With respect to the life insurance industry, the application of the federal Investment Advisers Act of 1940 arises in at least two contexts: (1) investment advice rendered to separate accounts funding the insurance products and (2) investment advice rendered to individuals who are prospective purchasers of insurance. The former was discussed previously; the latter is considered here. In this latter context, an investment adviser may be an individual providing personal financial services to a client and/or an organization (such as an insurance company or subsidiary thereof) offering such services.

The Advisers Act seeks to protect the public against the harmful and fraudulent conduct of persons who are paid to advise others as to the buying and/or selling of securities. It was aimed at two categories of advisers: those persons publishing market reports or newsletters, for paying subscribers, containing recommendations concerning securities and those persons providing advice on securities to individual clients. A major purpose of the law was and still is to reveal conflicts of interests which may cause the adviser to make recommendations more in his or her own interest vis-à-vis the interest of the client.

Any person who falls within the Advisers Act’s definition of an investment adviser (unless expressly excluded from the definition or exempted from the registration requirements) and who makes use of the mails or any instrumentality of interstate commerce is required to register with the SEC pursuant to the Act. The Act defines as an investment adviser any person who for compensation engages in the business of advising others as to the value of securities or as to the advisability of acquiring or disposing of securities.

To determine whether the Advisers Act applies to a person engaging in some form of financial planning activity, the starting point is ascertaining whether a "security" is involved. If not, the Act is inapplicable. However, the term "security" has been broadly defined for purposes of the federal securities laws both in statutory definitions and in judicial interpretation of such definitions. Just what constitutes an investment contract, hence a security, was set forth by the Supreme Court in the 1946 landmark case SEC v. T. W. Howey Co., in which the Court ruled that

Under this test virtually every investment which a financial planner might recommend for his or her client would appear to qualify as a security. The term security has been interpreted to embrace not only marketable securities traded on an organized exchange (such as the New York Stock Exchange) but also such instruments as limited partnerships, mutual funds, certificates of deposit, commercial paper, variable annuities and variable life insurance, and even some other types of interest sensitive life insurance products.

However, the mere fact that one deals with a security does not, by itself, render one an investment adviser. But over time, the SEC has viewed the definition of an investment adviser quite broadly. In 1987, the SEC issued Investment Advisers Act Release No. 1092, in which it treated many of the issues concerning the applicability of the Advisers Act to financial planners, pension plan consultants, etc. The SEC set forth the three definitional elements, all of which must be met, for a finding that a person or entity constitutes an investment adviser under the Act: (1) advice or analysis concerning securities, (2) engaged in the business of advising others regarding securities, and (3) receipt of compensation.

First, does the individual provide advice or issue reports or analyses regarding securities? If such advice relates to specific securities, clearly this test is met. However, the advice need not relate to specific securities, but rather may relate to the advisability of investing in securities generally. SEC staff has determined that a person who renders advice concerning the relative advantages and disadvantages of investing in securities in general as compared to other investments or who advises as to the desirability of investing in securities vis-à-vis other financial vehicles (for example, life insurance) meets this test. Also, almost any analyses or reports incorporating judgments concerning securities are deemed to be investment advice. Given the breadth of the definition of security, it would appear that virtually any person holding himself or herself out as a financial planner professional almost assuredly will render advice concerning a security.

Second, is the individual engaged in the business of providing such services about securities? Providing advice with some regularity, even when such is not the person’s primary business activity, is an important factor in rendering the person subject to the Act. Whether a person is "in the business" is to be determined by a facts and circumstances analysis, including consideration of the frequency of the activity. Furthermore, a person is deemed to be "in the business" if he or she (1) holds himself or herself out as an investment adviser, (2) receives separate or additional compensation which is a clearly definable charge for providing advice about securities, or (3) provides specific investment advice in other than isolated instances.

Third, does the person provide such services for compensation? The compensation element can be met by compensation in any form from any source. Even though a person providing advice concerning a security does not charge a separate fee for such advice, if he or she receives some form of economic benefit (whether as an advisory fee, some other kind of fee relating to total services rendered, a commission, or some combination thereof) in connection with such advice, the compensation test will be met. It is not necessary, in meeting the test, that the adviser’s compensation be paid directly by the person receiving the services, but only that he or she receive compensation from some source (for example, an insurance company) for such services.

