From 1940 until 2010, the Investment Advisers Act contained a provision called §203(b)(3) that exempted any adviser with fewer than 15 clients from SEC registration. For decades, private fund managers (including, most famously, Bernard Madoff) operated without registering as investment advisers under that rule. Madoff was finally forced to register in 2006. Three years later, in December 2008, his firm collapsed in the largest fraud in American financial history.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 repealed §203(b)(3). It no longer exists. It is replaced by two narrower exemptions (§203(l) for venture capital funds and §203(m) for private funds under $150 million), and it is also, to this day, the single most common trap in Chapter 6 of Series 63 prep materials. Any study guide that teaches the 15-client rule as current law is either wrong or 15 years out of date.
Section 1: Who Is an Investment Adviser (The ABC Test)
Under USA §401(f), an investment adviser is any person who, for compensation, engages in the business of advising others as to the value of securities or the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.
- A is for Advice about securities
- B is for Business (as part of a regular business)
- C is for Compensation
All three prongs must be present. If any one is missing, the person is not an IA.
A friend who recommends a stock at dinner is not an IA (no compensation, not a business). A Certified Financial Planner who charges for plans that include securities recommendations is an IA (all three prongs).
Section 2: LATE Exclusions and the De Minimis Rule
Even if someone meets the ABC test, §401(f) excludes six categories from the IA definition.
The Six Statutory Exclusions
- Banks, savings institutions, and trust companies acting in their traditional banking capacity
- LATE professionals: Lawyers, Accountants, Teachers, and Engineers whose performance is solely incidental to the practice of their profession
- Broker-dealers whose advice is solely incidental to their brokerage business AND who receive no special compensation for the advice
- Publishers of bona fide newspapers, news magazines, or business or financial publications of general and regular paid circulation
- Persons whose advice relates only to §402(a)(1) exempt securities (US, state, and municipal government securities)
- De minimis: no place of business in the state AND 5 or fewer non-institutional clients in any 12 consecutive months
Test tip: The LATE professional exclusion is lost the moment the professional starts billing separately for investment advice. If the tax accountant charges a separate fee for "portfolio review," the "solely incidental" requirement is broken.
The 5-Client De Minimis Rule
A person with no place of business in the state is not an IA in the state if either (a) the only clients are institutional, or (b) there are 5 or fewer non-institutional clients in any 12 consecutive months. Six clients crosses the line.
Section 3: The Dodd-Frank AUM Dividing Line
The National Securities Markets Improvement Act of 1996 (NSMIA) first drew a line between state and SEC jurisdiction over investment advisers. Before NSMIA, every state reviewed every registration, and a single adviser could face fifty separate filings. Dodd-Frank rewrote the line in 2010, raising the federal threshold and closing the §203(b)(3) 15-client loophole that had let the largest hedge funds (and Bernard Madoff) avoid registration entirely for decades.
AUM Tiers
| AUM | Registration |
|---|---|
| Below $25 million | State only (small adviser) |
| $25M to $100M | State only (mid-sized), unless state does not require registration |
| $100M to $110M | May elect SEC or state (buffer zone) |
| Above $110M | SEC required (federal covered adviser) |
| Falls below $90M | Must drop SEC registration and return to state |
The buffer between $100M and $110M exists to prevent constant flipping between state and SEC registration as AUM fluctuates.
Always-SEC Categories
Five types of advisers register with the SEC regardless of AUM:
- Advisers to registered investment companies or business development companies
- Pension consultants with at least $200 million in employee benefit plan assets
- Internet advisers providing advice through an interactive website to more than one client
- Private fund advisers with at least $150 million in private fund AUM (§203(m))
- Multi-state advisers registered in at least 15 states
The Repealed §203(b)(3) 15-Client Rule
Trap alert: The old §203(b)(3) "private adviser exemption" for advisers with fewer than 15 clients was REPEALED by Dodd-Frank in 2010. It no longer exists. Any prep material that teaches the 15-client rule is either wrong or 15 years out of date. Replacements: §203(l) (VC fund adviser) and §203(m) (private fund adviser with less than $150M AUM).
Section 4: Qualified Client Thresholds (Time-Sensitive)
Under SEC Rule 205-3, an investment adviser cannot charge performance fees unless the client is a qualified client. The thresholds adjust for inflation every 5 years under Dodd-Frank §418.
| Effective | AUM test | Net worth test |
|---|---|---|
| Current (August 16, 2021) | $1,100,000 | $2,200,000 (excluding primary residence) |
| Pending (SEC IA-6955, expected late June 2026) | $1,400,000 | $2,700,000 |
Study tip: The SEC proposed the new thresholds on March 27, 2026. The hearing deadline is April 27, 2026. If no hearing is requested, the order becomes final and the new thresholds take effect in approximately late June 2026. Until the order is final, the correct Series 63 answer is $1.1 million AUM or $2.2 million net worth. After it is final, the correct answer is $1.4 million or $2.7 million. Check the rule status before sitting for the exam.
Section 5: NASAA Custody Rule 102(e)(1)-1
Custody means holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them. It includes physical possession, general power of attorney over client accounts, and serving as general partner of an LP, managing member of an LLC, or trustee of a trust that owns client assets.
