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What Is The Investment Advisers Act of 1940
The Investment Advisers Act of 1940, also referred to as the Investment Adviser Act or simply the Advisers Act, is a federal piece of legislation governing investment advisors offering investment advice to their clients.
In other words, individuals who provide investment advice to others are required to respect and obey the Advisers Act rules so clients are better protected from fraud and misrepresentations.
The IAA of 1940 can be found in Title 15 of the United States Code.
The U.S. Securities And Exchange Commission is the primary body regulating investment advisors (also called “advisors” under the advisers act).
The reason why the federal government in the United States adopted the Investment Advisers Act of 1940 was further to the Great Depression of the late 1920s.
In fact, following the stock market crash of 1929, it was apparent that the United States government needed to act to protect investors by regulating the manner investment advisors and companies operated.
The Securities And Exchange Commission, shortly after the Great Depression, issued a report warning the US government that without legislation regulating investment advisors, clients may be at risk of financial loss due to lack of transparency and advisor accountability.
In 1940, the US Congress adopted two key pieces of legislation intended to better define the roles and responsibilities of investment advisors (Investment Advisers Act of 1940) and investment companies (Investment Company Act of 1940).
The fundamental objective behind various financial adviser regulations, particularly the Investment Advisers Act of 1940 rules, is to impose fiduciary duties on financial advisers so they act in the best interest of their clients.
In essence, financial advisers are required to provide all the relevant and material information to their clients when making an investment decision and exercise prudence and diligence in their role as advisors.
Further to the requirements of the Act, investment advisors must be registered advisors and pass exams demonstrating the competence and aptitude to act as an adviser.
According to the Securities And Exchange Commission, the Advisers Act of 1940:
Regulates investment advisers. (…) this Act requires that firms or sole practitioners compensated for advising others about securities investments must register with the SEC and conform to regulations designed to protect investors.
Here is the Investment Act of 1940 summary of its table of content:
- Section 201 — Findings
- Section 202 — Definitions
- Section 203 — Registration of Investment Advisers
- Section 203A — State and Federal Responsibilities
- Section 204 — Reports by Investment Advisers
- Section 204A — Prevention of Misuse of Nonpublic Information
- Section 205 — Investment Advisory Contracts
- Section 206 — Prohibited Transactions by Investment Advisers
- Section 206A — Exemptions
- Section 207 — Material Misstatements
- Section 208 — General Prohibitions
- Section 209 — Enforcement of Title
- Section 210 — Disclosure of Information by Commission
- Section 210A — Consultation
- Section 211 — Rules, Regulations, and Orders of Commission
- Section 212 — Hearings
- Section 213 — Court Review of Orders
- Section 214 — Jurisdiction of Offenses and Suits
- Section 215 — Validity of Contracts
- Section 216 — Annual Reports of Commission
- Section 217 — Penalties
- Section 218 — Hiring and Leasing Authority of the Commission
- Section 219 — Separability of Provisions
- Section 220 — Short Title
- Section 221 — Effective Date
- Section 222 — State Regulation of Investment Advisers
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Investment Advisors Act of 1940 Fiduciary Duty
For a person to act as an investment advisor, he or she must comply with the rules and regulations imposed by various laws either at the federal level or state level.
Depending on the nature of the adviser’s business activities and operations, advisers may either be regulated through the Securities and Exchange Commission or the equivalent agencies at the state level.
The advisers’ fiduciary obligations include this like:
- The adviser must act in the best interest of his or her client
- The adviser has a duty of loyalty when advising a client
- The adviser owes the client duty of care when executing his or her functions
- The advisor must provide the client with all material information impacting the investment decision
In other words, the role of investment advisors as investment counselors is to properly, fairly, and honestly provide investment advice and put the client’s interest above their own.
For example, prior to the adoption of the Investment Adviser Act of 1940, many investors were tricked, manipulated, or misled to invest money in the stock market when it was clearly not in their interest.
Also, many investment advisers performed trades and transactions intended to result in a higher commission for them as opposed to the best investment transaction for their clients.
