RULES AND REGULATIONS
Title 64--SECURITIES
SECURITIES COMMISSION
[64 PA. CODE CHS. 202, 203, 205, 206, 301--305, 404, 602 AND 603]
Registration of Securities; Investment Adviser Representatives; and Administration
[30 Pa.B. 4551] Statutory Authority
The Securities Commission (Commission), under the authority contained in sections 202(g), 203(j), (q) and (r), 205(b), 206(b), 301(b), 302(f), 303(a)--(e), 304(a), (b) and (e), 305(a) and (f), 404(a), 602(f), 603(c) and 609(a) of the Pennsylvania Securities Act of 1972 (70 P. S. §§ 1-202(g), 1-203(j), (q) and (r), 1-205(b), 1-206(b), 1-301(b), 1-302(f), 1-303(a)--(e), 1-304(a), (b) and (e), 1-305(a) and (f), 1-404(a), 1-602(f), 1-603(c) and 1-609(a)) (act) amends and adopts regulations concerning the subject matter of the act.
Publication of Notice of Proposed Rulemaking
Publication of a notice of proposed rulemaking appeared at 30 Pa.B. 2237 (May 6, 2000).
Public Comments
The Commission received comment letters from the Certified Financial Planners Board of Standards (CFP), the Investment Company Institute (ICI), the Financial Planning Association (FPA) and the Investment Counsel Association of America (ICAA). Under section 5(c) of the Regulatory Review Act (71 P. S. § 745.5(c)), comment letters were forwarded within 5 days of receipt to the Independent Regulatory Review Commission (IRRC) and the legislative standing committees. Comments were made with respect to the following regulatory proposals:
§ 303.012. The ICI and FPA commented that the amount specified in subsection (b)(1) should be raised from $500 to $1,200. This dollar figure refers to the amount of funds received by an investment adviser as prepayment of advisory fees 6 months or more in advance of when they are due. An investment adviser applying for registration with the Commission that fell into this category would be required to file an audited balance sheet prepared in accordance with generally accepted accounting principles. This requirement mirrors similar requirements for investment advisers required to be registered with the United States Securities and Exchange Commission (SEC) and uniform model rules adopted by the North American Securities Administrators Association (NASAA) for investment advisers who are regulated exclusively by the states.
In 1996, Congress enacted the National Securities Markets Improvement Act of 1996 (NSMIA). Prior to this legislation, investment advisers conducting business in this Commonwealth had to be registered with the Commission and, if they were engaging in interstate commerce, with SEC. In NSMIA, Congress recognized that there were basically two types of investment advisers--those who were small advisers that provided advice to an exclusively retail clientele and those who were money managers for institutions and individuals with significant assets under management.
In NSMIA, Congress determined that the SEC would have exclusive authority over investment advisers with assets under management of $25 million or more, known as Federally-covered advisers (FCAs) and states would have exclusive authority over investment advisers which had less than $25 million under management, known as state-registered advisers (SRAs). The NSMIA effectively split the universe of investment advisers into two distinct groups regulated by two distinct levels of government--State and Federal. Implicit in the NSMIA was legislative recognition that what may be appropriate regulation for FCAs may not be appropriate for SRAs. The NSMIA, however, did retain state authority over the FCAs with respect to fraudulent or deceptive conduct.
Post-NSMIA, the NASAA adopted a Memorandum of Understanding Concerning Investment Advisers and Investment Adviser Representatives (MOU) on April 27, 1997 (available at www.nasaa.org/iaoversight/iamou). The MOU recognized that uniformity of rules among states concerning investment advisers subject exclusively to state registration was crucial and a working group was established . The Commission subscribed to the MOU and this rulemaking seeks to implement model rules adopted by the NASAA in the context of the MOU (NASAA Model Rules).
Prior to this rulemaking, an applicant described in subsection (b)(1) was not required to file an audit report. To be uniform with the NASAA Model Rule 202(a)-1, the Commission proposed adoption of the requirement that an applicant who receives prepayment of advisory fees of $500 or more per client 6 months or more in advance of when they are due be required to file an audited statement of financial condition. The commentators note that the SEC recently issued a notice of proposed rulemaking to change various requirements for the FCAs and, in the SEC provision analogous to this one, the SEC proposes to raise the aggregate amount from $500 to $1,200. The commentators urged, for Federal/state uniformity, that the Commission do likewise for SRAs.
Although the NASAA Model Rule 202(d)-1 is set at $500, the new SEC provision will be found in Form ADV which is an application form used by both the states and the SEC. Therefore, most applicants will be apprised of the SEC rule allowing up to $1,200 in prepayment of fees and will have to perform further research to determine that the rule is not applicable to the SRAs. Also, the NASAA Model Rule could be changed in the future to reflect the new SEC provision. The Commission adopted the amendment with the $1,200 figure which is consistent with the SEC.
