Investment advisers who provide investment advice for compensation must register or claim an exemption from registration with either the Securities and Exchange Commission (the “SEC”) or state securities authorities (or both), depending on their operations. In California, if an adviser is not otherwise exempt from registration requirements under California law, the investment adviser has less than $100 million in regulatory assets under management (“RAUM”), and more than five clients located in the state of California, then it is required to register with the California Department of Financial Protection and Innovation (“DFPI”) through the Investment Adviser Registration Depositary (“IARD”) system (which is administered by the Financial Industry Regulatory Authority, or “FINRA”). Below is a brief overview of the ongoing compliance filing requirements of investment advisers registered with the state of California.
Annual Updating Amendment of Form ADV
If your firm is a California-registered adviser, it must amend its Form ADV each year on the IARD system within 90 days after its fiscal year end. For an adviser whose fiscal year ended December 31, the deadline to file the annual updating amendment of Form ADV is March 31 of the following year. The firm must update all of ADV Parts 1, 2A and 2B.
When you amend Part 1, the IARD system will prompt you to indicate the type of amendment. You should select “annual updating amendment” and indicate the fiscal year end that the amendment is for. Unlike Part 1, Parts 2A and 2B are not online forms. Instead, you must upload them to the IARD system as separate documents in text-searchable PDF format.
California Annual Fees
A California-registered adviser must pay a $125 annual fee in December each year in accordance with the IARD Renewal Program deadlines published at IARD.com. Annually, California-registered advisers should receive an electronic package from FINRA with instructions on how to pay this fee through the IARD system. An adviser that fails to pay the fee in December should receive a notice from FINRA and will have a “Failure to Renew” registration status on the SEC’s Investment Adviser Public Disclosure website at adviserinfo.sec.gov. An adviser that continues to fail to pay the fee will have its investment adviser certificate summarily revoked.
Other Amendments to Form ADV
A California-registered adviser must also amend Part 1 of its Form ADV promptly during the year to reflect any change in the information reported (other than financial information) and must amend Parts 2A and 2B through the IARD system within 30 days of the occurrence of a material change.
Part 2 Client Delivery Requirements
The DFPI encourages all California-registered advisers to deliver ADV Part 2 to clients on the same schedule that applies to SEC-registered advisers. An adviser whose Part 2A has materially changed since the last annual updating amendment must deliver to clients annually within 120 days after the adviser’s fiscal year end either (a) an amended Part 2A, including a material changes summary or (b) a separate material changes summary that also offers to provide a copy of Part 2A. For an adviser whose fiscal year ended on December 31, the deadline to deliver Part 2 would be April 30 of the following year. Clients that previously received Part 2B need not be provided with an updated copy of Part 2B unless the disciplinary information disclosed in it has changed materially.
Switching to SEC Registration
If your firm’s RAUM is $100 million or more on your annual updating amendment, you are required to switch to SEC registration, unless an exemption from SEC registration applies to the firm.
Switching to the California Private Fund Adviser Exemption
If your California-based firm’s RAUM is below $100 million, and it advises only private funds, it may be eligible for the California private fund adviser exemption, which is similar to the SEC exempt reporting adviser (“ERA”) exemptions under the Investment Advisers Act of 1940. An adviser that relies on the California ERA exemption from investment adviser registration in California is only eligible for this exemption if it provides advice solely to one or more qualifying private funds (which is a fund that qualifies for exclusion from the definition of investment company under one or more of ICA sections 3(c)(1), 3(c)(5), and 3(c)(7)). Please see our article on SEC and California Exempt Reporting Adviser Compliance Filing Requirements for a discussion on California ERAs.
Investment Adviser Representatives
A California-registered adviser must report its investment adviser representatives electronically on Form U4 via FINRA’s CRD system and must report a terminated investment adviser representative on Form U5 within 30 days after his or her termination.
Balance Sheet and Income Statement, Minimum Financial Requirements Computation and Verification
A California-registered adviser that has investment discretion over client assets or receives fees for advisory services 6 months or more in advance must (a) maintain in its records a written monthly calculation indicating that it satisfies California’s minimum financial requirements (generally, a minimum net worth of $10,000 for an adviser that does not have custody of client assets and $35,000 for an adviser that does have such custody) and (b) file with the DFPI an annual balance sheet and income statement prepared in accordance with generally accepted accounting principles (“GAAP”), together with a schedule showing that the adviser satisfies the minimum financial requirements. These financial statements must be audited unless the adviser has not held or accepted custody of funds or securities for any client or owed money/securities to any client, during the period covered by the report.
The financial statements and accompanying schedules should be filed as of the same date for each calendar year, except that the first report must be as of a date within 12 months after the adviser’s certificate became effective. You should submit the financial information with the verification form required by the DFPI within 90 days of the date the financial information is provided. The verification and minimum financial requirements forms can be found on the DFPI website. Your firm’s accountants may be able to assist you in preparing the statement of financial condition and income statement.
Custody
A California-registered adviser that holds, directly or indirectly, client assets or has the authority to obtain them must:
(a) Indicate that it has custody of client assets on its Form ADV;
(b) Maintain those assets with a “qualified custodian” in a separate account for each client;
(c) If advising a private fund:
- Send a statement to every investor at least quarterly that shows (A) the total amount of all additions to and withdrawals from the fund, (B) the opening and closing value of the fund for the reporting period, (C) a list of all of the fund’s securities positions on the closing date of the reporting period that are required to be disclosed under GAAP for non-registered investment partnerships, and (D) a list of all redemptions and withdrawals by the investor and the value of the investor’s interest in the fund; and
- Either (A) have the fund’s financial statements audited annually by a certified public accountant registered with and subject to regular inspection by the Public Company Accounting Oversight Board (“PCAOB”) and distribute the audited financials to investors within 120 days after the fund’s fiscal year end, or (B) enter into an agreement with an independent third party that must act in investors’ best interest, which agreement authorizes the independent third party to review, verify and approve invoices and receipts for all fees, expenses, and withdrawals.
(d) Additionally, an adviser that advises non-fund clients or uses the independent third-party procedure for a fund instead of the annual audit exemption must:
- Notify clients of the identity and location of the qualified custodian of the clients’ assets;
- Have a reasonable basis after due inquiry for believing the clients receive account statements at least quarterly directly from the qualified custodian that (A) identify the amount of assets in the account at the end of the reporting period and (B) list all transactions in the account; and
- Retain a certified public accountant to conduct a surprise examination of client assets at least once each year at a time chosen by the accountant. An adviser that has custody only because of its authority to deduct its fees from client accounts is not subject to this requirement if the adviser has written authorization to deduct its fee, sends invoices for the amount of the fee to its custodian and the client, and notifies the DFPI that it will rely on this exception to the rule.
Other State Registration Requirements
A California (or other state) registered adviser may also be required to register in states in which it has clients or any investment adviser representatives, depending on state law requirements.
Please contact one of the Shartsis Friese attorneys in the Investment Funds & Advisers Group if you have any questions regarding compliance with California investment adviser requirements.
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