The “scale and speed” of the SEC’s recent rulemaking activities have led the Investment Adviser Association to submit a rulemaking petition to the Commission, urging it to consider the impact of regulations on smaller advisers. The IAA would like to see the SEC amend the “small business” definition it uses for purposes of the Regulatory Flexibility Act and suggests the Commission use the number of employees as the appropriate size standard for purposes of determining the impact of its regulations on small advisers.
The IAA notes that the RFA requires the SEC to consider the impact of its rulemakings on entities that qualify as small businesses, analyze effective alternatives that minimize small entity impact, and make such analysis available for public comment.
Current definition questioned
The SEC’s current definition of a small adviser was questioned by the IAA. Presently, any adviser with less than $25 million in assets under management is considered to be small. However, advisory firms are not allowed to register with the Commission unless they have at least $100 million in AUM. This makes “any analysis the SEC does regarding the impact on smaller advisers virtually meaningless and contrary to the legislative intent of the RFA,” the IAA asserts.
The IAA’s 2023 Investment Adviser Industry Snapshot reported that 12 percent of registered investment advisers had $100 million or less in AUM. Contrast that with the finding that 92 percent of SEC-registered firms have less than 100 employees. The IAA suggests the threshold number of employees should be set at 100 or fewer. To underscore its point, the association notes that only 489 of the total 15,402 SEC-registered advisers are deemed small entities for purposes of the RFA.
Using the number of employees as the size standard offers the benefit of being more “evergreen,” in the IAA’s view, compared with asset-based standards “that are far more susceptible to fluctuation and will inevitably be distorted with the passage of time.” The association noted that the data on the number of employees is already captured and readily available in Item 5.A of Form ADV Part 1A. “We believe that number of employees is a more realistic measure of an adviser’s business and compliance challenges,” the rulemaking petition reads.
Congress has also been active on the issue. The Small Entity Update Act was passed by the House at the end of May and is supported by the IAA. The Act would require the SEC to update its definition of small entity under the RFA to ensure that it covers a meaningful number of businesses under its authority. “The agency would thereafter be required to analyze the impact of all proposed regulations on these small businesses and consider alternative approaches that minimize the regulatory burden imposed on them,” the IAA continued.
Over time, the IAA has suggested steps that could be taken to minimize the rulemaking impact on small advisers. Those steps have included “preserving a flexible, risk-and principles-based approach, where appropriate excluding or exempting smaller advisers from specific requirements, or scaling those requirements to the size of an adviser, and tiering and staggering compliance timetables within and among rules.”
The time to make a change in the small adviser definition is now in the IAA’s view. “Smaller advisers today are required to meet governance, operational, data management, security, and compliance demands at an unprecedented level,” the petition claims. A graph in the rulemaking petition depicting 18 Select SEC Rulemakings Affecting Investment Advisers paints a daunting picture for smaller advisers.
A perceived change in rulemaking was also called out by the IAA. “The Commission’s dramatic departure from the longstanding principles-based approach to regulating advisers to more prescriptive regulation makes it all the more challenging for smaller advisers to adapt and scale regulatory requirements to their specific circumstances,” the IAA stated.