 203(e)(4).36 The Commission

proposes to conform a cross-reference in

rule 206(4)–3(a)(1)(ii)(D) to the

redesignated section.37

3. Schedule I to Form ADV

Instructions to Schedule I provide

guidance on how an investment adviser

should determine the amount of its

assets under management for purposes

of section 203A of the Advisers Act. The

Commission is proposing to amend

Instruction 7 to Schedule I to clarify

that, in determining the total amount of

assets under management, investment

advisers may include only those

securities portfolios for which they

provide continuous and regular

supervisory or management services as

of the date of filing Schedule I. In

valuing these securities portfolios,

however, investment advisers may use

market values as determined within 90

days prior to the filing of Schedule I.

The Commission also is proposing

several other miscellaneous conforming

amendments to Schedule I.38

4. Transition Rule 203A–5 and Form

ADV–T

The Commission is proposing to

withdraw transition rule 203A–5 and

Form ADV–T. The rule and form are

unnecessary because the transition

under the Coordination Act is now

complete.

D. General Request for Comment

Any interested persons wishing to

submit written comments on the

proposed rule amendments and form

changes that are the subject of this

Release, to suggest additional changes

(including changes to the provisions of

the rules that the Commission is not

proposing to amend), or to submit

comments on other matters that might

have an effect on the proposals

described above, are requested to do so.

Commenters suggesting alternative

approaches are encouraged to submit

their proposed rule text.

III. Cost-Benefit Analysis

As discussed above, the proposed

multi-state investment adviser

exemption would permit investment

advisers required to register with 30 or

more states to register with the

Commission even though they do not

otherwise meet the criteria for

Commission registration.39 The

Commission has limited data on the

number of investment advisers that

would qualify for the proposed multistate investment adviser exemption.40

Because investment advisers must be

required to register in a large number of

states to qualify for the proposed multistate investment adviser exemption, the

Commission expects that only a few

investment advisers would be eligible.

For Paperwork Reduction Act purposes,

the Commission estimates that there

may be ten investment advisers that

would qualify each year. 41 Comment is

requested on whether there may be

more than ten investment advisers

eligible for this proposed multi-state

investment adviser exemption annually.

Investment advisers that believe they

would qualify for this exemption are

requested to notify the Commission.

The proposed multi-state investment

adviser exemption would benefit

investment advisers by permitting them

to save costs they otherwise would

incur if they were required to comply

with 30 separate sets of state

regulations, especially where state

regulations may be duplicative or

conflicting. These benefits would

include cost savings for complying with

state registration requirements, which

the Commission estimates may be as

much as $300,000 annually.42 Although

these annual costs may vary from

adviser to adviser, the Commission

assumes, for purposes of this analysis,

that it would cost each adviser $30,000

to comply with state-law registration

requirements.43 Based on that figure, the

Commission estimates that the annual

benefit from the proposed multi-state

investment adviser exemption, in the

form of the foregone costs of state

registration, would be approximately

$300,000 for all ten investment advisers

expected to be eligible for the proposed

multi-state investment adviser

exemption. Comment is requested on

the reasonableness of this cost estimate.

Commenters are requested to provide

factual support or assumptions

underlying any alternative cost estimate.

The benefits also would include

savings for investment advisers from the

cost of being examined by 30 different

state regulators. State regulators would

save the expense of examining these

investment advisers.44 The Commission

does not have information to estimate

the costs of state examinations for

investment advisers because the

Commission has no data on the

frequency with which these investment

advisers would be examined by a

particular state or the number of states

that would examine these investment

advisers each year. The Commission

requests comment on the state

examination costs saved by investment

advisers that are regulated only by the

Commission. Finally, the proposed

multi-state investment adviser

exemption would produce certain

unquantifiable regulatory benefits in

allowing qualifying investment advisers

to be regulated by one entity rather than

30 separate state regulators.

The proposed multi-state investment

adviser exemption would impose

certain costs on investment advisers

relying on the proposed exemption.

Under the proposed multi-state

investment adviser exemption, an

investment adviser would be required to

attach a representation to Schedule I
Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules 61871

45The Commission estimated this figure by

multiplying the aggregate burden hours required to

attach a representation to Schedule I to Form ADV

(240 hours) by an average hourly compensation rate

of $100. The estimation of the aggregate burden

hours for complying with the requirements of the

proposed multi-state exemption is based on the

Commission’s Paperwork Reduction Act

Submission. See infra section IV of this Release.

46See supra section II.B of this Release.

47This estimate of the number of investment

adviser representatives employed by Commissionregistered advisers was made for purposes of the

Implementing Amendments Cost-Benefit Analysis.

See Cost-Benefit Memorandum, supra note .

48 In the Implementing Amendments Cost-Benefit

Analysis, the Commission estimated the following

costs: $96 to take an exam, $850 for exam

preparation, and $150 annually per investment

adviser representative to monitor state registration

requirements. See Cost-Benefit Memorandum,

supra note .

49 In the Implementing Amendments Cost-Benefit

Analysis, the Commission estimated that foregone

revenue from the exam fees would $32 per exam.

Id.

50See supra note and accompanying text.

51See supra note and accompanying text. The

Commission does not believe that there are any

substantial costs to investor protection that would

be associated with this proposed amendment.

initially, when registering, and

annually, when amending Form ADV,

about the number of states in which the

investment adviser would be required to

register. The investment adviser also

would be required to maintain a record

of the states in which it believes it

would, but for the exemption, be

required to register that was the basis of

its representation included on the

attachment to Schedule I.

The Commission estimates that the

total cost to each eligible investment

adviser to comply with the requirements

of the proposed multi-state investment

adviser exemption would be

approximately $24,000.45 Thus, the

Commission estimates that the total cost

for the ten investment advisers expected

to be eligible for the proposed multistate investment adviser exemption

would be approximately $240,000.

There also may be incidental costs to

the Commission of registering

investment advisers that qualify for this

proposed multi-state investment adviser

exemption and costs associated with

examining those investment advisers.

Overall, the Commission believes that

the proposed rule amendments would

not impose significant additional costs

on investment advisers, but rather

would result in a net savings when

compared with the costs of complying

with state registration requirements.

Comment is requested concerning the

savings for complying with state

registration requirements and any

benefit to multi-state advisers in having

one regulator. Comment is also

requested concerning the costs

associated with the requirements of the

proposed multi-state investment adviser

exemption.

As discussed in more detail above, the

Commission is proposing two

alternative amendments to the

definition of investment adviser

representative.46 Although the

Commission has never registered

investment adviser representatives, the

Commission estimates that Commissionregistered advisers employ a total of

approximately 153,000 investment

adviser representatives.47 The

Commission, however, does not have

data on the number of representatives

who may be affected by the proposed

amendments. The Commission,

therefore, is unable to quantify the total

benefits and costs that may result from

these proposed amendments. The

Commission believes, nonetheless, that

the proposed amendments could

provide benefits to Commissionregistered investment advisers and their

supervised persons because the

proposed amendments would reduce

their regulatory burdens by permitting

supervised persons who provide

services to a few institutional clients to

have a small number of natural persons

as accommodation clients without being

subject to state qualification

requirements. The Commission requests

comment on the percentage of all

investment adviser representatives who

would be exempt from state

qualification requirements under each

of the alternatives being proposed.