The FPA and ICI also commented about application of this regulation to the SRAs whose principal place of business is not in this Commonwealth. Another part of the NSMIA adopted ''home state'' treatment with respect to net capital and bonding and books and records. For example, an SRA maintains its principal place of business in Maryland but has 10 retail clients in this Commonwealth which requires registration with the Commission. Under the NSMIA, the Commission is prohibited from requiring the Maryland SRA to comply with the requirements of any Commission regulation concerning net capital and bonding or books and records that exceed the requirements of the Maryland Securities Division if the Maryland SRA is registered or licensed in Maryland and is in compliance with applicable requirements of the Maryland Division of Securities.
Currently, the United States Senate Committee on Banking, Housing and Urban Affairs is drafting legislation known as the Securities Markets Enhancement Act (SMEA). The Commission, through the NASAA, has been actively involved with drafting of the SMEA as have ICI and FPA. One SMEA proposal is to provide ''home state'' treatment for financial reports. All relevant parties, including the FPA and ICI, have agreed to language to be included in section 222 of the Federal Investment Advisers Act of 1940 (1940 Act) to implement the treatment. The Commission added a provision that mirrors the language proposed to be amended into the 1940 Act by the SMEA.
§ 303.014. The ICI commented that the Commission should clarify that the rule included investment adviser representatives of the FCAs. The Commission agreed and inserted language suggested by the ICI. Another comment was that, in subsection (c), there should be a conjunctive ''or'' between investment adviser representative (IAR) and investment adviser rather than ''and.'' The apparent theory was that the Commission might be overstepping its authority under the NSMIA by requiring a FCA to file something with the Commission that was not filed with the SEC and the language may result in the Commission receiving duplicative filings.
Form U-4, which is the document which must be maintained current under this regulation, is a uniform form used by state securities regulators and industry for registration of IARs employed by SRAs and FCAs. Under the instructions to Form U-4, the ''Appropriate Signatory'' is ''the individual designated by the . . . investment adviser [SRA or FCA] . . . who is authorized to execute Form U-4 on its behalf.'' Since Form U-4 must be signed by the employing firm, an IAR cannot file an amendment on his own. Therefore, there is little scope for filing duplication and, in the 8 years since this regulation was last amended, this has not been the case.
The ICI's concern about the FCA's signing amendments to Form U-4 as violative of the NSMIA is misplaced. This regulation requires no more signatures than what currently is required by the instructions to Form U-4. No FCA has declined to sign Form U-4 on behalf of an IAR with a place of business in this Commonwealth or complained about this requirement. If the ICI's belief is sincere, the better course of action would be to request the NASAA and securities industry representatives to revise Form U-4. On this basis, the Commission declined to accept this comment.
§ 303.015. The ICI commented that the regulation should be revised to distinguish initial notice filings from renewal filings. The Commission agreed. Under section 303(a)(iii) of the act, a FCA must file a copy of its Form ADV as filed with SEC prior to acting as a FCA in this Commonwealth and pay a notice filing fee of $300. This is the initial filing requirement. For renewals, the FCA, under section 602(d.1) shall pay an annual notice filing fee of $300. The Commission revised this regulation to address ICI's concerns and also has indicated that renewals may be made through an investment adviser registration depository.
§ 303.021. The ICI urged a clarification to the language in subsection (c). The Commission agreed.
§ 303.032. The ICI, FPA and ICAA commented on this regulation. The CFP also commented. The CFP commented that the designation in proposed § 303.032(c) (1)(ii)(A) should read ''Certified Financial Planner Board of Standards, Inc.'' The Commission accepted this comment and modified the amendment accordingly.
The ICI, FPA and ICAA expressed two identical concerns. The first concern was that there was no provision which exempted an investment adviser or an IAR from taking the required examinations if the investment adviser or an IAR had taken the appropriate examination after January 1, 2000 (which date is important because new Series 65 and Series 66 examinations were implemented on that date), was registered continuously in another state as an investment adviser or an IAR since the date of the examination but applied for registration in this Commonwealth more than 2 years from the date of taking the examination. The Commission agreed with this comment and added subsection (a)(3) which would exempt persons from having to retake an examination if they met either of the criteria in subsection (a)(1) or (2) and had not been out of the business for more than 2 years immediately preceding the filing of an application for registration in this Commonwealth. This parallels an existing provision applicable to agents of broker-dealers in § 303.031.
The second issue raised was automatic waivers of the examination requirement provided in subsection (c) based upon a person possessing a specified designation and not having any disciplinary history requiring an affirmative response to the Disclosure Information section of Form U-4. The commentators argue that this was not part of the NASAA Model Rules even though they recognize that a state securities regulator may want to require additional examinations for any individual found to have violated state or Federal securities laws. The commentators claim that the proposed language is too broad as it would include bankruptcies and customer complaints in addition to Federal or state securities laws violations or proceedings.