Under this three-pronged definitional test (that is, providing advice or analysis concerning a security, engaged in the business, and receipt of compensation), all of the elements must be present for a finding that the person is an investment adviser under the Act. However, given the broad scope of each of the definitional elements, those engaged in financial planning activities are highly likely to be embraced by the Act’s definition of an investment adviser unless they come within some exclusion under the terms of the Act.

The basic regulatory mechanism of the Advisers Act is the requirement that any person falling within the definition of an investment adviser, unless excluded or exempted by other sections of the statute, must register with the SEC. The law makes it unlawful for an investment adviser to use the mails or any instrumentality of interstate commerce to conduct his or her business in the absence of registration. To register, the applicant must complete and submit to the SEC, along with a registration fee, a complex form known as Form ADV (Application for Registration as an Investment Adviser), which contains information as to the registering person’s identity, the form and place of organization, nature of business activities (such as advisory services and fees, types of securities, methods of analysis and sources of information), scope of authority with respect to client accounts and funds, prior disciplinary actions and convictions, educational background, business affiliations, and participation or interests in securities transactions. The registration becomes effective 45 days subsequent to the filing unless the SEC institutes a proceeding to determine whether the registration should be denied. Registration can be denied for certain specified reasons such as filing false or misleading information in a registration process before the SEC, failure to state material facts, convictions of certain crimes relating to securities (or arising out of conduct of the business of a broker, dealer, investment adviser, bank, insurance company, or fiduciary), and willful violation of the federal securities laws.

Most persons who are willing to go through the registration process and pay the fee can become registered as investment advisers. The Act imposes no particular competence requirements either in terms of education, training or business experience. Nor must a qualifying examination be taken and passed. The fact of registration is not intended to suggest that a person qualifies to be an investment adviser.

The fact that the SEC does not deny an application does not constitute any endorsement by the SEC. For an investment adviser to represent otherwise constitutes a violation of the law. Such would likely be viewed by the SEC as fraud and most certainly would invite determined attention by the SEC compliance staff.

A financial planner, as an investment adviser (which will usually be the case unless for some reason the person is exempted or excluded), is subject to a number of legal obligations in addition to the requirement of registration.

First, under its broad rulemaking authority the SEC has imposed extensive record keeping and reporting requirements. Investment advisers must keep their registrations with the SEC up to date by filing amendments as circumstances change. Certain records must be preserved and kept ready for inspections. Pursuant to Rule 204-2 under this section, the SEC generally requires that an investment adviser maintain typical accounting books and records (such as checkbooks, banking statements, and written agreements), as well as certain additional records (including personal securities transactions entered into by the adviser and his or her employee) to ensure compliance with fiduciary standards.

Second, an investment adviser is subject to inspection and examination by the SEC. Inspections are of two types; routine and "for cause." Inspectors look especially for evidence of "churning," scalping, practices contrary to the client’s interests, unsuitability, deceptive advertising and improper recordkeeping. At the same time visitorial inspection power raises more delicate questions as to investment advisers vis-à-vis broker-dealers. Investment advisers do counselling involving personal details of their client’s life. Thus, the Act imposes some limitations on public disclosure of both the fact of the examination and the examination’s substantive content.

Third, while almost any basis of compensation may be used (so long as it is not fraudulent), an investment adviser is prohibited from entering into an investment advisory contract if the contract provides for compensation based upon a share of the capital gains or capital appreciation of the client’s funds. Underlying this prohibition is the concern that the investment adviser might undertake undue investment risks with the client’s funds in efforts to achieve appreciation in value so as to enhance the adviser’s compensation. Furthermore, an advisory contract must provide that it cannot be assigned to someone else without the consent of the client.

Fourth, every investment adviser, when entering into an advisory contract, must deliver a written disclosure statement (often referred as the "brochure") to the prospective client at least 2 days before the advisory contract is entered into or at the time of entering into the contract if the client can terminate the contract within 5 days. Such statement must set forth information concerning the adviser’s background, education, experience, types of services offered, and investment techniques to be employed. The brochure can either be a copy of the relevant portions of Form ADV submitted to the SEC as part of the registration process or it can be a narrative summarizing such information. The principal philosophy of the Act is disclosure, through Form ADV and the brochure rule, to the client as to the adviser’s types of services offered, his or her educational and business background, and potential conflicts of interest. The SEC takes this brochure requirement quite seriously and shows little tolerance for attempts to circumvent its requirements. A current copy of the brochure must be offered to the client annually.

Fifth, the Act prohibits an investment adviser from representing that he or she is an "investment counsel" unless his or her principal business consists of acting as an investment adviser and a substantial portion of the business consists of providing investment advisory services.

Sixth, an investment adviser is permitted to pay finders fees, but only if certain conditions are complied with. There must be a written agreement between the adviser and the finder of business. The finder must provide to the prospective client not only a copy of the adviser’s brochure but also a separate disclosure statement outlining the arrangement between the adviser and finder, including the compensation to be paid by the adviser to the finder and whether the client will be charged for this service in addition to the advisory fee. It should be noted that the SEC does not look with favor upon this method of obtaining new business. Thus, if this method is used, great care should be taken to comply with all requirements.

Seventh, during the legislative process leading up to the enactment of the Advisers Act, much emphasis was placed upon the importance of the relationship of trust and confidence between an investment adviser and his or her clients. As a consequence, the Act contains an antifraud section detailing various types of conduct considered to be violative of the fiduciary nature of the investment advisory relationship. Among other things, the Act specifically prohibits the use of the mails or any means of interstate commerce to "employ any device, scheme or artifice to defraud client or prospective client" or "to engage in any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client." The United States Supreme Court elaborated in saying an investment adviser is a fiduciary owing his or her clients

The SEC has expressed that the duty of an investment adviser to refrain from fraudulent activity includes the affirmative obligations (1) to disclose all material facts as to any potential conflicts of interests so that the client can make an informed judgment whether to enter into or to continue the relationship with the investment adviser, (2) to disclose fully the nature and extent of any interest the adviser has in any given recommendation, (3) to inform clients of their right to execute recommended investment purchases or sales through other broker-dealers, (4) to disclose whether the adviser’s personal securities transactions are inconsistent with advice rendered to a client, and (5) to avoid engaging in any conduct which might result in the adviser preferring his own interests to those of his clients. It should also be noted that the antifraud provisions of the Advisers Act apply to any person who is an investment adviser, as defined by the Act, whether or not such a person is required to be registered with the SEC as an investment adviser. Although those persons who are excluded from the definition of an investment adviser are not subject to the antifraud provisions, those who fall within the definition of an investment adviser, even though not required to be registered, are subject to the antifraud provisions of the Advisers Act and the rules promulgated thereunder.

The most fundamental and criticized defect of the Investment Advisers Act is the absence of any educational and other qualification requirements for investment advisers even though such persons are engaged in an occupation which is likely to cause havoc if not performed by persons possessing appropriate background and standards. Among other things, suggestions have been made for the creation of a self-regulatory organization for investment advisers, presumably akin to the NASD. Hence, the potential exists for future amendments to the Act to incorporate qualification standards, perhaps even on a retroactive basis to persons already registered under the Act.

In administering the Advisers Act, the SEC relies upon review of the initial applications for registration, examinations of investment advisers, and enforcement actions. The examinations are of three types: routine periodic inspections, follow-up examinations to verify corrections of previously discovered deficiencies or to ascertain that major deficiencies which were subject to enforcement actions have not been repeated, and examinations for cause based upon specific complaints or staff perception of an emerging problem. The SEC can enforce the Act by sanctioning persons who violate the Act’s provisions by denying or revoking registration or by preventing association with an investment adviser of persons engaged in certain unlawful activity. The SEC may also suspend an individual or entity from associating with or acting as an investment adviser for a period of time. Also the SEC may seek judicial injunction from further violations and may seek to cause criminal prosecution against persons who willfully violate the Act or its rules.

Although there is no implied private right of action for damages under the antifraud provisions of the Advisers Act, clients of an investment adviser may rescind their investment adviser’s agreement and seek restitution. A person who willfully fails to register or willfully violates other provisions of the Act or its rules may be subject to criminal fines up to $10,000 and/or to imprisonment for up to 5 years^. Also, the Act authorizes the SEC to (1) assess civil penalties against an investment adviser for willful violation or abetting or inducing violation of federal securities laws and (2) issue cease and desist orders against future violations of the Act.

As a financial planner, one is expected to do more than simply review a client’s existing financial situation. The client expects that the planner will analyze a mass of financial information as a basis for offering concrete recommendations in various areas including investments. Engaging in such activity brings the planner squarely into the purview of various laws, including both federal and state investment adviser laws, which seek to regulate those individuals or companies providing advice about securities to a client.

Nevertheless, even though the federal legislation was enacted back in 1940, for a considerable period of time it was seldom applied to life insurance agents since they rarely offered advice about a security. But today, with the insurance product portfolios of insurers containing products which fall within the definition of securities and which are registered under the Securities Act of 1933 and with both insurers and agents broadening the scope of financial planning services to clients, the Investment Advisers Act has become much more generally applicable to those in the life insurance business.

A life insurance agent advising a prospect or a client on securities, such as variable insurance products (which are deemed to be securities for federal securities law purposes), in most cases presumably falls within the definition of an investment adviser in the absence of an applicable exclusion. However, the Act does contain an exclusion for a broker-dealer whose performance of investment advisory services is solely incidental to the conduct of its business as a broker-dealer and who receives no special compensation therefor. The SEC has made clear that for a broker-dealer, or an associated person of a broker-dealer (the typical situation involving life insurance agents), rendering investment advice is excluded from the definition of an investment adviser if (1) the performance of investment advisory services is solely incidental to the conduct of its business as a broker-dealer and (2) the broker-dealer or associated person does not receive special compensation for such advice. However, the exclusion is only available if the associated person or registered person providing investment advice does so within the scope of his or her employment with the broker-dealer. Thus, as a general proposition, this exclusion relieves the broker-dealer and its associated persons (for example, life insurance agents) from investment adviser status when they provide investment advice as an incidental component of their brokerage business.

However, if such incidental advice were offered while he or she was not under the supervision of the broker-dealer, he or she would be subject to the registration requirements. The SEC has said

Consequently, even though a life insurance agent is a registered representative of his or her insurance broker-dealer, if the agent engages in financial planning services on his or her own, he or she would have to register as an investment adviser.

This broker-dealer exclusion from the Investment Advisers Act constitutes a recognition that broker-dealers commonly render a certain amount of advice to their customers in the course of their regular business. However, the language referring to special compensation also amounts to a recognition that a broker-dealer who is specially compensated for giving investment advice should be considered an investment adviser. The essential distinction is between compensation for the advice itself and compensation for services of another character to which the advice is merely incidental. Thus life insurance agents rendering investment advice for which they receive special compensation are likely subjects of the Investment Advisers Act even if they are also registered as a broker-dealer or are registered representatives of a broker-dealer.

Importantly, however, in determining the availability of the broker-dealer exclusion, the SEC considers how individuals hold themselves out to prospective clients and the nature and manner of conducting their business. The exclusion is conditioned upon the individual’s investment advisory services being solely incidental to the performance of the broker-dealer business. Even if an insurance agent is a registered representative of a broker-dealer, if he or she holds himself or herself out as a financial planner or in fact acts as an investment adviser, the likelihood of being deemed an investment adviser increases. No longer are such activities likely to be viewed as solely incidental by the SEC. This, in turn, could result in the widespread application of the Advisers Act to even those life insurance agents who are broker-dealers or registered representatives with a broker-dealer.

Those engaged in financial planning sometimes assume that they need not register under the Investment Advisers Act since they are already registered as a securities representative of a broker-dealer or because they are associated with a broker-dealer who is exempt from registration under the Act. This can be a dangerous and erroneous assumption. Because of the manner in which the planner conducts his or her activities, the broker-dealer exclusion may be found inapplicable. Prudent financial planners, including those who are life insurance agents, should seriously consider the need and desirability to register under both the securities and the investment adviser registration provisions. On the other hand, a person that registers as a registered representative of a broker dealer under the Securities Exchange Act of 1934 and as an investment adviser under the Advisers Act may incur substantial and unnecessary double regulatory burden. Thus, it is important for persons participating in the securities business to determine whether their conduct brings them within the ambit of either the broker-dealer registration requirements, the investment adviser registration requirements, or both.

Furthermore, for insurance companies offering personal financial planning services, if they harbor any doubt, a prudent course also would be to assume that the insurer itself (or some separate subsidiary) is an investment adviser under the Act and proceed accordingly. Once an insurer determines to enable both the company and its agents to perform financial planning functions, the issue becomes who should register pursuant to the Advisers Act.

The first alternative is to register the insurer itself or a subsidiary thereof (probably newly created for this purpose) as the investment adviser, with the agents as "associated persons" with the registered investment advisory organization. In this case, the insurer (or its subsidiary) accepts the full supervisory and compliance responsibility for the conduct of the individual financial planners.

