The Interaction Between Dodd-Frank and Minnesota Regulation of Investment Advisers
Before enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the following rules applied under the Investment Advisers Act of 1940:
- The Investment Advisers Act precluded investment advisers with less than $25 million in assets under management from registering with the SEC and left the regulation of those investment advisers in the hands of the states.
- Investment advisers with more than $25 million under management but less than $30 million under management were eligible to register with the SEC as an alternative to registering with each state in which the advisers did business unless exempt under rules of the applicable state.
- Investment advisers with more than $30 million under management were required to register with the SEC.
Investment advisers often found SEC registration desirable as compliance was more easily achieved than registration and regulation by multiple states with differing regulatory and compliance regimes.
The Dodd-Frank Act attempts to shift regulation of investment advisers to the state level by making certain investment advisers who previously would have selected federal registration ineligible for registration with the SEC. Under Section 410 of the Dodd-Frank Act, investment advisers who meet the following definition are precluded from registering with the SEC, unless the investment adviser would be required to register with 15 or more states:
- The investment adviser is required to be registered as an investment adviser with the securities commissioner (or any agency or office performing like functions) of the state in which it maintains its principal office and place of business and, if registered, would be subject to examination as an investment adviser by any such commissioner, agency, or office; and
- The investment adviser has assets under management between $25 million and $100 million.
On its face, Section 410 of the Dodd-Frank Act appears to compel many investment advisers that previously used the federal registration system to register with each state in which they do business. However, under the Minnesota Securities Act and the associated rules, there are several exemptions available to investment advisers so that registration with the State of Minnesota would not be required in many circumstances. For example, investment advisers whose only clients in the State of Minnesota are accredited investors (as defined in Rule 501 of Regulation D) or “institutional investors” (as defined in Minn. Stat. 80A.41, subd. 12) are not required to register with the State of Minnesota. Investment advisers exempt from registration in the State of Minnesota with assets under management of between $25,000,000 and $100,000,000 would therefore still be required to register with the SEC because they would be neither “required to be registered” with the State of Minnesota nor “subject to examination” by the State.
Note that the Dodd-Frank Act also eliminates an exemption from federal registration for investment advisers with fewer than 15 clients, which is an exemption that has historically been relied upon by private equity groups and hedge funds. However, the Dodd-Frank Act provides a separate exemption from registration with the SEC for most private equity groups and hedge funds so long as those funds have assets under management of less than $150 million. It is likely those investment advisers are also exempt from registration with the State of Minnesota because the same exemptions discussed above are available.
Registration With the State of Minnesota
The following sections describe the process by which an investment adviser registers with the State of Minnesota.
An investment adviser makes an initial application for registration in Minnesota by paying a $100 filing fee and submitting a Uniform Application for Investment Adviser Registration on Form ADV. Form ADV must be filed electronically through the Investment Advisory Registration Depository, or IARD, which is a uniform electronic filing system maintained by the SEC to facilitate both federal and state registration of investment advisers. In addition, an investment adviser without a principal place of business in Minnesota must submit a consent to service of process in Minnesota and an appropriate resolution appointing the Commissioner of Commerce as its agent for such purposes, preferably on Form U-2 or U-2A. There are also several other requirements for registration in Minnesota that are described in more detail below, including the provision of proof relating to the experience of supervisory personnel, the submission of financial statements meeting certain standards, minimum financial requirements, and, in some cases, the posting of a surety bond.
Generally speaking, an application becomes effective on the 45th day after the filing of a completed application. Unless the investment adviser is a partnership, sole proprietorship, or Minnesota corporation, the adviser will need to qualify to do business in Minnesota as a foreign corporation. Application information is available from the office of the Minnesota Secretary of State (www.sos.state.mn.us/).
Proof of Experience of Supervisory or Control Individuals
An investment adviser seeking registration in Minnesota must submit proof that each person in a supervisory or control capacity has passed either the Uniform Investment Adviser State Law Examination (S65) or the Uniform Combined State Law Examination (S66) within the two year period immediately preceding the date of application. In addition, at least one person in a full-time supervisory position with the investment adviser must have been actively engaged in the securities business in a similar supervisory capacity for a minimum of three of the preceding five years. Since Form U-4 does not provide sufficient detail of such background for purposes of this requirement, the adviser should submit a detailed descriptive narrative of the employment history of the supervisory person or persons.
The exam requirement may be waived in certain circumstances. For example, if within the last two years the investment adviser has been registered in any other state that requires licensing, registration, or qualification of investment advisers, then the investment adviser is exempt from the examination requirement for purposes of its application for registration in Minnesota. In addition, the examination requirement is waived for persons who have been awarded certain professional designations relating to the financial services industry (e.g., Certified Financial Planner awarded by the Certified Financial Planners Board of Standards), provided such designation is current and in good standing.
If an investment adviser has custody of client funds or securities, or requires the payment of advisory fees six months or more in advance and in amounts in excess of $500 per client, then the investment adviser must submit an audited balance sheet as of the investment adviser’s most recent fiscal year along with the application for registration in Minnesota. If the investment adviser’s most recent fiscal year ended within 135 days of the date of application, then an audited balance sheet as of the adviser’s second most recent fiscal year is acceptable.
Investment advisers that do not have custody of client funds or securities, but do have discretionary authority over client funds or securities must submit a balance sheet along with the application for registration, although the balance sheet need not be audited.
Advisers whose principal place of business is outside of Minnesota need only submit the reports that are required by the adviser’s home state (provided the adviser is registered in its home state) along with the Minnesota application. If a balance sheet, audited or otherwise, is not required in the adviser’s home state, it will not be required for registration in Minnesota.
If an investment adviser seeking registration in Minnesota has or will have discretionary authority over or custody of client funds or securities, the adviser must post a surety bond or an irrevocable letter of credit in the amount of $25,000. There is an exemption from this bonding requirement for an investment adviser that continuously maintains net capital of at least $100,000.
For an investment adviser with its principal place of business in another state, the adviser need not post a surety bond or letter of credit, provided that it is registered in its home state and is in compliance with its home state’s bonding requirements.
Minimum Financial Requirements
Investment advisers registered in Minnesota are subject to one of several different net worth standards, depending on the nature of the adviser’s business. Investment advisers that have or will have custody of client funds or securities must maintain a net worth of at least $35,000. However, this net worth requirement does not apply if the investment adviser only has custody of client funds or securities by reason of direct fee deduction or advising pooled investment vehicles, provided the adviser complies with rules relating to the safeguarding of client assets and the manner and method of deductions from client funds.
Investment advisers that have discretionary authority, but not custody, over client funds or securities must maintain a net worth of at least $10,000. Investment advisers that have neither custody nor discretionary authority over client funds or securities, but that accept prepayment of more than $500 per client and six months or more in advance must maintain a positive net worth.
Note that “net worth” in this context has a specific definition that excludes the value of “all assets of intangible nature,” including intellectual property, as well as personal items that are not readily marketable, such as homes, home furnishings, and automobiles. The value of loans or advances to insiders such as stockholder, officers, or partners is also excluded from the definition of net worth.
In order to maintain its Minnesota licensure, an investment adviser must submit an application for annual renewal registration electronically with IARD, along with a $100 renewal fee and, if the adviser is subject to the surety bond requirement, a copy of the surety bond.