The Commission had established criteria for the waiver of exams in §§ 604.014 and 604.016 which is exerciseable by delegated authority under § 606.041(b) upon application. An intent of this amendment was to eliminate the application process and make certain waivers automatic if the applicant had no reportable disciplinary history.
Under the amendment, existence of reportable disciplinary history does not consign the applicant to never being eligible for a waiver of the examination requirement. It just would not make the waiver automatic. A waiver still could be granted on a case-by-case basis and subsection (c)(4) makes it clear that applicants have the ability to petition the Commission for an order waiving the examination requirement.
In recognition of the comments, however, the Commission did modify subsection (c)(1)--(3) to narrow the disciplinary history to an affirmative response to Items 23A-E or H of Form U-4 or successor item thereto. Items 23A and B address criminal convictions; 23C-E deal with proceedings before the SEC, CFTC, state securities regulators and self-regulatory organizations (stock exchanges, NASD) and Item 23H relates to court injunctions. The Commission believes this provides a balanced approach to the concerns of industry and the need to protect investors.
The FPA also commented that the regulation should not afford waivers to certified public accountants (CPAs) or attorneys. In the statement of policy published in § 604.016 in which the Commission expressed its disposition to grant waivers of examination requirements to persons holding certain designations referred to in subsection (c), the Commission also expressed a similar disposition with respect to CPAs and members of the bar who are in good standing. The Commission believes it would be unfair at this time and, without substantial evidence, to treat CPAs and attorneys differently than the other designations contained in the same statement of policy. Therefore, the Commission declined to accept this comment.
§ 303.042. The ICI commented on this proposal and raised the same issue as was raised with respect to § 303.012. The Commission determined to address this comment in the same manner as the ICI comment raised with respect to § 303.012.
The FPA commented on the proposal that a SRA with discretionary authority over client funds and securities, but without custody, would be required to maintain a minimum net worth of $10,000. The FPA was concerned that this would act as a barrier to entry into the business for first time advisers. The FPA suggested that this requirement be waived if: (1) the SRA had a certain amount of experience and a satisfactory disciplinary record; (2) the SRA provided evidence of errors and omissions insurance sufficient to cover investor losses, such as $100,000 per occurrence with an aggregate amount of coverage based on experience; or (3) the SRA's compensation is a fee based solely on the amount of assets under management, is a retainer or other flat fee, an administrative fee for services rendered under the Employee Retirement Income Security Act of 1974 and the adviser does not receive any other compensation or pecuniary benefit, directly or indirectly, as a result of any purchase or sale in the account.
Under the MOU, the NASAA adopted Model Rule 202(d)-1 which established uniform capital requirements for SRAs (CCH NASAA Reports ¶3529-3). To promote uniformity of regulation among the states, the Commission proposed to substantially lower its current capital requirements of $20,000 minimum net capital or $50,000 tangible net worth to $10,000 net worth contained in the NASAA Model Rule. Adoption of the amendment would provide substantial regulatory relief from the current net worth requirements for approximately 32% of registered investment advisers that have custody. For exceptional circumstances, the Commission does possess the authority to waive the requirements of this regulation on a case-by-case basis upon good cause shown. Therefore, the Commission adopted the amendment as proposed.
§ 304.012. The ICI suggested a minor clarifying amendment which the Commission accepted.
§ 304.022. The ICI again raised the same comments with respect to this section as it did with § 303.012. The Commission addressed the comments in the same manner as § 303.012.
§ 305.011. The ICI expressed two concerns. The first was that the regulation did not have a specific provision which addressed ''home state'' treatment afforded for books and records under the NSMIA. The second was that, to the extent that this regulation imposed recordkeeping requirements beyond those of the SEC with respect to broker-dealers, there was insufficient recognition that the NSMIA would preempt those provisions for broker-dealers registered under the Securities Exchange Act of 1934 (1934 Act).
On the first concern, the Commission added language consistent with the ''home state'' treatment for investment advisers with a principal place of business outside this Commonwealth. On the second concern, the Commission modified the regulation to be consistent with the Rules of Conduct for member firms of the National Association of Securities Dealers (NASD). Because the requirements of this regulation now mirror the NASD Conduct Rules applicable to SEC registered broker-dealers, the regulation does not extend beyond that permitted by the NSMIA. The requirements of subsection (c) parallel those contained in the following NASD Conduct Rules:
Subsection (c)(1)--NASD Conduct Rule 3010(a)(5) and 3010(b).
Subsection (c)(2)--NASD Conduct Rules 3010(a)(6) and (b).
Subsection (c)(3)--NASD Conduct Rules 3010(a), (b), (e) and 3110(c)(1).
