On March 27, 2024, the Securities and Exchange Commission (“SEC”) adopted a final rule (the “Final Rule”) amending SEC Rule 203A-1(E) (the “Internet Adviser Exemption”) promulgated under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The Final Rule (which is unchanged from the rule as originally proposed on July 26, 2023) updates the definition of “Internet Investment Advisers” and requires investment advisory services to be offered exclusively through an operational interactive website to qualify for the Internet Adviser Exemption. The Final Rule seeks to modernize the Internet Investor Exemption and takes into account the rapid evolution of technology and the investment adviser industry since its adoption over two decades ago. The full text of the adopting release, including the Final Rule can be viewed here.
Background:
In general, investment advisers are prohibited from registering with the SEC unless (i) they satisfy an assets under management threshold, (ii) advise a registered investment company, or (iii) qualify under an exception under the Advisers Act or SEC rules. The Internet Adviser Exemption, originally adopted in 2002, relieved certain advisers that provide investment advisory services primarily through the internet from the burdens of multiple state regulation and allowed them to register with the SEC. An adviser could rely on the Internet Adviser Exemption as originally adopted if, among other things, it provided all of its investment advice to clients exclusively through an interactive website, with a limited exception that allowed it to provide investment advice to fewer than fifteen clients by other means during the preceding 12 months. Since the initial adoption of the Internet Adviser Exemption, the use of technology in the investment sector has boomed and now is an essential way for investment advisers to provide products and services to clients. This has led to an increase in the number of advisers seeking to rely on the Internet Adviser Exemption. In its adopting release, the SEC underscores that the Internet Adviser Exemption was intended as a narrow exemption for entities that exclusively provide investment advice through an interactive website. In the SEC’s view, while some advisers use the exemption as intended, others have registered with the SEC while failing to satisfy the conditions of the exemption. The Final Rule seeks to better align with current practices in the investment adviser industry, enhance investor protections though more efficient use of the SEC’s resources to advisers with a national presence and allow smaller advisers with a local presence to be regulated by the states.
Operational Interactive Website:
The Final Rule renames “interactive website” to “operational interactive website,” and redefines it as a website or mobile application through which the investment adviser provides digital investment advisory services on an ongoing basis to more than one client (except during temporary technological outages of a de minimis duration). The new definition permits an investment adviser relying on the Internet Adviser Exemption to provide digital investment services through a broader form of technology, such as mobile applications. The Final Rule also amends Form ADV to require an adviser who is relying on the Internet Adviser Exemption as a basis for registration to represent on Schedule D of its Form ADV that, among other things, it has an “operational interactive website.”
Digital Investment Advisory Service:
The Final Rule defines “digital investment advisory service” to mean investment advice that is generated by the operational interactive website’s software-based models, algorithms, or applications based on personal information each client supplies through the operational interactive website. This definition emphasizes the requirement that an adviser must provide investment advice exclusively through an interactive website. Additionally, with the ever-growing artificial intelligence landscape, this new definition encompasses the use of algorithms to generate investment advice. It is important to differentiate this from human-directed, client-specific investment advice (which is delivered through electronic means) and not considered an eligible activity under the Internet Adviser Exemption.
Elimination of De Minimis Non-Internet Client Exception:
The Final Rule eliminates the de minimis exception that has permitted an internet investment adviser to provide investment advice to fewer than fifteen (15) non-internet clients during the preceding 12 months. Consequently, an internet investment adviser must provide advice to all of its clients exclusively through an operational interactive website. The de minimis exception was included in the Internet Adviser Exemption as originally adopted, since, at that time, providing investment advice through an interactive website was in its infancy. The SEC believes that given the widespread practice of providing advice over the web, the de minimis exception is no longer needed, and its removal better reflects the allocation of regulatory responsibility between the SEC and states, and will allow the SEC more effectively to identify advisers claiming reliance without meeting the requisite conditions of the exemption.
Compliance Dates:
The compliance date for the Final Rule is March 31, 2025. Advisers relying on the Internet Adviser Exemption must comply with the Final Rule’s new requirements conditions, including the requirement to amend their Form ADV to include a representation that the adviser is eligible to register with the SEC under the Internet Adviser Exemption, by the compliance date. An adviser no longer eligible to rely on the Internet Adviser Exemption, as amended, must register in one or more states and withdraw its registration with the SEC by filing a Form ADV-W by June 29, 2025. After this time, the SEC expects to cancel the registration of advisers no longer eligible to register with the SEC and who fail to withdraw.
For additional information related to the Final Rules, please contact one of the authors, or any member of our Securities Law Practice Group.