To protect investors and to promote confidence in the financial system, the US Congress had no other choice but to legally impose fiduciary standards on investment advisors so they are held accountable for their actions.
Investment Adviser Act of 1940 Requirements
In 1940, the investment advisers act rules were passed to monitor individuals offering advice to others for a fee.
Investment advice could be given to individuals, pension funds, financial institutions, or other parties.
As such, the investment adviser regulations are intended to keep track of who is in the industry, how they are advising their clients, and the need for them to register with the SEC.
For a person to be considered an adviser under the investment adviser act rules, the following criteria must be evaluated:
- What kind of advice is the person giving to others
- How do clients pay the adviser for his or her advice
- What is the proportion of the person’s revenue is generated from giving investment advice
Under the act, a person advising another on securities is considered an advisor.
There are also instances that a person claiming to be an adviser and leading the public to believe that he or she is an investment adviser of some sort, then the requirements under the act can get triggered as well.
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Advisor Registration Requirement
Investment advisers are required to register with the SEC or state regulators depending on the value of assets under their management or who they advise.
According to the SEC, if a person meets the following condition, then the advisor must register with the SEC:
Generally only advisers who have at least $100 million of assets under management or advise a registered investment company must register with the Commission. Other investment advisers typically register with the state in which the investment adviser maintains its principal place of business.
This means that advisors who manage small accounts will register with their state regulators whereas those managing over $100 million in assets will register with the SEC.
Prior to 2010, the threshold to register with the SEC was $25 million of assets under control but further to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the threshold was changed to $100 million.
In addition to those who manage assets over $100 million, those advising private funds must also register with the SEC although they used to be except.
Before the Dodd-Frank Act, “small advisers” were exempt from IAA registration if they had less than 15 US clients and did not claim to the public to be investment advisers.
However, further to the Dodd-Frank Act, the “small adviser” exemption was eliminated and replaced with three categories of investment advisors exempt from registration:
- Advisors to private funds that have less than $150 million of assets under management (this is referred to as the Private Fund Adviser Exemption)
- Advisors to venture capital funds (called the Venture Capital Adviser Exemption)
- Non-US advisors having less than $25 million in assets under management attributed to US clients and having less than 15 clients (this is the Foreign Private Adviser Exemption)
If you are looking to better understand whether or not you are exempt under the IAA of 1940 or whether you must register, you should consult with a qualified attorney experienced in the SEC rules and who understands the US Investment Advisors Act of 1940.
Investment Advisers Act Takeaways
So there you have it folks!
What is the Investment Advisers Act of 1940?
What does it regulate?
How does it work?
In essence, the Investment Advisers Act of 1940 is a federal law in the United States that was passed following the Great Depression in the late 1920s.
The objective of the Investment Advisers Act 1940 is to ensure that investment advisors that meet certain criteria register with the SEC and obey certain rules when giving investment advice to their clients.
By imposing various legal obligations on investment advisors, the idea is to help protect investors from dishonest practices and ensure that investors in general maintain confidence in advice and recommendations given by investment advisors.
The US Investment Advisers Act of 1940 provides:
- The legal basis for individuals acting as advisors
- Regulate the activities of individuals advising others such as institutional investors, individual investors, pension funds, or other
- The nature of the advice that can be given by an investment advisor
- The registration requirements with the SEC
Based on the terms of the Act, a person can be qualified as an advisor if:
- The person’s primary source of compensation is from giving investment advice
- Provides investment advice in risky financial markets
- Advertises or claims to be an investment advisor to the public
Those who provide investment advice on the side or incidental to their primary function may be exempt from registration requirements.
In some cases, financial planners, investment advisors or accountants may be considered as financial advisers under the Act or may be exempt in other instances.
If you need to get legal advice on the IAA 1940, you should consult with a securities lawyer who has experience in the SEC regulation of investment advisors, understands the investment advisers act of 1940 exemptions, and how it is applied.
I hope that I was able to provide you with the essentials you need to better understand the “Investment Advisers Act of 1940”, its objectives, and how it works.
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Investment Advisers Act of 1940 Summary
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