[Federal Register Volume 67, Number 243 (Wednesday, December 18, 2002)]
[Rules and Regulations]
[Pages 77620-77626]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-31843]



[[Page 77619]]

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Part IV





Securities and Exchange Commission





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17 CFR Parts 275 and 279



Exemption for Certain Investment Advisers Operating Through the 
Internet; Final Rule

  Federal Register / Vol. 67, No. 243 / Wednesday, December 18, 2002 / 
Rules and Regulations  

[[Page 77620]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release No. IA-2091; File No. S7-10-02]
RIN 3235-AI15


Exemption for Certain Investment Advisers Operating Through the 
Internet

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Commission is adopting rule amendments under the 
Investment Advisers Act of 1940 to exempt certain investment advisers 
that provide advisory services through the Internet from the 
prohibition on Commission registration. The rule amendments permit 
these advisers, whose businesses are not connected to any particular 
state, to register with the Commission instead of with state securities 
authorities.

EFFECTIVE DATE: The rule amendments will become effective on January 
20, 2003.

FOR FURTHER INFORMATION CONTACT: Marilyn Barker, Senior Counsel, or 
Jamey Basham, Special Counsel, at (202) 942-0719 or [email protected], 
Office of Investment Adviser Regulation, Division of Investment 
Management, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to 
rule 203A-2 [17 CFR 275.203A-2], Form ADV [(Part 1A, Item 2)] (17 CFR 
279.1) and Schedule D to Form ADV [17 CFR 279.1] under the Investment 
Advisers Act of 1940.

Executive Summary

    Section 203A of the Investment Advisers Act of 1940 (the ``Advisers 
Act'') generally prohibits an investment adviser from registering with 
the Commission unless that adviser has more than $25 million of assets 
under management or is an adviser to a registered investment company. 
The Commission is adopting new rule 203A-2(f) under the Advisers Act to 
exempt from the prohibition on Commission registration certain 
investment advisers that provide advisory services through the 
Internet.\1\ An adviser is eligible for registration under the rule if 
the adviser provides investment advice to all of its clients 
exclusively through the adviser's interactive Web site, except that the 
adviser may advise fewer than 15 clients through other means during the 
preceding 12 months.
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    \1\ Unless otherwise noted, when we refer to rule 203A-2 or any 
paragraph of the rule, we are referring to 17 CFR 275.203A-2 of the 
Code of Federal Regulations in which the rule is published, as 
amended by this release.
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I. Background

    The National Securities Markets Improvement Act of 1996 (``NSMIA'') 
amended the Advisers Act to divide the responsibility for regulating 
investment advisers between the Commission and state securities 
authorities.\2\ Section 203A of the Advisers Act effects this division 
by generally prohibiting investment advisers from registering with us 
unless they have at least $25 million of assets under management or 
advise a registered investment company, and preempting most state 
regulatory requirements with respect to SEC-registered advisers.\3\ The 
$25 million threshold was designed to distinguish investment advisers 
with a national presence from those that are essentially local 
businesses.\4\ Congress recognized, however, that some investment 
advisers should be regulated at the federal level even though they have 
less than $25 million of assets under management, and gave the 
Commission the authority in section 203A(c) of the Advisers Act to 
exempt investment advisers, by rule or order, from the prohibition on 
Commission registration in cases in which the prohibition otherwise 
would be ``unfair, a burden on interstate commerce, or otherwise 
inconsistent with the purposes'' of section 203A.\5\
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    \2\ Pub. L. No. 104-290, 110 Stat. 3416 (1996) (codified in 
scattered sections of the United States Code).
    \3\ 15 U.S.C. 80b-18a. Advisers prohibited from registering with 
us remain subject to the regulation of state securities authorities.
    \4\ See S. Rep. No. 293, 104th Cong., 2d Sess. 3-5 (1996) 
(hereinafter Senate Report).
    \5\ 15 U.S.C. 80b-3a(c). Section 203A was designed to allow the 
Commission to better use its limited resources by concentrating its 
regulatory responsibilities on advisers with national businesses, 
and to reduce the burden to investment advisers of the overlapping 
and duplicative regulation (existing prior to the enactment of 
NSMIA) by preempting state investment adviser statutes, thus 
subjecting advisers with national businesses to a single regulatory 
program administered by the Commission. See Senate Report at 2-4. 
Relying on this authority, the Commission has adopted and amended 
rule 203A-2 under the Advisers Act to permit nationally recognized 
statistical rating organizations, certain pension consultants, 
affiliated investment advisers, newly formed investment advisers, 
and advisers operating in multiple states to register with the 
Commission even if these advisers otherwise would not meet the 
criteria for Commission registration.
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    In April of this year, we proposed to use our exemptive authority 
under section 203A(c) to adopt new rule 203A-2(f), providing relief to 
certain investment advisers who, unlike state-registered advisers, have 
no local presence and whose advisory activities are not limited to one 
or a few states.\6\ These advisers, which we call ``Internet Investment 
Advisers,'' provide investment advice to their clients through 
interactive Web sites. Clients visit these Web sites and answer online 
questions concerning their personal finances and investment goals. 
Thereafter, the adviser's computer-based application or algorithm 
processes and analyzes each client's response, and then transmits 
investment advice back to each client through the interactive Web 
site.\7\ Clients residing in any state can, upon accessing the 
interactive Web site, obtain investment advice at any time.
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    \6\ Exemption for Certain Investment Advisers Operating Through 
the Internet, Investment Advisers Release No. 2028 (April 12, 
2002)[(67 FR 19500 (April 19, 2002))](''Proposing Release'').
    \7\ Internet Investment Advisers are required to provide these 
prospective Internet clients with a copy of their client brochure. 
Rule 204-3 [17 CFR 275.204-3](an investment adviser must deliver 
either a copy of their Part 2 of Form ADV [17 CFR 279.1] or a 
narrative brochure that contains at least the information required 
in Part 2). The personalized nature of the investment advice 
provided by these interactive Web sites makes the exception under 
Rule 204-3 for impersonal advisory services unavailable. Internet 
Investment Advisers may deliver their client brochure 
electronically, in compliance with previous SEC guidance on 
electronic delivery. See Use of Electronic Media by Broker-Dealers, 
Transfer Agents, and Investment Advisers for Delivery of 
Information, Investment Advisers Act Release No. 1562 (May 9, 1996) 
[61 FR 24644 (May 15, 1996)].
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    Internet Investment Advisers typically are not eligible to register 
with us. They do not manage the assets of their Internet clients, and 
consequently do not meet the $25 million statutory threshold for 
registration with the SEC. While traditional advisory firms with less 
than $25 million of assets under management usually must register in 
one or a few states, Internet Investment Advisers would be required as 
a practical matter to register in all the states absent an 
exemption.\8\ Furthermore, our existing exemptive rules do not work for 
Internet Investment Advisers.\9\
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    \8\ See discussion in text accompanying note 13, infra.
    \9\ See discussion in Proposing Release at section I.
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    In response to our proposal we received 22 comment letters, most of 
which supported our proposal.\10\ Ten commenters urged that we expand 
the

