Rule 3a-4 Compliance for Advisors

This is the fourth installment of our BCCP Summer Compliance Series.


When we think of investment advisor regulation, advisors are familiar with the typical SEC and/or state rules they must follow. However, there are a few rules in other Acts that apply to all market participants, regardless of regulator. One such rule is Rule 3a-4 under the Investment Company Act of 1940. This rule describes what discretionary managers must do, in order to make sure they are not considered to be a mutual fund.


Advisors may have portfolios comprised of securities that fall within certain risk categories, styles, time horizons, goals, or other factors that may create a unifying theme for that portfolio. For example, a “conservative” portfolio consisting of bonds and cash equivalents, or a “speculative” portfolio consisting of small-cap stocks and options. Across all clients’ holdings, a portfolio will have the same securities in roughly the same measure such that the portfolio is consistent with the stated theme. Additionally, securities may be purchased or sold in portfolios on a global basis. This has the dual benefit of keeping portfolios thematically consistent and may offer the opportunity for average pricing across all trades. It also allows an advisor to service a greater number of clients more efficiently. (You might be thinking, hmmm…this sounds a lot like a mutual fund.)


If you are a discretionary manager and if all of your clients get generally the same portfolio -- with the same securities in approximately the same measure -- you may be running a de facto mutual fund (in the eyes of regulators). In order to prevent being considered an investment company, you need to take a few steps.


Here’s what you need to do:


Rule 3a-4 spells out the steps you need to take to ensure that you do not find yourself running a de facto mutual fund -- and being required to register as an investment company:


  • Obtain sufficient personalized information about your client to manage the client’s account according to each individual client’s financial situation.

  • Give the client the opportunity to impose reasonable restrictions on the management of the account. Clients are not required to place restrictions on their account. You need only to offer your client the opportunity.

  • At least annually, contact your client to see if there has been any changes to the client’s financial situation. Give the client another opportunity to place reasonable restrictions on the account.

  • Ensure that clients are receiving account statements from their account custodians at least quarterly.

  • You must be reasonably available to the client for consultation.

  • The client must retain full ownership of all securities in the account, be able to vote proxies, receive timely notification of trades, and be allowed to withdraw cash and securities.

Please click here to read the full text of Rule 3a-4: https://www.ecfr.gov/current/title-17/chapter-II/part-270/section-270.3a-4


Policies and Procedures


It’s not enough for an advisor to say, “oh yeah, we do that.” Advisors need to codify what they’re doing in the form of adequate policies and procedures. These policies and procedures should cover the basic tenets of Rule 3a-4 and also provide for specific operational procedures to ensure that they do not run afoul of this rule.


Additionally, advisors should have a thorough client intake form or client profile to document client goals and objectives. A risk profile questionnaire will also help to give definition to your client’s investment needs.


Running an advisory practice in violation of Rule 3a-4 will have severe negative consequences. Registering and maintaining registration as an investment advisor is difficult enough. Registering as an investment company is a far more intensive and arduous process. It is far simpler just to obey Rule 3a-4.


If you’d like help with policies and procedures, client forms, or a review of your current practices to help ensure compliance with Rule 3a-4, please contact us. We’d be happy to assist you.


Dane Grouell is a Senior Advisory Board Member at BCCP and a 25-year veteran of the financial services industry. He has worked in executive management and compliance roles at various broker-dealers and investment advisors. Dane has previously been the Chief Compliance Officer of a $19 billion investment advisor and private fund manager and $80 million independent investment advisor. He has been responsible for nationwide supervision of national broker-dealers. Dane has done onsite audits of broker-dealers and investment advisors, registered new entities with the SEC and states, and responded to regulatory inquiries from nearly every regulatory body in the United States. He has rendered advice to firms domiciled in the United States, Europe, and Asia. Dane currently holds the Series 65 license and is a former Series 7, 24, 9, 10, and 52 holder.



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