February 7, 1997 Mr. Jonathan Katz Secretary U.S. Securities and Exchange Commission 450 5th Street, NW Washington, D.C. 20549 Subject: Rules Implementing Amendments to the Investment Advisers Act of 1940 Rel. No. IA-1601 File No. S7-31-96 Dear Secretary Katz:: The Washington State Securities Division (“Division”) is pleased to submit comments regarding the Commission’s rule proposals to implement certain provisions of the Investment Advisers Supervision Coordination Act. Although we disagree with some of the Commission’s views, we commend the Commission on its efforts. We support the Commission’s attempts to create uniformity when appropriate but we believe that certain areas are better left to the states. I. SCOPE OF PREEMPTION We believe that the Commission’s interpretation in the Executive Summary of the extent of preemption of state laws is both unnecessary and incorrect. In Subsection 203A(b), Congress only preempted state laws requiring the “registration, licensing, or qualification” of certain investment advisers. Subsection 203A(b)(2) clarifies that states still maintain fraud jurisdiction in their states and extraterritorially to the extent of state jurisdiction over investment advisers and associates who no longer have to register because of preemption. Nothing in Section 203A(b) limits state laws unrelated to registration, licensing or qualification. While states may no longer pass laws tantamount to imposing registration requirements, state regulatory provisions unconnected with registration are not preempted. See, e.g., provisions of Section 102 of the Uniform Securities Act which apply regardless of registration. If Congress had intended to preempt these non-registration provisions, Congress would certainly not have limited itself to the preempting language “ requiring the registration, licensing, or qualification.” Contrary to the argument advanced by the Commission, Section 307 does not support the argument that Congress sought a broader preemption than registration, licensing or qualification provisions. Section 307 covers filings and fees that are registration related provisions and, to avoid preemption, required preservation. Citing a section preserving registration related provisions that would have been preempted hardly supports the argument for preemption of non- registration provisions. The non-registration provisions do not present any conflict with the preemption of registration provisions and therefore are saved by Section 222(a). The Commission’s interpretation gives no meaning or purpose to Section 222(a). To promulgate meaningful rules after NSMIA, the Commission need not and should not render interpretations extending preemption beyond state registration provisions. II. INVESTMENT ADVISER REPRESENTATIVE In defining “investment adviser representative” the Commission is substantially overstepping its Congressional mandate. We believe it is up to the states to set standards in this area. Licensing is a traditional state function and the states are the regulatory bodies that are, in fact, going to license investment adviser representatives. The SEC has never licensed IA representatives and is not going to do so now. It appears that the only reason the term is included within NSMIA at all is to clarify that a state may license IA representatives with a place of business in that state even if the adviser to which the representative is attached is federally registered. Unlike other proposed definitions in the release, it is completely unnecessary to define IA representative in order to implement NSMIA. The Commission’s definition will create significant non uniformity. Very simply, Congress legislated that investment advisers representatives employed by state licensed investment advisers will continue to be licensed at the state level. Investment adviser representatives that are employed by federally licensed investment advisers do not have to register with a state unless they have a “place of business” in that state. The Commission’s incredibly bureaucratic rule that involves “natural persons” and “substantial portion” of business is uncalled for. The Commission should define “place of business” and leave it at that. “Investment adviser representative” is a well defined term in state law. The term is defined by every state which licenses such representatives as well as by the Uniform Securities Act (USA) which defines the term to mean: [A]ny partner, officer, director of (or a person occupying a similar status or performing similar functions) or other individual employed by or associated with an investment adviser, except clerical or ministerial personnel, who (1) makes any recommendations or otherwise renders advice regarding securities, (2) manages accounts or portfolios of clients, (3) determines which recommendation or advice regarding securities should be given, (4) solicits, offers or negotiates for the sale of or sells investment advisory services, or (5) supervises employees who perform any of the foregoing. This well known USA definition is followed relatively consistently by the states and it seems evident that Congress was well aware of this definition and took it into consideration in drafting NSMIA. We note that the term is not contained in the Investment Advisers Act of 1940. Congress could have borrowed other terms that were defined by the Advisers Act, but it did not. The only sources of a definition available to them were the USA and the states. The proposed definition is narrower than the USA definition, primarily because it introduces the brand new concept that only supervised persons having a significant number of “natural person” clients would be deemed to be investment adviser representatives. Although the Commission cites certain testimony by Dee Harris in his role as NASAA President, there is absolutely no evidence that Congress intended the Commission to limit the definition of “retail” to “natural persons”. No credible argument can be made to support the notion that an account with a natural person is a “retail” account while an account with that same person’s 100% owned small corporation is non- retail. It was certainly not NASAA’s intent on the states’ behalf to indicate such limits. In fact, the states have a compelling interest in regulating the conduct of investment advisers who advise individuals, sole proprietorships, small corporations, or any other retail client. Congress never intended to place such limits on the states to register investment advisers representatives that advise inherently local interests. In addition, fewer representatives would be required to register under this definition. This would negatively impact the stated Congressional intent that NSMIA be largely revenue neutral to the states. The proposed definition of investment adviser representative excludes solicitors. This is contrary to the USA definition discussed above. Indeed, many on the investment adviser representatives that are currently licensed with the states are so licensed because of their solicitation activities. Very often, the client’s primary and perhaps only personal contact in the rendering of advisory services will be with the solicitor. Therefore, it is important that the activities of such persons be regulated. Creating a new solicitor’s licensing regime would be difficult and costly. Modification of state licensing statutes would be required in many instances. New rules, databases and forms would be necessary. New examinations would need to be developed. The continued use of the USA definition presents none of these difficulties, and has worked well for years. We support the Commission’s attempt to clarify what Congress meant by ‘place of business” in order to better identify those investment adviser representatives employed by federally registered investment advisers that will have to register with the state. We believe that the term “regularly” is confusing not only because it is so general but also because it is unclear what “regularly” is meant to modify. We suggest that any investment adviser representative who comes into this state to give face-to-face, personal investment advice to retail customers and who does not meet the de minimus exemption, should be required to have a license. Finally, we believe that the Commission has gone beyond both Congressional intent and its statutory authority in considering whether to except securities agents from the definition of investment adviser representative.. It should be up to state legislatures to make the decision on this matter. The Washington State Legislature has decided that broker-dealer agents in this state should not be excepted from the definition of investment adviser representative. Broker-dealers and investment advisers, even if they share locations and personnel, are frequently separate legal entities. In other instances, an agent may be licensed with a completely separate investment adviser. In either case, it doesn’t make any sense to exclude a broker-dealer agent from the definition of an investment adviser representative. Agents and representatives can be subject to different licensing requirements, such as examinations and owe different fiduciary duties to their clients. Many professionals, of course, are subject to licensing from more than one regulatory body when they are performing different professional services. An attorney, for example, who is also a CPA, is dually licensed with the state bar and the accountancy board. To grant an exception will also violate the Congressional mandate that NSMIA be implemented to in a revenue neutral manner. Since the overwhelming majority of investment adviser representatives are dually-licensed, creating an exception will result in a substantial negative revenue impact. Finally we note that there is nothing in the definition of investment adviser representative nor in the Congressional Record that equates advisory activity with sales activity. The Commission should concentrate on issues regarding the implementation of NSMIA and leave state law to the state legislatures. We strongly recommend that the Commission withdraw its definition of investment adviser representative or conform it to the Uniform Securities Act definition. The USA definition is superior in that it focuses exclusively on the types of services that are provided and avoids arbitrary classifications that lack factual basis. III. ASSETS UNDER MANAGMENT In most cases the amount of assets an adviser has under management will determine whether the adviser will register with the states or the Commission. A. Continuous and regular supervisory or management services. The approach proposed in the release for non-discretionary accounts could be called “write your own registration”, presenting difficult factual decisions. In fact, a majority of the investment adviser firms we examine, most of which are the smaller investment advisers, tell us that they perform “portfolio management.” This approach will lead to an increase in the number of advisers unnecessarily subject to SEC registration. To be useful, any definition of “continuous and regular supervisory or management services” must be functional. The Commission contrasts functions of “financial planners” and “consultants”, which do not include continuous and regular supervisory or management services with the function of “traditional portfolio management” which does. However, this contrast does not provide further guidance because none of these three terms is defined. If it intends to use the concept of traditional portfolio management in determining which advisers have assets under management for the purpose of NSMIA, the Commission should adopt a definition of that term that describes the functions performed for advisory clients in traditional portfolio management. The definition should reflect normal usage among investment advisory clients. In our experience, most people understand traditional portfolio management to mean an arrangement in which an investment adviser, based on the goals of the client and the adviser’s knowledge of the securities markets, manages the securities portfolio of the client by causing transactions to be made in the client’s securities account using the discretionary authority the client has granted to the adviser. The Commission could, instead, equate “continuous and regular supervisory or management services” with discretionary authority. Any lesser standard is subject to endless uncertainties for those subject to registration. B. Securities Portfolio. We believe that the Commission’s interpretation of “securities portfolio” is unnecessarily restrictive and strays from the language and intent of Congress. Following the language of the bill, we think that securities portfolio should be defined to take into consideration only securities under management plus cash equivalents. The “cash” component of the portfolio could include money market accounts and other short term securities. Inclusion of non-securities components of a portfolio is not expressly sanctioned by the language of Congress and appears to be inconsistent with it. In addition it would artificially increase the number of advisers that would have to register federally. Calculating the value of securities including money market funds and other short term securities should pose little if any added burden to investment advisers who may consider themselves subject to SEC registration. Inclusion of non-securities components would certainly create difficulties, raising questions of the methods and certainty of valuation. In the alternative, the securities portfolio could be considered the amount upon which the investor is paying a fee for purposes of “assets under management”. That amount is obviously already calculated and is easily verified. Lastly, the following miscellaneous areas are worthy of mention. IV. TRANSITIONS The Commission should make the transitions from state to federal registration and from federal to state registration more alike. There is no reason to have a 90 day grace period to transition from Commission to state registration. An application for state registration is typically processed in our office in less than a week. Any cancellation proceedings by the SEC could be stayed if the applicant can show that it has applied for state registration. Although I believe that the states are prepared to begin this process immediately, I wonder if the short period of time provided in the bill for implementation is sufficient for the Commission. V. REGULATED OR REQUIRED TO BE REGULATED We support the Commission’s interpretation that the phrase “regulated or required to be regulated” was intended by Congress to be synonymous with state registration. Until such time as those states that have no registration authority over investment advisers obtain authority from their legislatures, it is important that the Commission register those advisers. In summary, we appreciate the opportunity to comment on this very important release. We hope you will consider our comments. Although there were other important questions identified in the release, we have chosen to comment only upon those that we feel are the most significant. Sincerely, Deborah Bortner Securities Administrator Comment letter on Release No. IA-1601 File No. S7-31-96 6 State of Washington DEPARTMENT OF FINANCIAL INSTITUTIONS JOHN L. BLEY Director SECURITIES DIVISION P.O. Box 9033 l Olympia, Washington 98507-9033 Telephone (360) 902-8760 l TDD (360) 664-8126 l FAX (360) 586-5068 DEBORAH R. BORTNER Assistant Director