The first proposed alternative

amendment to the definition of

investment adviser representative

would retain the present ten percent

allowance and also permit a supervised

person to have up to five natural person

clients. The first alternative definition

would benefit supervised persons who

provide advice to five natural person

clients because they would no longer be

subject to state qualification

requirements even if they are not able to

take advantage of the ten percent

allowance. Under the current rule, a

supervised person would need to have

ten institutional clients to have one

accommodation client. The first

proposed alternative amendment would

provide a bright line test that would

allow supervised persons and their

firms to determine easily when

supervised persons must register with

the states.

The first alternative would increase

the number of supervised persons of

Commission-registered advisers who

would no longer be subject to state

qualification requirements. This

proposal would benefit affected

supervised persons by permitting them

to save the expense associated with

investment adviser representative

qualification examinations, such as the

costs of monitoring state registration

requirements and preparing and

registering for state exams.48 The

Commission is unable to quantify the

total savings because the Commission

does not have data on the number of

representatives who would be affected

by this proposed amendment. Because

the Coordination Act preserved the

authority of states to require the

payment of state filing, registration, and

licensing fees, there would be no loss to

the states of fees collected.

Costs associated with the first

proposed amendment include the

foregone fees collected by the National

Association of Securities Dealers

Regulation (‘‘NASDR’’) and the North

American Securities Administrators

Association, Inc. (‘‘NASAA’’) for state

examinations for investment adviser

representatives.49 The Commission is

unable to quantify the total costs

because the Commission does not have

data on the number of representatives

who would be affected by this proposed

amendment. Comment is requested on

the effect this provision will have on the

costs incurred or avoided by investment

advisers and their supervised persons

and on the exam fees collected by the

NASDR and NASAA.

As detailed above, the second

alternative proposed amendment to the

definition of investment adviser

representative would replace the ten

percent allowance and allow supervised

persons to have accommodation clients

who have a familial or business

relationship with the supervised

persons or their institutional clients

without limitation on the number of

accommodation clients. This alternative

proposal might have the effect of either

increasing or decreasing the number of

supervised persons subject to state

qualification requirements, and

comment is requested on which

outcome is more likely.

To the extent that the second

alternative increases the number of

supervised persons who are no longer

subject to state qualification

requirements, affected supervised

persons would save state examination

and examination preparation fees.50 The

costs associated with such an increase

would be the foregone fees collected by

the NASDR and NASAA for the state

examinations.51

If the second alternative decreases the

number of supervised persons who are

not subject to state qualification

requirements, the alternative would
61872 Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules

52See supra note and accompanying text.

53 44 U.S.C. 3501 et seq.

54Under rule 203A–5 of the Advisers Act, all

investment advisers registered with the

Commission were required to file a completed Form

ADV–T with the Commission by July 8, 1997,

indicating whether they remain eligible for

Commission registration. Of the 23,350

Commission-registered investment advisers,

approximately 7,200 advisers indicated that they

remain eligible for Commission registration, 10,600

advisers withdrew their registrations, and 5,800

advisers did not file their Form ADV–T. The

Commission believes that most of the investment

advisers that did not file Form ADV–T are either no

longer in the advisory business or no longer eligible

to register with the Commission. The Commission

expects to cancel the registrations of most of these

investment advisers.

produce unquantifiable benefits by tying

the accommodation client exception

more closely to the purpose for which

it was adopted. The second alternative

would permit supervised persons to

accept clients who have a relationship

with the supervised person or his

institutional clients that would result in

the individual client being considered

an accommodation client. The costs of

the second alternative, if it decreases the

number of supervised persons not

subject to state qualification

requirements, would be the expense

associated with state investment adviser

representative examinations.52

Comment is requested on the effect of

the second alternative amendment on

the costs incurred or avoided by

investment advisers and their

supervised persons.

The other proposed rule amendments

would revise the time period for

determining the value of assets of plans

for pension consultants, clarify the

instructions in Schedule I to Form ADV,

and provide an additional instruction in

Schedule I to Form ADV. The benefits

of these proposed amendments would

be to eliminate any confusion that the

language of the rules or instructions

may have created. The Commission

believes that these amendments would

not impose any additional costs to

investment advisers.

Comment is requested on this costbenefit analysis. Commenters are

requested to provide views and

empirical data relating to any costs and

benefits associated with the proposed

rule amendments.

For purposes of making

determinations required by the Small

Business Regulatory Enforcement

Fairness Act of 1996, the Commission is

requesting information regarding the

potential effect of the proposed rule

amendments on the economy on an

annual basis. Commenters should

provide data to support their views.

IV. Paperwork Reduction Act

Certain provisions of the proposed

rule amendments contain ‘‘collection of

information’’ requirements within the

meaning of the Paperwork Reduction

Act of 1995,53 and the Commission has

submitted them to the Office of

Management and Budget (‘‘OMB’’) for

review in accordance with 44 U.S.C.

3507(d) and 5 CFR 1320.11. The title for

the collections of information are ‘‘Form

ADV’’ and ‘‘Schedule I to Form ADV,’’

both under the Advisers Act. Form ADV

and Schedule I to Form ADV, which the

Commission is proposing to amend,

contain currently approved collections

of information under OMB control

numbers 3235–0049 and 3235–0490,

respectively. The proposed rule

amendments are necessary to clarify

previously-adopted rules that

implemented changes to the Advisers

Act. An agency may not sponsor,

conduct, or require response to an

information collection unless a

currently valid OMB control number is

displayed.

Form ADV

Form ADV is required by rule 203–1

[17 CFR 275.203–1] to be filed by every

adviser that applies for registration with

the Commission as an investment

adviser. Rule 204–1 [17 CFR 275.204–1]

sets forth the circumstances requiring

the filing of an amendment to Form

ADV. Registrants must file an amended

Form ADV when information on the

initial Form ADV has changed, either at

the end of the fiscal year or promptly for

certain material changes. In addition,

rule 204–1 also requires an investment

adviser to file the cover page of Form

ADV (along with a Schedule I) annually

within 90 days after the end of the

investment adviser’s fiscal year

regardless of whether other changes

have taken place during the year.

After 1997, the Commission estimates

approximately 7,300 investment

advisers would be registered with the

Commission and required to amend

Form ADV on an annual basis as

required by rule 204–1.54 The

Commission previously estimated that

there would be 750 new investment

advisers registering with the

Commission each year. The Commission

estimates that an additional ten

investment advisers each year would be

eligible for Commission registration

under the proposed multi-state

exemption. Thus, the annual number of

responses for filing an application for

investment adviser registration is

estimated to be approximately 760. The

760 new advisers each year also will be

subject to the annual amendment

requirement. The Commission estimates

that there would be 8,060 total

respondents to this collection of

information on an annual basis.

