SEC Enhances Exemption Rules for Internet-Based Investment Advisers

On April 9, 2024, the Securities and Exchange Commission (SEC) announced new amendments to the rule allowing internet-based investment advisers to register with the SEC rather than state regulatory agencies (the “Internet Adviser Exemption”).

The amendments stipulate that an internet investment adviser must provide investment advice to all of its clients exclusively through an “operational” interactive website at all times while relying on the Internet Adviser Exemption. The revisions also remove the exception in the current rule that allowed internet investment advisers to have fewer than 15 non-internet clients in the preceding 12 months; they introduce the term “digital investment advisory service”; require advisers to serve more than one client with ongoing digital investment advisory services; add an exception for “temporary technological outages of a de minimis duration”; and mandate advisers to make a representation of eligibility on Schedule D of Form ADV.

The amended rule will take effect on July 8, 2024, with a compliance deadline of March 31, 2025. Advisers that are no longer eligible to rely on the amended Internet Adviser Exemption and have no other basis for registration with the SEC must register in one or more states and withdraw their registration with the SEC by June 29, 2025. If not withdrawn after this date, the SEC expects to cancel the registration of those advisers no longer eligible.

Background

The responsibility for regulating investment advisers is divided between the SEC and state regulatory agencies. Generally, the Investment Advisers Act of 1940 (the “Advisers Act”) prohibits investment advisers from registering with the SEC unless the adviser has more than $25 million in assets under management or is an adviser to a registered investment company. Under this framework, an internet-based adviser would typically need to register with state regulatory agencies because the adviser would not meet the SEC registration thresholds.

To alleviate the registration burden on internet-based advisers, the SEC introduced the Internet Adviser Exemption in 2002. This exemption allowed advisers that provide investment advice to all of their clients exclusively through an interactive website and those that served fewer than 15 non-internet clients within the previous 12 months to register with the SEC under the Advisers Act.

2024 Amendment

Since the exemption’s implementation in 2002, the asset management industry has seen significant growth and change, with technology becoming central to how many investment advisers deliver their products and services to clients. Advisers are increasingly using technology to interact with clients, including through email, websites, mobile applications, investor portals, text messages, chatbots, and other digital platforms.

With the growth in assets under management and the evolution of technology in the investment advisory industry, there has been an increase in the number of advisers seeking to rely on the Internet Adviser Exemption. However, the Internet Adviser Exemption was initially a narrow exemption for those that exclusively provide investment advice through an interactive website, defined in the current rule as a “website in which computer software-based models or applications provide investment advice to clients based on personal information each client supplies through the website”. Numerous advisers did not qualify for the exemption, leading to an increase in registration withdrawals and cancellations of internet investment advisers, often because the adviser did not have an operational interactive website.

To modernize the exemption, address technological and other industry developments that have occurred since 2002, and preserve the exemption’s narrow scope, the SEC adopted the following amendments:

A. Operational Interactive Website Advisers relying on the internet adviser exemption to register with the SEC must provide their investment advice exclusively through an operational interactive website, defined as “a website, mobile application or similar digital platform through which the investment adviser provides digital investment advisory services on an ongoing basis to more than one client (except during temporary technological outages of a de minimis duration).” The adviser must provide the services through the website at the time of the adviser’s registration and at all times the adviser is registered in reliance on the amended Internet Adviser Exemption.

The definition of an operational interactive website differs from the definition of “interactive website” in the current rule as it acknowledges not only websites but other types of digital platforms and recognizes that different types of technologies may develop in the future, while reinforcing that qualifying technologies must be ones through which an adviser can provide digital advisory services consistent with the rule. A hardship clause is also incorporated into the definition to allow an internet investment adviser to satisfy the rule despite temporary technological outages of the operational interactive website of a de minimis duration.

B. Digital Investment Advisory Service To qualify for the exemption, the investment advice to clients must be “generated by” the website’s software-based models, algorithms, or applications based on personal information supplied by each client through the operational interactive website. Human-directed client-specific investment advice, even if delivered through electronic means, would not be eligible activity under the Internet Adviser Exemption. So, for example, if an adviser’s personnel generate, modify, or otherwise provide client-specific investment advice through the operational interactive website, the activity would not qualify for the exemption.

Does this mean that advisory personnel cannot interact with advisory clients? No. The amendments do not prohibit advisory personnel from all interactions with advisory clients. Consistent with the current rule, advisory personnel can continue to assist clients with technical issues or collect feedback in connection with the use of the website (e.g., accessing the website). They can also assist clients with explanations of how the algorithm generating the investment advice was developed or operates. These services can be provided via telephone, email, live electronic chats, and similar forms of electronic communication.

C. Elimination of De Minimis Exception for Non-Internet Clients The amendments eliminated the de minimis exception that permitted an internet investment adviser to provide investment advice to fewer than 15 non-internet clients during the preceding 12 months. As a result, advisers relying on the Internet Adviser Exemption may no longer provide services to any non-internet clients. All services must be provided exclusively through the adviser’s operational interactive website. Advisers with non-internet clients may register with state regulatory agencies or rely on another exemption for SEC registration.

D. Form ADV The rule also amended Form ADV to require an investment adviser relying on the exemption as a basis for registration to represent on Schedule D of its Form ADV that, among other things, it has an operational interactive website. The amendments also require advisers to make additional representations that more clearly note the requirements of the exemption. This will help ensure that advisers seeking reliance on the exemption are aware of the new “operational interactive website” requirement and avoid erroneous registrations.

 
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