Form ADV Registration Considerations; Form ADV and Form PF Reporting Considerations (Part I)

As described more fully below:

• the concept of “regulatory assets under management” (RAUM) plays a central role in determining whether an investment adviser is eligible or required to register with the SEC, or to withdraw its SEC registration; and
• an investment advisor must calculate its RAUM for purposes of several reporting items on SEC Forms ADV Part 1A and Form PF.

So, when must an investment adviser include or exclude particular types of crypto assets from its calculation of RAUM for registration and reporting purposes? 

(Also, Item 9 of Part 1A of SEC form ADV requires an adviser to state whether it has “custody” of any advisory clients’ “cash or bank accounts” or “securities,” and to answer various related questions. We will address this particular topic in a later blog post in connection with our discussion of an adviser’s duties with respect to “custody” of crypto assets.) 

SEC Registration Based on Calculation of RAUM

In many situations, the key component in determining whether an investment adviser is eligible or required to register with the SEC, or to withdraw its SEC registration, is the amount of the adviser’s “regulatory assets under management” (RAUM).

For a description of these situations, see, e.g.: (1) Instructions 2.a, 2.b, 2.d, 2.g, 2.j and 6.e(3) to Part 1A of SEC Form ADV and (2) related Items 2.A.(1), 2.A.(2) and 2.A.(6) of Part 1A of SEC Form ADV. RAUM is also relevant in determining whether an adviser may take advantage of the exemptions from registration under the IAA provided by Section 202(a)(30) of the IAA and Rule 202(a)(30)-1 thereunder (relating to “foreign private advisers”), and Section 203(m) of the IAA and Rule 203(m)-1 thereunder (relating to certain “private fund advisers”).

Form ADV/Form PF Reporting Requirements Based on Calculation of RAUM

In addition to registration status issues that hinge on an investment adviser’s RAUM, many of the reporting items on SEC Forms ADV Part 1A and Form PF require a registered investment adviser to calculate its RAUM.

For a description of the situations in which an investment adviser is required to calculate its RAUM for reporting items on Forms ADV Part 1A and PF, see, e.g.: (1) Items 5.C, 5.D, 5.F, 5.I, 5.J, 5.K and 12 of Part 1A; (2) Sections 5.G.(3), 5.K.(1), 5.K.(2) and 5.K.(3) of Schedule D to Part 1A; (3) Section 2.A of Schedule R to Part 1A; and (4) Item B of Section 1a of Form PF and Item B.14 of Section 1b of Form PF. See also the note to Item 4 of Part 2A of Form ADV.

Form ADV Instructions Regarding Calculation of RAUM

Item 5.b of the Instructions to Part 1A specifies the manner in which an adviser is required to calculate its RAUM. Specifically, Item 5.b.(1) states that:

In determining the amount of your regulatory assets under management, include the securities portfolios for which you provide continuous and regular supervisory or management services[1] as of the [relevant] date.

If an account is a “securities portfolio,” the entire value of the account—not just the value of the portion of the account attributable to “securities” —constitutes RAUM. See Item 5.b.(5) of the Instructions to Part 1A.

What Is a “Securities Portfolio”?

As its name implies, a securities portfolio is one that consists principally of securities:

An account is a securities portfolio if at least 50% of the total value of the account consists of securities. For purposes of this 50% test, you may treat cash and cash equivalents (i.e., bank deposits, certificates of deposit, bankers acceptances, and similar bank instruments) as securities.[2] (See Item 5.b.(1) to the Instructions to Part 1A of SEC Form ADV.)

Special considerations apply to so-called “private funds,” which we will discuss in a subsequent blog post.

Determinations an Investment Adviser Must Make

So, for purposes of Form ADV registration purposes, as well as Form ADV and Form PF reporting purposes, an adviser must determine whether:

• the crypto assets in its accounts are “securities”; and
• whether the account that holds such crypto assets should be included in RAUM by virtue of being a “securities portfolio,” that is, an account at least 50% of the total value[3] of which consists of securities and cash and cash equivalents (and over which the adviser provides continuous and regular supervisory or management services).

Question: Should “virtual currencies” or “cryptocurrencies” that are not securities (e.g., Bitcoin, Ether) be treated as “cash” or “cash equivalents” for purposes of determining whether a client’s portfolio is a “securities portfolio,” such that, if the value of the securities held by such portfolio, together with the value of such virtual currencies and other cryptocurrencies and the value of other cash and cash equivalents held by such portfolio, is at least 50% of the value of such portfolio, such portfolio will be treated as a “securities portfolio”?

Or must “virtual currencies” or “cryptocurrencies” that are not securities (e.g., Bitcoin, Ether) be treated as non-security assets for purposes of the 50% test?

Answer: This question has not been definitively answered by the SEC or its staff, but I suspect the answer is that virtual currencies or cryptocurrencies will not be considered “cash” or “cash equivalents” and therefore must be treated as non-securities assets for purposes of the 50% test.

So, for example, assume that an adviser manages a portfolio composed of:

• $4,000,000.00 in stocks, bonds and crypt assets that are securities
• $1,000,000.00 in cash and cash equivalents
• $5,250,000.00 in virtual currencies that are not securities (e.g., Bitcoin, Ether)

$10,250,000.00 TOTAL

Is the portfolio a “securities portfolio,” the value of which is included in the adviser’s RAUM?

In this case, if we assume that (1) the virtual currencies are not securities, and that (2) the SEC would not view such virtual currencies as “cash” or “cash equivalents,” then 51% of the value of the portfolio ($5,250,000.00/$10,250,000.00) would be attributable to assets that are not securities or cash and cash equivalents, and, as a result, the portfolio would not qualify as a “securities portfolio” and therefore would be excluded from the adviser’s RAUM.

In our next post, we will address the special considerations that apply to the calculation of RAUM in the context of a so-called “private fund,” that is, a fund that would be an investment company as defined in Section 3 of the Investment Company Act (ICA) but for the exclusion from that definition provided by Section 3(c)(1) or 3(c)(7) of the ICA.

---

[1]Item 5.b.(3) of the Instructions to Part 1A provides the definition of the term “continuous and regular supervisory or management services” to be used for this purpose.

[2]In calculating its RAUM, an adviser must include not only its customary securities portfolios, but also securities portfolios that are: (1) family or proprietary accounts; (2) accounts for which the adviser receives no compensation for its services; and (3) accounts of clients who are not United States persons. See Item 5.b.(1) to the Instructions to Part 1A.

[3]Under Item 5.b.(4) to the Instructions to Part IA of SEC Form ADV, an adviser must determine value using the same method it uses to report account values to clients or to calculate fees for investment advisory services.