LAW-16-14-00008-P Registration and Conduct of Investment Advisors

4/23/14 N.Y. St. Reg. LAW-16-14-00008-P

NEW YORK STATE REGISTER

VOLUME XXXVI, ISSUE 16

April 23, 2014

RULE MAKING ACTIVITIES

DEPARTMENT OF LAW

PROPOSED RULE MAKING

NO HEARING(S) SCHEDULED

 

I.D No. LAW-16-14-00008-P

Registration and Conduct of Investment Advisors

PURSUANT TO THE PROVISIONS OF THE State Administrative Procedure Act, NOTICE is hereby given of the following proposed rule:

Proposed Action:

Amendment of sections 11.1(d), 11.14(a), 11.15; repeal of sections 11.7, 11.13(a)(6) and 11.16 of Title 13 NYCRR.

Statutory authority:

General Business Law, section 359, art. 23-A

Subject:

Registration and conduct of investment advisors.

Purpose:

To provide investors with information to reduce possibility of fraud; clarify current rules; and conform them with Federal law.

Text of proposed rule:

Section 11.1(d) of title 13 is amended to read as follows:

(d) Designation. The Attorney General may by regulation, rule or order designate the web-based Investment Adviser Registration Depository ("IARD") operated by [NASD] FINRA to receive and store filings and collect related fees from the investment advisers on behalf of the Attorney General.

Section 11.14(a) of title 13 is amended to read as follows:

(a) Financial statements of an investment adviser shall be prepared in accordance with generally accepted accounting principles including reserves or liabilities for unfulfilled subscriptions. Where financial statements are unaudited by an independent public accountant, a certification by management is required attesting to the accuracy of such statements. Nothing in this regulation shall abrogate the requirement, set forth in Form ADV: Part 2A, Item 18 A.1., that investment advisers charging certain fees six months or more in advance must submit audited financial statements.

Section 11.15 of title 13 is amended to read as follows:

Distribution of investment adviser statement. Each [New York client of an] investment adviser registered in the State of New York must:

(a) deliver to a client or prospective client [shall annually be sent a statement indicating that New York State clients may obtain from the investment adviser] either a copy of the investment adviser statement Form ADV, or a [publication] brochure containing all of the information set forth therein[.Such documentation must be furnished to clients who request it in writing within seven (7) days of the receipt of the request. A charge may be made for such copy.] , before or at the time of entering into an investment advisory contract with that client; and

(b) deliver to each client, annually within 120 days after the end of the fiscal year of such adviser, and without charge, if there are material changes in such statement or brochure since any annual updating amendment:

(i) a current statement or brochure, or

(ii) the summary of material changes to any statement or brochure as required by Item 2 of Form ADV, Part 2A that offers to provide your current brochure without charge, accompanied by the Web site address (if available) and an e-mail address (if available) and telephone number by which a client may obtain the current statement or brochure from you, and the Web site address for obtaining information about you through the Investment Adviser Public Disclosure (IAPD) system.

Sections 11.7(a), 11.13(a)(6) and 11.16 of title 13 are hereby repealed.

Text of proposed rule and any required statements and analyses may be obtained from:

Gregory Krakower, Department of Law, 120 Broadway, New York, NY 10271, [phone], email: [e-mail]

Data, views or arguments may be submitted to:

Same as above.

Public comment will be received until:

45 days after publication of this notice.

This rule was not under consideration at the time this agency submitted its Regulatory Agenda for publication in the Register.

Regulatory Impact Statement

1. Statutory Authority. Section 359-eee of the General Business Law requires investment advisers to register with the Attorney General. Section 359-eee grants the Attorney General authority to promulgate rules and regulations governing the registration of investment advisers. See, e.g., General Business Law section 359-eee(2)(B), (4)(B), (5), (6), (9), (10).