The Commission estimates that each

of the 7,300 investment advisers

registered with the Commission will

amend Form ADV, as required by rule

204–1, an average of 1.5 times annually.

Of the 760 new advisers each year, 660

will amend Form ADV an average of

once annually. The estimated 100

newly-formed investment advisers that

will rely on rule 203A–2(d) will amend

Form ADV an average of twice annually.

Thus, the annual number of responses

for completing amended Form ADV is

estimated to be approximately 11,810.

The total number of annual responses

for Form ADV (initial registration and

amendments) is estimated to be 760

responses for new advisers (including

ten responses for new advisers relying

on the proposed multi-state exemption)

and 11,810 responses for annual

amendments. The average burden hours

for completing Form ADV for initial

registration is 9.0063 hours for each

respondent (unchanged from previous

estimate). The average burden hours for

completing Form ADV as an annual

amendment is 1.0672 hours (unchanged

from previous estimate). The total

burden hours imposed by Form ADV is

estimated to be 19,448.42.

The collection of information required

by Form ADV is mandatory, and

responses are not kept confidential.

Schedule I

Schedule I requires an investment

adviser to declare whether it is eligible

for Commission registration. Schedule I,

as part of Form ADV, is required to be

filed with an investment adviser’s initial

application on Form ADV. The rules

imposing this collection of information

are found at 17 CFR 275.203–1 and 17

CFR 279.1. Rule 204–1 [17 CFR

275.204–1] sets forth the circumstances

requiring the filing of an amended Form

ADV. Rule 204–1 requires an

investment adviser registered with the

Commission to file an amended

Schedule I to Form ADV annually

within 90 days after the end of the

investment adviser’s fiscal year.

The Commission estimates that 7,300

investment advisers registered with the

Commission would respond to the

information collection requirements of

Schedule I to Form ADV an average of

once a year. In addition, the

Commission estimates that

approximately 760 new advisers each

year will file Schedule I of Form ADV.

Of the 760 advisers, 660 will file

Schedule I to Form ADV an average of

once each year, and the remaining 100

that rely on the exemption provided by
Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules 61873

55 Investment advisers also would be required to

maintain a record of the states in which they

believe they would, but for the exemption, be

required to register that was the basis of their

representation included on the attachment to

Schedule I. The Commission believes that the

requirement that the investment advisers maintain

a record would impose a nominal burden on

investment advisers because the information would

have to be gathered for purposes of making the

representation.

56The total hourly burdens for Form ADV and

Schedule I would change because (1) the proposed

multi-state exemption would permit a small

number of additional advisers to register with the

Commission, and (2) the tabulation of information

from the completed Forms ADV–T has provided the

Commission with a more accurate number of

advisers it regulates after the July 8, 1997 division

of regulatory responsibilities between the federal

and state governments.

57See Adopting Release, supra note 6.

58Rule 275.0–7 [17 CFR 275.0–7]. In January

1997, the Commission proposed to revise this

definition of ‘‘small entity.’’ See Definitions of

‘‘Small Business’’ or ‘‘Small Organization’’ Under

the Investment Company Act of 1940, the

Investment Advisers Act of 1940, the Securities

Exchange Act of 1934, and the Securities Act of

1933, Release Nos. 33–7383, 34–38190, IC–22478,

and IA–1609 (Jan. 22, 1997) [62 FR 4106 (Jan. 28,

1997)]. The Commission expects to adopt a revised

definition of small investment adviser for

Regulatory Flexibility Act purposes to reflect the

Coordination Act.

59See supra note 41.

rule 203A–2(d) will file Schedule I to

Form ADV an average of twice each

year. It is estimated that the total

number of responses would be 8,160.

For the 765 investment advisers that

must calculate assets under

management for the purpose of

completing Schedule I (9.5% of

respondents—excluding the ten

investment advisers expected to rely on

the proposed multi-state exemption),

compliance with the requirement to file

an amended Schedule I would impose

a total annual burden for each

investment adviser of approximately 2

hours (unchanged from previous

estimate). For the 7,285 investment

advisers that either do not need to

calculate assets under management to

complete Schedule I or calculate assets

under management as part of their

normal business operations (90.5% of

respondents—excluding the ten

investment advisers expected to rely on

the proposed multi-state exemption)

this burden would be 0.75 of an hour

(unchanged from previous estimate).

The Commission estimates that an

additional ten investment advisers

would be eligible for the proposed

multi-state exemption. For the ten

investment advisers that would rely on

the proposed multi-state exemption, the

Commission estimates compliance with

the requirement to file an amended

Schedule I attaching a representation

that the investment adviser is required

to register as an investment adviser in

30 or more states would impose a total

annual burden for each investment

adviser of approximately 240 hours.55

The total burden hours imposed by

Schedule I to Form ADV is estimated to

be 9,480.313.

The collection of information required

by Schedule I is mandatory, and

responses are not kept confidential.

The Commission estimates that these

collections of Form ADV and Schedule

I together would impose a total hourly

burden of 28,928.73 hours.

The total burdens associated with

Form ADV and Schedule I to Form ADV

would change from the filing of the last

Paperwork Reduction Act Submission

because of the proposed multi-state

exemption and the tabulation of Form

ADV–Ts.56 The current total Form ADV

burden is 18,127.88 hours. The new

total Form ADV burden would be

19,448.42 hours. The total change in

burden hours for Form ADV would be

1,320.54 hours. The current total burden

for Schedule I is 6,418.94 hours. The

new total burden for Schedule I would

be 9,480.313 hours. The total change in

burden for Schedule I of Form ADV

would be 3,061.373 hours.

Pursuant to 44 U.S.C. 3506(c)(2)(B),

the Commission solicits comments to (i)

evaluate whether the proposed

collections of information are necessary

for the proper performance of the

functions of the agency, including

whether the information will have

practical utility; (ii) evaluate the

accuracy of the agency’s estimate of the

burden of the proposed collections of

information; (iii) enhance the quality,

utility, and clarity of the information to

be collected; and (iv) minimize the

burden of the collections of information

on those who are to respond, including

through the use of automated collection

techniques or other forms of information

technology.

Persons desiring to submit comments

on the collection of information

requirements should direct them to the

Office of Management and Budget,

Attention: Desk Officer for the

Securities and Exchange Commission,

Office of Information and Regulatory

Affairs, Washington, D.C. 20503, and

should also send a copy of their

comments to Jonathan G. Katz,

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Stop 6–9, Washington, D.C. 20549 with

reference to File No. S7–28–97. OMB is

required to make a decision concerning

the collections of information between

30 and 60 days after publication, so that

a comment to OMB is best assured of

having its full effect if OMB receives it

within 30 days of publication.

V. Summary of Regulatory Flexibility

Analysis

The Commission has prepared an

Initial Regulatory Flexibility Analysis

(‘‘IRFA’’) in accordance with 5 U.S.C.

603 regarding amendments to rules

203A–2, 203A–3, 206(4)–3 and

Schedule I to Form ADV, and the

withdrawal of rule 203A–5 and Form

ADV–T under the Advisers Act. The

following summarizes the IRFA.

