State-registered Investment Adviser

Harkaway Wealth is filing its initial application to register as an investment adviser with the Administrator of State L. Its compliance consultant is listing what the Administrator will require. Which combination is correct?

1. A.A copy of every advertisement the firm plans to run and a list of the prospective clients it intends to solicit.Incorrect. No state requires a roster of prospects, and advertising is reviewed through examination rather than pre-cleared at registration.
2. B.Form BD, a FINRA membership application and fingerprint cards for every employee.Incorrect. Those are broker-dealer requirements. An investment adviser registers on Form ADV.
3. C.Form ADV Parts 1 and 2 through the IARD system, a consent to service of process, the filing fee, Form U4 filings for its representatives, and financial statements showing it meets the state net worth requirement.Correct. These are the standard components of an initial state investment adviser registration.
4. D.Only Form ADV Part 1 and the filing fee; Part 2, the consent and representative registrations come later, once the firm has clients.Incorrect. Part 2, the consent and representative filings are part of the initial application, not a later step.

Why: A state investment adviser registration is assembled from a predictable set of pieces. Form ADV Parts 1 and 2 are filed electronically through the IARD system, accompanied by the filing fee and a consent to service of process appointing the Administrator to receive legal process. Every individual who will act as an investment adviser representative registers separately on Form U4. Finally, the firm files financial statements showing that it satisfies the state minimum net worth or bonding requirement for the kind of authority it will exercise.

Halverlea Advisory is a state-registered investment adviser that has deliberately structured itself to avoid custody: it uses an unaffiliated qualified custodian, has no authority to withdraw client assets, and never asks clients to send it anything. On Monday morning a client, without being asked, posts Halverlea a cheque for $40,000 made payable to her custodian, together with a note asking the adviser to see that it is invested. Under the NASAA model custody rule, what must Halverlea do to avoid being deemed to have custody?

1. A.Nothing, because the cheque is payable to the qualified custodian rather than to Halverlea.The payee line does not control. The adviser is in possession of a client asset and must act to negate custody.
2. B.Forward the cheque to the qualified custodian within three business days of receiving it.Forwarding is not the prescribed cure under the model rule. The asset must go back to the sender.
3. C.Return the cheque to the client within three business days of receiving it.Correct. Returning inadvertently received funds or securities to the sender within three business days prevents the adviser from being deemed to have custody.
4. D.Deposit the cheque in a separate account maintained solely for inadvertently received client funds.Depositing the cheque anywhere places the adviser in control of client assets, which is precisely what having custody means.

Why: An adviser that inadvertently receives client funds or securities is not automatically treated as having custody, provided it acts quickly. The model rule gives the firm a short window: it must return the funds or securities TO THE SENDER WITHIN THREE BUSINESS DAYS of receiving them. Forwarding the cheque onward to the custodian is not the prescribed cure, and neither is holding it while seeking instructions, because both leave the adviser in possession of client assets. The rule's logic is that custody is about possession and control, so the only reliable way to negate an inadvertent receipt is to put the asset straight back where it came from, promptly, and to document that you did.

Wrenmarsh Counsel charges 2.75% a year on assets under management for a straightforward balanced-portfolio service. Advisers in its market charge between 0.80% and 1.20% for essentially the same service. Wrenmarsh does not mention the comparison to prospective clients. Under NASAA model rules, Wrenmarsh:

1. A.has done nothing improper, because a client who signs the advisory contract has accepted the feeConsent to a fee the client cannot evaluate does not satisfy the disclosure obligation.
2. B.has violated the rules, because state-registered advisers may not charge more than the prevailing rate in their marketNo rule caps advisory fees at a market rate.
3. C.has violated the rules, because an adviser charging fees materially higher than those generally charged for similar services must disclose that fact to clientsCorrect. The obligation is to disclose a materially higher fee so clients know comparable services may cost less elsewhere.
4. D.has done nothing improper, because fee disclosure is required only where the adviser also receives commissionsThe disclosure obligation does not depend on the adviser receiving commissions.

Why: An adviser is not required to be the cheapest, and the model rules do not set a fee schedule. What they do require is disclosure: where an adviser charges fees materially higher than those generally charged for similar services, it should disclose that fact so the client understands comparable services may be available elsewhere for less. Charging a fee that is unreasonable in relation to the services rendered is itself an unethical practice, but the immediate failing on these facts is the silence, because the client cannot evaluate the fee without knowing it is well outside the market.

Threlkeld Bay Advisers is a state-registered investment adviser whose principal place of business is in State V, where it is registered and fully compliant with State V books and records and net worth rules. It is also registered in State W, whose rules would require a longer retention period and a higher minimum net worth. Under the Uniform Securities Act, State W:

1. A.may not impose recordkeeping or net worth requirements greater than those of State V, the adviser principal place of businessCorrect. Home state requirements govern so long as the adviser is licensed there and in compliance.
2. B.may enforce its own longer retention and higher net worth requirements, because the adviser chose to register thereRegistering in a second state does not subject the adviser to that state stricter books and records or financial rules.
3. C.may impose any requirement it wishes, because the preemption of state rules applies only to federal covered advisersThis home state rule is separate from federal preemption and applies among the states to state-registered advisers.
4. D.may enforce the higher net worth requirement but not the longer retention periodBoth categories are covered by the same home state rule. Neither may be raised.

Why: For a state-registered investment adviser, the recordkeeping and financial requirements of the state where the adviser maintains its principal place of business control, provided the adviser is licensed in that state and in compliance with its rules. Other states in which the adviser is registered may not impose requirements that exceed the home state standards. This prevents an adviser with clients in many states from having to satisfy the strictest rule in each.