“Two roads diverged in a wood, and I
I took the one less traveled by
And that has made all the difference.”
— Robert Frost
Overview
Robert Frost probably was not thinking about investment adviser registration when he wrote those words, but the concept fits surprisingly well.
Firms often assess whether they are eligible for state or SEC registration when establishing their advisory business. Many firms begin by evaluating whether they qualify for state or SEC registration at the outset of their business. In the early stages, eligibility often depends on factors such as assets under management, client base, firm structure, and available registration exemptions. As firms grow and evolve, however, the question of whether state or SEC registration is appropriate can become an increasingly important strategic and regulatory consideration.
At the end of the day, both paths lead to the same destination: fulfilling fiduciary responsibilities and protecting clients under applicable securities laws.
The difference lies in how you get there and how smooth, or complicated, the road may be along the way.
Two Lanes on the Same Highway
State and SEC registration are best viewed as two lanes on the same highway. While the destination is ultimately the same (i.e., being a fiduciary), the experience of getting there can be very different.
Regardless of whether a firm is state or SEC registered, an investment adviser generally registers or notice files in the state in which it maintains its principal office and place of business. From there, the regulatory obligations begin to branch out depending on the firm’s size, structure, and where its clients are located.
The State Lane: More Turns, More Detail
The state route can be a bit like driving through multiple jurisdictions, with each having its own traffic patterns, road signs, and driving rules.
Firms often encounter different requirements depending on the state, additional notice filings or registrations once any de minimis thresholds are met, and varying interpretations of similar rules across jurisdictions. While the overall framework remains familiar, the details can differ enough to require close attention and ongoing monitoring.
For growing firms, state registration can be manageable, but it is often more administrative and detail oriented than firms initially expect. This is especially true when a firm is registered with more than one state and subject to each state’s compliance and regulatory requirements, which can at times clash.
The SEC Lane: A Broader Highway
Transitioning to SEC registration can feel more like merging onto a larger interstate highway.
The rules become more centralized, expectations are generally more uniform, and examinations focus on the firm’s overall compliance program, supervisory structure, operational controls, along with adherence to federal securities laws.
While SEC registration may reduce some of the fragmentation that comes with multi-state regulation, it also brings broader expectations and requirements related to policies, procedures, testing, documentation, and firmwide supervisory oversight.
Because the road becomes wider, the SEC expects firms to have stronger compliance and monitoring systems in place to manage that larger roadway.
There Is More Than One Way Onto the SEC Highway
Many firms assume the only path to SEC registration is reaching $100 million in regulatory assets under management (“RAUM”),[1] but there are actually several different ways a firm may qualify.
These include:
- Mid-sized advisers with between $25 million and $100 million in RAUM that are not required to register with, or be examined by, their home state.[2]
- Advisers with a principal office and place of business outside the United States
- Advisers or sub advisers to registered investment companies
- Advisers to business development companies with at least $25 million in RAUM
- Pension consultants advising plans with at least $200 million in assets
- Affiliated advisers operating under common control with an SEC registered adviser
- Firms relying on the 120-day rule because they reasonably expect to become eligible (i.e., have $100 million or more in RAUM) within 120 days of becoming registered with the SEC.
- Multi state advisers that would otherwise be required to register in 15 or more states
- Internet advisers that provide advice exclusively through an interactive website (e.g. robo-adviser)
Firms Relying on the 120 Day Rule
One important point that many firms overlook is that this pathway is conditional.
A newly formed adviser may register with the SEC if it reasonably expects to become eligible for SEC registration within 120 days. However, if the firm does not ultimately meet the eligibility requirements, it will need to transition to appropriate state registration(s) in order to continue to provide advisory services to clients.
In other words, not every firm that enters the SEC highway necessarily stays there.
When Do You Merge?
For most firms, the transition point from state to SEC registration comes down to growth and timing.
Questions often begin to surface such as:
- Is the firm approaching $100 million in RAUM?
- Has the firm already crossed the threshold but not yet transitioned?
- Is the firm expanding into additional states and approaching multi-state registration requirements?
These are not just strategic business questions. They also carry regulatory timing obligations that firms cannot afford to overlook.
Unlike Frost’s version of the fork in the road, firms do not have unlimited time to stand still before making a decision.
What Happens When Firms Drift Between Lanes?
This is where registration and compliance issues often emerge.
Common mistakes state registered firms make include: (i) expanding their business into multiple states and not making required registration filings, (ii) delaying switching to SEC registration after surpassing mandated threshold[3], (iii) assuming state and SEC requirements are interchangeable, and/or (iv) remaining in an extended “transition phase” after becoming SEC registered and not fully updating policies, procedures, and disclosures to address federal securities regulations.
Regulators typically do not view transition periods as informal grace periods. Instead, they view them as periods of heightened regulatory risk where firms are expected to obtain and maintain accurate registrations, update compliance policies and procedures, and implement additional supervisory controls to meet SEC requirements.
Key Takeaways
- State and SEC registration are built on the same fiduciary foundation, but they operate differently in practice
- State registration tends to be more localized and books and records focused
- SEC registration is generally more centralized and systems driven
- Firms can qualify for SEC registration in multiple ways, not solely through RAUM growth
- SEC registration is based on qualifications and not always permanent, and firms may need to register with, or transition to state registration
- Growth naturally creates decision points between regulatory regimes
- Planning ahead and being knowledgeable of the requirements makes transitions significantly smoother and easier to manage
Closing Thought
Frost wrote about choosing a path and reflecting on where it ultimately led.
Compliance is a little different.
Firms do not simply choose a road. They need to determine which road is applicable for their business model and then prepare for it.
Both paths lead to the same destination, registration as an investment advisory firm. The real question is whether your firm is prepared for the road it is currently on and ready for the turns that inevitably come next.
Core Compliance can assist your firm with registration, no matter which road you choose to take. Our consultants have years of experience with registration obligations, interfacing with regulators and ensuring your firm is set up for success from day one. For more information, contact us (619) 278-0020, or visit www.corecls.com.
Author: Rashaunia Fuller, Sr. Compliance Consultant; Editor: Tina Mitchell, Managing Director, Consultation Services; Core Compliance & Legal Services (“Core Compliance”). Core Compliance works extensively with investment advisers, broker-dealers, investment companies, and private fund managers on regulatory compliance issues.
This article is for information purposes and does not contain or convey legal or tax advice. The information herein should not be relied upon regarding any particular facts or circumstances without first consulting with a lawyer and/or tax professional.
[1] Defined in Form ADV Instructions – https://www.sec.gov/about/forms/formadv-instructions.pdf
[2] Currently, New York is the only state where this applies.
[3] Under Rule 203A-1(a)(1) of Investment Advisers Act of 1940, advisory firms with $110 million or more in RAUM are required to switch to SEC registration.