2. Legislative Objectives. The objectives of the rule are to: (1) ensure that all investors are provided with information to reduce the possibility of fraud and to empower them to make sound decisions in connection with doing business with an investment adviser; (2) clarify current rules; and (3) update current rules that have become outdated or moot because of changes to federal law or other reasons.

3. Needs and Benefits. Clients and prospective clients of investment advisers need to be provided with, or have access to, certain information about an investment adviser’s business to better enable them to make sound investment decisions and to reduce the risk that they will be victimized by fraud. The proposed rule will further these objectives by increasing the amount of information that must be delivered to clients of certain investment advisers, and by clarifying current rules to improve the financial statements that certain investment advisers must file when they register with the Attorney General. Specifically, the rule does the following:

(a) Requires investment advisers that register with the Attorney General to deliver a statement or brochure describing their business to clients and prospective clients, along with any material changes to those statements or brochures. This requirement fills in the gap created by the current interaction of federal and state law whereby investment advisers with over $25 million of assets under management have to deliver (as opposed to offer to deliver) such statements and brochures, but those with less than $25 million of assets under management only have to offer to deliver such statements and brochures. The gap is created because federal law mandates that all investment advisers registered with the Securities and Exchange Commission (SEC) actually deliver such statements and brochures to clients and prospective clients, but it does not require New York investment advisers with less than $25 million of assets under management to register with the SEC. New York rules, meanwhile, require investment advisers with less than $25 million of assets under management to register with the Attorney General but only requires them to offer to deliver the statements and brochures. Accordingly, the proposed rule will result in investment advisers with less than $25 million of assets under management having to deliver (as opposed to merely offer to deliver) such statements and brochures to their clients and prospective clients;

(b) Clarifies existing requirements that registered investment advisers who charge fees in advance must provide audited financial statements (as opposed to unaudited financial statements) when they register with the Attorney General; and

(c) Updates current rules that have become outdated or moot by deleting references to registration exemption requirements that no longer exist, expired provisions, and a regulatory organization that no longer exists. The proposed rule will eliminate confusion that may be caused by the outdated provisions.

4. Costs. (A) The rule will result in costs on investment advisers with less than $25 million of assets under management by requiring them to deliver (as opposed to offer to deliver) a statement or brochure describing their business to prospective clients and any material changes to those statements or brochures, and preventing them from charging a specific fee for such delivery. Accordingly, such investment advisers might have to bear additional costs of delivering additional statements and brochures because of the rule. However, while the rule prevents covered investment advisers from charging a specific fee for delivering such brochures, it does not prevent them from passing on the costs to their clients through increased fees. (B) Although current rules clearly require investment advisers that charge fees six months or more in advance to provide audited statements when they register with the Attorney General by using Form ADV, see 13 N.Y.C.R.R. § 11.4, there may be some confusion as to whether language in 13 N.Y.C.R.R. § 11.14 contradicts this requirement by referencing unaudited financial statements. The proposed rule simply clarifies that investment advisers who charge fees six months or more in advance from their clients must provide audited financial statements. The rule may result in some registered investment advisers bearing additional costs of providing audited financial statements with their registration, although the rule does not impose any additional requirement that results in such costs: those affected will merely be formerly non-compliant regulated advisers brought into compliance with the rule. (C) There will be no additional costs imposed on any state agency because of the rule.

5. Paperwork. The rule will require investment advisers with less than $25 million dollars of assets under management to create and deliver additional statements and brochures to their clients and prospective clients.

6. Local Government Mandates. None.

7. Duplications. Federal law requires New York investment advisers doing business in New York with over $25 million of assets under management to register with the SEC and notice file in New York. New York law requires New York investment advisers with less than $25 million of assets under management to register with the Attorney General. The provision of the proposed rule requiring that investment advisers registered with the Attorney General actually deliver (as opposed to offer to deliver) brochures and statements to clients and prospective clients conforms with federal rules regarding investment advisers registered with the SEC. The rule thus creates a single uniform standard for all investment advisers with respect to such deliveries, regardless of whether they are registered with the Attorney General, the SEC, or both agencies.