As set forth in greater detail in the

IRFA, the Coordination Act, which

became effective on July 8, 1997,

amended the Advisers Act by

reallocating federal and state

responsibilities for regulation of

investment advisers. On May 15, 1997,

the Commission adopted new rules and

rule amendments to implement the

Coordination Act.57 The Commission

proposes to revise some of these

implementing rules. The IRFA states

that the proposed rule amendments

would exempt multi-state investment

advisers from the prohibition on

Commission registration, amend the

definition of investment adviser

representative, and clarify certain other

implementing rules.

The IRFA sets forth the statutory

authority for the proposed rule

amendments. The IRFA also discusses

the effect of the proposed rule

amendments on small entities. For

purposes of the Advisers Act and the

Regulatory Flexibility Act, an

investment adviser generally is a small

entity (i) if it manages assets of $50

million or less, in discretionary or

nondiscretionary accounts, as of the end

of its most recent fiscal year or (ii) if it

renders other advisory services, has

$50,000 or less in assets related to its

advisory business.58

The proposed multi-state exemption

for investment advisers would be

available to any investment adviser that

is prohibited from registering with the

Commission and is required to register

in 30 or more states. The Commission

estimates that there may be ten such

investment advisers that would be

eligible for the proposed multi-state

exemption each year.59 Therefore, the

Commission believes that there would

be a few small entities that would be

affected by the proposed rule.

The proposed rule amendments

minimize regulatory burdens on smallentity investment advisers that are

eligible for the proposed multi-state

exemption by permitting the investment

adviser, once registered with the
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60This estimate of the number of small entities

was made for purposes of the Final Regulatory

Flexibility Analysis for the rules implementing the

Coordination Act. See Adopting Release, supra note

6, at nn. 189–190 and accompanying text. Of the

23,350 Commission-registered investment advisers,

5,800 advisers have not filed their Form ADV–T,

indicating their eligibility to remain registered with

the Commission. See supra note 54. The

Commission also expects to adopt a revised

definition of small entity for purposes of the

Regulatory Flexibility Act. See supra note 58.

Therefore, the Commission plans to revise its

estimate of the number of Commission-registered

advisers that are small entities after the transition

is complete so that the Commission would have

more accurate information to estimate the number

of small entities under the new definition of that

term.

61The proposed multi-state investment adviser

exemption also would require investment advisers

to maintain a record of the states in which they

would, but for the exemption, be required to

register.

Commission, to continue to be eligible

for the proposed multi-state exemption

until it is obligated to register in less

than 25 states. This five-state difference

prevents an investment adviser from

being required to register and then deregister frequently with the Commission

as a result of a change in its registration

obligation in one state or few states.

The proposed amendments to the

definition of investment adviser

representative would permit supervised

persons of Commission-registered

investment advisers who only have a

few business or institutional clients to

accept accommodation clients. The

Commission does not have information

from which to estimate the number of

Commission-registered investment

advisers managing assets of $50 million

or less or having less than $50,000 in

assets relating to its advisory business

whose supervised persons would be

exempt from the definition of

investment adviser representative under

the proposed amendments.

The other proposed rule amendments

affect only Commission-registered

investment advisers. For purposes of

these amendments, the Commission

estimates that approximately 850

investment advisers are small entities.60

These proposed amendments clarify the

implementing rules and do not impose

any additional burden on investment

advisers. Therefore, the Commission

believes that it is reasonable to estimate

that these clarifying amendments would

not have a significant economic effect

on small entities. Comment is requested

on the number of small entities that

would be affected by these proposed

amendments.

The proposed withdrawal of rule

203A–5 and Form ADV–T would have

no effect on small entities because no

investment advisers currently should be

filing Form ADV–T.

The proposed rule amendments

would impose certain new reporting

and recordkeeping requirements and

eliminate certain other requirements.

Investment advisers relying on the

proposed multi-state exemption would

be required at initial registration to

attach a representation to Schedule I

that the investment adviser has

determined that it must register in at

least 30 states and a representation on

Schedule E to Form ADV that it will

withdraw from Commission registration

when it is no longer required to register

in at least 25 states.61 Thereafter, in the

annual amendment to Form ADV

revising Schedule I, the investment

adviser would be required to submit a

representation that it has concluded

that, but for the proposed multi-state

exemption, it would be required to

register in at least 25 states. If the

amended Schedule I indicated that the

investment adviser was no longer

eligible for Commission registration, the

proposed amendment would require the

investment adviser to file a Form ADV–

W within 90 days to withdraw its

registration with the Commission.

The Commission estimates that it will

take approximately 240 hours, annually

on average, to comply with these

requirements. This burden on

investment advisers that use this

proposed rule would be outweighed by

the cost savings and benefits to the

multi-state investment advisers relying

on the proposed multi-state exemption.

The proposed withdrawal of Form

ADV–T and rule 203A–5 would

eliminate any incidental burden that

may continue to be imposed by the

transition rule. The proposed rule

amendments to rule 206(4)–3 and Form

ADV would not impose any new

reporting, recordkeeping or other

compliance requirements.

The Commission believes that there

are no rules that duplicate, overlap, or

conflict with, the proposed rule

amendments.

The IRFA discusses the various

alternatives considered by the

Commission in connection with the

proposed rule amendments that might

minimize the effect on small entities,

including (a) the establishment of

differing compliance or reporting

requirements or timetables that take into

account resources available to small

entities; (b) the clarification,

consolidation, or simplification of

compliance and reporting requirements

under the rule for small entities; (c) the

use of performance rather than design

standards; and (d) an exemption from

coverage of the rule, or any part thereof,

for small entities.

As stated in the IRFA, after taking into

account the resources available to small

entities and the potential burden that

could be placed on investment advisers

that may no longer qualify for the

proposed multi-state exemption because

of a change in the registration

obligations in a few states, the

Commission proposes to permit an

investment adviser, once registered with

the Commission, to continue to be

eligible for the proposed multi-state

exemption as long as it would be

obligated to register in at least 25 states,

five fewer states than when it initially

registered. Moreover, the burdens

associated with complying with the

requirements of the rule would affect

only a very small number of investment

advisers each year.

With respect to the other proposed

rule amendments, the Commission

believes that the establishment of

different compliance or reporting

requirements for small entities is neither

necessary nor practicable. The

information required by Form ADV and

Schedule I is necessary for the

Commission to determine whether the

investment advisers are eligible for

Commission registration. The proposed

rule amendments will not change

significantly any compliance costs.

Further clarification, consolidation or

simplification of the requirements for

small entities does not seem feasible.

The Commission believes that the rule

amendments, as proposed, will not

adversely affect small entities and,

instead, include regulatory alternatives

that minimize the effect on small

entities.

The IRFA includes information

concerning the solicitation of comments

with respect to the IRFA generally, and

in particular, the number of small

entities that would be affected by the

proposed rule amendments. A copy of

the IRFA may be obtained by contacting

Carolyn-Gail Gilheany, Securities and

Exchange Commission, 450 5th Street,

N.W., Mail Stop 10–6, Washington, D.C.

20549.

