The hedge fund industry has asked the SEC to adopt in the Dodd-Frank mandated municipal advisor rules a clear, consistent definition of municipal advisor that does not apply to an investment adviser managing a pooled investment vehicle that has both municipal entity and non-municipal entity investors. In a letter to the SEC, the Managed Funds Association feared that imposing an artificial threshold would create uncertainty for private fund managers, require burdensome, ongoing monitoring of the level of municipal entity investments, and limit or even prevent municipal entities from investing in private funds.
The MFA also asked the Commission to provide additional guidance on the definition of municipal advisor to avoid potential overlapping and duplicative regulation of already regulated entities that engage in investment advisory activities, including investment advisers registered under the Investment Advisers Act and commodity trading advisors (CTAs) registered under the Commodity Exchange Act.
Under the proposed rules, a registered investment adviser would not be able to rely on the exclusion from the definition of municipal advisor for already regulated entities if the adviser engages in municipal advisory activities other than providing investment advice that would subject the adviser to the Advisers Act. Similarly, a registered CTA would be excluded from being a municipal advisor only to the extent the CTA is providing advice on swaps.
The SEC provides two examples of the types of municipal advisory activities that are not investment advice under the Advisers Act or advice related to swaps, and thus would cause an investment adviser or CTA to fall outside the exclusion of municipal advisor. An SEC-registered investment adviser or registered CTA would be required to register as a municipal advisor if it provides advice with respect to how a municipal entity should structure or issue municipal securities, or solicits a municipal entity on behalf of a municipal advisor.
The hedge fund industry fears that the proposed interpretation of the exclusion could have the unintended consequence of requiring registered investment advisers and CTAs to register as municipal advisors due exclusively to their performance of ordinary investment advisory services. An investment adviser in the normal course of its advisory services may provide clients with services ancillary to its investment advice, such as advising them on investments other than securities, such as bank deposits, or providing them with research and other related reports and information.
These types of activities may not cause the adviser to fall within the definition of investment adviser under the Advisers Act, even if the adviser performs the activities in connection with investment advisory services. Similarly, a CTA may, in connection with providing advice about swaps, provide clients with research or advice about instruments other than swaps. If these ancillary services fall within the scope of municipal advisory activities, and yet are not deemed to be the type of investment advice or advice about swaps described in the exclusion, a registered adviser or CTA that performs these services for a municipal entity client would need to register as a municipal advisor, leading to duplicative and even confusing regulation.
In addition, the proposed rules would create widespread uncertainty among registered advisers and CTAs as to whether the services they perform for municipal entities are the type that would require registration as a municipal advisor. In order to comply with the proposed rules, managers would need to regularly monitor each service they provide to municipal entities, determine which of the services are municipal advisory activities, and further determine which, if any, of the services may not be deemed to be investment advice or advice related to swaps.
Thus, the MFA urged the SEC to clarify that the exclusion from registration as a municipal advisor applies to registered investment advisers and CTAs that perform services ancillary to providing investment advice or advice related to swaps, such as providing research or advice about instruments other than securities or swaps, to municipal entities in the ordinary course of their advisory activities.
The MFA further urged the SEC to treat state-registered investment advisers consistently with SEC-registered advisers in connection with its regulation of municipal advisors and exempt them from municipal advisor registration to the same extent as SEC-registered advisers. The statutory exclusion from the definition of municipal advisor for investment advisers registered under the Advisers Act reflects a legislative intent to avoid applying the registration requirements to investment advisers that are already subject to extensive federal regulation. The MFA believes that the same policy reasons exist to exempt state-registered investment advisers from additional regulation as municipal advisors in performing investment advisory services for a municipal entity.
Under Section 410 of the Dodd-Frank Act, investment advisers with between $25 million and $100 million of assets under management will be prohibited from registering with the SEC if they are required to register as an investment adviser with, and subject to examination by, a state securities commission. In the MFA’s view, these requirements ensure that a mid-sized adviser that does not register with the SEC will nevertheless be subject to meaningful regulation at the state level.
Finally, the MFA urged the SEC to provide an exemption from registration as a municipal advisor for non-registered advisers that are affiliated with a registered adviser and that comply with the requirements set out in a series of SEC no-action letters. Under the terms of the proposed rules, such a non-registered affiliated adviser may be required to register as a municipal advisor if it provides investment advice to a municipal entity, even though its affiliated SEC-registered adviser would not be required to register.
In the MFA’s view, this outcome would be incongruous with the longstanding approach the SEC has taken in regulating such affiliates of registered investment advisers, in which it has not required such advisers to register with the SEC, but rather has ensured that it has appropriate access to information and oversight of such entities, and in particular those that provide advice to U.S. clients.
Under the SEC's current policy, non-registered advisers that are affiliated with an SEC-registered adviser are not required to register with the SEC as long as they operate under participating affiliate agreements with the registered adviser and comply with the specific guidance the SEC has provided in a series of no-action letters. This approach provides the SEC with full oversight of the U.S. activities of non-registered advisers and avoids unnecessary firm registrations that would require additional SEC resources. The MFA believes that the public policy purposes of both the Dodd-Frank Act and the Advisers Act can be achieved without requiring these affiliates to register as municipal advisors, and that requiring registration would simply add costs to the industry and regulators without additional public policy benefits.