Investment Advisers Act
The Investment Advisers Act of 1940 is the primary federal law in the United States governing investment advisers—including hedge fund managers who provide investment advice for compensation—establishing registration requirements with the SEC, fiduciary duties, disclosure obligations, prohibited practices, and recordkeeping requirements for the $110+ trillion U.S. investment advisory industry. Amendments through the Dodd-Frank Act of 2010 significantly expanded the Act's reach by eliminating the 'private adviser exemption' that had allowed most hedge funds to avoid SEC registration.
Key takeaways
- Advisers managing more than $110 million in assets under management (AUM) are generally required to register with the SEC as Registered Investment Advisers (RIAs); smaller advisers register with state regulators.
- Registered investment advisers owe a fiduciary duty to clients, requiring them to act in the client's best interest and fully disclose all material conflicts of interest.
- Form ADV (Parts 1 and 2) is the primary disclosure document filed with the SEC, describing the adviser's business, ownership, investment strategies, fees, disciplinary history, and conflicts of interest.
- The Dodd-Frank Act of 2010 eliminated the private adviser exemption, requiring most hedge fund managers with 15+ clients to register; private fund advisers (Exempt Reporting Advisers) report limited information via Form ADV Part 1 without full registration.
- Rule 206(4)-7 requires registered advisers to adopt compliance programs, appoint a Chief Compliance Officer (CCO), and conduct annual reviews—creating a substantial infrastructure burden that has driven consolidation among smaller managers.
Explanation
The Investment Advisers Act of 1940 was enacted in the aftermath of the Great Depression and the Securities Acts of 1933 and 1934, completing the New Deal framework for regulating the securities industry. The Act's primary objectives are to protect investors who entrust their assets to investment advisers by ensuring these advisers meet professional standards, disclose conflicts of interest, and are subject to regulatory oversight. The Act established a registration and examination system for advisers, creating the foundational regulatory infrastructure that the modern SEC inspection program builds upon.
The fiduciary standard imposed by the Act on registered investment advisers is the highest duty of care in U.S. securities law—stricter than the broker-dealer 'suitability' standard and the 'best interest' standard applicable to broker-dealers under Regulation Best Interest (Reg BI). An investment adviser's fiduciary duty encompasses two components: the duty of loyalty (avoiding conflicts of interest or, where unavoidable, fully disclosing and obtaining informed consent from clients) and the duty of care (providing investment advice based on a reasonable understanding of the client's objectives, circumstances, and risk tolerance). This fiduciary standard means advisers cannot prioritize their own economic interests (e.g., recommending high-fee products that benefit the adviser) over client welfare without full disclosure.
Registration under the Advisers Act entails filing and maintaining Form ADV, which consists of multiple parts. Part 1 provides organizational and operational information (business form, ownership structure, assets under management, regulatory disciplinary history). Part 2A is the 'brochure'—a plain-language narrative describing investment strategies, fees, conflicts of interest, and relevant business practices. Part 2B contains individual adviser representative brochures for supervised persons providing investment advice directly to clients. These documents are publicly available through the SEC's IAPD (Investment Adviser Public Disclosure) database, enabling investors to conduct due diligence on any registered adviser.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 fundamentally restructured the registration landscape for hedge fund managers. Prior to Dodd-Frank, the 'private adviser exemption' under Section 203(b)(3) allowed advisers with fewer than 15 clients to avoid SEC registration, and most hedge fund managers qualified by counting each fund (rather than each underlying LP) as a single client. Dodd-Frank eliminated this exemption, replacing it with the 'private fund adviser exemption' (Section 203(m)) that exempts advisers managing only private funds with less than $150 million in AUM from registration requirements, while creating the 'Exempt Reporting Adviser' (ERA) status for those managing more than $150 million in private funds who must file Form ADV Part 1 but are not subject to full registration requirements.
The ongoing regulatory oversight of registered hedge fund advisers involves periodic SEC examination (inspection) programs, which conduct routine and for-cause examinations of adviser books and records, compliance programs, trading practices, and client disclosures. The SEC's Division of Examinations focuses particular attention on: conflicts of interest in fee and expense allocation; cross-trades between funds managed by the same adviser; insider trading compliance programs; custody and valuation of fund assets; and the accuracy of marketing materials and performance representations. Violations can result in enforcement actions, disgorgement of profits, civil penalties, and, in egregious cases, suspension or revocation of registration.
Example
A hedge fund manager based in New York City manages three private equity funds and two hedge funds with combined AUM of $2.4 billion. Under the Investment Advisers Act, the firm must register with the SEC as a Registered Investment Adviser because its AUM exceeds the $110 million threshold. The firm files Form ADV Part 2A disclosing: a 2-and-20 fee structure (2% management fee, 20% performance fee with high-water mark), material conflicts of interest including the ability to co-invest alongside funds and to allocate investment opportunities across client accounts, reliance on prime brokerage services that may generate soft dollar credits, and related-party transactions involving portfolio companies. The firm appoints a Chief Compliance Officer, adopts written compliance policies covering insider trading, personal trading pre-clearance, and anti-money laundering, and conducts an annual compliance review as required by Rule 206(4)-7. The SEC conducts a routine examination in year 3 of the firm's registration, reviewing 3 years of trading records, fee allocations, investor communications, and compliance program documentation.
Related terms
Broker Dealer Cftc Registration Chief Compliance Officer Compliance Program Dodd Frank Act Equity Exempt Reporting Adviser Fiduciary Duty Form Adv Gdpr Data Privacy Hedge Fund Insider Trading