Subsection (c)(4)--NASD Conduct Rule 3010(d).
Subsection (c)(5)--NASD Conduct Rule 3010(c).
Subsection (c)(6)--NASD Conduct Rules 3010(a), (b) and 3110(d).
Subsection (c)(7)--NASD Conduct Rules 3010(d) and 3110(c)(3).
Subsection (c)(8)--NASD Conduct Rules 3010(b)--(d).
Subsection (c)(9)--NASD Conduct Rule 3010(a)(7)
Subsection (c)(10)--NASD Conduct Rule 3010(c) and NASD Notice to Members 98-38.
The Commission did modify the amendment to add a new subsection to clarify the length of time records are required to be kept under subsection (c)(9) and (10)(iii) and the manner in which they may be kept. The Commission could find no similar time limitation in the NASD Rules. The relevant NASD rule on inspections states that ''Each member shall retain a written record of the dates upon which each review and inspection is conducted.'' As there appears to be no controlling provision Federally, the Commission does not believe it is constrained by the NSMIA. The Commission's experience is that, in supervision cases, usually 3 years have passed before the investor files a complaint. Therefore, the Commission adopted a requirement to keep any records required by this section for 5 years, the first 2 years in an easily accessible place.
§ 305.019. The ICAA expressed a concern that, since this section covered IARs who may work for a FCA, the Commission may be attempting to regulate conduct of FCAs which is impermissible under the NSMIA (except to the extent that the conduct of a FCA constitutes fraud or deceit). The ICAA suggested that the regulation be limited solely to IARs of SRAs. The Commission disagrees.
The Commission, per the NSMIA and Act 109 of 1998, has no registration authority over FCAs. The purpose of this regulation is to place all registrants under the Commission's jurisdiction (including the SRAs and IARs) on notice as to what types of activity may be deemed ''dishonest or unethical'' which could form the basis for revocation, suspension or conditioning of their license pursuant to section 305(a)(ix) of the act. Under that section, the Commission only has authority to affect the licenses of persons over whom it has registration jurisdiction.
Even if the SRAs or IARs would engage in conduct described in this regulation, a revocation, suspension or conditioning of a license is not automatic. The Commission must institute a separate proceeding against the registrant. If, in its investigation of an IAR of a FCA for activity described in this regulation, the Commission concluded that the FCA was responsible for the activity and not the IAR, the Commission could proceed against the FCA only by issuance of an Order to Show Cause and only if the activity constituted fraud or deceit. Under Federal law, the Commission cannot affect the ability of the FCA to conduct advisory business in this Commonwealth.
To adopt the ICAA's proposal would be to leave out an significant number of IAR registrants over which the Commission has full regulatory authority from the ambit of this regulation which would create an unequal playing field between the IARs of FCAs and IARs of SRAs. This is not desirable regulatory policy. To address the ICAA's concern, the Commission, however, did add a new subsection to make it clear that the regulation does not apply to the FCAs unless the conduct otherwise is actionable under section 401(a) or (c) or 404 of the act.
§ 305.061. The ICAA commented that, under the investment adviser registration depository scheme, Form ADV-W only will be used to withdraw the registration of a FCA from SEC. The Commission made changes to this amendment for withdrawing a notice filing by a FCA consistent with this comment. The Commission also added a provision to address withdrawal from registration with the Commission in instances where an SRA becomes a FCA.
§§ 303.012--306.061. The ICAA recommended that all references in these regulations to a central registration depository be replaced with a reference to an investment adviser registration depository. The ICAA was concerned that persons may confuse the registration depository for investment advisers with the Central Registration Depository run by the NASD for broker-dealers and agents. The Commission agreed with the ICAA's comment and changed references.
§ 404.010. The ICAA and ICI both commented on this amendment. Both were concerned about indirect regulation of FCAs. The ICAA asserted that firms, not IARs, advertise. The Commission's experience is otherwise as there have been many instances where a IAR has advertised without the knowledge, consent or authorization of the employing firm. This regulation, which is issued under section 404 of the act makes it clear in subsection (c) that the prohibitions imposed by that section apply to FCAs only to the extent that the prohibited conduct involves fraud or deceit.
Like the similar suggestion made on § 305.019 (the ICI did not raise this comment on § 305.019), to adopt the ICAA's proposed language (and the ICI's with respect to this amendment) would be to leave out a significant number of IAR registrants over which the Commission has full regulatory authority from the ambit of this regulation. This would create uneven regulation between the IARs of FCAs and the IARs of SRAs. That is not desirable regulatory policy. To address this issue, the Commission, however, added a subsection to indicate that this section does not apply to FCAs unless the conduct otherwise is actionable under sections 401(a) or (c) or 404 of the act.
