Investment Advisers Act of 1940

The Investment Advisers Act of 1940 is the law that regulates investment advisers — professionals and firms that manage money or provide investment advice for compensation. The Act requires advisers to register with the SEC (if they manage $100 million or more) or with state regulators, disclose their conflicts of interest, maintain books and records, and act as fiduciaries — putting the client’s interest ahead of their own.

Who is an investment adviser

An investment adviser is a person or firm that, for compensation, provides advice about investing in securities or issues analyses or reports about securities. This includes wealth managers, registered investment advisers (RIAs), advisers embedded in brokerage firms, and advisers to hedge funds. The definition is broad — it covers anyone giving paid investment advice.

The Act sets a threshold for SEC registration: advisers with $100 million or more in assets under management must register with the SEC. Smaller advisers typically register with state regulators (the state securities departments). Some advisers fall into exemptions — for example, an adviser whose clients are all institutional investors, or whose clients are primarily in the same state.

The fiduciary duty

The core duty imposed by the Act is the fiduciary duty. An investment adviser must act as a fiduciary — putting the client’s interests ahead of its own. This means (1) disclosing conflicts of interest, (2) not self-dealing (the adviser cannot favor its own interests), (3) not taking bribes or kickbacks, and (4) providing suitable advice.

The fiduciary duty is judge-made and is tighter than the “suitability” standard that applies to brokers. A suitability standard requires that an adviser recommend something that is suitable for the client. A fiduciary standard requires that the adviser recommend the best option, or disclose why it is recommending something that is not best.

Registration and disclosure

An adviser must file Form ADV with the SEC or state regulators. Form ADV Part 1 contains basic information (name, address, services offered, fees, conflicts). Form ADV Part 2 is a brochure that the adviser must give to clients, describing the adviser’s business, fees, conflicts, and credentials. The adviser must update Form ADV promptly after any material change.

The adviser must also maintain books and records — files showing all client accounts, holdings, transactions, fees charged, and advice given. These records allow regulators to verify that the adviser is complying with the law and serving client interests.

Compensation and conflicts

The Act scrutinizes adviser compensation. An adviser cannot charge an “unreasonable fee,” though Congress left this undefined and it is typically tested by competition and negotiation. More problematically, the adviser faces conflicts of interest. For example, an adviser may receive a higher commission if it recommends a fund managed by its own company; it may have an incentive to churn (trade excessively) to earn more commissions; it may be tempted to allocate the best investment opportunities to its largest clients.

The Act requires advisers to disclose these conflicts. However, disclosure alone may not eliminate the conflict — a client may sign a disclosure form but not fully understand it. To address this, the SEC has increasingly focused on requiring advisers to implement controls: “Chinese walls” (information barriers) to prevent trading on inside information, ethics rules prohibiting personal trading ahead of client recommendations, and compensation structures that do not reward excessive trading.

State versus SEC regulation

The dual regulatory structure — SEC for large advisers, states for small advisers — creates some gaps. A small adviser might operate in a state with lenient regulation, and state regulators often lack resources to police properly. Conversely, the SEC’s focus on large advisers means it may miss emerging risks in the small-adviser space.

Standards of care and the best-interest rule

Historically, the distinction between advisers (fiduciaries) and brokers (salespeople) was clear. An adviser owed a fiduciary duty; a broker merely had to meet a suitability standard. Over time, the lines blurred — many advisers are also licensed as brokers, and this dual licensing created opportunities for the adviser to waive its fiduciary duty in certain transactions.

The SEC has tried to raise broker standards. In 2020, the SEC adopted Regulation Best Interest, which requires brokers to act in the client’s best interest when providing advice (not just when selling their own products). This has narrowed the gap between the adviser and broker standards, though disputes over implementation continue.

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