The Investment Advisers Act of 1940 : Regulation by Accretion

The centerpiece of U.S. regulation of money managers — the Investment Advisers Act of 1940 — is perhaps best known for its brevity. Particularly when compared to its companion statute, the Investment Company Act of 1940, the Advisers Act places relatively few substantive burdens on entities that fall within its registration requirements. Indeed, by its terms, the Advisers Act sets out few specific prohibitions on conduct, relying instead on broad proscriptions to curtail fraudulent conduct by investment advisers. Reflecting the general nature of these proscriptions, the Act has been traditionally cited as a disclosure and record-keeping statute. Officials of the Securities and Exchange Commission have, from time to time, suggested that these characteristics make the Advisers Act a “principles-based” regulatory scheme rather than one based on rules.The perception of the Advisers Act as principally a disclosure statute seems not to match the reality that money managers face today in complying with the Act. Over the course of time, the SEC and its staff have effectively imposed a substantial number of standards of conduct on investment advisers registered under the Act — and even on those exempt from registration. Many of these standards have been developed through the Commission's institution and contemporaneous settlement of enforcement actions under the Advisers Act rather than through the Commission's rulemaking authority under theAct. This article reviews the use of SEC enforcement actions as a tool for rulemaking in the context of the Advisers Act, taking an in-depth look at how the Commission has effectively set standards for investment advisers through enforcement in a number of different areas. The article then discusses the anti-fraud rule recently adopted by the Commission under the Advisers Act, asserting that the rule is the latest means through which the Commission can be expected to impose, through enforcement actions, other substantive requirements on advisers. Following this discussion is a critique of the rules of conduct for investment advisers developed through enforcement and suggests that the time may be right for a comprehensive review of those rules with an eye toward improving or replacing them with ones that are the product of the Commission's formal rulemaking procedures