§§ 404.011 and 404.012. The ICI suggested that these two rules more closely conform to the revisions to SEC rules proposed in its recent release on Form ADV. For instance, the SEC proposes to incorporate the wrap fee brochure disclosure into the investment adviser disclosure brochure. The Commission agreed and has incorporated the provisions of § 404.012 into § 404.011 consistent with the SEC proposals. This, of course, necessitated re-numbering of §§ 404.013 and 404.014.
In the new Form ADV which is used by the SEC and state securities regulators, the FCAs and SRAs both will have to develop a disclosure brochure as part of completing Form ADV. Therefore, no investment adviser can be registered either with the SEC or with a state unless it has developed a brochure. Under the Commission's proposed rulemaking, an SRA did not have to provide a disclosure brochure to those clients for whom it provided impersonal advisory services requiring a payment of less than $200.
Because Form ADV requires each SRA to create a disclosure brochure as part of the application process, the Commission believes that every client should be entitled to receive the same disclosure about the adviser. This requirement adds no burden to the registrant as it must develop the disclosure brochure anyway as part of the application process. This being the case, the Commission determined to delete the language which appeared in § 404.011(d) in the proposed rulemaking and modify accordingly the language which had appeared in § 404.011(b) and (g).
By letter dated June 26, 2000, Commission staff advised the ICI, FPA and ICAA of the foregoing responses to their comments and provided them with the text of the final-form regulations. By letter dated June 28, 2000, the ICI expressed support for adoption of the final-form regulations as they appear herein. On the same date, representatives of the FPA and ICAA advised Commission staff by telephone that those organizations joined the ICI in their support for adoption of the final-form regulations.
Commission Comments
§ 603.031. The Commission revised subsection (f) to insure that the confidentiality provisions of this section will apply to individuals who are investment advisers doing business as sole proprietors and individuals who are principals of broker-dealer and investment adviser firms.
Comments of the SEC
By letter dated May 30, 2000, and received on June 5, 2000, SEC Chairman Arthur Levitt wrote each state securities administrator urging state regulators to require investment advisers and Federally covered advisers to participate in a Web-based, one-stop electronic filing system for investment advisers known as the Investment Adviser Registration Depository (IARD). Mr. Levitt noted that the SEC has expended $3.2 million in Federal funds to develop the IARD and will be requiring all investment advisers subject to SEC jurisdiction to make filings through that system. Chairperson Levitt explained that full participation by the states to require receipt of notice filings by FCAs through IARD as well as registration applications for SRAs will result in keeping user fees as low as possible for SRAs.
In its proposed form rules and in minor revisions suggested by commentators and included in the final-form regulations, the Commission will have authority to designate, by order, the IARD as the filing depository for the FCAs, SRAs and IARs. As the availability of the IARD for filing by these various groups will be phased in over the next 12-18 months, the Commission envisions issuance of a series of orders at differing times designating the IARD as the filing depository.
The Commission further noted that the United States Senate Banking Committee is considering amendments to the Investment Advisers Act of 1940 which would preempt state jurisdiction over notice filings and fee payments by the FCAs and registration applications and fee payments by out-of-State investment advisers subject to State registration if the Commission did not accept filings made through the IARD. The Commission agrees with the SEC that compulsory filings with the IARD will provide a more complete database for investor protection and lowering of costs to participants. It also preserves state jurisdiction if Congress enacts the proposed amendments.
Comments of the IRRC
By letter dated July 6, 2000, the Commission received the following comments of IRRC.
§ 303.012. IRRC reiterated the comments of the ICI and FPA with respect to increasing the threshold in subsection (b)(1) from $500 to $1,200 and asked the Commission to consider raising the threshold. In its final form rules, the Commission increased the threshold to $1,200.
IRRC restated the comments of the ICI and FPA concerning the filing of certain statements of financial condition by out-of-State investment advisers. In its final form rules, the Commission adopted subsection (f) that gives ''home state'' treatment to these financial reports which mirrors a proposed amendment to the 1940 Act being considered by Congress.
IRRC pointed out a typographical error in subsection (b)(2). In its final form rules, the Commission corrected the error.
§ 303.014. IRRC agreed with a comment made by the ICI to clarify the application of subsections (a) and (b) with respect to Federally covered advisers. In its final form rules, the Commission adopted clarifying language.
With respect to the ICI's comment on subsection (b), IRRC requested the Commission to explain its position. As set forth under the Public Comments, the Commission explained why it disagreed with the ICI's assertion that this subsection creates the potency for duplicative filings and demonstrated that, historically, such has not been the case. By letter dated June 28, 2000, the ICI stated its support for the final form rules which, in this respect, were unchanged from the proposed form rules.
