IAA: Use headcount, not AUM, to classify small firms

What makes an advisory firm count as "small" for regulatory purposes?

According to the Investment Adviser Association, an industry and lobbying group, firms should count as small if they have 100 or fewer employees. The criteria federal regulators now use to assign the "small" designation, the IAA argues, let federal regulators ignore how newly proposed regulations are likely to affect the vast majority of investment advisors.

At the heart of the IAA's concerns is the Federal Regulatory Flexibility Act of 1980, a law requiring the Securities and Exchange Commission to try to predict what any regulation it proposed will mean specifically for small firms. Ever since 1996, the SEC has defined small investment advisors as those with less than $25 million in assets under management and less than $5 million in assets on their balance sheet at the end of the previous fiscal year. 

That, according to a petition the IAA submitted to the federal Wall Street regulator on Thursday, leaves out the vast majority of firms. Of the 15,402 investment advisors registered with the SEC last year, only 489 met the definition of small firms.

Rather than look at assets under management, the IAA thinks federal regulators should consider advisors small if they have 100 or fewer employees. That criteria would capture 92% of registered firms.

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"While advisers with lower AUM are likely to be small businesses, these advisers comprise only a subset of the larger group of advisers that are small businesses facing small-business challenges," the IAA wrote in its petition.

The IAA also notes that most investment advisors, with few exceptions, are prohibited from registering with the SEC unless they have at least $100 million in assets under management. That makes "any analysis the SEC does regarding the impact on smaller advisers virtually meaningless and contrary to the legislative intent," of the Regulatory Flexibility Act, according to the IAA.

The IAA argues in its petition that small firms tend to be more heavily burdened than large ones by new regulations. Small businesses, it contends, rarely have in-house personnel dedicated to certain tasks like compliance and cybersecurity. They also lack the heft that big firms can bring to contract negotiations with third-party firms that can provide some of these services.

The IAA also repeats its often-made complaint that the SEC is now proceeding with too many proposed regulatory changes at once. As these rules come into effect, the group contends, small firms will once have fewer resources than their large rivals to devote to making sure they stay in compliance.