[[Page 77621]]

exemption, six wanted us to narrow it, and six asserted that we should 
take no action. Several commenters representing state securities 
authorities objected to the rule, arguing that they should continue to 
be responsible for Internet Investment Advisers; some supported a 
narrower version of the rule.
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    \10\ These comment letters and a summary of comments prepared by 
our staff are available for public inspection and copying at our 
Public Reference Room in File No. S7-10-02. The comment summary is 
also available on our Internet Web site at <http://www.sec.gov/rules/extra/s71002commsumm.htm.
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II. Discussion

    We are today adopting an exemption for Internet Investment Advisers 
in a form modified to reflect comments submitted to us. Rule 203A-2(f), 
which we discuss in more detail below, provides a narrow exemption for 
a type of adviser whose activities do not fall neatly into the model 
assumed by Congress when it added Section 203A to the Act to divide 
regulatory authority over advisers.\11\ We have concluded that, as 
applied to these advisers, the application of the prohibition on 
Commission registration would be ``unfair, a burden on interstate 
commerce, or otherwise inconsistent with the purposes of [Section 
203A].'' \12\
    In framing the scope of the exemption, we have carefully balanced 
the burdens of multiple state registration requirements for Internet 
Investment Advisers with the design of NSMIA to allocate responsibility 
for regulating smaller advisers to state securities authorities. 
Several commenters urging us to expand the rule suggested approaches 
that would or could result in the migration of a large number of 
smaller advisers to Commission registration. On the other hand, some of 
the commenters opposing or arguing for substantial narrowing of our 
proposed exemption seemed not to appreciate fully the burdens of 
multiple registration on Internet Investment Advisers.
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    \11\ See Section I. of the Proposing Release.
    \12\ Section 203A(c).
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    Absent an exemption, Internet Investment Advisers would likely 
incur the burden of temporarily registering in every state and later 
de-registering. State investment adviser registration statutes 
generally obligate advisers to register in every state in which the 
adviser obtains more than a de minimis number of clients. Because an 
Internet Investment Adviser uses an interactive Web site to provide 
investment advice, the adviser's clients can come from any state, at 
any time. As a result, an Internet Investment Adviser must as a 
practical matter register in every state. This ensures that the 
adviser's registrations will be in place when it later obtains the 
requisite number of clients from any particular state. The adviser may 
subsequently become eligible for our existing exemption under Rule 
203A-2(e), permitting Commission registration for advisers otherwise 
obligated to register in at least 30 states, but not before the adviser 
had already incurred the burden of registering in every state.\13\
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    \13\ An Internet Investment Adviser relying on the multi-state 
adviser exemption provision would not be eligible for that exemption 
until the adviser had obtained the requisite number of clients in 30 
states to trigger its registration obligations in those states. 
Under that rule, the adviser must represent that it has reviewed its 
obligation under state and federal law and has concluded that it 
would be required to register with the securities administrators of 
at least 30 states. Rule 203A-2(e)(2).
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A. New Rule 203A-2(f)

