A dead Greek guy named Heraclitus is most often attributed as the source of the following platitude: “the only constant in life is change.” Though he predated the state/Federal divide of investment adviser regulation by about 2,500 years, his observation is apropos to advisers that are on the bubble of SEC registration eligibility.
On the one hand, a state-registered investment adviser that grows its assets under management above a certain threshold may become eligible or required to transition from state to SEC registration. On the other hand, an SEC-registered investment adviser that drops below a certain threshold of assets under management may be required to transition from SEC registration to state registration.
The specific triggers, buffers, and logistics associated with such transitions (whether state-to-SEC or SEC-to-state) are discussed below – and they are not exactly intuitive.
SEC Registration Eligibility
As discussed at length in a prior article entitled How To Register Your RIA: State Vs SEC Registration And When Notice Filing Is Required, the SEC and the states have taken a divide-and-conquer approach with respect to regulating investment advisers. The SEC’s jurisdiction is exemptive in nature, meaning that an adviser must avail itself of an exemption from the default prohibition against registration with the SEC. If an adviser is not eligible for SEC registration, it will generally be required to register with one or more states.
While there are several paths to SEC registration (most of which are discussed in the aforementioned article), the one most traveled is taken by advisers with $100 million or more in Regulatory Assets Under Management (RAUM), which are defined by the SEC in Part 1A Instruction 5.b of the Form ADV – General Instructions as “securities portfolios for which you provide continuous and regular supervisory or management services.” It is through the lens of RAUM that this article will analyze when and how an adviser may be permitted – or is required – to switch between state and SEC registration.
Before diving in, however, it is important to acknowledge one Empire-Building-sized exception to the $100 million RAUM path to SEC registration: Advisers with a principal place of business in New York must register with the SEC if they have RAUM of just $25 million – well below the $100 million threshold that would otherwise apply if the adviser’s principal place of business were located in any other state.
The reason? State-registered investment advisers with a principal place of business in New York are not subject to examination by the New York Investor Protection Bureau (the division of the New York Attorney General Office tasked with enforcing the New York State securities law, commonly known as the Martin Act). Every other state’s securities authority examines state-registered investment advisers principally domiciled within its borders, but New York does not.
Wild, right?
Technically, any adviser with RAUM of $25 million to $100 million is referred to as a “mid-sized adviser” and must register with the SEC if certain conditions are met. As stated in the SEC Division of Investment Management’s Frequently Asked Questions Regarding Mid-Sized Advisers:
…a mid-sized adviser must register with the Securities and Exchange Commission if it:
1. is not required to be registered as an adviser with the state securities authority in the state where it maintains its principal office and place of business; or
2. is not subject to examination as an adviser by the state where it maintains its principal office and place of business.
Until Wyoming first required the registration of investment advisers in July 2017, mid-sized advisers with a principal office and place of business in Wyoming fit into the first category enumerated above and were also required to register with the SEC. As of the date of this article, though, New York is the lone remaining state to trigger the mid-sized adviser requirement to register with the SEC.
And no, an adviser can’t just use a Post Office Box in Syracuse, a seldom-used WeWork in Manhattan, or that hipster nephew’s loft in Brooklyn as its principal office and place of business and skip to SEC registration at the $25 million mark. The term “Principal Office and Place of Business” is specifically defined in the Glossary to Form ADV (which begins on p. 26) as “Your firm’s executive office from which your firm’s officers, partners, or managers direct, control, and coordinate the activities of your firm.”
This is all to say that any time this article references $100 million as the primary dividing line between state and SEC registration, remember this New York quirk.
Switching Between State And SEC Registration
To illustrate the various scenarios in which an adviser may or must transition from state to SEC registration, let’s again follow the journey of our favorite hypothetical advisory firm, Backwoods Advisors. Backwoods Advisors is a state-registered adviser registered with the Missouri Secretary of State, and 2022 was a banner year. With its RAUM about to eclipse the $100 million mark, it must evaluate whether and when it can (or must) transition from state registration to SEC registration.
Let’s assume that, like most advisers, the fiscal year-end of Backwoods Advisors is December 31; this means that its annual ADV amendment is due to be filed by the end of March each year (i.e., 90 days after its fiscal year-end).
SCENARIO #1: WHEN SEC REGISTRATION IS PERMITTED BUT NOT REQUIRED
In August 2022, Backwoods Advisors sponsored a prospective client event at the Shootout boat race at the Lake of the Ozarks, and the resultant influx of new clients and assets caused the firm’s RAUM to skyrocket from $50 million before the Shootout to $150 million by September 2022. Since the firm’s RAUM is now in excess of $100 million, must it immediately apply to register with the SEC? No.