Core Custody Requirements
- Notice to the Administrator on Form ADV
- Qualified custodian (bank, BD, FCM, or foreign financial institution) holds assets in a separate account for each client
- Notice to clients of the qualified custodian's name, address, and how assets are held
- Reasonable basis to believe the custodian sends each client an account statement at least quarterly
- Surprise examination by an independent CPA at least once each calendar year
- CPA files Form ADV-E with the Administrator within 120 days of the exam date
- CPA reports material discrepancies within 1 business day
- CPA reports resignation or dismissal within 4 business days
- First exam within 6 months of becoming subject to the rule
Inadvertent Receipt Safe Harbor
If the IA inadvertently receives client funds or securities (for example, a check mailed to the wrong address) and returns them to the sender within 3 business days, the IA is not deemed to have custody.
Section 6: Recordkeeping and Advisory Contracts
NASAA Recordkeeping Rule 203(a)-2
IA books and records must be maintained and preserved in an easily accessible place for at least 5 years from the end of the fiscal year in which the last entry was made, with the first 2 years in the principal office of the investment adviser. Compare to the broker-dealer default of 3 years under USA §203(a).
NASAA Advisory Contract Rule 502(c)
An investment advisory contract must be in writing and must provide:
- Services to be provided, term, fee, fee formula, prepaid fee refund on termination, and any grant of discretionary power
- No assignment or transfer of the contract without client consent
- No compensation based on a share of capital gains or capital appreciation (performance fee prohibition), except for qualified clients under SEC Rule 205-3
- If the IA is a partnership, notification to clients of any change in partnership membership within a reasonable time
The Assignment Definition
"Assignment" includes any transaction or event that results in a change to the individuals or entities with the power to direct management or vote more than 50 percent of any class of voting securities of the IA, compared to when the contract was first entered into. If a majority of the IA's equity changes hands, it is an assignment and requires client consent to continue the advisory contract.
Section 7: Written Policies and Procedures Consolidated Rule
On November 24, 2020, NASAA adopted a Written Policies and Procedures Consolidated Rule that replaced the 2019 standalone Information Security and Privacy Rule. Every state-registered IA must establish, maintain, and enforce written policies and procedures covering seven areas: compliance, supervision, proxy voting, physical security and cybersecurity, code of ethics, material non-public information, and business continuity.
NIST Cybersecurity Framework 5 Functions
- Identify organizational security risk
- Protect critical services
- Detect information security events
- Respond to detected events
- Recover impaired capabilities
"Know it, guard it, watch for it, fight it, fix it."
The privacy policy must be delivered upon client engagement and annually thereafter. Code of ethics access persons must file holdings reports no later than 10 days after becoming an access person (with holdings current as of no more than 45 days prior), and transaction reports within 30 days after the end of each calendar quarter.
Section 8: Thresholds, Traps, and Memory Tactics
Quantitative Thresholds for Chapter 6
| Threshold | What it governs |
|---|---|
| 5 clients / 12 months | IA de minimis rule (no place of business) |
| $1,000,000 | Employee benefit plan institutional threshold |
| $25M / $100M / $110M / $90M | Dodd-Frank AUM state/SEC dividing lines |
| $150 million | Private fund adviser SEC threshold (§203(m)) |
| $200 million | Pension consultant always-SEC threshold |
| 15 states | Multi-state adviser always-SEC threshold |
| $1.1M / $2.2M | Current qualified client thresholds (through ~June 2026) |
| $1.4M / $2.7M | Pending qualified client thresholds (SEC IA-6955) |
| 3 business days | Custody safe harbor for inadvertent receipt |
| 120 days | Form ADV-E filing after CPA surprise exam |
| 1 business day | CPA material discrepancy reporting |
| 4 business days | CPA resignation reporting |
| 6 months | First CPA exam after becoming subject to custody rule |
| 5 years / first 2 in principal office | IA recordkeeping retention |
| 10 business days | IA oral discretion window (see Chapter 3) |
| 50% voting change | "Assignment" trigger under Rule 502(c) |
Common Traps
Trap 1: The 15-client rule. REPEALED by Dodd-Frank in 2010. Does not exist. Replaced by §203(l) VC and §203(m) under-$150M private fund exemptions.
Trap 2: Qualified client thresholds are about to change. Current $1.1M / $2.2M through late June 2026. Pending $1.4M / $2.7M after IA-6955 becomes final.
Trap 3: IA retention is 5 years, not 3. BD default is 3 years under USA §203(a). IA rule is 5 years, first 2 in the principal office.
Trap 4: Always-SEC thresholds. Pension consultant is $200M (not $100M). Private fund adviser is $150M. Multi-state is 15 states. These three numbers get swapped.
Trap 5: LATE exclusion is incidental only. The moment investment advice stops being "solely incidental" to the profession, the exclusion is lost.
Trap 6: §102 antifraud has no exemptions. Even an adviser excluded from the IA definition can still be sued for fraud under §102.
Trap 7: BD vs. IA discretion. BDs need written authority before the first trade. IAs get 10 business days of oral discretion. See Chapter 3.
Trap 8: Form ADV-E is filed by the CPA, not the IA. The 120-day filing is the CPA's obligation.
Memory Tactics
- A-B-C. Advice, Business, Compensation.
- LATE. Lawyers, Accountants, Teachers, Engineers, incidental only.
- $25 / 100 / 110 / 90. Dodd-Frank AUM tiers.
- 200 / 150 / 15. Pension consultant / private fund / multi-state.
- 5 / 2. IA recordkeeping.
- ADV-E within 120. CPA filing after surprise exam.
- I-P-D-R-R. NIST 5 functions.
- $1.1M / $2.2M (current) or $1.4M / $2.7M (pending). Qualified client.
Chapter 6 is small by exam count (3 questions) but dense in content. Chapter 7 covers the humans who actually deliver advice on behalf of these firms.