The question of whether or not a person is an investment adviser frequently arises in a real estate, insurance or other sales context. Such salespeople would not generally think they are subject to the securities laws, but, depending on their activities, they may be.
The following will be addressed:
• What makes an individual an “investment adviser”?
• What steps may be taken to avoid being deemed an investment adviser?
“Investment advisers” generally must be licensed by an applicable regulator. Investment advisers are regulated by both federal and state law.
At the federal level, investment advisers are governed by the Investment Advisers Act of 1940 (the “Act”). The Act defines an investment adviser as “any person who, for compensation, engages in the business of advising others…as to the value of securities or as to the advisability of investing in, purchasing, or selling securities….” (Section 203(a)). “Securities” include a broad array of instruments and agreements, including much more than the commonly-used definition of the word.
Special rules apply to investment advisers, including specific prohibitions against fraudulent practices, undisclosed conflicts of interest, fee splitting with unregistered investment advisers, deceptive advertising, limitations on referral fees and prohibitions of certain advisory fees. Additionally, investment advisers generally must be registered with federal or state regulators. Violations of these rules can subject investment advisers to civil and criminal penalties.
The SEC has set out the following three requirements, all of which must be satisfied to be an investment adviser. A person is an investment adviser if the person:
• Provides advice, or issues reports or analyses, regarding securities (“investment advice”);
• Is in the business of providing such services; and
• Provides such services for compensation.
SEC Interpretive Release No. IA-1092, 1987 SEC No-Act. LEXIS 2555 (Oct. 8, 1987) (referred to as “IA-1092”).
Each requirement will be discussed.
Provides Investment Advice
There are few clear-cut rules to define investment advice. Most of the guidance has come through SEC no-action letters dealing with the following particular situations.
Giving advice on specific securities is investment advice, such as providing market timing services (Lee F. Richardson, 1990 SEC No-Act. LEXIS 32 (Jan. 9, 1990)). A person who provides advice concerning securities, even if the advice does not reference specific securities, is generally an investment adviser (IA-1092). This includes advising clients concerning the relative advantages and disadvantages of investing in securities in general as compared to other investments (Richard K. May, 1979 SEC No-Act. LEXIS 3967 (Dec. 11, 1979)). Encouraging people to liquidate securities to purchase real estate, insurance or other assets could be considered investment advice.
Situations That May Be Investment Advice
A person could be providing investment advice if, in the course of developing a financial program, he recommends that clients allocate certain percentages of their assets to life insurance, high yielding bonds, and mutual funds (IA-1092). Investment advice also may include analyzing information to give categories of investments that similar investors historically have been satisfied with (Financial Psychology Corporation, 1988 SEC No.-Act. LEXIS 413 (Mar. 23, 1988)). A person providing advice as to the selection or retention of an investment manager also may be giving investment advice (IA-1092).
Situations That Are Not Investment Advice
Providing general, impersonal and historical information does not constitute investment advice. Describing investment options available through an employee benefit plan, without including analysis or recommendation with respect to options, is not investment advice (Pension and Welfare Benefits Administration, 1996 SEC No-Act. LEXIS 316 (Feb. 22, 1996)). Providing merely administrative or ministerial functions does not constitute investment advice (League Central Credit Union, 1987 SEC No-Act. LEXIS 2369 (Aug. 21, 1987)).
In another example, a publisher of a financial bulletin that indicated prices at which it recommended buying or selling publicly-traded stocks gave seminars to promote its bulletin (Laketon Corporation, 1993 SEC No-Act. 912 (Jul. 26, 1993)). At the seminars it offered only general, impersonal advice, explaining the statistical basis for the bulletin’s recommendation, the methods it used to recommend investments and why investors should follow its approach. The seminars were not designed to require attendance for more than one session. The SEC declined to take action against the publisher based on the fact that (1) the seminars were only designed to solicit subscriptions; (2) the seminars offered only general, impersonal advice about the publisher’s investment strategy; and (3) each program was discrete and was not designed to attract or require attendance on more than one occasion.
The line between what constitutes giving “investment advice” (requiring a person to be licensed as an investment adviser) and what does not, unfortunately, is not a clear line. The determination of whether any person should be licensed as an investment adviser (or otherwise) will require a review of the facts and circumstances for each individual (IA-1092). The SEC generally will not issue no-action letters regarding financial planning activities, so it is difficult to obtain further guidance (George J. Dippold, 1990 SEC No-ACT. LEXIS 748 (May 7, 1990)).
Providing general, impersonal and historic information is not investment advice. However, personalizing the information, if it emphasizes that alternative investments are superior to securities, could become investment advice. Special care should be taken to avoid personalizing the information. Explaining options does not constitute investment advice, but recommending a particular option becomes investment advice.
The “Business” Standard
The second requirement involves whether a person’s activities constitute being “in the business” of an investment adviser. Giving investment advice must be a business activity occurring with some regularity, but even the frequency of giving advice is not determinative.