§ 303.015. In noting a comment made by the ICI, IRRC asked the Commission to explain the renewal process for the FCAs. In its final-form rules, the Commission substantially revised this section to distinguish initial notice filings and renewals. Section 303(a)(iii) of the act requires the initial notice filing on Form ADV and section 602(d.1) of the act requires an annual notice filing fee. The Commission also would have the authority to require renewals to be made through IARD which basically would consist of electronic transmittal of the annual filing fee to the Commission's depository bank.
§ 303.021. IRRC restated an ICI comment that registered investment advisers should be added to this section. In its final-form rules, the Commission included registered investment advisers.
§ 303.032. With respect to subsection (a)(1) and (2), IRRC reiterated the comments of ICI and FPA concerning application of the 2-year limitation. In its final-form rules, the Commission added a new paragraph (3) to address this issue and resolve the potential problem raised in the ICI and FPA comment letters. By letter dated June 28, 2000, the ICI expressed support for adoption of the final form rules and, on the same day, a representative of the FPA advised Commission staff by telephone that FPA also supported adoption of the Commission's final form rules.
IRRC also noted the FPA's concern about providing waivers of the examination requirement for attorneys and certified public accountants. This explanation has been provided in the Public Comments Section of this Preamble and, on June 28, 2000, a representative of the FPA advised Commission staff by telephone that the FPA supported adoption of the Commission's final form rules.
IRRC further noted a comment from the Certified Financial Planners Board of Standards that the designation contained in the proposed form rules was imprecise. In its final-form regulations, the Commission adopted the designation appropriate to this organization.
§ 303.042. IRRC raised the same comment as the ICI and FPA concerning the $500 or $1,200 threshold issue which also was raised with respect to § 303.012. In its final form rules, the Commission adopted a threshold of $1,200.
With respect to subsection (d), IRRC requested an explanation of the circumstance under which the Commission may require a current appraisal of an asset, the value of which is being submitted to establish the required net worth. For instance, if an investment adviser possessed a work of art which he wanted to assign a value for purposes of calculating the net worth required for an investment adviser under the act and regulations, the Commission may request an apprisal of that object rather than accept the value submitted by the registrant. The same may be true with respect to shares in a closely-held company or a general or limited partnership. In practice, this provision is rarely used as a registrant that must demonstrate a certain net worth usually does so in cash, cash equivalents or marketable securities.
§ 303.051. IRRC requested an explanation of why the Commission used the term ''may'' instead of ''shall'' in subsection (a)(1) which deviates from the NASAA model rule. The reason for this deviation was that the Commission wanted to retain discretion as to whether it would allow an investment adviser to make up its net worth deficiency through a surety bond. While the Commission does not necessarily foresee any particular circumstance under which it would not grant such an order, adopting ''shall'' would forever foreclose the Commission from raising any objection.
With respect to subsection (c), IRRC requested a description of the circumstances under which the Commission would request evidence of existence of a surety bond. One instance is when an investment adviser is filing an annual financial report under § 304.022 which indicates that the adviser is meeting its net worth requirement through a surety bond (assuming original approval was granted by the Commission under § 303.051). The Commission may ask for evidence of the surety bond to insure that it is current and in full effect for the appropriate amount. The Commission conducts routine and for cause examinations of investment adviser and broker-dealer branch offices throughout this Commonwealth. One of the items which is checked during an examination is that the investment adviser has the requisite net worth. Again, if the investment adviser is relying on a surety bond to meet the applicable net worth requirement, the examiner may ask for evidence that it is current and in full effect for the appropriate amount.
§ 304.012. IRRC reiterated the ICI's comment that an introductory clause should be added to subsection (a) indicating in the forepart of the regulation that the requirements of this section do not apply to persons specified in subsection (j). In its final form rules, the Commission adopted an introductory clause.
In its comments, IRRC asserted that the definition of ''investment adviser representative'' in this rule was at variance with the definition of that term in section 102(j.1) of the act. The Commission believes that an individual described in subsection (a)(12)(iv) and (13)(v) would be an investment adviser representative under section 102(j.1) of the act and that it has not gone beyond the statutory definition. In reality, the definition used in paragraphs (12) and (13) is a subset of the statutory definition.
As IRRC noted, this language is consistent with the NASAA Model Rule on this subject. The NASAA (which follows identical statutory language as section 102(j.1) of the act) and the Commission felt that it was important to communicate a more precise nature of a person's activities for whom the investment adviser would have the compliance burden of maintaining books and records. This gives the firm's principals a better, ''plain English'' understanding than the statutory definition otherwise may impart. The important issue is that the Commission not go beyond the statutory definition and include persons within the ambit of the regulation that the Legislature did not intend. IRRC is appropriately sensitive to this issue as is the Commission.