8. Alternatives. The Attorney General considered keeping the current rules in respect to the delivery of statements and brochures for investment advisers with less than $5 million of assets under management to avoid imposing any added costs on relatively small investment advisers. However, this alternative was rejected because it would result in New York investors who were clients or prospective clients of such advisers not having necessary information to make sound investment choices, and being more vulnerable to fraud.

9. Federal Standards. The proposed rule adopts the federal standards with respect to investment advisers registered with the SEC by requiring them to deliver (as opposed to offer to deliver) a statement or brochure describing their business to prospective clients and any material changes to those statements or brochures, and preventing them from charging a specific fee for such delivery. The proposed rule thus creates a single uniform standard for all investment advisers with respect to such deliveries, regardless of whether they are registered with the Attorney General, the SEC, or both agencies. The proposed rule also eliminates an exception to when an investment adviser must register with the Attorney General that is based on a provision of federal law addressing so-called “private advisers” that no longer exists, thus conforming OAG regulations with federal law in this regard.

10. Compliance Schedule. Regulated persons should be able to comply with this rule immediately.

Regulatory Flexibility Analysis

1. Effect of rule on small businesses and local governments: (A) Small businesses. The rule is expected to apply to approximately 1,234 investment advisers. Some, but not all, of these investment advisers will be small businesses or employed by small businesses. (B) Local governments. By virtue of its subject matter, the rule does not apply to local governments.

2. Compliance requirements: The rule will result in a small amount of paperwork to small businesses that are New York investment advisers with less than $25 million of assets under management and registered with the Attorney General. Such businesses will be required to deliver (as opposed to merely offer to deliver) a statement or brochure describing their business to prospective clients and any material changes to those statements or brochures, and prevents them from charging a specific fee for such delivery. Accordingly, such investment advisers might have to engage in additional reporting requirements as a result of delivering additional statements and brochures.

3. Compliance costs: (A) The rule may result in some costs to small businesses that are investment advisers with less than $25 million of assets under management and registered with the Attorney General. Such small businesses will be required to deliver (as opposed to merely offer to deliver) a statement or brochure describing their business to prospective clients and any material changes to those statements or brochures, and preventing them from charging a specific fee for such delivery. Accordingly, such investment advisers might have to bear additional costs of delivering additional statements and brochures because of the rule. However, while the rule prevents covered investment advisers from charging a specific fee for such delivery, it does not prevent businesses from passing on the costs to clients through increased fees. Since investment advisers under current rules have to deliver such statements and brochures to clients upon request, the rule is not expected to require small businesses to have to use additional professional services in order to comply with the rule. (B) Although current rules clearly require investment advisers that charge certain fees six months or more in advance to provide audited statements when they register with the Attorney General by using Form ADV, see 13 N.Y.C.R.R. § 11.4, there may be some confusion as to whether language in 13 N.Y.C.R.R. § 11.14 contradicts this requirement by referencing unaudited financial statements. The proposed rule clarifies that investment advisers who charge fees six months or more in advance from their clients or more must provide audited financial statements. Accordingly, the rule may result in some registered investment advisers that are small businesses bearing additional costs of providing audited financial statements with their registration, although the rule does not impose any additional requirement that results in such costs: those affected will merely be formerly non-compliant regulated advisers brought into compliance with the rule.

4. Feasibility of compliance: Small businesses that are covered by the rule will easily be able to comply with the rule. The costs and additional paperwork required by the rule are small. Furthermore, current law already mandates that businesses covered by the rule offer to deliver such statements and brochures to clients and prospective clients, and deliver them upon request. Accordingly, small businesses covered by the rule are expected to have little trouble complying with the rule.

