When the SEC first laid the path for registration as an “Internet investment adviser” in late 2002, the business model of rendering investment advice exclusively through an interactive website was still very much in its infancy. Wealthfront and Betterment, 2 of the earliest robo-advisers on the scene, didn’t register with the SEC until 2008 and 2009, respectively.
Somewhat hilariously, the original Adopting Release for rule 203A-2(f) under the Advisers Act (colloquially referred to as the “Internet Adviser Exemption” and subsequently renumbered as Rule 203A-2(e)) estimated that “as many as 20 firms” would be eligible to register with the SEC as Internet investment advisers as a result of the new rule. The Adopting Release cited unidentified “news articles” as the basis for this staggering number of impacted advisers.
Joking aside, it’s important to give credit where credit is due. The SEC was quite prescient in predicting that the ensuing years would see a significant increase in the number of Internet investment advisers as well as the initial boom of robo-advisers. According to the Adopting Release, as of June 2023, 261 advisers with an aggregate of $1.09 billion in assets under management were registered with the SEC under the Internet Adviser Exemption. Between the 2002 introduction of the Internet Adviser Exemption and June 2023, approximately 937 advisers have relied on the Internet Adviser Exemption, of which 772 initially registered exclusively in reliance on the exemption.
On March 27, 2024, the SEC amended the Internet Adviser Exemption for the first time since its original adoption in 2002. While the amendments do not turn the existing rule on its head, they do afford an opportunity to revisit how an adviser can register – and remain registered – as an Internet investment adviser.
Eligibility For SEC Registration Generally
Readers of my past work know that I tend to bemoan the regulatory burden laden on state-registered advisers who are required to be registered in multiple states as, absent an exemption from the prohibition against registering with the SEC, investment advisers are generally required to register in one or more states. Said another way, there are only a handful of paths for an investment adviser to register with the SEC instead of one or more states.
While I explored the various paths to SEC registration in further detail in this prior article, I’ve summarized the most well-trodden paths below:
- The “large advisory firm” – an adviser with at least $100 million in regulatory assets under management;
- The “pension consultant” – a consultant with respect to assets of plans having an aggregate value of at least $200,000,000;
- The “related adviser” – an adviser controlling, controlled by, or under common control with an SEC-registered adviser (more on this path later);
- The “120-day adviser” – an adviser that, immediately before it registers with the SEC, is not registered or required to be registered with the SEC or a state securities authority of any state and has a reasonable expectation that it would be eligible to register with the SEC within 120 days after the date the adviser’s registration becomes effective (more on this path later);
- The “multi-state adviser” – an adviser that, upon submission of its application for registration with the SEC, is required by the laws of 15 or more states to register as an investment adviser with the state securities authority in the respective states;
- The “mutual fund/BDC adviser” – an adviser to a registered investment company or a business development company;
- The “mid-sized adviser” – an adviser with regulatory assets under management of at least $25 million, but less than $100 million, whose principal place of business is in New York (this path still exists only because New York doesn’t examine investment advisers registered there); and
- The “foreign adviser” – an adviser with its principal office and place of business outside the U.S.
Each such path to SEC registration has its own quirks and features, but the overarching point is that it is intentionally not easy to skip state registration and simply register directly with the SEC. The paths to SEC registration were generally only laid when the SEC exercised its congressional authority under Section 203A(c) of the Advisers Act as set forth below:
The Commission, by rule or regulation upon its own motion, or by order upon application, may permit the registration with the Commission of any person or class of persons to which the [prohibition against SEC registration] would be unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes of this section.
In other words, the SEC has the congressional authority to clear a path for certain advisers with less than $100 million in regulatory assets under management to register with the SEC when it believes that not doing so would be unfair, a burden on interstate commerce, or otherwise inconsistent with the congressional intent built into Section 203A(c) of the Advisers Act.
When it originally adopted the Internet Adviser Exemption in 2002, the SEC cited this exact rationale:
Absent an exemption, Internet Investment Advisers would likely incur the burden of temporarily registering in every state and later de-registering. State investment adviser registration statutes generally obligate advisers to register in every state in which the adviser obtains more than a de minimis number of clients. Because an Internet Investment Adviser uses an interactive website to provide investment advice, the adviser’s clients can come from any state at any time. As a result, an Internet Investment Adviser must, as a practical matter, register in every state. This ensures that the adviser’s registrations will be in place when it later obtains the requisite number of clients from any particular state. The adviser may subsequently become eligible for our existing exemption [as a multi-state adviser], permitting Commission registration for advisers otherwise obligated to register in at least 30 [now 15] states, but not before the adviser had already incurred the burden of registering in every state.
We have concluded that, as applied to these advisers, the application of the prohibition on Commission registration would be “unfair, a burden on interstate commerce, or otherwise inconsistent with the purposes of [Section 203A].”
Thus, the Internet Adviser Exemption was born.
The Narrower Path To SEC Registration For Internet Investment Advisers
Lest anyone believe that simply buying a URL, propping up a website with an off-the-shelf automated chatbot, and interacting with clients solely via email, Zoom, and AI will open up the door to registration with the SEC as an Internet investment adviser, please allow me to crush your dreams. It ain’t that easy.
As a threshold matter, the Adopting Release for the 2024 amendment to the Internet Adviser Exemption emphasizes that the exemption “was intended as a narrow exemption for entities that exclusively provide investment advice through an interactive website.” This original intent remains and has been narrowed even further due to “numerous compliance deficiencies by advisers relying on the [Internet Adviser Exemption]”. The genesis of this observed non-compliance can be traced back to a 2021 Risk Alert entitled Observations from Examinations of Advisers that Provide Electronic Investment Advice. SEC Risk Alerts, in this respect, can sometimes foreshadow future rulemaking activity by the SEC.
Even when the original Internet Adviser Exemption was adopted in 2002, it was only available to advisers who provided investment advice to clients exclusively through an interactive website (save for a de minimis exemption of fewer than 15 clients served outside of the interactive website within the preceding 12 months). The interactive website was required to be “a website in which computer software-based models or applications provide investment advice to clients based on personal information provided by each client through the website.” The rule was not intended to be available to advisers that “merely use websites as marketing tools or that use Internet vehicles such as Email, chat rooms, bulletin boards and webcasts or other electronic media in communicating with clients.”
While the fundamental principles set forth in the original 2002 version of the rule remain, the 2024 amendment is intended to “better reflect what it means in 2024 truly to provide an exclusively internet-based service.”
In summary, the 2024 amendment to the Internet Adviser Exemption (i) clarifies that an interactive website must be “operational” at “all times”, (ii) defines what it means to provide a “digital investment advisory service”, (iii) eliminates the de minimis exception that permitted the provision of investment advice to fewer than 15 non-Internet clients during the preceding 12-month period, and (iv) adds additional Form ADV representations regarding an Internet investment adviser’s reliance on the Internet Adviser Exemption.
Operational Interactive Website
Though it may appear that the addition of the word “operational” to “interactive website” as a defined term is redundant and unnecessary, the Adopting Release makes the case that this seemingly pedantic revision is, in fact, necessary to drive home the point that an Internet investment adviser’s interactive website must, in fact, actually work.
The SEC cites “an increase in the number of registration withdrawals and cancellations of internet investment advisers” as its primary rationale, as many such withdrawals and cancellations were apparently a result of “the adviser not having an operational interactive website.” Reading between the lines, the SEC is simply tired of dealing with faux Internet investment advisers that purport to have an interactive website and deploying limited SEC staff resources to force the withdrawal or cancellation of their respective registrations.
In addition to adding the word “operational” to the “interactive website” as a defined term, the SEC also took the opportunity to rewrite what it actually means to meet the definition of an operational website:
A website, mobile application, or similar digital platform through which the investment adviser provides digital investment advisory services on an ongoing basis to more than one client (except during temporary technological outages of a de minimis duration).
Let’s unpack a few keywords and phrases from this new definition.
WEBSITE, MOBILE APPLICATION, OR SIMILAR DIGITAL PLATFORM
The original 2002 definition of an interactive website solely contemplated just that – a website. The introduction of the iPhone and consumer-facing mobile applications was still 5 years away, and thus, the mere concept of investment advisers rendering investment advice through mobile applications or other digital platforms was not even on the SEC’s radar.
Advancements in technology over the last 22 years have obviously changed the game, and the SEC took this rulemaking opportunity to specifically account for investment advice solely rendered through a mobile application and not just a website. The SEC also endeavored to future-proof the definition of an operational interactive website to account for “similar digital platforms” that haven’t even been conceived yet. In this sense, the SEC is essentially technology agnostic so long as the digital platform actually results in the delivery of “digital investment advisory services”.
As a sidebar, perhaps the SEC should do the same to the Adviser Act’s recordkeeping rule, which still references microfilm and microfiche as potential storage media. But I digress…
DIGITAL INVESTMENT ADVISORY SERVICES
To meet the new definition of an operational interactive website, “digital investment advisory services” must actually be delivered through such an operational interactive website.
Would-be Internet investment advisers should not take for granted the fact that they must actually render investment advice through the operational interactive website to definitionally qualify for registration. As the Adopting Release makes clear: “In order to rely on the Internet Adviser Exemption, a person must first meet the definition of investment adviser under the Advisers Act. See section 202(a)(11) of the Advisers Act.”
Particularly with respect to Internet-based promoters/solicitors for other investment advisers and those delivering purely financial planning services through a mobile application, for example, meeting the threshold definition of investment adviser under the Advisers Act may not be as easy as it appears.
If you don’t meet the Advisers Act’s definition of an investment adviser, you don’t meet the definition of an Internet investment adviser.
Assuming that one does actually meet the definition of investment adviser under Section 202(a)(11) of the Advisers Act, an Internet investment adviser’s operational interactive website must utilize “software-based models, algorithms, or applications.” This effectively negates the ability of any Internet investment adviser personnel to “generate, modify, or otherwise provide client-specific investment advice through the operational interactive website or otherwise.” “Human-directed client-specific investment advice, even if delivered through electronic means, would not be eligible activity under the Internet adviser exemption.”
Thus, a human should not, for example, design a portfolio allocation for any client, modify the algorithmically developed portfolio allocation for any client, or otherwise render an opinion on the appropriateness of a particular portfolio allocation for a client. Though it obviously requires a human to design the algorithm that ultimately generates the investment advice (words that might not age well given the advances in artificial intelligence), the same human must remain cloaked as the man behind the curtain, so to speak, and remain unavailable to clients to render advice in the algorithm’s stead.
That said, personnel of Internet investment advisers “can continue to assist clients with technical issues or collect feedback in connection with the use of the website (e.g., accessing the website), including by assisting clients with explanations of how the algorithm generating the investment advice was developed or operates.” So long as such personnel do not cross the line into rendering investment advice, they can still interact with clients to ensure a positive client experience.
The final requirement of a digital investment advisory service is that each client’s personal information must be supplied to the Internet investment adviser “through the operational interactive website.” Thus, the Internet investment adviser’s personnel should not be the one sending or collecting a client suitability questionnaire, risk tolerance questionnaire, or other client information manually in the course of a phone call or email exchange. The operational interactive website should have this functionality built in.
ELIMINATION OF THE PREVIOUS DE MINIMIS THRESHOLD
The original 2002 iteration of the Internet Adviser Exemption included a de minimis exception that permitted Internet investment advisers to provide advice outside of the interactive website to fewer than 15 non-Internet clients during the preceding 12 months (i.e., a human investment adviser representative could render investment advice to fewer than 15 clients within the preceding 12 months).
This de minimis exception has been eliminated. An Internet investment adviser must provide advice to all of its clients exclusively through an operational interactive website without exception.
The SEC reasoned that “the de minimis exception is no longer needed in light of the widespread use of the internet, the relative ease of building and maintaining a website and applications, and other technological advances that better allow advisers to monitor to whom their advice is being provided.”
ONGOING BASIS
The reference to providing digital investment advisory services on an “ongoing basis” is somewhat misleading, as it suggests that a client engagement with a limited duration or for a set period would not be enough. But this doesn’t appear to be the case:
An internet investment adviser generally is providing investment advice on an ongoing basis through its website to a client if the advice is within the scope of the adviser-client relationship.
This particular sentence doesn’t make any sense to me no matter how many times I read it, but the Adopting Release goes on to essentially say that after the delivery of a one-time financial plan for a one-time fee, or otherwise after the expiration or termination of a client agreement, an Internet investment adviser is no longer providing digital investment advisory services on an ongoing basis.
I would think this is fairly self-apparent, but the ongoing basis component remains in the definition of an operational interactive website nonetheless.
MORE THAN ONE CLIENT
At a bare minimum, an Internet investment adviser must be rendering digital investment advisory services to at least 2 clients at all times. While one commentator to the proposed rule suggested that the minimum client threshold should be 15 or more clients, the SEC took the position that requiring a larger minimum number of clients would be “inconsistent with the general policy objective that underpins the internet adviser exemption” and “would burden advisers that do not fall neatly within the State and Federal regulatory framework established by Congress with the obligation of registering in several States before the adviser would be eligible for Commission registration.”
This 2-client minimum may appear unworkable for newly registered Internet investment advisers who haven’t yet engaged with any clients, but the Internet Adviser Exemption’s interplay with the “120-day exemption”, as discussed below, should allay any concerns.
TEMPORARY TECHNOLOGICAL OUTAGES
The Internet Adviser Exemption now explicitly includes a “hardship clause” that reflects the SEC’s understanding that unforeseen technological issues outside of an adviser’s control occur at times, and that an operational interactive website may be “temporarily inoperable due to periodic maintenance.”
Thus, there is no “100% uptime” Service-Level Agreement requirement inferred within the Internet Adviser Exemption. The outage, however, must be de minimis in duration. The Adopting Release doesn’t specify the temporal bounds of a de minimis duration, and such temporal bounds would likely depend on the facts and circumstances. For example, a technological outage of a day may be more than de minimis for a high-frequency trading strategy that reacts to intraday market movement, whereas a technological outage of the same duration for a buy-and-hold trading strategy with occasional rebalancing may be de minimis.
If an operational interactive website experiences an outage that is longer than a de minimis duration, a footnote in the Adopting Release indicates that an adviser can seek exemptive relief so long as the exemption is “necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Advisers Act.”
Form ADV Part 1 Representations; Unintentional Form ADV Part 2A Guidance
The inclusion of 2 Internet investment adviser representations in Form ADV Part 1 is essentially the SEC’s way of driving home the initial and ongoing obligations imposed on those initially registering or continuing their registration as Internet investment advisers. To use the SEC’s own words from the Adopting Release, “the amendments to Form ADV will help ensure that registrants are aware of the new ‘operational interactive website’ requirement and avoid erroneous registrations.” Read: you better be sure you’re actually an Internet adviser before submitting Form ADV to us; don’t waste our time.
Thus, if you are applying for registration as an investment adviser with the SEC or changing your existing Item 2 response regarding your eligibility for SEC registration, you must make the following representation: “I will provide investment advice on an ongoing basis to more than one client exclusively through an operational interactive website.”
If you are filing an annual updating amendment to your existing registration and are continuing to rely on the Internet Adviser Exemption as the basis for your SEC registration, you must make the following representation: “I have provided and will continue to provide investment advice on an ongoing basis to more than one client exclusively through an operational interactive website.”
Though the Adopting Release does not impose any new requirements with respect to Form ADV Part 2A, it unintentionally(?) provides Internet investment advisers with a baseline framework for disclosing the risks and limitations of investment advice that is solely rendered through an operational interactive website.
This ‘guidance’ is buried in a footnote, but is worth quoting in its entirety:
Given the unique aspects of internet investment advisers’ business models and because client relationships may occur with limited, if any, human interaction, internet investment advisers generally should consider the most effective way to communicate to their clients the limitations, risks, and operational aspects of their advisory services. For example, internet investment advisers generally should effectively disclose to clients, among other matters, that an algorithm is used to manage individual client accounts with a description of the particular risks inherent in the use of an algorithm to manage client accounts. In addition, internet investment advisers generally should consider whether such disclosures are presented prior to client sign-up so that information necessary to make an informed investment decision is available to clients before they engage. Finally, an adviser should carefully consider whether its disclosure is sufficiently specific so that a client is able to understand the material facts or conflicts of interest and make an informed decision whether to provide consent. See Fiduciary Interpretation.