VI. Statutory Authority

The Commission is proposing

amendments to rule 203A–2 pursuant to

the authority set forth in section 203A(c)

of the Investment Advisers Act of 1940

[15 U.S.C. 80b–3a(c)].

The Commission is proposing

amendments to rule 203A–3 pursuant to

the authority set forth in sections

202(a)(17) and 211(a) of the Investment

Advisers Act of 1940 [15 U.S.C. 80b–

2(a)(17), 80b–11(a)].

The Commission is proposing

amendments to rule 206(4)–3 pursuant

to the authority set forth in sections 204,
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206, and 211 of the Investment Advisers

Act of 1940 [15 U.S.C. 80b–4, 80b–6,

80b–11].

The Commission is proposing to

withdraw rule 203A–5 pursuant to the

authority set forth in sections 204 and

211(a) of the Investment Advisers Act of

1940 [15 U.S.C. 80b–4, 80b–11(a)].

The Commission is proposing

amendments to Schedule I to Form ADV

pursuant to the authority set forth in

sections 203(c)(1) and 204 of the

Investment Advisers Act of 1940 [15

U.S.C. 80b–3(c)(1) and 80b–4].

The Commission is proposing to

remove and reserve rule 279.3 and

proposing to remove Form ADV–T

pursuant to the authority set forth in

sections 204 and 211(a) of the

Investment Advisers Act of 1940 [15

U.S.C. 80b–4, 80b–11(a)].

List of Subjects in 17 CFR Parts 275 and

279

Reporting and recordkeeping

requirements, Securities.

Text of Proposed Rule and Form

Amendments

For the reasons set out in the

preamble, Title 17, Chapter II of the

Code of Federal Regulations is proposed

to be amended as follows:

PART 275—RULES AND

REGULATIONS, INVESTMENT

ADVISERS ACT OF 1940

1. The authority citation for Part 275

is revised to read as follows:

Authority: 15 U.S.C. 80b–2(a)(17), 80b–3,

80b–4, 80b–6(4), 80b–6a, 80b–11, unless

otherwise noted.

Section 275.203A–1 is also issued under 15

U.S.C. 80b–3a.

Section 275.203A–2 is also issued under 15

U.S.C. 80b–3a.

Section 275.204–2 is also issued under 15

U.S.C. 80b–6.

Section 275.205–3 is also issued under 15

U.S.C. 80b–5(e).

2. Section 275.203A–2 is amended by

revising the introductory text of

§ 275.203A–2 and paragraph (b)(3) and

adding paragraph (e) to read as follows:

§ 275.203A–2 Exemptions from prohibition

on Commission registration.

The prohibition of section 203A(a) of

the Act (15 U.S.C. 80b–3a(a)) shall not

apply to:

* * * * *

(b) * * *

(3) In determining the aggregate value

of assets of plans, include only that

portion of a plan’s assets for which the

investment adviser provided investment

advice (including any advice with

respect to the selection of an investment

adviser to manage such assets).

Determine the aggregate value of assets

by cumulating the value of assets of

plans with respect to which the

investment adviser was last employed

or retained by contract to provide

investment advice during the 12-month

period ended within 90 days of filing

Schedule I to Form ADV (17 CFR 279.1).

* * * * *

(e) Multi-State Investment Advisers.

An investment adviser that:

(1) Upon submission of its application

for registration with the Commission, is

required by the laws of 30 or more

States to register as an investment

adviser with securities commissioners

(or any agencies or officers performing

like functions) in the respective States,

and thereafter would, but for this

section, be required by the laws of at

least 25 States to register as an

investment adviser with securities

commissioners (or any agencies or

officers performing like functions) in the

respective States;

(2) Attaches a representation to

Schedule I to Form ADV (17 CFR 279.1)

that the investment adviser has

reviewed the applicable State and

federal laws and has concluded that, in

the case of an application for

registration with the Commission, it is

required by the laws of 30 or more

States to register as an investment

adviser with the securities

commissioners (or any agencies or

officers performing like functions) in the

respective States and, in the case of an

amendment to Form ADV revising

Schedule I to Form ADV, it would be

required by the laws of at least 25 States

to register with the securities

commissioners (or any agencies or

officers performing like functions) in the

respective States within 90 days prior to

the date of filing Schedule I;

(3) Includes on Schedule E to its Form

ADV (17 CFR 279.1), an undertaking to

withdraw from registration with the

Commission if an amendment to Form

ADV revising Schedule I to Form ADV

indicates that the investment adviser

would be required by the laws of fewer

than 25 States to register as an

investment adviser with the securities

commissioners (or any agencies or

officers performing like functions) in the

respective States, and, within 90 days

after filing Schedule I to Form ADV,

files a completed Form ADV–W (17 CFR

279.2) whereby the investment adviser

withdraws from registration with the

Commission if the amendment to Form

ADV revising Schedule I indicates that

the investment adviser would be

prohibited by section 203A of the Act

(15 U.S.C. 80b–3a) from registering with

the Commission; and

(4) Maintains in an easily accessible

place a record of the States that the

investment adviser has determined it

would, but for the exemption, be

required to register for a period of not

less than five years from the filing of a

Schedule I to Form ADV that includes

a representation that is based on such

record.

3. In § 275.203A–3 the introductory

text and paragraph (a) are revised to

read as follows:

Proposal I

§ 275.203A–3 Definitions.

For purposes of section 203A of the

Act (15 U.S.C. 80b–3a) and the rules

thereunder:

(a)(1) Investment Adviser

Representative. Investment adviser

representative of an investment adviser

means a supervised person of the

investment adviser:

(i) Who has more than five clients

who are natural persons other than

excepted persons described in

paragraph (a)(3)(i) of this section; or

(ii) More than ten percent of whose

clients are natural persons other than

excepted persons described in

paragraph (a)(3)(i) of this section.

(2) Notwithstanding paragraph (a)(1)

of this section, a supervised person is

not an investment adviser representative

if the supervised person:

(i) Does not on a regular basis solicit,

meet with, or otherwise communicate

with clients of the investment adviser;

or

(ii) Provides only impersonal

investment advice.

(3) For purposes of this section:

(i) Excepted person means a natural

person who is a qualified client as

defined in § 275.205–3(d)(1).

(ii) Impersonal investment advice

means investment advisory services

provided by means of written material

or oral statements that do not purport to

meet the objectives or needs of specific

individuals or accounts.

(4) Supervised persons may rely on

the definition of client in

§ 275.203(b)(3)–1 to identify clients for

purposes of paragraph (a)(1) of this

section, except that supervised persons

need not count clients that are not

residents of the United States.

Proposal II

§ 275.203A–3 Definitions.

For purposes of section 203A of the

Act (15 U.S.C. 80b–3a) and the rules

thereunder:

(a)(1) Investment Adviser

Representative. Investment adviser

representative of an investment adviser

means a supervised person of the
61876 Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules

investment adviser whose clients are

natural persons other than excepted

persons described in paragraph (a)(3)(i)

of this section.

