The SEC’s Division of Investment Management has closed a potential loophole in the federal securities laws through which some fund advisers may have attempted to squeeze to avoid registration.
The loophole involves the definition of an investment adviser. Section 2(a)(20)(iii) of the Investment Company Act of 1940 excludes from the definition of an investment adviser anyone who provides advisory services “at cost” to one or more investment companies, insurance companies, or other financial institutions.” Section 2(a)(20)(iii) was not, however “intended to provide an exclusion for investment advisers who provide services temporarily at cost to particular clients.”
Section 2(a)(20)(iii) is pertinent when an advisory contract with a registered investment company automatically terminates because of its assignment (resulting, for example, from a change of control of the adviser). In that case, the adviser may, under certain conditions, rely on Rule 15a-4 under the 1940 Act to provide temporary advisory services under an interim advisory contract prior to obtaining shareholder approval of a new contract. If fund shareholders fail to approve a permanent agreement, the investment adviser may be paid its costs of providing the interim services.
This begs the question: If the adviser is providing services at cost, does it fall outside the definition of an investment adviser, and thus escape registration?
Not so fast, the Division says in Compliance Update No. 2013-13. Investment advisers cannot claim an exemption from registration when they provide temporary advisory services to registered investment companies at cost or for no compensation after an “assignment” of an investment advisory contract. To look at this otherwise would be inconsistent with the investor protections of the 1940 Act.