Prior to conducting business in any state, a broker dealer must be properly registered or exempt from registration in that state. The first test when deciding if the broker dealer must register is determining if the firm has an office in the state. If the firm maintains an office within the state, it must register with that state. An agent must register in their state of residence even if their firm is located in another state.
Agents also must register in the states where they sell securities or offer to sell securities as well as where they advertise. If the firm does not have an office in the state, they may or may not be required to register depending on with whom they do business. If a broker dealer does not have an office in the state and engages in securities transactions with the general public, then they must register. If a broker dealer with no office in the state conducts business exclusively with any of the following, they are not required to register in that state:
A broker dealer will not be deemed to have a place of business in a state where it does not maintain an office simply by virtue of the fact that the firm's website is accessible from that state as long as the following conditions are met:
It is unlawful for a broker dealer to employ any agent who is not properly registered under the Uniform Securities Act (USA). When determining if an agent must register, first look for whom the agent works. If the agent works for a broker dealer, the agent must register. The only exception is for officers and directors of a broker dealer who have no involvement with customers, securities transactions, or supervision. If the agent works for an exempt issuer, the agent is exempt from registration no matter what security is involved. Exempt issuers are:
An agent is also exempt from registering if they represent an issuer in the sale of an exempt security such as:
A broker dealer wishing to become registered in a state must first file an application with the state securities administrator. The broker dealer must also pay all filing fees and sign the consent to service of process. By signing the consent to service of process, the broker dealer appoints the administrator as their attorney in fact and allows the administrator to receive legal papers for the applicant. Any legal papers received by the administrator will have the same force and effect as if they were served on the broker dealer. All applications must also include:
The firm's registration will become effective at noon 30 days after the initial application has been received or at noon 30 days after the administrator has received the last piece of required information. Registering a broker dealer in a state automatically requires that any officers and directors who act in a sales capacity register as agents in that state.
A broker dealer must be able to meet the minimum capital requirements set forth by the state securities administrator. If the broker dealer is unable to meet this capital requirement, they must post a surety bond to ensure their solvency. Broker dealers that meet the Securities Exchange Commission's (SEC) minimum net capital requirements are exempt from USA's capital and surety bond requirements. The amount of the bond required by the administrator for broker dealers who have custody or discretion over client accounts is limited to the amount of capital required by the Securities Exchange Act of 1934. No bond may be required of broker dealers whose capital exceeds the amount of the bond required by the administrator. The administrator may require that an officer or agent of the broker dealer take an exam that may be oral, written, or both.
As the financial services business continues to bring together investments services with other more traditional banking services, it is more common to see brokerage services offered at retail bank locations. Broker dealers who offer investment services at bank branches must follow certain guidelines. The setting in which the broker dealer conducts its business should be separate from where the retail banking business is being conducted, if practical. Broker dealers must disclose to the customer—at or before the time that the customer opens the account—that their deposits are not guaranteed by the FDIC or the financial institution and are subject to the loss of principal. These same disclosures must also appear in all advertising and sales literature issued by the broker dealer operating on the location of other financial institutions. The host financial institution must sign an agreement stating that FINRA and the SEC are allowed to have access to any location where the member conducts its business. The member is required to promptly notify the financial institution if it terminates an associated person for cause.
Most states require that agents successfully complete the Series 65 exam before they may conduct business within their state. In addition to successfully passing the Series 65 exam, an agent also must:
When an agent changes firms, the agent, former employer, and new employer all must notify the state securities administrator. This is done in most cases quite easily through the central registration depository (CRD) system for all firm and agent information. An agent's termination becomes effective 30 days after notifying the state unless the administrator is in the process of suspending or revoking the agent's registration. The administrator may still revoke an agent's registration for up to one year after their registration has been terminated. If an agent is denied a registration as the result of information received on the agent's form U5 termination notice filed by the agent's previous employer then only the new employer and the agent will be notified of the denial.
If a broker dealer is acquiring another broker dealer, the successor firm must file an application for registration within the state. The successor firm's regis-
tration will become effective upon completion of the transaction. The registration fees for the successor firm will be waived.
All state registrations expire on December 31 and all broker dealers, investment advisers, and agents are required to file a renewal application and pay a renewal fee. The consent to service of process does not get refiled with the renewal application. The consent to service of process remains in effect as long as the registration of the agent or firm is in effect with the state.