    Under rule 203A-2(f), an adviser is exempt from the prohibition on 
Commission registration if the adviser provides investment advice to 
all of its clients exclusively through an interactive Web site. A 
limited exception, however, permits an adviser relying on the rule to 
provide investment advice to fewer than 15 clients through other means 
during the preceding 12 months. In addition, advisers registering with 
us in reliance on the rule must keep records demonstrating that they 
meet the conditions of the rule. We discuss each of the elements of the 
new exemption below.
1. Interactive Web Site
    The exemption is available only to an adviser that provides 
investment advice to clients exclusively through an ``interactive Web 
site,'' except as permitted by the de minimis exception described 
below. The rule defines ``interactive Web site'' as a Web site in which 
computer software-based models or applications provide investment 
advice to clients based on personal information provided by each client 
through the Web site.\14\ The rule is thus not available to advisers 
that merely use Web sites as marketing tools or that use Internet 
vehicles such as E-mail, chat rooms, bulletin boards and webcasts or 
other electronic media in communicating with clients. The Commission 
recognizes that most advisers today use (or could use) the Internet in 
some aspect of their business. As a result, expansion of the rule to 
include such activities as suggested by some commenters could undermine 
NSMIA's allocation of regulatory responsibility over smaller advisers 
to state securities authorities.
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    \14\ Rule 203A-2(f)(2). In response to one comment requesting 
technical clarification of the definition, we have added language 
clarifying that an interactive Web site is one which provides advice 
based on personal information supplied by the client, in order to 
distinguish Web sites covered by the exemption from other types of 
Web sites that aggregate and provide financial information in 
response to user-provided requests that do not include personal 
information.
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    In addition, the exemption is for advisers that provide investment 
advice to their Internet clients ``exclusively'' through their 
interactive Web sites. An adviser relying on the exemption may not use 
its advisory personnel to elaborate or expand upon the investment 
advice provided by its interactive Web site, or otherwise provide 
investment advice to its Internet clients, except as permitted by the 
de minimis exception discussed below.\15\
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    \15\ The firm may still provide clients with assistance in the 
technical aspects of accessing and using the interactive Web site.
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2. De Minimis Exception for Non-Internet Clients
    The new rule includes an exception that would permit an adviser 
relying on the rule to advise clients through means other than its 
interactive Web site, so long as the adviser had fewer than 15 of these 
non-Internet clients during the preceding 12 months. This is a change 
from the proposal, under which an adviser would have been eligible to 
rely on the rule so long as at least 90 percent of the adviser's 
clients obtained their investment advice exclusively through the 
interactive Web site. We included the ``90 percent test'' in our 
proposal to prevent Internet Investment Advisers from losing the 
exemption as a result of providing advice to a de minimis number of 
clients through means other than an interactive Web site.
    A few commenters thought the rule should employ a lower percentage 
threshold permitting a greater level of non-Internet clients, which we 
believe would be inconsistent with the purpose of the exemption. Other 
commenters urged a narrower exemption, arguing that an adviser having a 
large number of Internet clients could, under the proposed 90 percent 
test, have as many or more non-Internet clients than many advisers have 
clients.
    The commenters have persuaded us that the 90 percent test, as 
proposed, would have permitted more than a de minimis number of non-
Internet clients. Accordingly, we have decided to replace the 90 
percent test with a provision permitting an adviser relying on the rule 
to have fewer than 15 non-Internet clients during the course of the 
preceding twelve months.\16\ In