(2) Notwithstanding paragraph (a)(1)

of this section, a supervised person is

not an investment adviser representative

if the supervised person:

(i) Does not on a regular basis solicit,

meet with, or otherwise communicate

with clients of the investment adviser;

or

(ii) Provides only impersonal

investment advice.

(3) For purposes of this section:

(i) Excepted person means a natural

person who is a:

(A) Qualified client as defined in

§ 275.205–3(d)(1);

(B) Partner, officer, director, (or other

person occupying a similar status or

performing similar functions), of the

investment adviser for whom the

supervised person works or of a client

that is not a natural person of the

investment adviser for whom the

supervised person works;

(C) Relative, spouse, or relative of

spouse of such partner, officer or

director; or

(D) Relative, spouse or relative of

spouse of the supervised person.

(ii) Impersonal investment advice

means investment advisory services

provided by means of written material

or oral statements that do not purport to

meet the objectives or needs of specific

individuals or accounts.

(4) Supervised persons may rely on

the definition of client in

§ 275.203(b)(3)–1 to identify clients for

purposes of paragraph (a)(1) of this

section, except that supervised persons

need not count clients that are not

residents of the United States.

§ 275.203A–5 [Removed and Reserved]

4. Section 275.203A–5 is removed and

reserved.

§ 275.206(4)–3 [Amended]

5. In § 275.206(4)–3, paragraph

(a)(1)(ii)(D) is amended by revising the

cite ‘‘203(e)(3)’’ to read ‘‘203(e)(4)’’.

§§ 275.203A–1 and 275.203A–2 [Amended]

6. In 17 CFR part 275 remove ‘‘[15

U.S.C. 80b–3A(a)]’’ and add, in its place,

‘‘(15 U.S.C. 80b–3a(a))’’ in the following

places:

a. Section 275.203A–1 (b)(2), (c), and

(d); and

b. Section 275.203A–2 (d)(2) and

(d)(3).

PART 279—FORMS PRESCRIBED

UNDER THE INVESTMENT ADVISERS

ACT OF 1940

7. The authority citation for Part 279

continues to read as follows:

Authority: The Investment Advisers Act of

1940, 15 U.S.C. 80b–1, et seq.

8. By revising Schedule I to Form

ADV (referenced in § 279.1) to read as

follows:

Note: The text of Schedule I to Form ADV

(§ 279.1) does not and the amendments will

not appear in the Code of Federal Regulation.

Schedule I is attached as Appendix A.

§ 279.3 [Removed and Reserved]

9. Section 279.3 is removed and

reserved.

10. Form ADV–T is removed.

Note: Form ADV–T does not appear in the

Code of Federal Regulation.

Dated: November 13, 1997.

By the Commission.

Jonathan G. Katz,

Secretary.

BILLING CODE 8010–01–P
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BILLING CODE 8010–01–C
61880 Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules

Schedule Instructions

Instruction 1. General Instructions

(a) SEC’s Collection of Information.

An agency may not conduct or sponsor,

and a person is not required to respond

to, a collection of information unless it

displays a currently valid control

number. Sections 203(c)(1) and 204 of

the Advisers Act authorize the

Commission to collect the information

on this Schedule from applicants. See

15 U.S.C. §§ 80b–3(c)(1) and 80b–4.

Filing of this Schedule is mandatory.

The principal purpose of this collection

of information is to enable the

Commission to determine which

investment advisers are eligible to

maintain their registration with the

Commission and to provide for the

withdrawal from Commission

registration for advisers that are no

longer eligible. The Commission will

maintain files of the information on this

Schedule and will make the information

publicly available. Any member of the

public may direct to the Commission

any comments concerning the accuracy

of the burden estimate on page one of

this Schedule, and any suggestions for

reducing this burden. This collection of

information has been reviewed by the

Office of Management and Budget in

accordance with the clearance

requirements of 44 U.S.C. § 3507. The

applicable Privacy Act system of records

is SEC–2, and the routine use of the

records are set forth at 40 Federal

Register 39255 (Aug. 27, 1975) and 41

FR 5318 (Feb. 5, 1976).

(b) For Further Information:

Additional information about the rules

referred to in this Schedule is found in

the Commission’s adopting release,

Rules Implementing Amendments to the

Investment Advisers Act of 1940,

Investment Advisers Act Rel. No. 1633

(May 15, 1997).

Instruction 2. Principal Place of

Business

Applicant’s principal place of

business reported in Form ADV, Part I,

Item 2.A. is the applicant’s principal

office and place of business, i.e., the

executive office from which the officers,

partners, or managers of the applicant

direct, control, and coordinate

applicant’s activities. See rule 203A–

3(c).

Instruction 3. Advisers in Colorado,

Iowa, Ohio, or Wyoming; Foreign

Advisors

Under the Advisers Act, an applicant

whose principal office and place of

business (see Instruction 2) is in a State

that does not register investment

advisers is required to register with the

Commission, even if none of the criteria

for SEC registration (e.g., $25 million of

assets under management) is met.

Currently these States are Colorado,

Iowa, Ohio, and Wyoming. Applicants

that have their principal office and

place of business in one of these States

should check the box in item (a)(ii) of

Part I.

An applicant whose principal office

and place of business is located in a

country other than the United States

(i.e., not in the United States, the

District of Columbia, Puerto Rico, the

Virgin Islands, or any other possession

of the United States) also is required to

register with the Commission. Such an

applicant should check the box in item

(a)(iii) of Part I.

Instruction 4. Advisers to Investment

Companies

An applicant should not check item

(a)(iv) of Part I unless applicant

currently provides advisory services

pursuant to an investment advisory

contract to an investment company

registered under the Investment

Company Act of 1940. The investment

company must be operational, i.e., have

assets and shareholders (other than just

the organizing shareholders).

Instruction 5. Exemptions

(a) Pension Consultants. An applicant

that provides investment advice to

employee benefit plans with respect to

assets having an aggregate value of more

than $50 million during the 12-month

period ended within 90 days of filing

this Schedule may register with the

Commission. An investment adviser

seeking to rely on the pension

consultant exemption must aggregate: (i)

the value of assets for which it provided

advisory services at the end of the 12-

month period, and (ii) the value of any

other assets for which it provided

advisory services at the end of its

employment or contract (if terminated

before the end of the 12-month period).

See rule 203A–2(b).

(b) Affiliated Advisers. An applicant

that controls, is controlled by, or is

under common control with, an

investment adviser that is eligible to

maintain its registration with the

Commission (‘‘eligible adviser’’) is itself

eligible to maintain its registration with

the Commission if the principal office

and place of business of the applicant is

the same as that of the eligible adviser.

See rule 203A–2(c).

(c) Newly Formed Advisers. A newly

formed investment adviser may register

with the Commission at the time of its

formation if the adviser has a reasonable

expectation that within 120 days of

registration it will become eligible for

Commission registration. At the end of

the 120-day period, the adviser is

required to file an amended Schedule I.

If the investment adviser indicates on

the amended Schedule I that it has not

become eligible to register with the

Commission, the adviser is required to

file a Form ADV–W concurrently with

the Schedule I, thereby withdrawing

from registration with the Commission.