Over the course of a calendar year, a state-registered adviser’s RAUM can dip to $10 or crest to $10 billion without requiring the adviser to transition from state registration to SEC registration. The reason for this intra-year flexibility is to eliminate the nonsensical need to ping-pong back and forth from state to SEC registration and back as its RAUM flutters slightly above or slightly below the $100 million threshold over the course of the year.
However, even though Backwoods and its $150 million RAUM may not be required to apply for SEC registration in September 2022, is it still permitted to apply for SEC registration since it is now eligible to do so by virtue of exceeding the $100 million RAUM threshold? Yes.
As soon as a state-registered adviser crosses the $100 million RAUM threshold over the course of a year, it is free to apply for SEC registration and transition from state registration. I generally advise against pulling the trigger and voluntarily transitioning from state registration to SEC registration before an adviser is required to do so (more on that below), primarily because a subsequent RAUM drop may necessitate transitioning from SEC registration back to state registration, leaving the adviser right where it started (and having incurred unnecessary application filing fees and expending unnecessary time to endure the state registration process all over again from scratch).
We’ll explore when an SEC-to-state transition is required below, but for now, the primary takeaway is that an adviser shouldn’t be overly eager to join the SEC club lest it subsequently finds itself unwinding the transition process in short order.
There are, admittedly, a few potential exceptions to this general advice:
- The state(s) in which the adviser is registered present an undue burden to the adviser (by virtue of overly prescriptive advisory fee limitations, overzealous examiners, untenable contractual restrictions with clients, impermissibility of testimonials, etc.). Several states have made it on my naughty list in these regards.
- The adviser has just acquired another adviser firm and significantly increased its RAUM, such that it is well above the $100 million RAUM threshold without reasonable expectation of a decline.
- The adviser wants to offer a particular investment product to its clients, but the product sponsor requires that the adviser be SEC-registered before its clients can become eligible to purchase such products.
Overarching takeaway: Intra-year RAUM increases above $100 million do not require an adviser to immediately transition to SEC registration.
SCENARIO #2: WHEN SEC REGISTRATION IS REQUIRED
Backwoods Advisors is able to sustain the RAUM growth it experienced as a result of its Lake of the Ozarks Shootout sponsorship and ends the year with $150 million RAUM. In preparing its annual ADV amendment for filing by the end of March 2023, it reports this amount in ADV Part 1A, Item 5.F.(2)(c). Since the firm reports RAUM in excess of $100 million on its annual ADV amendment filing, must it now apply to register with the SEC? Yes.
The only point in time that matters for purposes of assessing whether an adviser must transition from state registration to SEC registration is at the time the adviser files its annual ADV amendment. Rule 203A-1(b)(1) under the Advisers Act directs as follows:
If you are registered with a state securities authority, you must apply for registration with the Commission within 90 days of filing an annual updating amendment to your Form ADV reporting that you are eligible for SEC registration and are not relying on an exemption from registration under sections 203(l) or 203(m) of the Act (15 U.S.C. 80b-3(l), (m)).
Because Backwoods Advisors reported RAUM of $150 million in its annual ADV amendment, it is clearly “eligible for SEC registration” and thus must apply for registration with the SEC within 90 days of filing its annual ADV amendment. Note that the 90-day SEC application submission clock starts ticking on the date the adviser files its annual ADV amendment.
Thus, if Backwoods Advisors waits until the last minute to submit its annual ADV amendment and does so on the very last day of March, it need not file its registration application with the SEC until 90 days afterward, at the end of June. As the SEC has a statutory maximum of 45 days by which to approve or institute proceedings to deny a new application, Backwoods Advisors may conceivably not officially become SEC-registered until as late as mid-August 2023 (just in time for another Lake of the Ozarks Shootout).
Of course, advisers don’t have to avail themselves of the full 90-day window in which to submit their SEC registration application and can make such submission the day after it submits its annual ADV amendment if desired.
SCENARIO #3: WHEN THE RAUM BUFFER ZONE OFFERS SOME FLEXIBILITY FOR FIRMS TO CHOOSE WHETHER TO REGISTER WITH THE SEC
The 4th quarter of 2022 was not favorable to Backwoods Advisors, and its RAUM dropped from its high of $150 million in September to $105 million by year-end. In preparing its annual ADV amendment for filing by the end of March 2023, it reports $105 million in ADV Part 1A, Item 5.F.(2)(c). Since the firm reports RAUM in excess of $100 million on its annual ADV amendment filing, must it now apply to register with the SEC? No.