The SEC considers a person to be “in the business” of an investment adviser if the person satisfies any of the following three tests:
• The person holds himself out as an investment adviser or as one who provides investment advice;
• The person receives any separate or additional compensation that represents a clearly definable charge for providing advice about securities or receives transaction-based compensation if the client implements the investment advice; or
• The person provides specific investment advice on anything other than rare, isolated and non-periodic instances. Specific investment advice does not include advice limited to a general recommendation to allocate assets in securities, life insurance and tangible assets (IA-1092).
Individuals not registered as investment advisers should never hold themselves out as investment advisers. This includes not using titles with the words “investment adviser”, “financial adviser”, “financial planner”, “financial consultant”, “financial counselor” or similar terms. Such terms should not be used for an entity name, on business cards, in an office or in introductions.
Individuals not registered as investment advisers should not encourage others to sell securities. Additionally, they should not be compensated based on giving investment advice. Individuals not registered as investment advisers should never give any advice concerning specific securities.
The compensation element is interpreted broadly by the SEC, being satisfied by the receipt of any economic benefit, whether specifically for investment advisory services or not (IA-1092). However, not charging a separate fee for investment advice may be relevant to whether a person is “in the business” of giving investment advice.
Compensation does not need to be paid by the person receiving investment advice; it may come from any source (IA-1092). For example, a person providing investment advice while receiving insurance commissions would be receiving compensation within the meaning of the Act.
Since the SEC interprets this element expansively, those not registered as investment advisers should focus on not giving investment advice and avoiding being in the business of investment advisers.
There are exceptions to the definition of investment adviser. These include banks, lawyers, accountants, engineers or teachers rendering such advice incidental to their professions; broker-dealers; and publications rendering impersonal investment advice (Act Section 202(a)(11)). Exceptions are not discussed here.
States also regulate investment advisers. Investment advisers with less than $25 million in assets under management are not regulated federally, but by the states. Generally, state laws are based on the Act and the above analysis should be similar for many states. However, individual state regulations may vary.
In Utah, the Division of Securities has adopted certain rules and regulations in an attempt to add clarity to the “line” where one must be licensed as an investment adviser. Pursuant to R164-4-2(G)(4), those engaging in any one of the following activities are required to be licensed as an investment adviser:
• A person that advertises or otherwise holds oneself out as a provider of investment advice;
• A person who publishes a newspaper, news column, news letter, news magazine, or business or financial publication, which, for a fee, gives investment advice based upon the specific investment situations of clients; or
• A person that receives a fee from an investment adviser for client referrals.
What constitutes “investment advice” in Utah is broadly defined. Utah statute specifically includes advising others “as to the value of securities or as to the advisability of investing in, purchasing, or selling securities” as giving investment advice (U.C.A. § 61-1-13(q)(i)(A)). Again, this is similar to the definition of investment under the Act.
While the above distinction between giving specific advice and simply offering a “general recommendation” does not provide a clear path to follow, such a distinction should be remembered and any advice should be appropriately tailored. Individuals not registered as investment advisers, therefore, should:
• avoid giving specific securities recommendations (purchase or sale);
• structure services more along the lines of educational instruction where the client makes his/her own decisions as to allocations of financial resources;
• avoid accepting any compensation for any type of advisory or financial planning services;
• avoid holding oneself out as an financial advisor or planner; and
• seek legal advice with any questions.
As good advice to follow, insurance agents, pursuant to the rules and regulations of the Division of Insurance are restricted from using the following terms to describe their services: (i) “financial planner,” (ii) “investment advisor,” (iii) “financial consultant” or (iv) “financial counseling” unless they are properly licensed to do so (R590-79-6(C)). Additionally, insurance agents are not permitted to represent insurance instruments as “investments.” In any event, using such terms absent licensing can lead to one being found to have held oneself out as a provider of investment advice and therefore be required to be licensed to do so.
Steps to Take to Avoid Being Deemed Investment Advisers
Unlicensed individuals should NOT:
• Give advice about specific securities.
• Personalize presentations to specific individuals. This includes comparing them to other individuals who may have similar backgrounds or experiences.
• Encourage individuals to sell securities.
• Hold themselves out as investment advisers. This includes not:
o Using titles or descriptions including the words “investment adviser”, “financial adviser”, “financial planner”, “financial consultant”, “financial counselor” or similar terms.
o Using “investment” without specifically tying it to a non-securities asset. It is best to avoid using the term.
o These should not be used as an entity name, on business cards, in an office or in introductions.
Unlicensed individuals SHOULD:
• Provide only general, impersonal and historical information.
• Explain options without giving a recommendation.
WHY THIS MATTERS
In Utah, a person may not transact business as an investment adviser without being licensed (U.C.A. § 61-1-3(3)). Acting as an unlicensed investment adviser is a third-degree felony (U.C.A. § 61-1-21(1)(a)). A third degree felony is punishable by up to five years in prison and a fine of up to $5,000 (U.C.A. § 76-3-203(3); U.C.A. § 76-3-301(1)(b)).
To avoid risking such heavy penalties, attorneys should review their clients’ activities to ensure that they are not acting as investment advisers without proper licensing. They should also counsel their clients with respect to their obligations to avoid giving investment advice.
The determination of whether or not investment advice is being given or if a person is acting as an investment adviser will always be determined on the particular facts and circumstances of the situation. Counsel should be very careful in advising clients as to the types of communications that are permitted in connection with any investment situation.