A Canadian firm or agent may engage in securities transactions with financial institutions and existing customers without registering under the USA as long as they do not maintain an office within the state. A Canadian broker dealer or agent who is a member in good standing with a Canadian securities regulator is allowed to register through a simplified registration process. The state registration will become effective 30 days after the application has been received with the consent to service process. The Canadian broker dealer must advise the state of any disciplinary action.
It is unlawful for an investment adviser to conduct securities business without being properly registered or exempt from registration. State registration exemptions are provided for investment advisers who:
If a state registered investment adviser with no office in the state advertises to the public the ability to meet and offer investment advisory services with clients in a hotel or other temporary location, the investment adviser is required to register with the state.
An investment adviser will not be deemed to have a place of business in a state where it does not maintain an office simply by virtue of the fact that the firm's website is accessible from that state as long as the following conditions are met:
The National Securities Markets Improvement Act of 1996 eliminated regulatory duplication of effort and established registration requirements for investment advisers. A federally covered investment adviser must register with the SEC and is any investment adviser who:
All federally registered investment advisers must pay state filing fees and notify the administrator in the states in which they conduct business. The state securities administrator may not audit a federally covered investment adviser unless that adviser's principal offices are located in that administrator's state. An investment adviser is required to register with the state if they manage less than $100,000,000. Once the investment adviser reaches $100,000,000 in assets under management (AUM), the adviser becomes eligible for federal registration. An investment adviser who manages between $100,000,000 and $110,000,000 may choose to register either with the state or with the SEC. If the investment adviser thinks that he asset base will exceed $110,000,000, he or she should register with the SEC. An investment adviser who manages $110,000,000 or more must register with the SEC within 90 days of reaching $110,000,000 in AUM. An adviser applying for federal registration with the SEC will file Form ADV and the adviser's registration will become effective within 45 days. If a federally covered investment adviser's AUM falls below $90,000,000, the adviser must withdraw the federal registration by filing Form ADV-W within 60 days and is required to register with the appropriate states within 180 days. Like most regulations, there are rare exceptions to the rule of when an investment adviser may register with the SEC. The Dodd-Frank Wall Street Reform Act of 2010 increased the AUM for federal registration to its current levels and defined three categories of investment advisers as follows:
Pension consultants must have at least $200,000,000 AUM to be eligible to become federally registered.
All investment adviser representatives who maintain an office within the state must register within the state. An investment adviser representative is an individual who:
An investment adviser may not employ any representative who is not properly registered. Clerical and administrative employees are not considered representatives and do not need to register. An investment adviser representative who has no place of business in the state and who offers to meet a client in a hotel or other place of convenience is not considered to have an office in the state as long as the representative does not advertise the office and only offers the ability to meet directly with clients.
An investment advisory firm that is required to register with the state must file the following with the state securities administrator before they become registered:
State registered investment advisers must maintain a minimal level of financial solvency. For advisers with custody of a customer's cash and securities, the investment adviser must maintain a minimum net capital of $35,000. If the adviser is unable to meet this requirement, they may post a surety bond. Deposits of cash and securities will alleviate the surety bond requirement. An adviser is considered to have custody if they have their customers' cash and securities held at their firm or if they have full discretion over their customers' accounts. Full discretion allows the adviser to withdraw cash and securities from the customer's account without consulting the customer. Advisers who have only limited discretionary authority over customers' accounts need to maintain a minimum of $10,000 in net capital. An adviser with limited discretionary authority may only buy and sell securities for the customer's benefit without consulting the customer. They may not withdraw or deposit cash or securities without the customer's consent. If a state registered investment adviser meets the capital requirements in the home state, then he or she will be deemed to have met the capital requirements in any other state in which the adviser wishes to register, even if the other states have higher net capital or bonding requirements. Should a state registered adviser's net capital fall below the minimum requirement, the adviser must notify the state administrator of the adviser's net worth by the close of the next business day. The adviser then must file a financial disclosure report with the administrator by the end of the next business day. If the adviser has fallen below the net worth requirement the adviser will be required to post a bond to cover any capital deficiency. The amount of the bond will be rounded up to the nearest $5,000. Investment advisers with custody of funds must maintain a positive net worth at all times. Investment adviser representatives are not required to maintain a minimum level of liquidity. Federally registered investment advisers are not required to meet any capital or net worth requirements.