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determining how many clients the adviser provided investment advice 
through means other than the adviser's interactive Web site for 
purposes of determining eligibility for the exemption, the rule 
provides that an Internet Investment Adviser may rely on the definition 
of ``client'' in rule 203(b)(3)-1.\17\
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    \16\ The new rule's de minimis exception is similar to section 
203(b)(3) of the Advisers Act [15 U.S.C. 80b-2(b)(3)], which exempts 
from the requirement to register with the Commission any adviser 
that, during the course of the preceding 12 months, has had fewer 
than 15 clients. We did not include the other requirements under 
section 203(b)(3), that the adviser may not hold itself out 
generally to the public as an investment adviser, and may not act as 
investment adviser to any registered investment company or business 
development company.
    \17\ See rule 203A-2(f)(3) (citing rule 203(b)(3)-1 [17 CFR 
275.203(b)(3)-1]). Rule 203(b)(3)-1 provides a safe harbor provision 
for purposes of determining who may be deemed to be a single client 
for purposes of section 203(b)(3).
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3. Precluding Use of Rule 203A-2(c)
    One commenter expressed concern that, absent changes to the 
language of the proposed rule, some advisers might use rule 203A-2(c) 
to attempt to evade the limit on the number of non-Internet clients 
under new rule 203A-2(f). Rule 203A-2(c) exempts an adviser from the 
prohibition on Commission registration if the adviser controls, is 
controlled by, or is under common control with, another SEC-registered 
adviser with the same principal place of business. The commenter 
expressed concern that an Internet Investment Adviser intent on evading 
the restrictions on non-Internet clients under new rule 203A-2(f) might 
attempt to organize a subsidiary firm to serve its non-Internet 
clients, and assert rule 203A-2(c) as a basis to register the 
subsidiary with the SEC, even though the subsidiary does not manage $25 
million of client assets.\18\ To forestall any such efforts, 203A-2(f), 
as adopted, is unavailable to an Internet Investment Adviser if another 
adviser in a control relationship with the Internet Investment Adviser 
relies on the Internet Investment Adviser's registration under rule 
203A-2(f) as the basis for its own registration under rule 203A-
2(c).\19\
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    \18\ Such an attempt would not, however, be successful because 
it would violate section 208(d) of the Advisers Act [15 U.S.C. 80b-
8(d)], which makes it unlawful for any person ``indirectly, or 
through or by any other person, to do any act or thing which it 
would be unlawful for such person to do directly'' under the 
Advisers Act.
    \19\ Rule 203A-2(f)(1)(iii). An investment adviser controlled, 
controlling, or under common control with two or more SEC-registered 
investment advisers, only one of which is an Internet Investment 
Adviser, may still rely on the Commission registration of the other 
adviser to establish its eligibility for the exemption in rule 203A-
2(c), and the Internet Investment Adviser will not be precluded from 
relying on rule 203A-2(f).
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4. Recordkeeping Requirements
    The rule requires an adviser relying on the exemption to maintain 
records demonstrating that it provides investment advice to its clients 
exclusively through an interactive Web site in accordance with the 
limits of the exemption.\20\ An advisory firm relying on the exemption 
could comply with this requirement by maintaining records showing which 
of its clients the firm advised exclusively through its interactive Web 
site and which, if any, of its clients the firm advised through non-
Internet means.\21\
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    \20\ Rule 203A-2(f)(1)(ii).
    \21\ Internet Investment Advisers maintaining these records in 
electronic form must do so in compliance with the Commission's rules 
on electronic recordkeeping, rule 204-2(g) [17 CFR 275.204-2(g)].
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B. Form ADV

    We are also amending Part 1 of Form ADV, the Uniform Application 
for Investment Adviser Registration. Advisers register with us by 
electronically submitting the information required by Part 1 of Form 
ADV through the Investment Adviser Registration Depository (the 
``IARD''). We are adding the exemption under rule 203A-2(f) to the list 
of exemptions in Item 2 of Part 1, in which advisers registering with 
us indicate the basis upon which they are eligible to register with the 
SEC.
    It will be some number of months before the National Association of 
Securities Dealers (``NASD''), which operates the IARD for us, 
completes reprogramming the IARD to implement this change to Item 2 of 
Part 1. In the interim, advisers relying on the 203A-2(f) exemption to 
register with us should select current Item 2(10), for registrants 
eligible for registration by SEC order, and in Schedule D, current Item 
2.A(10), enter ``203A-2(f)'' in lieu of an application number. Upon 
NASD's implementation of the new 203A-2(f) exemption selection on IARD, 
registrants should amend their Item 2 selection and remove the Schedule 
D reference to the rule no later than their next annual amendment of 
Part 1.

III. Effective Date

    The effective date of the new rule and rule amendments is January 
20, 2003.

IV. Cost-Benefit Analysis

A. Background

    The Commission is sensitive to the costs and benefits imposed by 
its rules. New rule 203A-2(f) provides relief to Internet Investment 
Advisers. Under the rule, an Internet Investment Adviser is exempt from 
the prohibition on Commission registration if the adviser provides 
investment advice to all of its clients exclusively through its 
interactive Web site (except that the adviser may advise fewer than 15 
clients through other means during the preceding 12 months). In 
addition, advisers registering with us in reliance on the rule must 
keep records demonstrating that they meet the conditions of the rule. 
Without the exemption to the prohibition on Commission registration as 
provided by new rule 203A-2(f), Internet Investment Advisers typically 
would not initially be eligible to register with us, as they do not 
manage the assets of their Internet clients, and, consequently, would 
not meet the $25 million statutory threshold for SEC-registration. 
Unlike a typical state-registered adviser, an Internet Investment 
Adviser's advisory activities are not confined to one or a few states. 
Because an Internet Investment Adviser uses an interactive Web site to 
provide investment advice, the adviser's clients can come from any 
state, at any time, without the adviser's prior knowledge. As a result, 
an Internet Investment Adviser must register in all states, ensuring it 
has its registration in place when the firm obtains the requisite 
number of clients from any particular state. Consequently, these 
advisers would be required, absent an exemption, to register in every 
state.
    Moreover, the Commission's existing exemptive rules would not work 
for these advisers. For example, an Internet Investment Adviser relying 
on the multi-state exemption under rule 203A-2(e) must represent that 
it has reviewed its obligations under state law and has concluded that 
it would be required to register as an investment adviser with the 
securities administrators of at least 30 states. The state registration 
obligations of Internet Investment Advisers depend on the residences of 
their clients, and their clients can come from any state at any time. 
Thus, as a practical matter, these advisers would still need to 
register in every state and wait until they encounter registration 
obligations in 30 states before registering under rule 203A-2(e) and 
then canceling their state registrations.
    Nor is it likely Internet Investment Advisers could rely on rule 
203A-2(d) to carry them through an initial period of operation without 
state registration in anticipation of eligibility under the multi-state 
exemption. If an adviser relying on rule 203A-2(d) has not become 
eligible for SEC registration within 120 days, it must withdraw its 
registration. Internet Investment Advisers must typically register 
early in their development and testing phase in order to obtain venture 
capital, and many may not even be fully operational 120 days later.
    In adopting rule 203A-2(f) and amendments to Form ADV, the

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Commission has given consideration to the costs, as well as the 
benefits of the new exemption.

B. Benefits

    Rule 203A-2(f) will, we believe, provide several important benefits 
to Internet Investment Advisers. We have limited data on the number of 
Internet Investment Advisers who would be eligible to obtain these 
benefits, since most do not currently register with us. Based on news 
articles, we estimate that as many as 20 firms could avail themselves 
of the exemption. In the Proposing Release, we requested that 
commenters with additional data provide it to us. However, few 
commenters addressed the number of Internet Investment Advisers 
potentially eligible for the exemption, and none provided supporting 
data. Importantly, while these commenters were not in agreement whether 
our estimate was too high or too low, all agreed that the number of 
firms eligible to benefit by the exemption would likely grow in the 
future.
    The rule will benefit Internet Investment Advisers by relieving 
them of the burden of registering temporarily in every state and 
subsequently deregistering upon becoming eligible under the multi-state 
exemption, as discussed above. To register in every state, an advisory 
firm will, in all likelihood, need assistance of counsel to perform 
several tasks. These include evaluating the statutes and regulations of 
each state to check for any disparities, responding to varying comments 
on the firm's registration submissions from multiple state securities 
administrators, reviewing the firm's operations for compliance with the 
statutory and regulatory requirements of every state, and the like. 
Several small firms commenting on the rule stated that the burden of 
complying with the registration requirements of multiple states 
prohibited or significantly impeded their firm's ability to provide 
investment advice to clients in multiple states.
    To estimate the approximate cost advisory firms would incur to 
obtain these services, our staff engaged in discussions with counsel 
familiar with state adviser registration and regulatory issues. Based 
on these discussions, we estimate the cost to be approximately $50,000 
for each adviser, for a total of $1 million for all 20 advisers.\22\ 
Some commenters asserted that the $50,000 estimate was significantly in 
excess of true costs, but none of these commenters provided any cost 
data or estimates of their own. One of these commenters asserted the 
estimate was flawed because it was based on registration with every 
state, whereas an Internet Investment Adviser would only be required to 
register in 29 states, and would then become eligible for the multi-
state exemption once the adviser's registration obligations were 
triggered in a thirtieth state. However, this commenter did not explain 
how the Internet Investment Adviser, whose clients can come from any 
state at any time, would be able to predict which 29 states to register 
with as an initial matter. This commenter also argued the $50,000 
estimate should be reduced to reflect the amount a firm would save on 
costs associated with SEC registration. We did not include such costs 
as an offset in our estimate, since the firm would still incur them 
upon reaching eligibility for our multi-state exemption.
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    \22\ $50,000 x 20 = $1,000,000. This figure does not, however, 
include the time to complete Form ADV initially and the fees to file 
Form ADV through the IARD, since advisers relying on the exemption 
will still incur these costs in registering with us. Similarly, this 
figure does not include state registration fees. States impose 
notice filing requirements upon Commission-registered advisers doing 
business in their states, with associated fees approximately 
equivalent to state registration fees.
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    The benefits of rule 203A-2(f) would also include other benefits 
that are difficult to quantify. Subjecting Internet Investment Advisers 
to the cost of registering temporarily in all states and to multiple 
state regulation acts as an impediment to launching these businesses. 
Rule 203A-2(f) would benefit this segment of the advisory industry by 
removing this potential barrier to entry, and may enable more firms to 
offer these types of Internet-based services. Other benefits include 
the savings to affected advisers from the cost of examinations by 
multiple states' regulators, as well as the savings to state securities 
authorities that would no longer examine these firms.

C. Costs

    Rule 203A-2(f) would impose certain costs on advisers relying on 
the exemption. The Commission estimated that the total cost to each 
Internet Investment Adviser to comply with the recordkeeping provision 
of the new rule would be approximately $138.80,\23\ such that the total 
cost for the 20 advisers that may be eligible for the new exemption at 
this time would be $2,776.\24\
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    \23\ The Commission estimated this figure by multiplying the 
burden hours to comply with the proposed rule's recordkeeping 
requirements (4 hours) by an average hourly compensation rate of 
$34.70. This compensation rate includes overhead and is the rate for 
an operations supervisor outside of New York City, based on a 2000 
study by the Securities Industry Association. The estimate of burden 
hours is based on the Commission's submission for the proposed rule 
under the Paperwork Reduction Act and reflects recent discussions 
with counsel familiar with advisers' recordkeeping issues. See infra 
Section V of this Release.
    \24\ 20 x $138.80 = $2,776.
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    We have concluded that the benefits of rule 203A-2(f) and form 
amendments adopted today justify their costs.

V. Paperwork Reduction Act

    As set forth in the Proposing Release, certain provisions of rule 
203A-2(f) and form amendments that we are adopting today contain 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (the ``PRA'').\25\ The titles for the 
collections of information are ``Exemption for Certain Investment 
Advisers Operating Through the Internet'' and ``Form ADV,'' both under 
the Advisers Act. The Commission submitted those collection of 
information requirements to the Office of Management and Budget 
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11. The collection of information for Form ADV has been previously 
approved under OMB control number 3235-0049 (expires June 30, 2003). 
The collection of information for rule 203A-2(f) has recently been 
approved by OMB; the OMB control number is 3235-0559 (expires November 
30, 2005). An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number.
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    \25\ 44 U.S.C. 3501-3520.
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A. Rule 203A-2(f)

    Rule 203A-2(f) includes a recordkeeping provision requiring an 
adviser registering under the new rule to maintain a record 
demonstrating that, with the exception of fewer than 15 clients during 
the preceding 12 months, all of its clients obtained investment advice 
exclusively through the adviser's interactive Web site. This 
recordkeeping provision contains a new ``collection of information'' 
requirement within the meaning of the PRA. Although we anticipate that 
most Internet Investment Advisers would generate the necessary records 
in the ordinary conduct of their Internet advisory business, we 
believe, as discussed in the Proposing Release, that the recordkeeping 
requirement might impose a small additional burden on these advisers.
    In the Proposing Release, we estimated that the recordkeeping 
burden under the proposed rule should not

[[Page 77624]]

exceed an average of four hours annually per Internet Investment 
Adviser. We also estimated that there would be approximately 20 
potential respondents to the collection of information, for a total 
burden of 80 hours annually. We requested comments on the recordkeeping 
requirements, as well as on the number of Internet Investment Advisers 
likely to register with the Commission under the proposed rule.
    Only one commenter addressed our request for comment on the 
reasonableness of our estimate of the recordkeeping burden of the 
proposed rule. The commenter noted that the burden appeared reasonable 
and necessary. As for the number of advisers likely to register with us 
under the proposed rule, four commenters responded with views on this 
issue. One of the four thought our estimate was too low, suggesting 50 
instead. Another of the four, however, considered our estimate of 20 
too high. All four commenters opined that the number of Internet 
Investment Advisers would likely grow in the future.
    Rule 203A-2(f) is being adopted as proposed, with the exception 
that the de minimis exception for non-Internet clients was revised to 
state that an adviser relying on the rule may only accept fewer than 15 
such clients during the preceding 12 months, and the adviser may not 
rely on the rule if another adviser with whom it is in a control 
relationship relies solely on the Internet adviser`s registration under 
rule 203A-2(f) to register under rule 203A-2(c). The burden estimate is 
unchanged. Providing the information required under rule 203A-2(f) is 
mandatory, as Commission staff uses this collection of information in 
its examination and oversight program. Responses to the information 
generally will not be kept confidential.

B. Form ADV

    Rule 203A-2(f) adds a new category of advisers eligible for 
Commission registration and requires that Form ADV be amended. The 
addition of Internet Investment Advisers will increase the total burden 
under Form ADV, but these advisers' burden for completing Form ADV 
would not differ from that for current registrants. The Commission has 
revised its estimate of the burden hours required by Form ADV as a 
result of a change in the number of estimated respondents. We estimated 
in the Proposing Release that approximately 20 Internet Investment 
Advisers would register with the Commission under the proposed rule, 
and that each of these advisers would file one complete Form ADV and 
one amendment annually. The increase in the total annual burden for 
this collection of information results in a total revised burden of 
46,921 hours. We requested comments on these estimates. As stated 
above, only one commenter addressed our request for comment on the 
reasonableness of the estimated recordkeeping burden of the proposed 
rule, by noting that the estimated burden appeared reasonable and 
necessary.
    Providing the information required by Form ADV is mandatory, and 
responses to the information will not be kept confidential. The 
amendments to Form ADV were adopted substantially as proposed, and the 
burden estimate has not changed.

