Investment Advisers Act of 1940: Definition & Summary

Instructor: Jon Hooks

Jon has taught Economics and Finance for 32 years. He holds a Ph.D., in Economics from Michigan State University, and is a CFA charter holder.

This lesson provides an overview of the Investment Adviser Act of 1940. It includes a discussion of its origins, provisions, and the organizations and individuals covered by the Act.

Origins of the Investment Company Act

Many people consult with or seek advice from an investment adviser at some point in their life. The Investment Advisers Act of 1940 traces its origins back to the financial collapse of 1929 and the subsequent passage of the Securities Act of 1933 and the Securities Exchange Act of 1934. While the 1933 Act focused on the regulations of securities and public disclosure, the 1934 Act created the Securities and Exchange Commission (SEC), which was charged with overseeing the securities industry.

Mutual funds date back to 1924, but went largely unregulated until the Investment Company Act of 1940, which regulated the activities and disclosures of closed-end and open-end mutual funds. This was followed by the Investment Advisers Act, which regulated investment advisers

Defining an Investment Adviser

The Investment Advisers Act of 1940 defines an investment adviser as, ''any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.''

Filing Requirements

Under most circumstances, individuals and firms that meet this definition and have at least $100 million of assets under management must register with the SEC. This process includes completing Form ADV and paying a registration fee. The SEC requires the applicant to provide educational background, industry experience, the nature of the business, and, most importantly, a history of any legal or criminal disciplinary actions. These details comprise the basis for a brochure that registered advisers must provide to clients. Form ADV must be updated annually.

Purpose of Registration

Completion of Form ADV doesn't indicate the SEC's endorsement of the adviser's competency. Instead, the overriding purpose of the Act, beyond providing background information on the adviser, is to ensure that advisers act in the best interest of their clients. This precludes advisers from engaging in excessive trading (churning) resulting from their advice to clients. Moreover, while advisers may charge a fee for their advice, they may not profit personally from trading activity based on advice provided to clients. Through the SEC registration, potential clients can easily check an adviser's criminal and ethical background.

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