State registered vs.

federal covered
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Federal investment adviser laws

The Series 65 is a state-based exam primarily focused on the Uniform Securities Act (USA), but
also focuses on federal laws like the Investment Advisers Act of 1940. Investment advisers,
which are financial firms in the business of providing advice, are primarily subject to federal or
state regulation.
In the mid-1990s, the National Securities Market Improvement Act of 1996 (NSMIA) was
enacted to reduce over-regulation and promote efficiency in the securities markets. Prior to this
legislation, investment advisers were required to register with both the SEC and each relevant
state administrator (similar to how broker-dealers operate). In some circumstances, rules and
regulations conflicted at the two different levels, causing confusion among investment advisers
(who do you listen to - the state administrator or the SEC?). NSMIA effectively divided
investment advisers into two different categories: state-registered and federal-covered.
NSMIA created the term federal-covered adviser, which is an investment adviser subject to SEC
registration and regulation, and excluded from state registration and regulation. Although
federally covered advisers are not required to register with the state administrator, they are still
obligated to provide a notice filing in every state they plan on doing business. We’ll discuss
more about this type of filing in the next chapter.
The primary reason an investment adviser qualifies as a federally covered adviser (or,
sometimes referred to as simply a ‘covered’ or ‘SEC adviser’) relates to assets under
management (AUM). This is a measurement of the value of the assets an adviser manages on
behalf of its customers. The larger an adviser’s AUM, the more likely they’re considered
federally covered.
Another law defined these numbers specifically - the Dodd-Frank Wall Street Reform
Act (usually referred to as Dodd-Frank). Dodd-Frank specifically defined three categories of
investment advisers:
 Large investment advisers
 Mid-size investment advisers
 Small investment advisers
Large investment advisers
Advisory firms with at least $100 million of AUM are considered large investment advisers. Once
a firm obtains $100 million of AUM, they are eligible to register with the SEC as a federally
covered adviser. If the firm exceeds $110 million of AUM, they must register with the SEC as a
federally covered adviser.
Advisers tend to register as federally covered advisers once they reach $100 million of AUM. In
fact, Dodd-Frank allows advisers that expect to reach at least $100 million of AUM within 120
days to register as a federal-covered adviser (meaning they’re eligible, but are not required to
do so). Many advisers continue to grow their business by bringing in new clients and through
capital appreciation (growth) of the assets they manage. However, what if an adviser’s AUM
starts declining due to losing clients or investments losing value?
Federal-covered advisers that qualify for SEC registration may maintain their federal-covered
status until they fall below $90 million AUM. At this point, the adviser is forced to withdraw
their federal registration and register with all relevant states.
AUM fluctuates on a daily basis due to inflows and outflows of client assets, and market activity.
So, what if an adviser drops below $90 million for a day, then bounces back above? Thankfully,
these numbers are only looked at once per year. At the end of an adviser’s fiscal year, they are
obligated to file paperwork (discussed in detail in the next chapter) updating the state
administrator on changes made to the business over the past year. It is at this time the adviser
will declare their current AUM level.
Definitions
Fiscal year
An arbitrarily established year by a business for tax or accounting purposes
Example: ABC Investment Adviser’s fiscal year ends June 30th
It’s possible to see a test question relating to how quickly an adviser must change their
registration. A state-registered adviser that reaches $110 million of AUM has 90 days from filing
their annual updates to register with the SEC. Conversely, a federal-covered adviser that falls
below $90 million AUM has 180 days to de-register from the SEC and register with the
appropriate state administrators.
Mid-size investment advisers
Advisory firms with at least $25 million of AUM, up to $100 million AUM, are considered mid-
size investment advisers. Firms in these categories tend to register with relevant state
administrators. There are a few circumstances where a mid-size adviser becomes eligible for SEC
registration as a federal-covered adviser:
 If not required to be registered in state where its principal place of business exists*
 If registered with the state administrator where the principal place of business exists,
but not subject to examination (regulation) by that state administrator*
 If registered in 15 or more states (referred to as the “multi-state adviser rule”)
*Don’t worry about the specifics here. The language quoted above comes directly from SEC
rules and refers to uncommon situations. Understanding that advisers in these situations could
be considered federal-covered advisers is the important part. Don’t worry about the context.