5. Minimizing adverse impact: The rule will not have a significant adverse impact on small businesses or local governments. The Department of Law minimized any impact on such businesses by refraining from requiring them to include any information in their reports or brochures that is not currently required to be included under current law. Indeed, small business and local governments will benefit from the rule if they contract with an investment adviser covered by the rule because the adviser will be required to deliver investment statements and brochures as opposed to just offer to deliver them.

6. Economic and technological feasibility: The rule imposes no additional technological requirements on small businesses.

7. Local government and small business participation: In order to ensure that small businesses and local governments have an opportunity to participate in the rule making process, a copy of the proposed rules has been sent to the Executive Director of the New York State Association of Counties, the New York Conference of Mayors, the Chamber of Commerce, the New York State Business Counsel, and the Business Law Section of the New York Bar Association. A copy of the proposed rules will also be posted on the web site of the Attorney General.

Rural Area Flexibility Analysis

1. Types and estimated numbers of rural areas. The rule applies uniformly throughout the state, including all rural areas. Executive Law, Article 19-F Rural Affairs Act, Section 481(7) defines a rural area as a county with a population of less than 200,000. New York currently has 44 counties that would constitute rural areas. The rule is expected to apply to approximately 1,234 New York investment advisers. Some, but not all, all of these investment advisers will be small businesses, or employed by small businesses, and a small portion of these may be located in rural areas.

2. Compliance requirements. The rule will result in a small amount of paperwork to those small businesses in rural areas that are New York investment advisers with less than $25 million of assets under management and registered with the Attorney General. Such businesses will be required to deliver (as opposed to merely offer to deliver) a statement or brochure describing their business to prospective clients and any material changes to those statements or brochures, and prevented them from charging a specific fee for such delivery. Accordingly, such investment advisers might have to engage in additional reporting requirements as a result of delivering additional statements and brochures. Since investment advisers under current rules have to deliver such statements and brochures to clients upon request, the rule is not expected to require small businesses in rural areas to have to use additional professional services in order to comply with the rule.

3. Compliance costs. (A) The rule may result in some costs to investment advisers in rural areas with less than $25 million of assets under management and registered with the Attorney General. Such small businesses will be required to deliver (as opposed to merely offer to deliver) a statement or brochure describing their business to prospective clients and any material changes to those statements or brochures, and preventing them from charging a specific fee for such delivery. Accordingly, such investment advisers might have to bear additional costs of delivering additional statements and brochures because of the rule. However, while the rule prevents such investment advisers from charging a specific fee for such delivery, it does not prevent businesses from passing on the costs to its clients through increased fees. (B) Although current rules clearly require investment advisers that charge certain fees six months or more in advance to provide audited statements when they register with the Attorney General by using Form ADV, see 13 N.Y.C.R.R. § 11.4, there may be some confusion as to whether language in 13 N.Y.C.R.R. § 11.14 contradicts this requirement by referencing unaudited financial statements. The proposed rule clarifies that investment advisers who charge fees six months or more in advance from their clients must provide audited financial statements. Accordingly, the rule may result in some registered investment advisers that are located in rural areas bearing additional costs of providing audited financial statements with their registration, although the rule does not impose any additional requirement that results in such costs: those affected will merely be formerly non-compliant regulated advisers brought into compliance with the rule.

4. Minimizing adverse impact. The rule will not specifically impact rural areas in any way, and relatively few investment advisers located in rural areas will be affected by the rule. The Department of Law minimized any impact on any covered businesses in rural areas by refraining from requiring them to include any information in their reports or brochures that is not currently required to be included under current law. Indeed, businesses and investors in rural areas will benefit from the rule when they contract with an investment adviser covered by the rule because the adviser will be required to deliver investment statements and brochures as opposed to just offer to deliver them.

5. Rural participation. In order to ensure that interested parties in rural areas have an opportunity to participate in the rule making process, a copy of the proposed rule will be given to the New York State Business Counsel and the Business Law Section of the New York Bar Association. A copy of the rule will be posted on the Attorney General's website.