The Commission is satisfied that the definition contained in paragraphs (12) and (13) does not go beyond the statutory definition. In fact, it explicitly does not include solicitors which are included in the statutory definition of investment adviser in section 102(j.1)(i)(D) of the act. Under section 609(a) of the act, the Commission is authorized to define ''any terms, whether or not used in this act, insofar as the definitions are not inconsistent with the act.'' The Commission posits that the definition of ''investment adviser representative'' adopted for purposes of paragraphs (12) and (13) are not inconsistent with section 102(j.1) of the act.
The Commission also believes that uniformity, particularly in the area of books and records, is important. This language is taken directly from the relevant NASAA Model Rule. A change in this provision may inject uncertainty for investment advisers and the professionals who counsel them in the interpretation of their legal obligations under the act.
§ 304.052. IRRC requested whether the Commission could specify what constitutes ''adequate.'' In its final-form regulations, the Commission deleted the phrase ''adequately disclosed to each client in writing'' because the disclosure of compensation is now covered by adoption of § 404.011 which requires delivery of a brochure containing all the information required by Part 2 to Form ADV. Part 2 of Form ADV, which also applies to FCAs, requires disclosure of material information about the firm and its business practices, including fees and compensation. The Commission thinks that the disclosure of fee information is best addressed in § 404.011 and in uniformity with the requirements of Form ADV.
§ 305.011. With respect to subsection (a)(1), IRRC commented on use of the term ''timely'' and whether a specific period of time should be adopted. The Commission reviewed this section and, in its final rules, adopted language used in NASD Rule of Conduct 3010 upon which it is modeled which does not include use of that term. Revisions were made to subsections (a)(1) and (c).
On subsection (c), IRRC restated the ICI's comment about recordkeeping requirements for out-of-state investment advisers. In its final form rules, the Commission added subsection (e) which addresses this comment in the same fashion as a similar comment raised on § 303.012.
Also on subsection (c), IRRC suggested that the Commission should establish the specific length of time records required under this section need be kept. In its final form rules, the Commission added subsection (d) which specifies 5 years, the first 2 years being in an easily accessible place. This language is taken from a similar provision in the NASD Rules of Conduct.
§ 305.061. IRRC noted the comment made by the ICAA. In its final form rules, the Commission adopted provisions allowing withdrawals from registration through the IARD, including withdrawals from State registration resulting from a registrant becoming a FCA.
§ 404.011. IRRC expressed concern that this section may be inconsistent with Federal rules. In its final-form rulemaking, the Commission adopted this section which is modeled on the Federal rule proposed in the SEC Release on Form ADV. This action included combining (a la the Federal model) proposed rules §§ 404.011 and 404.012. The Commission does not anticipate that the SEC rule proposal will change significantly upon final adoption by the SEC. In the event that the Federal rule would change, the Commission would use its powers under section 609(a) of the act to waive any provision of this section which would be inconsistent with the final Federal rule.
Summary and Purpose of Final-Form Regulations
§ 202.070. The change clarifies when the exemption would be available to certain nonemployes included in compensatory plans or compensatory contracts.
§ 203.101. The change allows attorneys to give a clear legal opinion on the availability of the exemption.
§ 203.171. The change allows attorneys to give a clear legal opinion on the availability of the exemption.
§ 203.185. The change allows attorneys to give a clear legal opinion on the availability of the exemption.
§ 203.186. The change allows attorneys to give a clear legal opinion on the availability of the exemption.
§ 203.192. The new regulation creates a registration exemption for certain rights offerings and exchange tender offers made by foreign private companies to residents of this Commonwealth that are exempt from registration with the SEC.
§ 205.021. The change replaces Form 205 with Form R and eliminates the requirement to file Form R for all issuers applying for registration under section 205 of the act except those relying on SEC Regulation A.
§ 206.010. The change replaces Form 206 with Form R and restricts the requirement to file Form R to issuers making an offering under sections 3(a)(4) or (11) of the Securities Act of 1933, Rule 504 of SEC Regulation D or SEC Regulation A.
§ 301.021. This regulation has been repealed because its provisions have been superseded by a new Web-based electronic transfer program.
§ 302.063. This change codifies a No Action Letter issued by the Commission in 1999 concerning third-party brokerage activities in a limited purpose bank branch office.
§ 303.012. This change anticipates electronic filing through an investment adviser registration depository and eliminates the requirement for investment adviser applicants that do not have custody, possession or discretion over clients' funds or securities to file a statement of financial condition.
§ 303.014. This change utilizes the new term ''investment adviser representative'' and anticipates electronic filing through an investment adviser registration depository.
§ 303.015. This new regulation implements the notice filing requirement imposed on the FCAs by Act 109 of 1998.
§ 303.021. This change accords the same treatment to notice filings by the FCAs for successor firms as is accorded to registered investment advisers.
§ 303.032. This change repeals the experience requirement for agents and the IARs, adopts new uniform examinations for investment advisers and the IARs, uniform grandfathering provisions and uniform waivers of the examination. These are based upon on a uniform model adopted by the NASAA.
§ 303.042. This change reduces net worth requirements for investment advisers and eliminates the current net worth requirement for investment advisers that do not have custody, possession or discretion over clients' funds or securities. These changes are based on a NASAA model rule and conform to Federal law as provided by the NSMIA.
§ 303.051. This change revises the surety bond requirements to conform to a NASAA Model Rule and the requirements of the NSMIA.
§ 304.012. This change establishes recordkeeping requirements for investment advisers in Subpart C. This change conforms to a NASAA Model Rule and the NSMIA.
§ 304.022. This change requires investment adviser financial reports. It conforms to the NSMIA, a proposed amendment to the NSMIA and a NASAA Model Rule.
§ 304.052. This change recognizes that standardized commission rates charged by National securities exchanges have been eliminated.
§ 305.011. This change expands coverage of this regulation to IARs and incorporates requirements found in the NASD Code of Conduct Rules.
§ 305.019. This change expands coverage of this regulation to IARs and includes failure to comply with investor suitability requirements as a basis for taking action against a person's license.
§ 305.061. This change anticipates electronic filing through an investment adviser registration depository and extends the regulation to withdrawal of notice filings by the FCAs and SRAs who become the FCAs.
§ 404.010. This change extends this regulation to the IARs.
§ 404.011. This new regulation makes it a fraudulent, deceptive or manipulative act or practice within the meaning of section 404 of the act for an investment adviser to fail to furnish a disclosure statement to prospective clients. Also, an investment adviser who sponsors a wrap fee program must furnish a wrap fee disclosure statement to prospective clients. Similar rules apply to the FCAs.
§ 404.012. This new regulation makes it a fraudulent, deceptive or manipulative act or practice within the meaning of section 404 of the act for an investment adviser to make cash payments to persons who solicit business for the investment adviser unless certain requirements are met. A similar provision already applies to FCAs.
§ 404.013. This new regulation makes it a fraudulent, deceptive or manipulative act or practice within the meaning of section 404 of the act for an investment adviser to have custody or possession of clients' funds or securities unless certain requirements are met. This regulation is similar in scope to § 404.020 which is being deleted. A similar provision already applies to the FCAs.
§ 404.020. This regulation was repealed in favor of § 404.013 which codifies current requirements.
§ 602.060. This change deletes the subscription fee for the Commission's Bulletin and Annual Report. These publications are now available to the public free of charge.
§ 603.031. This change would clarify that any record which the Commission deems excluded from the definition of a public record in 65 P. S. § 66.1(2) may be withheld from the public and that confidential treatment would be provided for Social Security numbers, home addresses and dates of birth of individuals appearing on Form U-4, Form BD and Form ADV.
Persons Affected by these Final-Form Regulations
The first eight proposed regulatory actions will affect issuers relying on certain exemptions from registration to issue securities and issuers of securities in registered offerings. The bulk of the remaining proposed regulatory actions will affect, to varying degrees, broker-dealers, agents, the FCAs, SRAs and IARs. These actions are required to implement Act 109 of 1998 and the NSMIA.
Fiscal Impact
Investment Advisers; Federally Covered Advisers. Regulatory actions affecting investment advisers will lower compliance costs by reducing or eliminating net worth requirements, reducing or eliminating required financial reports, waiving examination requirements for certain classes of applicants and conforming Commission rules to uniform NASAA Model Rules and provisions of the NSMIA. The FCAs will benefit from significant cost reductions by being able to make one electronic filing and fee payment to satisfy notice filing and fee payment requirements in every state they transact business.
The final-form regulations permit the Commission to issue orders requiring participation in the IARD. These user fees slightly will offset the significant savings afforded by these final-form regulations to SRAs by the elimination of the current $5,000 net capital/$12,500 tangible net worth requirement for two-thirds of investment advisers registered in this Commonwealth (those without custody or discretion) and a reduction from $20,000 net capital/$50,000 tangible net worth to $10,000 net worth for the other one-third of investment advisers registered in this Commonwealth (those with discretion) versus a projected $125 annual IARD user fee for the SRAs. The final-form rules are expected to save the SRAs a total of $10 million in collective net worth requirements versus collective annual IARD user fees of $58,750.
Development of the IARD by the SEC was mandated by Congress in the NSMIA. Although the SEC has expended $3.2 million in Federal funds to underwrite development costs, the IARD will require payment of a user fee to cover operating costs. This user fee would be in addition to license fees and assessments required under sections 602(d.1) and 602.1 of the act. Nevertheless, all the commentators, which represent the FCAs and SRAs, commented favorably on the final form rules wherein the Commission, by order, can require filings to be made through the IARD.
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