Before your robo-adviser can accept its first client, it must be registered. Like other investment advisers, robo-advisers have two possible initial registration pathways. They either register with the SEC or they register with the state(s) where they maintain a place of business. Due to the additional complexity associated with state registration, most robo-advisers seek to qualify for SEC registration from the start. Here’s how you can do the same.
First, let’s talk about how the two processes work.
Whether a firm registers with the SEC or at the state level, it must complete and file the principal registration document, Form ADV. Form ADV is divided into Part 1 (a check-the-box form that is mostly for use by the regulator), and Part 2 (a narrative brochure that is the principal client disclosure document).
But that’s where the similarities end.
If the firm is seeking SEC registration, once the agency reviews and approves the firm’s Form ADV, it will declare the firm’s registration effective within approximately 45 days.
By contrast, many states use the initial ADV filing as only the first step in the registration process. After a state reviews and comments on an adviser’s initial Form ADV filing, it will often ask for and review other operational documents, such as a compliance manual or client agreement (as discussed in May). A state may even ask an adviser to submit financial statements and require an individual license (we’ll talk more about individual licenses later). Only after all requested documents have been reviewed and approved will a state declare a registration effective. And this process usually takes significantly more than 45 days.
These differences in registration routes tend to make advisers want to register with the SEC. But you have to qualify first. So let’s discuss that now.
To be eligible to register with the SEC, a robo-adviser must gather at least $100 million in assets under management (“AUM”) within 120 days of registration or commit to operate as an “internet investment adviser” under Advisers Act Rule 203A-2(e). Because the former is a big hurdle, firms often choose the latter.
To qualify as an “internet investment adviser,” a company must provide its investment advice exclusively through an online algorithmic-based program that clients interact with directly. Otherwise stated, you can’t any provide advice like traditional advisers do, using human interaction, except for a de minimis number of clients. Because this is the typical way robo-advisers deliver their services, qualifying as an internet investment adviser doesn’t present a problem for many firms. If you decide to register with the SEC based on your status as an internet investment adviser, be sure to keep written records that demonstrate that you have operated in a way consistent with that status, as required by the rule. In addition, you should adopt policies and procedures designed to ensure your firm continues to operate as an internet investment adviser.
If, however, you won’t have the required AUM in time or decide not to operate as an internet investment adviser (because, for example, you also use human interaction to deliver investment advice), then you’ll likely be required to initially register with the state(s) where you maintain a place of business. On this front, there’s good news and bad news. The bad news is that once registered and taking clients, you’ll have to register in additional states where you either add places of business or take on clients. The good news is that, as stated above, you can transition to SEC registration once you hit $100 million in AUM. Moreover, the SEC recognizes that being registered in too many states can be a compliance nightmare – you’re allowed to move to the SEC’s jurisdiction once you have to register with at least 15 states.
Thanks for reading! We hope you’ll come back for our next post from Josh Hinderliter, who will dive a little deeper on a specific part of Form ADV. In particular, Josh will discuss how robo-advisers should approach their obligation to prepare and deliver “brochure supplements,” which describe the backgrounds of certain advisory personnel.