While the above-cited footnote does not specifically reference Form ADV Part 2A, I’ll go out on a limb and assert that Internet investment advisers should essentially use this footnote as a framework for what to disclose in Form ADV Part 2A (perhaps in Item 4 or Item 8 – the items respectively entitled “Advisory Business” and “Methods of Analysis, Investment Strategies & Risk of Loss”).
In summary, Internet investment advisers should craft a disclosure that specifically addresses the risks and limitations inherent in the use of an algorithm to manage client accounts, the lack of human interaction or intervention, and the operational experience a client should expect.
The Form ADV Part 2A is the natural candidate for the location of such disclosure, as the Form ADV Part 2A is required to be delivered to clients before or at the time an investment adviser enters into an advisory agreement with a client.
Other Important Restrictions
As briefly mentioned above, another path to SEC registration may be traversed by a “related adviser” as defined in Rule 203A-2(b) – an adviser controlling, controlled by, or under common control with an SEC-registered adviser. In other words, an investment adviser that is not itself eligible for SEC registration (the related adviser), but that is in a control relationship with another investment adviser that is eligible for SEC registration (the registered adviser), may rely on the registered adviser’s SEC registration to itself be eligible for SEC registration. To satisfy this path to SEC registration, the related adviser must share a principal place of business with the registered adviser.
The catch is that an Internet investment adviser cannot also be a registered adviser on whom a related adviser is relying for its own SEC registration. For example, our favorite hypothetical advisory firm, Backwoods Advisors, cannot register with the SEC as an Internet investment adviser, establish a wholly-owned subsidiary that renders human-delivered financial planning services, and attempt to register such wholly-owned subsidiary with the SEC as a related adviser.
In short, the Internet Adviser Exemption cannot be used to sneak an otherwise ineligible investment adviser through the back door to SEC registration as a related adviser.
Interplay With The 120-Day Path To SEC Registration
Though the Internet Adviser Exemption may not play nicely with the related adviser exemption set forth in Rule 203A-2(b), it does play nicely with the 120-day exemption set forth in Rule 203A-2(c).
The 120-day exemption allows an investment adviser that is not registered with the SEC but has a reasonable expectation that it will be eligible for registration within 120 days to register with the SEC in anticipation of its separate eligibility. You can think of the 120-day exemption as a temporary 4-month runway for newly registered investment advisers to become eligible for SEC registration via one of the other paths described earlier.
Importantly, the 120-day exemption is not available to investment advisers that are registered or required to be registered with the SEC or any state securities authority immediately before submitting a registration application with the SEC. For example, a state-registered investment adviser cannot preemptively register with the SEC because it expects to grow to $100 million in regulatory assets under management within the next 120 days.
On the other hand, a new would-be Internet investment adviser can submit its initial SEC registration application under the 120-day exemption and then file a Form ADV amendment to switch its SEC registration basis to that of an Internet investment adviser before the 120-day period expires. As the Adopting Release conveys, “Advisers seeking to rely on the internet adviser exemption may use the 120-day rule to develop, test, and launch an operational interactive website and obtain initial clients by the time the 120-day temporary registration expires.”
While the Internet Adviser Exemption may not have any grace period of its own for meeting its conditions (including providing an operational interactive website), the 120-day exemption affords a one-time grace period of sorts to ensure the operational interactive website is actually operational and interactive, and that the adviser has a chance to obtain at least 2 clients.
Compliance Dates
The compliance date for the amended Internet Adviser Exemption is March 31, 2025, the same date that most advisers are required to file their 2025 annual ADV amendment (i.e., 90 days after a December 31, 2024, fiscal year end).
Advisers that are no longer eligible for SEC registration under the amended Internet Adviser Exemption must de-register with the SEC by filing a Form ADV-W by June 29, 2025 (90 days after the compliance date), find another path to SEC registration, or convert to state registration.
The Internet Adviser Exemption was originally intended to be a narrow path to SEC registration, and the recent amendments constrict this path even further. On the other hand, the recent amendments and associated Adopting Release set forth additional clarity and remain technology agnostic in a way that should make the Internet Adviser Exemption evergreen for years to come.
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This article originally appeared in Michael Kitces’ Nerd’s Eye View on May 1, 2024.