A second alternative is to register individual agents or agencies as separately registered investment advisers. Although under this approach the insurer might take the position that it is not responsible for the individual agent’s activities, SEC no action letters suggest that the "real principal" (for example, the insurer) is unlikely to escape responsibility.

A third alternative is to enter into a relationship with an unrelated third party registered investment adviser with which the agents would be "associated persons" and which would assume the regulatory and compliance responsibilities. Such an organization could be a broker-dealer firm which is also registered as an investment adviser.

Each of these alternatives for registration poses somewhat different legal, regulatory (including state insurance holding company laws), and business considerations.

The regulatory law applying to financial planners through the Investment Advisers Act should not be viewed as frozen or stagnant. The manner of regulating investment advisers under the Act has been the subject of regulatory and legislative inquiry for at least two decades. In 1976, the SEC supported unsuccessful legislation which would have empowered the Commission to establish standards of minimum professional qualifications and financial responsibility for investment advisers. Also, for a number of years the SEC has complained that it has lacked the resources to regulate investment advisers under the Act. In 1989, legislation was introduced to authorize the creation of one or more self-regulatory organizations, akin to the NASD, to regulate investment advisers. In 1992, upon recommendation of the SEC as to its inability to adequately enforce the Act due to the vast increase in the number of persons falling within the definition of an investment adviser and the lack of staff and financial resources, both Houses of Congress had under consideration several changes to the Act. These included improved financing of enforcement through annual fees on registered advisers with revenue earmarked for more SEC inspectors; imposition of a suitability rule requiring advisers to recommend only investments suited to the clients’ needs; fidelity bonding of investment advisers in certain circumstances; more frequent initial, periodic, and follow-up inspections of investment advisers; private right of action for fraudulent investment adviser activities; and disclosure of fees earned by investment advisers including sales commissions. However, through mid-1994, such legislative changes have yet to be enacted.

Financial planners, including those insurers providing financial planning services, need to be aware of the potential applicability of the Employee Retirement Income Security Act, commonly referred to as ERISA. Offering investment advice to a client concerning assets in the client’s employee benefit plan may trigger the application of the fiduciary rules in ERISA. Furthermore, if the client is a trustee or investment manager for the assets of an employee plan, it should be anticipated that ERISA does apply to a financial planner making recommendations to such client. Also, if a client is a participant in an employee benefit plan and under such plan is entitled to manage the assets in his or her own account, a financial planner’s recommendations to the client as to the assets in his or her account may trigger the application of ERISA. This situation might also arise when the financial planner offers advice concerning assets in a client’s self-directed Keogh plan or a 401(k) plan.

If and when the ERISA is triggered, Title I sets forth four general standards of conduct on those deemed to be fiduciaries under the Act: (1) a duty to act exclusively for the benefit of the pension plan, (2) a prudence requirement, (3) a duty to diversify plan assets, and (4) a duty to comply with plan documents. In addition, Title I bars fiduciaries from engaging in certain prohibited transactions and activities and provides for civil actions against fiduciaries for violation of the fiduciary rules. Furthermore, the Internal Revenue Service may levy excise tax penalties upon financial planners who, as fiduciaries under ERISA, engage in activities and transactions that are banned under Title II of the Act. Thus, the potential repercussions of an even inadvertent violation of Title I or Title II afford strong incentives for individual persons and insurers providing financial planning services to avoid violation of ERISA.

However, in providing financial planning services to employee benefit plan participants, insurers can act in such a way as to minimize the risk of running afoul of ERISA. Under Labor and Treasury Department regulations, a person is deemed to be an ERISA fiduciary by virtue of offering investment advice only if he or she possesses discretionary authority or control over the plan assets or if he or she renders advice with the understanding that such advice will serve as a primary basis for the investment decisions of the employee benefit plan. By avoiding such control over a client’s employee benefit plan assets, both insurers and individual agents providing personal financial planning services can minimize the likelihood of being deemed a fiduciary for purposes of ERISA. This might be achieved, for example, by explicitly stating in their written financial planning services agreement that all investment decisions are made solely by the client and not by the insurance company financial planner. Furthermore, such statement could be supplemented by always offering clients a variety of financial alternatives to avoid the advice serving as the primary basis of investment decisions. Also it is crucial that the insurance company’s financial planning representatives avoid any arrangement with clients which a court might construe as giving the representative discretionary authority or control over the purchase and sale of the client’s securities.