An applicant registering with the

Commission in reliance on this

exemption must include on Schedule E

of Form ADV an undertaking to

withdraw from registration if, at the end

of the 120-day period, the investment

adviser would be prohibited from

Commission registration. See rule

203A–2(d).

(d) Multi-State Advisers. An

investment adviser may register with

the Commission if it is required to

register as an investment adviser with

the securities authorities of 30 or more

states. To take advantage of this

exemption, an applicant must (i) attach

to this Schedule a representation that it

has reviewed the state and federal laws

and has concluded that it must register

with the securities authorities of at least

30 states within 90 days prior to the

date of filing this Schedule, and (ii)

include on Schedule E to Form ADV an

undertaking to withdraw from

registration if it would no longer be

required to register in at least 25 states

when it files its annual amendment to

Form ADV revising this Schedule. Each

year (and for so long as the investment

adviser continues to rely on the multistate investment adviser exemption),

when the adviser updates its Schedule

I, it must attach a new representation

that it has concluded that, but for the

exemption, it would be required to

register with the securities authorities of

at least 25 states within 90 days prior to

the date of filing Schedule I.

Additionally, each time the adviser

makes such a representation, the adviser

must create and maintain a list of the

states that, but for the exemption, it

would be required to register. This list

must be maintained in an easily

accessible place for a period of not less

than five years from the date each

representation is filed as an attachment

to this Schedule. See rule 203A–2(e).

Instruction 6. Part I, Item (b)

If item (b) of Part I is checked,

registrant’s investment registration with

the SEC must be withdrawn within 90

days after the date this Schedule I was

required by rule 204–1(a) to have been

filed with the Commission. Thus,

registrant’s registration must be

withdrawn no later than 180 days after

the end of its fiscal year. If registrant’s
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registration is not withdrawn within

this time period, registrant will be

subject to having its registration

cancelled pursuant to section 203(h) of

the Advisers Act. See rule 203A–1(c).

Instruction 7. Determining Assets Under

Management

Not all applicants are required to

provide the amount of their assets under

management. An applicant must report

its assets under management in Part II

only if item I(a)(i) is check yes ‘‘(x)’’ and

the amount of assets applicant has

under management is the sole basis for

applicant’s eligibility for SEC

registration (i.e., applicant has not

checked any of items I(a)(ii) through

(x)).

In determining the assets applicant

has under management, include the

‘‘securities portfolios’’ (or portions

thereof) for which applicant provides

‘‘continuous and regular supervisory or

management services’’ as of the date of

filing this Schedule.

(a) Securities Portfolios. An account is

a securities portfolio if at least 50% of

the total value of the account consists of

securities. For purpose of this 50% test,

applicant may treat cash and cash

equivalents (i.e., bank deposits,

certificates of deposit, bankers

acceptances, and similar bank

instruments) as securities.

Applicants may include securities

portfolios that are: (i) Family or

proprietary accounts of the applicant

(unless applicant is a sole proprietor, in

which case the personal assets of the

sole proprietor must be excluded); (ii)

accounts for which applicant receives

no compensation for its services; and

(iii) accounts of clients who are not U.S.

residents.

(b) Value of Portfolio. Include the

entire value of each securities portfolio

(or portion thereof) for which applicant

provides ‘‘continuous and regular

supervisory or management services.’’ If

applicant provides continuous and

regular supervisory or management

services for only a portion of a securities

portfolio, include as assets under

management only the portion of the

securities portfolio that receives such

services. Exclude, for example, a portion

of an account:

(1) under management by another

person; or

(2) that consists of real estate or

businesses the operations of which are

‘‘managed’’ on behalf of a client but not

as an investment.

No deduction is required for

securities purchased on margin.

(c) Continuous and Regular

Supervisory or Management Services.

General Criteria. An applicant

provides continuous and regular

supervisory or management services

with respect to a securities portfolio if

the applicant either—

(1) has discretionary authority over

and provides ongoing supervisory or

management services with respect to the

account; or

(2) does not have discretionary

authority over the account, but has an

ongoing responsibility to select or make

recommendations, based upon the

needs of the client, as to specific

securities or other investments the

account may purchase or sell and, if

such recommendations are accepted by

the client, is responsible for arranging or

effecting the purchase or sale.

Factors. Applicants should consider

the following factors in evaluating

whether continuous and regular

supervisory or management services are

being provided.

(1) Terms of the advisory contract. A

provision in an advisory contract by

which the applicant agrees to provide

ongoing management services suggests

that the account receives such services.

Other provisions in the contract, or the

actual management of the applicant,

however, may rebut such a suggestion.

(2) Form of compensation. A form of

compensation based on the average

value of assets under management over

a specified period of time would suggest

that the applicant provides continuous

and regular supervisory or management

services. On the other hand, a form of

compensation based upon time the

applicant spends with a client during a

client visit would suggest otherwise. A

retainer based upon a percentage of

assets covered by a financial plan would

not suggest that the applicant provides

continuous and regular supervisory or

management services.

(3) The management practice of the

applicant. The extent to which the

applicant is actively managing the assets

or providing advice bears on whether

the services are continuous and regular

supervisory or management services.

However, infrequent trades (e.g., based

on a ‘‘buy and hold’’ strategy) should

not alone form the basis for a

determination that the services are not

provided on a continuous and regular

basis.

Examples. To assist applicants, the

Commission is providing examples of

accounts that may receive continuous

and regular supervisory or management

services, based upon the criteria and

factors discussed above. These examples

are not exclusive.

Accounts that may receive continuous

and regular supervisory or management

services:

(1) Accounts for which the applicant

allocates assets of a client among mutual

funds (even if it does so without a grant

of discretionary authority, but only if

the general criteria for non-discretionary

accounts is satisfied and the factors

suggest that the account receives

continuous and regular supervisory or

management services); and

(2) Accounts for which the applicant

allocates assets among other managers—

but only under a grant of discretionary

authority by which it may hire and fire

managers and reallocate assets among

them.

Accounts that do not receive

continuous and regular supervisory or

management services:

(1) Accounts for which the applicant

provides market timing

recommendations (to buy or sell) but

has no ongoing management

responsibilities;

(2) Accounts for which the applicant

provides only impersonal advice, e.g.,

market newsletters;

(3) Accounts for which the applicant

provides an initial asset allocation,

without continuous and regular

monitoring and reallocation; and

(4) Accounts for which the applicant

provides advice only on an intermittent

or periodic basis, upon the request of

the client, or in response to some market

event, e.g., an account that is reviewed

and adjusted on a quarterly basis.

(d) Value of Assets Under

Management. Calculate the total amount

of applicant’s assets under management

by including the value, as determined

within 90 days prior to the date of filing

this Schedule, of securities portfolios (or

portions thereof) for which applicant

provides continuous and regular

supervisory or management services as

of the date of filing this Schedule.

Current market value should be

determined using the same method as

that used to determine the account

value reported to clients or fees for

investment advisory services.

(e) Example. To assist applicants, the

Commission is providing an example of

the method of determining whether a

client account may be included as

‘‘assets under management.’’