Small investment advisers
Advisory firms with less than $25 million of AUM are considered small investment advisers.
Similar to mid-size advisers, small advisers are typically state-registered. However, it’s still
possible for a small adviser to be federal-covered. The only relevant exception for small advisers
is the multi-state adviser rule (cited above). If operating in 15 or more states, the adviser
qualifies for SEC registration as a federal-covered adviser.
In addition to AUM size, NSMIA defined two other circumstances an adviser would be
considered federal-covered:
  Advisers to registered investment companies
 Persons excluded from IA40’s investment adviser definition
Advisers to registered investment companies
As we learned in a previous chapter, there are several types of investment companies:
 Management companies
o Open-end management companies (mutual funds)
o Closed-end management companies (closed-end funds)
 Unit investment trusts (UITs)
 Face amount certificates
Investment companies are registered and regulated under the Investment Company Act of
1940, which is a federal law enforced by the SEC. While you don’t need to know much about
these types of securities, you must assume investment advisers are hired to manage these
funds.
For example, most stock-based Vanguard funds are managed by a registered investment adviser
known as Vanguard Equity Index Group. This firm (which is a subsidiary of Vanguard) is a
federal-covered adviser, registered and regulated by the SEC. The same would go for any other
investment adviser hired to manage an investment company.
Excluded persons
The IA40 explicitly excludes several persons in various circumstances from the definition of an
investment adviser. Many of these exclusions overlap with the state, and we’ll cover those in
depth later in this unit. There’s one specific exclusion that does not exist in the USA.
A person who provides advice solely on US Government securities is excluded from the
definition of an investment adviser according to federal laws. There’s no mention of this
exclusion in the USA. Regardless, the state administrator has no power to enforce registration
and regulation on a person the SEC and IA40 exclude from registration. If the federal laws and
regulators exclude a specific person or circumstance, the states have no power to enforce
regulation themselves. Therefore, this rule also applies at the state level.
The way this rule is enforced can be attributed to NSMIA. One of the components of this law
states that federal rules and regulations supersede state rules and regulations. If there’s
common jurisdiction, the federal laws will always prevail. This is why state administrators can’t
enforce higher financial requirements on broker-dealers than the SEC.
It’s different with investment advisers because they register with either the SEC or the states
(not both). One of the purposes of NSMIA was to reduce conflicting laws between federal and
state regulators, and it successfully accomplishes this for the most part. With the “line in the
sand” drawn between state-registered and federal-covered advisers, compliance with relevant
laws is easier. State-registered advisers generally are subject to the laws of the USA, while
federal-covered advisers are subject to the laws of the IA40.
Sidenote
Pension consultants
You learned about pension consultants in a previous chapter, which are persons who assist in
managing the assets of a pension fund. While SEC Release IA-1092 explicitly defines a pension
consultant as an investment adviser, it does not rule how they are regulated (state or federal).
Dodd-Frank does provide some insight for these entities. Any pension consultant with at least
$200 million of AUM is eligible to register with the SEC as a federal-covered adviser. Keep in
mind this leaves the choice up to the consultant - they may register with each state they’re
doing business in, or solely with the SEC.
The following video summarizes the key points from this chapter:
Key points
Investment Advisers Act of 1940
 Federal law regulating investment advisers
National Securities Market Improvement Act (NSMIA)
 Established the term “federal-covered”
 Enforces federal laws over state laws if common jurisdiction exists
Federal-covered advisers
 Register with and regulated by the SEC
 Provide notice filing to the state
Mandatory registration as federal-covered adviser
 Advisers exceeding $110 million AUM
 Advisers to registered investment companies
Eligible for registration as federal-covered adviser
 Advisers with $100 - $110 million AUM
 Advisers operating in 15 or more states
 Pension consultants with $200 million+ AUM
 Advisers expecting to qualify as federal-covered within 120 days
Required to de-register as federal-covered adviser
 If falling below $90 million AUM
If only providing advice on US Gov’t securities
 Excluded from the definition of investment adviser under IA40
 Considered a federal-covered adviser (from the state’s perspective)