VI. Summary of Final Regulatory Flexibility Analysis

    An Initial Regulatory Flexibility Analysis (``IRFA'') was published 
in the Proposing Release. No comments were received on the IRFA. The 
Commission has prepared a Final Regulatory Flexibility Analysis 
(``FRFA''), in accordance with 5 U.S.C. 604, regarding rule 203A-2(f) 
and the amendments to Form ADV. The following summarizes the FRFA.
    The FRFA discusses the need for, and objectives of, the new rule 
exempting Internet Investment Advisers from the prohibition on 
Commission registration. Advisory firms eligible for the exemption will 
be relieved of the burden of temporarily registering in every state.
    The FRFA also discusses the effect of the rule and rule amendments 
on small entities. For purposes of the Advisers Act and the Regulatory 
Flexibility Act, an investment adviser generally is a small entity if 
(i) it manages assets of less than $25 million reported on its most 
recent Schedule I to Form ADV; (ii) it does not have total assets of $5 
million or more on the last day of the most recent fiscal year and 
(iii) it is not in a control relationship with another investment 
adviser that is not a small entity.\26\ The FRFA states that the 
Commission estimates that approximately 20 advisers will be affected by 
rule 203A-2(f), and all 20 are likely to be small entities.
---------------------------------------------------------------------------

    \26\ Rule 0-7 [17 CFR 275.0-7].
---------------------------------------------------------------------------

    As discussed in the FRFA, rule 203A-2(f) imposes no new reporting 
requirements, but does impose recordkeeping requirements on advisers, 
including small advisers, that provide advisory services through 
interactive Web sites. Rule 203A-2(f) requires advisers registering 
under the new rule to maintain in an easily accessible place a record 
demonstrating that, with the exception of fewer than 15 clients during 
the preceding 12 months, all of its clients obtained investment advice 
exclusively through the adviser's interactive Web site. As the FRFA 
notes, these advisers will likely generate these records in the 
ordinary course of their business, and the Commission believes they 
will not incur any significant burden under the recordkeeping 
requirement. The FRFA also notes that the amendments to Form ADV, 
requiring advisers relying on the exemption to check a box indicating 
their eligibility for the exemption, would have no measurable effect on 
these advisers.
    The FRFA discusses alternatives considered by the Commission in 
adopting the rule that might minimize adverse effects on small 
advisers, including (a) the establishment of differing compliance or 
recordkeeping requirements or timetables that take into account 
resources available to small advisers; (b) the clarification, 
consolidation, or simplification of compliance and recordkeeping 
requirements under the new rule and rule amendments for small advisers; 
(c) the use of performance rather than design standards; and (d) an 
exemption from coverage of the new rule and rule amendments, or any 
part thereof, for small advisers.
    The FRFA states that the compliance and reporting requirements 
contained in the new rule will not impose a significant burden on small 
advisers relying on the rule. As such, it does not appear necessary to 
establish differing compliance and reporting requirements for small 
entities. The FRFA also states that small advisers will likely generate 
records to satisfy the compliance and recordkeeping requirements in the 
ordinary course of their businesses, and as a result it is not 
necessary to clarify, consolidate, or simplify these requirements. 
Regarding the use of performance rather than design standards, the FRFA 
discusses that the rule uses performance standards in that the rule 
does not specify the means by which an adviser must keep records to 
demonstrate its compliance with the rule. Finally, the FRFA notes that 
exempting small advisers from these recordkeeping requirements would be 
inconsistent with NSMIA's allocation of regulatory responsibility for 
smaller advisers to the states, because the Commission will use these 
records in connection with its examination and oversight program to 
verify an adviser's eligibility to register with the Commission under 
the exemption

[[Page 77625]]

instead of registering with state securities authorities.
    The FRFA is available for public inspection in File No. S7-10-02. A 
copy of the FRFA may be obtained by contacting Marilyn Barker, Senior 
Counsel, Securities and Exchange Commission, 450 Fifth Street, NW, 
Washington, DC 20549-0506.

VII. Statutory Authority

    The Commission is adopting new rule 203A-2(f) pursuant to the 
authority set forth in section 203A(c) of the Investment Advisers Act 
of 1940 [15 U.S.C. 80b-203A(c)].

List of Subjects in 17 CFR Parts 275 and 279

    Investment advisers, Reporting and recordkeeping requirements, 
Securities.

Text of Rule and Rule Amendments

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is amended as follows:

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    1. The authority citation for Part 275 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3A, 80b-
4, 80b-6(4), 80b-6a, 80b-11, unless otherwise noted.
* * * * *

    2. Section 275.203A-2 is amended by adding paragraph (f) to read as 
follows:


Sec.  275.203A-2  Exemptions from prohibition on Commission 
registration.

* * * * *
    (f) Internet investment advisers. (1) An investment adviser that:
    (i) Provides investment advice to all of its clients exclusively 
through an interactive website, except that the investment adviser may 
provide investment advice to fewer than 15 clients through other means 
during the preceding twelve months;
    (ii) Maintains, in an easily accessible place, for a period of not 
less than five years from the filing of a Form ADV that includes a 
representation that the adviser is eligible to register with the 
Commission under paragraph (f) of this section, a record demonstrating 
that it provides investment advice to its clients exclusively through 
an interactive website in accordance with the limits in paragraph 
(f)(1)(i) of this section; and
    (iii) Does not control, is not controlled by, and is not under 
common control with, another investment adviser that registers with the 
Commission under paragraph (c) of this section solely in reliance on 
the adviser registered under paragraph (f) of this section as its 
registered adviser.
    (2) For purposes of paragraph (f) of this section, interactive 
website means a website in which computer software-based models or 
applications provide investment advice to clients based on personal 
information each client supplies through the website.
    (3) An investment adviser may rely on the definition of client in 
Sec.  275.203(b)(3)-1 in determining whether it provides investment 
advice to fewer than 15 clients under paragraph (f)(1)(i) of this 
section.

PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 
1940

    3. The authority citation for Part 279 continues to read as 
follows:

    Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1, 
et seq.


    4. Form ADV (referenced in Sec.  279.1) is amended by:
    a. Revising Item 2e. of Instructions for Part 1A;
    b. Revising the last sentence of the third undesignated paragraph 
of Item 2f. of Instructions for Part 1A;
    c. Revising the third undesignated paragraph of Item 2g. of 
Instructions for Part 1A;
    d. Redesignating Item 2h. as Item 2i. of Instructions for Part 1A;
    e. Adding a new Item 2h. of Instructions for Part 1A;
    f. In newly designated Item 2i., revising the phrase ``box 11'' to 
read ``box 12'' in the two places it appears;
    g. In Part 1A revising the introductory text of paragraph A, and 
paragraphs A(10) and A(11);
    h. In Part 1A, adding paragraph A(12); and
    i. In Schedule D, revising the heading ``Section 2.A(10) SEC 
Exemptive Order'' to read ``Section 2.A(11) SEC Exemptive Order''.
    The revisions and additions read as follows:


    Note: The text of Form ADV does not and the amendments to it 
will not appear in the Code of Federal Regulations.

Form ADV

* * * * *

Form ADV: Instructions for Part 1A

* * * * *
2. Item SEC Registration
* * * * *
    e. Item 2.A(7): Affiliated Adviser. You may check box 7 only if you 
are eligible for the affiliated adviser exemption from the prohibition 
on SEC registration. See SEC rule 203A-2(c). You are eligible for this 
exemption if you control, are controlled by, or are under common 
control with an investment adviser that is registered with the SEC, and 
you have the same principal office and place of business as that other 
investment adviser. Note that you may not rely on the SEC registration 
of an Internet investment adviser under rule 203A-2(f) in establishing 
eligibility for this exemption. See SEC rule 203A-2(f)(iii). If you 
check box 7, you must also complete Section 2.A(7) of Schedule D.
    f. Item 2.A(8): Newly-Formed Adviser. * * *
* * * * *
    * * * If you indicate on that amendment (by checking box 12) that 
you are not eligible to register with the SEC, you also must at that 
same time file a Form ADV-W to withdraw your SEC registration.
    g. Item 2.A(9): Multi-State Adviser. * * *
* * * * *
    If, at the time you file your annual updating amendment, you are 
required to register in less than 25 states and you are not otherwise 
eligible to register with the SEC, you must check box 12 in item 2.A. 
You also must file a Form ADV-W to withdraw your SEC registration. See 
Part 1A Instructions 2.i.
    h. Item 2.A(10): Internet Investment Adviser. You may check box 10 
only if you are eligible for the Internet adviser exemption from the 
prohibition on SEC registration. See SEC rule 203A-2(f). You are 
eligible for this exemption if:
    [sbull] You provide investment advice to your clients through an 
interactive Web site. An interactive Web site means a Web site in which 
computer software-based models or applications provide investment 
advice based on personal information each client submits through the 
Web site. Other forms of online or Internet investment advice do not 
qualify for this exemption.
    [sbull] You provide investment advice to all of your clients 
exclusively through the interactive Web site, except that you may 
provide investment advice to fewer than 15 clients through other means 
during the previous 12 months; and
    [sbull] You maintain a record demonstrating that you provide 
investment advice to your clients exclusively through an interactive 
Web site in accordance with these limits.
* * * * *

Part 1A

* * * * *
Item 2 SEC Registration
* * * * *

[[Page 77626]]

    A. To register (or remain registered) with the SEC, you must check 
at least one of the Items 2.A(1) through 2.A(11), below. If you are 
submitting an annual updating amendment to your SEC registration and 
you are no longer eligible to register with the SEC, check Item 
2.A(12). You:
* * * * *
[ballot] (10) Are an Internet investment adviser relying on rule 203A-
2(f);

    See Part 1A Instructions 2.h. to determine whether you should check 
this box.

[ballot] (11) Have received an SEC order exempting you from the 
prohibition against registration with the SEC;

    If you checked this box, complete Section 2.A(11) of Schedule D.

[ballot] (12) Are no longer eligible to remain registered with the SEC.

    See Part 1A Instructions 2.i. to determine whether you should check 
this box.

* * * * *

    Dated: December 12, 2002.

    By the Commission.

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-31843 Filed 12-17-02; 8:45 am]
BILLING CODE 8010-01-P