Example

A client’s portfolio consists of the

following:

$6,000,000 stocks and bonds

$1,000,000 cash and cash equivalents

$3,000,000 non-securities (collectibles,

commodities, real estate,

etc.)
61882 Federal Register / Vol. 62, No. 223 / Wednesday, November 19, 1997 / Proposed Rules

1 15 U.S.C. 80a–2(a)(51)(A).

2 15 U.S.C. 80b–5(a)(1).

3H.R. Rep. No. 2639, 76th Cong., 3d Sess. 29

(1940). Performance fees were characterized as

‘‘heads I win, tails you lose’’ arrangements in which

the adviser had everything to gain if successful and

little, if anything, to lose if not. S. Rep. No. 1775,

76th Cong., 3d Sess. 22 (1940). See also SEC,

Investment Trusts and Investment Companies, H.R.

Doc. No. 477, 76th Cong., 3d Sess. 30 (1939).

Congress, however, recognized that performance

fees may not be harmful in every context and

initially excluded from the prohibition contracts

between investment advisers and investment

companies. Investment Advisers Act of 1940, ch.

686, § 205(1), 54 Stat. 847, 852 (1940) (amended

1970).

4Trusts, governmental plans, collective trust

funds, and separate accounts referred to in section

3(c)(11) of the Investment Company Act [15 U.S.C.

80a–3(c)(11)] are not eligible for this exception from

the performance fee prohibition under section

205(b)(2)(B) of the Advisers Act [15 U.S.C. 80b–

5(b)(2)(B)].

5 15 U.S.C. 80b–5(b). A fulcrum fee generally

involves averaging the adviser’s fee over a specified

period and increasing and decreasing the fee

proportionately with the investment performance of

the company or fund in relation to the investment

record of an appropriate index of securities prices.

See Adoption of Rule 205–2 Under the Investment

Advisers Act of 1940, as Amended, Defining

‘‘Specified Period’’ Over Which the Asset Value of

the Company or Fund Under Management is

Averaged, Investment Advisers Act Release No. 347

(Nov. 10, 1972) (37 FR 24895 (Nov. 23, 1972));

Adoption of Rule 205–1 Under the Investment

Advisers Act of 1940 Defining ‘‘Investment

Performance’’ of an Investment Company and

$10,000,000 Total Assets

First, is the account a ‘‘securities

portfolio?’’ The account is a securities

portfolio because securities as well as

cash and cash equivalents (which the

applicant has chosen to include as

securities)

($6,000,000+$1,000,000=$7,000,000)

comprise at least 50% of the value of the

account (here, 70%). (See Instruction

7(a))

Second, does the account receive

‘‘continuous and regular supervisory or

management services?’’ The entire

account is managed on a discretionary

basis and is provided ongoing

supervisory and management services,

and therefore receives continuous and

regular supervisory or management

services. (See Instruction 7(c))

Third, what is the entire value of the

account? The entire value of the account

($10,000,000) is included in the

calculation of the investment adviser’s

total assets under management.

[FR Doc. 97–30296 Filed 11–18–97; 8:45 am]

BILLING CODE 8010–01–P

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Part 275

[Release No. IA–1682, File No. S7–29–97]

RIN 3235–AH25

Exemption To Allow Investment

Advisers To Charge Fees Based Upon

a Share of Capital Gains Upon or

Capital Appreciation of a Client’s

Account

AGENCY: Securities and Exchange

Commission.

ACTION: Proposed rule.

SUMMARY: The Commission is proposing

amendments to the rule under the

Investment Advisers Act of 1940 that

permits investment advisers to charge

certain clients performance or incentive

fees. The amendments would modify

the rule’s criteria for clients eligible to

enter into a contract under which a

performance fee is charged and

eliminate provisions specifying required

contract terms and disclosures. The

amendments would provide investment

advisers greater flexibility in structuring

performance fee arrangements with

clients who are financially sophisticated

or have the resources to obtain

sophisticated financial advice regarding

the terms of these arrangements.

DATES: Comments must be received on

or before January 20, 1998.

ADDRESSES: Comments should be

submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Stop 6–9, Washington, D.C. 20549.

Comments also may be submitted

electronically at the following E-mail

address: rule-comments@sec.gov. All

comment letters should refer to File No.

S7–29–97; this file number should be

included on the subject line if E-mail is

used. Comment letters will be available

for public inspection and copying in the

Commission’s Public Reference Room,

450 Fifth Street, N.W., Washington, D.C.

20549. Electronically submitted

comment letters also will be posted on

the Commission’s Internet web site

(http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT:

Kathy D. Ireland, Attorney, or Jennifer

S. Choi, Special Counsel, at (202) 942–

0716, Task Force on Investment Adviser

Regulation, Division of Investment

Management, Stop 10–6, Securities and

Exchange Commission, 450 Fifth Street,

N.W., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The

Commission is requesting public

comment on proposed amendments to

rule 205–3 [17 CFR 275.205–3] under

the Investment Advisers Act of 1940 [15

U.S.C. 80b–1 et seq.] (‘‘Advisers Act’’).

Table of Contents

Executive Summary

I. Background

II. Discussion

A. Elimination of Specific Contractual and

Disclosure Requirements

B. Qualified Clients

C. Identification of the Client

D. Transition Rule

E. General Request for Comment

III. Cost-benefit Analysis

IV. Summary of Regulatory Flexibility

Analysis

V. Statutory Authority

Text of Proposed Rule Amendments

Executive Summary

Rule 205–3 under the Advisers Act

permits investment advisers to charge

performance fees to clients with at least

$500,000 under the adviser’s

management or with a net worth of

more than $1,000,000. The rule requires

certain terms to be included in contracts

providing for performance fees and

specific disclosures to be made to

clients entering into these contracts. The

Commission is proposing to eliminate

the provisions of the rule that prescribe

contractual terms and require specific

disclosures. In addition, the

Commission is proposing to revise the

threshold levels for determining client

eligibility to reflect the effects of

inflation on the levels set in 1985 when

the rule was adopted and to add a third

criterion for eligibility. Under the

proposed amendments, eligible clients

must have assets under management

with the adviser of at least $750,000, net

worth of more than $1,500,000, or be

‘‘qualified purchasers’’ under section

2(a)(51)(A) of the Investment Company

Act of 1940 (‘‘Investment Company

Act’’).1

I. Background

Section 205(a)(1) of the Advisers Act

generally prohibits an investment

adviser from entering into, extending,

renewing, or performing any investment

advisory contract that provides for

compensation to the adviser based on a

share of capital gains on, or capital

appreciation of, the funds or any portion

of the funds of the client.2 Congress

enacted the prohibition against

performance fees in 1940 to protect

advisory clients from compensation

arrangements that it believed might

encourage advisers to take undue risks

with client funds to increase advisory

fees.3

In 1970, Congress provided an

exception from the prohibition in

section 205(a)(1) for advisory contracts

relating to the investment of assets in

excess of $1,000,000,4 so long as an

appropriate ‘‘fulcrum fee’’ is used.5 This