The Investment Advisers Act of 1940

Contents

1. The statute in brief
2. The companion act of the same year
3. The first registrations
4. The duty read into the act
5. Credentials and the legal duty
6. Who the act does not reach
7. The act in the modern debate
8. Where the evidence is strongest

Brent O’Mara holds the Certified Fund Specialist and Accredited Investment Fiduciary designations, and the second of those designations carries a word that traces back to a federal statute written in the last years of the New Deal. The Investment Advisers Act became law in 1940, registration under it opened that December, and by the following February the Securities and Exchange Commission had a first roster of registrants.¹ Nearly eight decades later, in June 2019, the same agency published a formal interpretation of the standard of conduct the act imposes.² Between those dates sits most of the modern argument about what an adviser owes the people who pay for advice.

The statute in brief

The act is short on poetry and long on definitions. Its central move is to say who counts as an investment adviser and to require that such a person register. The SEC’s own plain language summary describes an investment adviser as a firm or person that, for compensation, engages in the business of advising others about the value of securities or about investing in them, or that issues reports or analyses about securities as part of a regular business, and the agency’s definition turns on those three elements together: compensation, the business of advising, and securities.⁴ A neighbor who shares an opinion for free is not an adviser under the act. A firm paid to give that opinion as its trade is.

Figure

The act in five dates

1. 01
   1940Congress passes the Investment Advisers Act alongside the Investment Company Act, both aimed at conflicts in the business of managing other people's money.
2. 02
   December 1940Registration opens; by February 18, 1941 the SEC had registered 709 advisers, and fifty three applications became effective in the first two months of the new year.
3. 03
   2009 to 2016Columnists and state officials press the question of why only some advice givers are held to the fiduciary standard the act created.
4. 04
   June 5, 2019The SEC publishes an interpretation of the standard of conduct advisers owe under the act, release IA 5248.
5. 05
   July 12, 2019The interpretation appears in the Federal Register at 84 FR 33669.

The companion act of the same year

Congress passed a second statute in 1940 that is often read beside the first. The Investment Company Act regulates pooled investment funds, and the legal reference service at Cornell explains the worry behind it: once the people who owned a fund were separated from the people who controlled it, there was no effective way to watch what the managers were doing, and a fear grew that managers would act in their own interest.⁸ The remedy was registration, mandatory disclosure, limits on borrowing, and governance rules that required a share of a fund’s directors to be independent of its adviser, and the Cornell summary notes that the act also imposed fiduciary duties on a fund’s officers, directors and investment advisers.⁸ Among its governance rules, at least 40 percent of a fund’s directors had to be unaffiliated with its adviser or sponsor, and transactions between a fund and its affiliates were limited; private funds offered to fewer than 100 owners, or only to qualified purchasers, fell outside the act altogether.⁸ The two acts share a premise: that handling other people’s money creates conflicts the law should name and constrain.

The first registrations

The earliest public record of the act in operation is a wire report from Washington. On February 20, 1941, the SEC announced that 709 investment advisers had registered under the new law by February 18, and that between December 19, 1940 and February 18, 1941 fifty three applications had become effective, six registrations had been withdrawn and one canceled.¹ The newspaper account then listed the New York registrants by name and street address, a mix of sole proprietors, statistical services and established investment houses, which gives a sense of how varied the trade already was.¹ The same dispatch recorded that four New York registrations had been withdrawn in the period and one, in Rochester, canceled, a reminder that the register was a living list from its first weeks.¹

Figure

The advice industry in 2016

share of the advice industry made up of registered investment advisers, long bound by law to act in clients' best interest

15 percent

share made up of brokers and other advisers often not bound to the fiduciary standard

85 percent

retirement savings held by Americans at the time of the rule

$14 trillion

The duty read into the act

The text of the act does not speak of fiduciaries the way a trust instrument would. The duty arrived through interpretation. The SEC’s 2019 release describes itself as an interpretation of the standard of conduct for investment advisers under the act, issued on June 5, 2019 and published in the Federal Register on July 12 of that year.² A retirement columnist summarizes the agency’s position in one line: the fiduciary duty an adviser owes under the 1940 act includes duties of both care and loyalty, and the column stresses that this legal duty is distinct from a moral commitment or a professional code of ethics.³ Those two duties, care and loyalty, are the same pair that bind a trustee, and the entry on the duty of loyalty in trust law follows that older thread.

Credentials and the legal duty

The same columnist makes a point that matters to anyone reading a business card. A designation, an oath or a training program may be valuable, but it does not by itself create a legal fiduciary relationship; the writer names the Accredited Investment Fiduciary designation as one that reflects fiduciary related training, an examination and an ethics requirement, while cautioning that the legal standard that applies to a given piece of advice comes from the law under which the adviser is registered, not from the letters after a name.³ The column sorts the word into three senses: a moral fiduciary, who tries to do right out of character; an ethical fiduciary, who has agreed to a professional code; and a legal fiduciary, who is subject to fiduciary obligations under federal or state law because he or she acts as an investment adviser or an adviser’s representative.³ Only the third sense is the statute’s. Under the Advisers Act, registration is what attaches the duty.

Who the act does not reach

A 2009 personal finance column drew the boundary plainly. Registered investment advisers are overseen by the SEC or by the states where they do business and must legally adhere to the fiduciary standard, while stockbrokers fall under an industry body and are not held to it; a broker who is also registered as an adviser must act as a fiduciary when giving investment advice but need not when selling products as a broker.⁵ State securities administrators said much the same in 2013, noting that anyone licensed as an investment adviser must, by law, act as a fiduciary and put the interests of clients ahead of his or her own, and that with so many brokers calling themselves financial advisers, investors might assume every such person was licensed under the act.⁶ The entry on suitability versus fiduciary duty explains the standard brokers answer to instead.

Figure

Two kinds of professional under the law

	Registered investment adviser	Stockbroker
Who oversees them	The SEC or the states where they do business	An industry self regulatory body
Standard of conduct	Must legally act as a fiduciary	Not held to the fiduciary standard
When both licenses are held	Fiduciary when giving investment advice	Not a fiduciary when selling products as a broker

The act in the modern debate

By 2016 the gap between the two regimes had become a matter of national policy. A public television report on the Labor Department’s retirement rule observed that registered investment advisers had for decades been obligated by law to act in their clients’ best interest, yet represented only about 15 percent of the advice industry, with the remaining 85 percent often not bound to the fiduciary standard.⁷ That report put the retirement savings at stake at around $14 trillion, and described a rule more than six years in the making that would let brokers keep earning commissions only after signing an enforceable contract promising to serve the customer’s interest.⁷ State administrators had already called on federal authorities to hold every professional giving advice to retail investors to a fiduciary standard.⁶ The later chapters of that effort are covered under ERISA and retirement plan fiduciaries and Regulation Best Interest and Form CRS.

Where the evidence is strongest

Three things about the act rest on firm ground. The definition is statutory and the SEC restates it in plain words: compensation, the business of advising, securities.⁴ The twin duties, care and loyalty, are the agency’s own stated reading, set out in a 2019 interpretive release.² And the registration regime began working at once, with hundreds of filings in the first months.¹ What is less settled is everything around the edges: which titles may be used, how a person holding two licenses switches between standards, and how far the fiduciary idea should extend beyond those the act names. How any of this bears on a particular household depends on individual circumstances, so it is a question for qualified professionals rather than for a general reference. The statute itself, now well past its eightieth year, remains the point from which every such question starts.