The state securities administrator may require investment adviser representatives as well as the officers and directors of the firm to take an exam, which may be oral, written, or both. All registration becomes effective at noon 30 days after the application has been filed or at noon 30 days after the last piece of information is received by the administrator. The administrator may require that an announcement of the investment adviser's intended registration be published in the newspaper.
| Requirement | Broker Dealer | Investment Adviser | Agents |
| Net capital | Yes | Yes | No |
| Surety bond | Yes | Yes | Yes |
| Exams | Yes | Yes | Yes |
| Fees | Yes | Yes | Yes |
All advertising and sales literature for an investment adviser must be filed with the state securities administrator. The administrator may require prior approval of:
Investment advisers must keep the following records for a minimum of five years unless the state securities administrator requires a different period of time:
All investment advisers must keep accurate records relating to the following:
All books and records must be kept for five years readily accessible and for two years at the adviser's office. Records may be kept on a computer or microfiche as long as the data may be viewed and printed.
An investment adviser is required to provide all prospective clients with a brochure or with Form ADV Part 2A and 2B at least 48 hours prior to the signing of the contract or at least at the time of the signing of the contract, if the client is given a five-day grace period to withdraw without penalty. The brochure or Form ADV Part 2A and 2B will state:
The NASAA Model Rule regarding direct fee deduction from client accounts, by advisers who use a qualified custodian, requires advisers who automatically deduct fees to have written authorization from each client to deduct the fees directly from client accounts. An invoice must be sent to the client detailing the fee as well as the formula for determining the fee. If the fee is based on the value of the account, then the value of the account at the time the fee is charged must be provided. The statements for client accounts will be sent by the qualified custodian and not from the investment adviser. NASAA considers a qualified custodian to be any of the following three entities:
An investment adviser charges a fee for his or her services for advising clients as to the value of securities or for making recommendations as to which securities should be purchased or sold. Unlike a broker dealer, the investment adviser has a contractual relationship with his or her clients and must always adhere to the highest standards of professional conduct.
In addition to the fees charged by an investment adviser, an investment adviser may also:
These sources of additional revenue must be disclosed to the client in writing prior to the investment adviser executing such transactions.
Compensation may be paid to the investment adviser directly or indirectly for the benefit of the person receiving the advice. It is the receipt of compensation that causes the person to meet the definition of an investment adviser and requires the person to register. Some of the ways compensation may be received are as follows:
An agency cross transaction is one in which the investment adviser represents both the purchasing and selling security holder either as an investment adviser or as a broker dealer. If the investment adviser is going to execute an agency cross transaction, he or she must get the advisory client's authorization in writing. The authorization may be pulled at any time verbally and the adviser may not have solicited both sides of the trade. The investment adviser still maintains a duty to obtain the best execution for both clients and may not execute the cross at a price that favors one client over the other. The adviser must send notice to all clients annually detailing the number of all agency cross transactions completed by the adviser.
An investment adviser must update form ADV annually within 90 days of the fiscal year end. Additionally, the investment adviser must provide each client with an updated brochure annually within 120 days of the adviser's fiscal year end. The brochure must be provided free of charge and must provide a summary of material changes to the advisory firm.
If the change to the investment adviser's business is material, it must be disclosed promptly. Of critical importance is to know what changes to the investment advisory firm are deemed material and when those changes must be disclosed. Most investment advisory firms other than small sole proprietorships are organized either as a corporation or as a partnership. A material change to the ownership or control of the adviser is considered to be material and must be disclosed promptly. If the adviser is a corporation and one of the firm's major stockholders sells, pledges, or assigns their block of controlling voting shares, this would be seen as both material and as an assignment of the contract and must be disclosed promptly. If the nature of the transfer is deemed to be an assignment, the client would also have to give their consent to continue the relationship. A person is deemed to control the investment adviser if they own 25% or more of the adviser's outstanding stock, have contributed 25% or more of the adviser's capital or are entitled to receive 25% or more of the adviser's assets upon dissolution. However, if an officer of the corporation leaves, no disclosure is required. If the advisory firm is organized as a partnership and a major partner dies or departs from the partnership, this would be considered material and as an assignment. Therefore, the material change must be disclosed promptly and the client must give consent to continue the advisory relationship. However, if the partnership adds or removes minority partners, these events would not be deemed material.