Huh?
Rule 203A-1(b)(1) under the Advisers Act does indeed say that an adviser “must apply” for SEC registration within 90 days of filing an annual ADV amendment if it is “eligible” for such SEC registration. Backwoods is clearly “eligible” for SEC registration if it reports RAUM of $105 million, which is in excess of the $100 million RAUM threshold. Yet, in this scenario, transitioning to SEC registration is not required. What gives?
Rule 203A-1(a)(1) additionally provides as follows:
You may, but are not required to register with the Commission if you have assets under management of at least $100,000,000 but less than $110,000,000.
This buffer is again intended to prevent unnecessary ping-ponging between state and SEC registration. This means that a state-registered adviser that reports at least $100 million RAUM but less than $110 million RAUM in its annual ADV amendment may voluntarily transition to SEC registration but is not required to do so.
SCENARIO #4: WHEN AN ADVISER MUST REGISTER DEPENDS ON WHEN THEIR ANNUAL ADV AMENDMENT IS FILED
Backwoods Advisors successfully registered with the SEC in the second quarter of 2023 and withdrew its Missouri state registration as a result (more on the state deregistration process below). Due to the success of its prospective client event sponsorship at the 2022 Lake of the Ozarks Shootout, it decided to return as a sponsor again in August 2023. However, Backwoods Advisors ran out of the famous “Lake Water” cocktail it was serving (a mix of Malibu coconut rum, fruity liqueurs, Blue Curacao, and pineapple juice), and prospective clients were not impressed (or sufficiently imbibed) during its event. As a result, its RAUM dropped to $70 million by September 2023. Since the firm’s RAUM is now below $100 million, must it immediately deregister from the SEC and transition back to registration with the state of Missouri? No.
As described in Scenario #1 above, a state-registered adviser’s RAUM can dip to $10 or crest $10 billion during the course of the year without requiring the adviser to transition from state registration to SEC registration. The inverse is true as well: an SEC-registered adviser’s RAUM can dip to $10 during the course of the year without requiring the adviser to transition from SEC registration to state registration.
And as described in Scenario #2 above, the only point in time that matters for purposes of assessing whether an adviser must transition from state registration to SEC registration is at the time the adviser files its annual ADV amendment. The inverse is true as well: The only point in time that matters for purposes of assessing whether an adviser must transition from SEC registration to state registration is at the time the adviser files its annual ADV amendment.
SCENARIO #5: ADVISERS WITH $90M OR MORE CAN REMAIN SEC-REGISTERED
Backwoods Advisors can’t seem to fully recover from its Lake Water incident, and it finishes 2023 at $95 million. In preparing its annual ADV amendment for filing by the end of March 2024, it reports this amount in ADV Part 1A, Item 5.F.(2)(c). Since the firm reports RAUM below $100 million on its annual ADV amendment filing, must it now transition to state registration? No.
Again, one must review the entirety of Rule 203A-1 under the Advisers Act to arrive at the correct answer.
Rule 203A-1(b)(2) initially implies that an SEC-registered adviser that reports that it is not “eligible for SEC registration” (i.e., has less than $100 million RAUM) must withdraw its SEC registration within 180 days of the adviser’s fiscal year-end:
If you are registered with the Commission and file an annual updating amendment to your Form ADV reporting that you are not eligible for SEC registration and are not relying on an exemption from registration under sections 203(l) or 203(m) of the Act (15 U.S.C. 80b-3(l), (m)), you must file Form ADV-W (17 CFR 279.2) to withdraw your SEC registration within 180 days of your fiscal year end (unless you then are eligible for SEC registration).
However, Rule 203A-1(a)(1) also states:
[…] you need not withdraw your registration unless you have less than $90,000,000 of assets under management.
In other words, so long as an SEC-registered adviser reports RAUM of at least $90 million on its annual ADV amendment, it can remain registered with the SEC and not transition to state registration.
SCENARIO #6: WHEN ADVISERS MUST SWITCH FROM SEC TO STATE REGISTRATION
To compound the fallout of the Lake Water incident in August 2023, an investment adviser representative of Backwoods Advisors resigned from the firm in September 2023 and took almost half of the firm’s clients and RAUM with him. As a result, Backwoods Advisors ended the year with RAUM of $50 million.
In preparing its annual ADV amendment for filing by the end of March 2024, it reported this amount in ADV Part 1, Item 5.F.(2)(c). Since the firm reported RAUM below $90 million on its annual ADV amendment filing, must it now transition to state registration? Yes, but with a caveat.
