Updated: Dec 9, 2021
The Investment Advisers Act of 1940 (“Act”) is a U.S. federal law that was primarily intended to regulate the business of rendering personalized investment advice to individuals and businesses.. Personalized investment advice is individualized advice attuned to a particular client’s needs. It does not include generalized information or information that generally circulates to the public. After the stock market crash of 1929 and the depression of the 1930s, the Act was designed to eliminate certain abuses in the securities industry that were found to have contributed to these events. This included holding Investment Advisers accountable if they provided fraudulent or deceitful advice to a client or prospective client. The Act also specifies what qualifies as investment advice and stipulates when an investment adviser is required to register with State and federal securities regulators.
To begin, we must define the roles of an Investment Advisor. According to the Act an “investment adviser” is any person or company that counsels entrepreneurs and business owners on the value of securities so that they may make sound investment choices. An Investment Adviser should be able to give unbiased advice and should not share in the profits of their clients. Their fees are usually structured by charging a percentage of the client’s overall portfolio value, hourly fees, or both. Advisers may be held accountable through the full disclosure of their practices.
Clients may also hold Investment Advisers accountable by seeking court action for bad acts. The Securities and Exchange Commission (“SEC”) is authorized to bring enforcement actions against Investment Advisers who violate the Act, or individuals who aid and abet such violations.
Investment Advisers must register with the SEC before they engage in the counseling of others, except where they are exempt from registration. Some investment Advisers are exempt from registering with the SEC as a Iegistered investment Adviser. These include :
1. An Adviser whose clients are solely in one state;
2. Advisers whose only clients are insurance companies;
3. Advisers that have a charitable purpose or that advises a charitable organization;
4. Advisers of venture capital funds; and
5. Advisers of private funds that have assets under management of less than $150,000,000.
Furthermore, certain persons and firms do not need to register with the SEC as Investment Advisers under the Act. These include as domestic banks, professionals where advisory services are solely incidental to their professions, such as lawyers, accountants, brokers, and teachers,, publishers of bona fide newspapers, news magazines, business or financial publications, and U.S. government-sponsored corporations whose advice, analyses, or reports are only related to securities designated by the Secretary of Treasury. You should talk to a securities attorney to determine if you are excluded from this definition as the answer is not always cut and dry.
For instance, let’s say you have a company that educates members, provides socializing activities, and offers opportunities to invest together in various investment opportunities . You have about thirty (30) members so far, all of whom may be considered both accredited and non-accredited investors, and are charging them annual membership fees that amount to $100,000. Does the Act apply to your business? It depends.
Your company may be considered an investment club due to its membership nature. Most investment clubs are not required to register as investment companies. The offer or sale of membership or partnership interests within an investment club is usually exempt from registering with the SEC because investment clubs and the agreements that govern them are not usually considered securities. However, this could change if any of your members stop being active within the club such as where their investment becomes passive and reliant on others to make a return on investment. In other words, if some of your members begin to rely on you or other members to make investment decisions on behalf of the whole group, then this could require that the investment club be registered as an Investment Company, and you and the other active members as Investment Advisers under the Act.
Of course, you and your club may still be exempt from registering under either the Investment Advisers Act or the Investment Company Act of 1940 since the club has less than 100 members and less than $100 million in assets under management. Still, you will need to find an exemption from registering your membership interests or fees with the SEC under the U.S. Securities Act of 1933 should it have passive, dues-paying, members. You may also have trouble finding the appropriate exemption of your club or company since your members are both accredited and non-accredited investors, and some States may still require that you register even though you may qualify for an exemption at the federal level.
Nonetheless, you may be able to make an argument that your social and educational activities are more substantial than any investment opportunities, and therefore, it is neither an investment club or company at all. Due to all of these nuances, it is important that you make these decisions upon the advice and counsel of a securities lawyer to make sure that you are not violating any securities laws. Learn more about Investment Companies here, and contact us to determine whether you are required to register with the SEC as an Investment Advisor.
*co-authored by Managing Attorney, Elizabeth L. Carter, Esq.