An investment adviser may not:
An investment adviser with custody of customer's funds must:
State registered investment advisers who charge upfront fees of $500 or more and more than 6 months in advance are considered to have custody of funds and must provide clients with a balance sheet and make required disclosures relating to the location of assets. A federally registered adviser will be deemed to have custody if the upfront fees are $1,200 or more and more than 6 months in advance. The above guidelines are based on the rules regarding substantial prepayment of fees. One additional point to note is that NASAA requires that any state registered investment adviser who inadvertently receives a check made payable to a client must return that check to the sender within 72 hours (3 days). If the adviser does not return the check in the time required, then NASAA will consider the adviser to have custody of client funds. This rule does not apply at the federal level or in cases where clients write a check payable to a third party such as a bank, brokerage firm, or other third parties.
All investment adviser contracts must be in writing and must contain disclosures of:
While most adviser contracts have the approval for discretionary authority incorporated into the contract, NASAA will allow state registered advisers to exercise discretion for 10 business days from the date of the first transaction. After 10 business days written discretionary authorization must be received from the client prior to exercising further discretion.
As the business services offered by various professionals have expanded, so has the definition of who must register as an investment adviser. Sports and entertainment representatives now often advise their clients on how or with whom to invest their earnings. As a result, the representative is considered an investment adviser, even if investment advice is only a small part of the services they perform. Sports and entertainment representatives who advise clients on investments, where to invest, tax planning, and budgeting would be required to register as an investment adviser. Individuals who advise pension funds on the merits of portfolio managers or who act as pension consultants also must register as investment advisers.
A private investment company/3C7 fund may charge performance-based compensation to clients, provided that the clients have a minimum of $1,000,000 of assets under the adviser's management or have a net worth of $2,000,000. Corporations with $25 million in assets and individuals with at least $5 million in investments also may participate.
Advisers, who manage accounts for investment companies or accounts with a value greater than $1 million (if those accounts are not for trusts or retirement plans), may charge fulcrum fees. A fulcrum fee provides the adviser with additional compensation for outperforming a broad-based index such as the S&P 500 and less compensation for underperforming the index. The amount of the additional compensation received for outperforming the index must be equal to the amount of compensation that would be lost for underperformance. The index used as the basis to determine the adviser's performance must contain similar securities and risks.
A wrap account is an account that charges one fee for both the advice received as well as the cost of the transaction. All clients who open wrap accounts must be given the wrap account brochure known as schedule H that will provide all of the information that is found on Form ADV Part 2. Broker dealers who offer wrap accounts must be registered as investment advisers. Individuals who receive fee-based compensation generated by wrap fee programs must be registered as investment adviser representatives.
Brokerage firms will oftentimes provide investment advisers with services to assist the investment adviser in their business that go beyond execution and research. These services are provided in exchange for commission business and are known as soft dollars. The services received should normally be research related. However, there are instances when the services received are used for other purposes and benefit the adviser. In order for the soft dollar arrangement to be included the safe harbor provisions, investment advisers must ensure that the services received are for the benefit of the client and need to pay careful attention to the disclosure requirements relating to all soft dollar arraignments.
If an adviser receives soft dollar compensation from a broker dealer to whom the adviser directs customer transactions (known as directed transactions) the adviser must disclose any arrangement to clients. The fees charged to execute the transactions should by fair and reasonable, in line with what is available in the marketplace and in line with the value of the services offered to the adviser and clients. The execution fees are not required to be the lowest and simply using a broker dealer whose services are more expensive will not constitute a breach of the adviser's fiduciary duty. If the adviser directs transactions to a broker dealer in exchange for services that benefit the adviser the adviser must disclosure all facts relating to the arrangement and receive the client's written consent to enter into the arrangement even if such arrangement does not increase the costs to the client. Client consent for soft dollar compensation may be obtained on a separate authorization or as part of the adviser's form ADV disclosure. The disclosure on form ADV must include a list of the products and services provided to the adviser, the process the adviser uses to allocate customer order execution, and if the fees being paid are higher than they otherwise would be.
The SEC has divided soft dollar consideration into the following categories: