The Securities and Exchange Commission (SEC) has proposed significant changes to how it defines “small entities” in the investment advisor industry. The proposed rule would raise the asset threshold for advisors to be considered small from $25 million to $1 billion. This change could have a major impact on how rules and regulations affect smaller advisory firms.
The Regulatory Flexibility Act, passed by Congress in 1980, requires federal agencies to analyze and minimize the economic impact of regulations on small businesses. By reevaluating which advisors and companies should be classified as small entities, the SEC aims to modernize regulatory requirements and promote the effectiveness and efficiency of its regulations.
MarketCounsel CEO Brian Hamburger believes that the proposed changes will lead to fewer “one-size-fits-all” assumptions in new rules. This could result in more realistic compliance timelines, reduced documentation requirements, and a more thoughtful cost-benefit analysis for advisors.
Currently, the SEC considers an investment company a small entity if its net assets are under $50 million, while an investment advisor is deemed small if their assets under management do not exceed $25 million. These thresholds were last updated in 1998 and have been criticized for being outdated.
Many industry participants, including the Investment Adviser Association, have long advocated for raising the asset threshold for small entity investment advisors. The current $25 million threshold is seen as virtually meaningless, as most advisors cannot register with the SEC unless they manage at least $100 million in assets.
In a letter to the SEC in 2023, IAA CEO Karen Barr highlighted that the advisory industry is primarily made up of small businesses, with 92% of advisors employing 100 or fewer people. The association supports the SEC’s proposal to increase the asset threshold for small entities, recognizing the unique resource constraints faced by smaller firms.
The proposed changes would qualify about 75% of SEC-registered advisors as small entities, reflecting the industry’s composition of predominantly small businesses. While the $1 billion asset threshold may seem high, it acknowledges the scale and complexity of different advisory firms, ensuring that regulatory impact is assessed accordingly.
In addition to the proposed changes for investment advisors, there is also discussion about reevaluating the regulatory split between federal and state-registered advisors. The current $100 million threshold for SEC registration, established as part of the Dodd-Frank Act in 2010, may be subject to revision to better align with Congress’s intent of focusing SEC resources on larger, more complex advisors.
Overall, the SEC’s proposal to redefine small entities in the investment advisor industry represents a significant shift towards a more tailored and proportionate regulatory framework. By acknowledging the diversity of advisory firms and their unique challenges, the SEC aims to create a more effective and efficient regulatory environment for all market participants.