Because Backwoods Advisors is below the $90 million RAUM downside threshold as reported on its annual ADV amendment, it must withdraw its SEC registration by the end of June 2024 (i.e., 180 days after its fiscal year-end). To avoid a gap in registration as an adviser, it must also become registered as an adviser in the state of Missouri by the end of June 2024 as well.
The caveat, however, is explained in the SEC’s Form ADV and IARD Frequently Asked Questions:
Form ADV: Item 2.A(1)
Q: My firm is registered with the SEC and reported having regulatory assets under management of less than $90 million on its annual updating amendment. Is the firm required to withdraw from SEC registration if it obtains $90 million or more in regulatory assets under management within 180 days of the firm’s fiscal year end?
A: No. An investment adviser registered with the SEC that files an annual updating amendment reporting that the adviser is not eligible for SEC registration must withdraw from registration within 180 days of its fiscal year end, unless the adviser then is eligible for SEC registration. See rule 203A-1. If the adviser obtains $90 million or more in regulatory assets under management at any time during that 180 day period, the adviser may amend Form ADV and check Item 2.A(1) to remain SEC-registered. (Posted May 7, 2012).
If Backwoods Advisors can manage to increase its RAUM from the $50 million it reported on its annual ADV amendment to at least $90 million by the end of June 2024, it can remain registered with the SEC and not transition to registration with the state of Missouri.
The dilemma faced by Backwoods Advisors in this scenario is how long to afford itself to hit the $90 million RAUM threshold before biting the bullet and initiating the registration process with the state of Missouri such that it can be comfortably approved by the end of June (i.e., before it must withdraw from SEC registration). As explained in a prior article, state registration timeframes can vary dramatically.
If the prospect of reaching $90 million RAUM by the end of June is unlikely, it’s best to initiate the state registration process well in advance of the 180-day deadline from fiscal year-end. If an adviser is just below the $90 million RAUM threshold, has new RAUM waiting to be onboarded, is acquiring a book of business, or is otherwise confident of its near-term RAUM-growth opportunities, waiting until the second half of the 180-day window to make the state registration application decision may be justified.
It’s imperative not to wait too long to initiate the state registration process, though, lest the adviser not be approved by applicable state(s) before the end of the 180-day window and is forced to withdraw from SEC registration, thus creating a potential gap in the adviser’s registration (during which it could not operate as an investment adviser for compensation).
Transition Logistics
The state-to-SEC and SEC-to-state transition processes are effectively mirror images of each other. The sequence of events is nonetheless crucial to avoid a registration gap.
State-to-SEC
- Apply for registration with the SEC by initiating the application process through the Investment Adviser Registration Depository (IARD), which generally involves filing applicable parts of Form ADV and paying a fee.
- Only after the SEC deems the adviser’s registration to be effective (i.e., approves the registration application), submit a partial Form ADV-W through IARD to withdraw the adviser’s registration at the state level.
SEC-to-State
- Apply for registration with the applicable state(s) by initiating the application process through IARD, which generally involves filing applicable parts of Form ADV and paying a fee. The adviser will also generally need to submit various other ancillary documents directly to the applicable state(s) (i.e., outside of IARD).
- Only after the applicable state(s) approve the registration application, submit a partial Form ADV-W through IARD to withdraw the adviser’s registration with the SEC.
To re-emphasize, a state-registered adviser should not withdraw its registration from the state(s) until after the SEC has approved, and an SEC-registered adviser should not withdraw its registration from the SEC until after the applicable state(s) have approved.
A logical question that may arise in this process is whether an adviser can be registered with both the SEC and one or more states at the same time. In short, yes. It is effectively unavoidable for an adviser switching from state to SEC registration or SEC to state registration to not be at least temporarily registered both at the state and federal level after the adviser’s new regulator has approved its application but before it files its Form ADV-W to withdraw registration from its former regulator.
It is advisable to minimize this overlapping registration period if for no other reason than to close the door on being unnecessarily examined by the regulator whose jurisdiction the adviser is bidding adieu. Said another way, for so long as an adviser is registered with both the SEC and one or state(s), both the SEC and one or more state(s) can initiate an examination of the firm. No thanks.
The upshot of this entire article is that most advisers will only need to contemplate switching from state to SEC registration or SEC to state registration once a year at the time of filing its annual ADV amendment. Bearing in mind the RAUM thresholds, buffers, transition timeframes, and application/withdrawal logistics described above, advisers should hopefully be in a better position to evaluate whether a jurisdictional transition is required or optional… and also how to make a Lake Water cocktail!
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This article originally appeared in Michael Kitces’ Nerd’s Eye View on April 19, 2023.