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– Your principal place of business is in one state, and you give no advice regarding securities on a listed national exchange
– Your clients are limited to insurance companies
– You had fewer than 15 clients in the preceding 12 months and do not hold yourself out as an investment adviser.
d. A publisher of any bona fide newspaper, news magazine, business or financial publication of general and regular circulation, e. Any person whose advice, analyses, or reports relate to no securities other than securities which are direct obligations of or obligations guaranteed as to principal or interest by the United States, or securities issued or guaranteed by Corporations in which the United States has a direct or indirect interest which shall have been designated by the Secretary of the Treasury, pursuant to Section 3(a)(12) of the Securities Exchange Act of 1934, as exempted securities for the purposes of that Act, or f. Such other persons not within the intent of this paragraph, as the commission may designate by rules and regulations or order.
The SEC, in Release No. IA-1092, has adopted a three-pronged test to determine whether a firm or individual person needs to be registered as an investment adviser. The release also looked at financial planning activities and how they apply to the Act. Although this Release applies to SEC RIAs, many states will use the same analysis. Persons need to be an RIA or affiliated with one if they:
• Provide advice, issue reports, or analyze securities • Are in the business of providing such services
• Provide such services for compensation.
As few people reading this book are excluded from the “in the business” element, it will simplify matters to focus on three words: compensation, advice, and securities. Each of these words is construed very broadly by the SEC. COMPENSATION Receiving any economic benefit from any source is, according to the SEC, compensation. Contrary to popular opinion, it is not necessary for the benefit to be a separate fee directly related to the investment advice or financial plan. Nor is it necessary for this to be a commission from the sale of securities. It has been determined that the receipt of commissions from a client’s insurance product or other investment is sufficient to satisfy the compensation test.24 In short, any fees for plans, commissions from product sales, or remuneration from any source is compensation.
GEORGE, A LIFE INSURANCE salesperson, holds himself out to be an estate planner. In performing his services, he reviews a client’s balance sheet and makes recommendations for specific insurance products. At a meeting with Mr. and Mrs. Client, he makes the following recommendation: “Since your ABC stock has been underperforming for the last five years, I recommend selling that stock and placing the proceeds in a whole life insurance policy.” George receives no fees for investment advice and no commission from the sale of the ABC stock. He will, however, receive commissions from the sale of the whole life insurance policy.
Question: Has George received compensation under the rule and is he required to be an RIA?
Answer: Yes. George gave advice regarding securities and he was compensated by an insurance commission. George has just committed a felony, could be facing five years in jail, and probably does not even know it. George could eliminate this problem completely either by registering as an investment adviser or by limiting all his recommendations to insurance and avoiding any advice about securities.
ADVICE is also interpreted broadly by the SEC. It is not unusual to find planners or consultants trying to avoid registering as an Investment Adviser by not giving specific investment advice. Instead of recommending the client buy the XYZ mutual fund, they will just recommend generic balanced mutual funds. The SEC, however, has found giving general advice about securities is sufficient to trigger the registration requirement; the advice need not be specific.25 The giving of advice need not constitute the primary or even major activity in order to satisfy that part of the test.26 The SEC envisioned that in order for most financial planners to do their jobs properly, they must discuss both the pros and cons of a particular investment with their clients.27 It is difficult to imagine any financial planner doing a good job without making some comments regarding the client’s savings and investment strategy. If planners fail to discuss securities with their clients, they would probably be breaching their fiduciary duty.
The following have been found to fit the requirements of advice:
1. Analyses or valuations of particular securities, or securities markets in general, even without specific buy, hold, or sell recommendations.28
2. Market timing recommendations concerning the time to move a percentage of assets into a category of investments such as mutual funds or foreign stocks.29
3. Advising clients on the choice or retention of another investment adviser (a solicitor) or serving as a person who evaluates investment advisers.30
4. Providing statistical or historical data about securities that incorporate the writer’s judgments.31
TOM, A CFP LICENSEE with a large brokerage firm, does not hold himself out to be a financial planner, although he does do financial planning incidental to his business as a broker. To build a client base, he has developed a seminar entitled “Financial Planning for the 21st Century.” This seminar is offered to current and prospective clients for the nominal fee of $25. The fee was designed to cover the cost of renting a hotel room, refreshments, and printing a 100-page workbook. During the seminar, Tom reviews all aspects of financial planning, including how to evaluate stocks and bonds and what to look for in investment purchases. He does not give anyone individual advice regarding securities at the seminar, but he may meet with them privately later.
Question: Is Tom giving advice regarding securities for which he is compensated, and must he register as an investment adviser; or does he fit into one of the exclusions?
Answer: Tom would be required to register. Even though the modest fee for attending the class was used only to cover Tom’s expenses and Tom did not make a profit, it is still considered compensation. Furthermore, Tom does not fit into the broker-dealer exclusion because the activities of giving a seminar are not considered to be incidental to his brokerage business.
SECURITIES Once again, the SEC has construed the word “security” in the widest possible sense. The legal definition of a security is quite lengthy and includes any scheme involving the investment of money in a common enterprise with profits to come solely from the efforts of others.32 It includes all sorts of investments that most people never consider to be securities, such as certificates of deposit, notes, and mortgages. There are only two exclusions under the definition: annuities and life insurance.
THE INVESTMENT ADVISERS ACT and numerous rules, regulations, and releases have defined not only who is required to register but also who is not. Note: there is a big difference between exemptions and exclusions. Those persons or entities who are exempt from registering must still follow the laws; for example, anti-fraud provisions. This group consists of those few advisers who limit their clients to insurance companies, have fewer than 15 clients or limit their practice to one state, and do not give advice regarding nationally listed securities. However, those who are excluded from registration are not considered to be investment advisers and therefore need not follow the anti-fraud or other provisions.33
Three excluded categories are pertinent to this section: certain professionals, broker-dealers, and exempted advisers.
PROFESSIONALS Some professionals, including accountants,