Investment Advisers Act of 1940: Registration, Duties, and Penalties

The Investment Advisers Act of 1940 is the federal law that governs anyone who charges for advice about securities. It defines who counts as an investment adviser, requires most of them to register with either the Securities and Exchange Commission or a state regulator, imposes a fiduciary duty to clients, and backs those obligations with compliance rules, recordkeeping, marketing limits, examinations, and penalties that reach into six and seven figures per violation.

Who the Act Covers

The statute uses a three-part test. A person or firm is an investment adviser if they (1) provide advice about the value of securities or whether to buy or sell them, (2) do so as a regular part of their business rather than as an isolated occurrence, and (3) receive compensation for the service.¹ All three elements must be present. Someone who gives a friend free stock tips at a dinner party isn’t covered, and neither is someone who gives paid advice on a single occasion without making it part of their livelihood.

The compensation element is broader than most people assume. It doesn’t require a direct advisory fee. Any economic benefit tied to the advice will do, including commissions, asset-based fees, or non-cash perks. The “business” element is similarly flexible: the advice doesn’t need to be the person’s primary occupation, just a regular activity.

Who Is Excluded or Exempt

Several categories of professionals are excluded from the definition entirely, meaning the Act simply does not apply:

Banks and bank holding companies, because they’re already regulated by federal banking authorities. A bank that advises a registered investment company must still comply through a separately identifiable department.¹
Lawyers, accountants, engineers, and teachers, but only when investment advice is solely incidental to their main profession. An accountant who mentions a tax-efficient fund while preparing a return is fine; an accountant who routinely picks stocks for clients has crossed the line.¹
Broker-dealers, when their advice is solely incidental to brokerage services and they receive no special compensation for it.
Publishers of newspapers, news magazines, and financial publications of general circulation.¹
Family offices as defined by SEC rules, nationally recognized statistical rating organizations, and advisers who only cover U.S. government securities.

Exemptions work differently from exclusions. An exempt adviser meets the legal definition but is excused from full SEC registration. The most significant exemption covers private fund advisers: firms that advise only qualifying private funds and manage less than $150 million in private fund assets don’t need to register, though they must still file as “exempt reporting advisers” and remain subject to the Act’s anti-fraud rules.² Excluded professionals can largely ignore the Act. Exempt advisers still operate under its anti-fraud umbrella and face SEC examination authority.

Where to Register

Whether an adviser registers with the SEC or a state securities regulator depends primarily on assets under management. The statute creates three tiers:

Under $25 million: the firm registers with the state where it maintains its principal office. Federal registration is generally prohibited below this threshold.³
$25 million to $100 million: mid-size advisers generally remain state-registered if their home state requires registration and subjects them to examination. If the state doesn’t examine advisers, the firm may register with the SEC instead.³
$100 million or more: SEC registration is required.³

Some advisers qualify for SEC registration regardless of size, including firms that advise registered investment companies and firms registered in states that don’t conduct examinations.

The Form ADV Process

Registration happens through the Investment Adviser Registration Depository, an electronic filing system where advisers submit Form ADV. The form has two main parts. Part 1A collects administrative information: ownership, employee count, services provided, and disciplinary history of anyone associated with the firm.⁴ Part 2A, known as the “brochure,” is a plain-English narrative delivered to every client. It describes fees, investment strategies, potential conflicts of interest, and the backgrounds of people who provide advice.⁵

The SEC must either grant registration or begin proceedings to deny it within 45 days of receiving the application.⁶ Registration isn’t a one-time event. Advisers must file an annual updating amendment within 90 days after the end of their fiscal year, refreshing every response in Parts 1A, 1B, 2A, and 2B.⁷ Missing this deadline is a compliance failure that shows up in examinations. State-registered advisers face similar annual filing requirements and fees that vary by jurisdiction.

The Fiduciary Duty

The Act imposes a fiduciary duty on investment advisers, meaning they must act in their clients’ best interests at all times. The Supreme Court established this principle definitively in the 1963 case SEC v. Capital Gains Research Bureau, Inc., holding that Congress recognized “the delicate fiduciary nature of an investment advisory relationship” and intended the Act to eliminate or expose all conflicts that might lead an adviser to give self-serving recommendations.⁸

The obligation has two components. The duty of care requires advisers to give advice suited to each client’s financial situation, risk tolerance, and goals. The same aggressive growth portfolio can’t be recommended to a retiree living on savings and a 30-year-old with decades of earning ahead. The duty of loyalty requires advisers to put clients’ interests ahead of their own. Where a conflict exists, the adviser must disclose it fully so the client can evaluate whether the recommendation is genuinely objective.⁹

The Court imposed an “affirmative duty of utmost good faith and full and fair disclosure of all material facts.” An adviser who earns a commission for steering clients toward a particular fund can’t quietly pocket the payment. The adviser must tell the client about the commission, explain how it creates a conflict, and let the client decide whether to proceed.⁹

Compliance and Recordkeeping Obligations

Every registered adviser must adopt written compliance policies reasonably designed to prevent violations of the Act. The firm must review those policies at least annually and designate a chief compliance officer to administer them.¹⁰ The CCO oversees the firm’s code of ethics, monitors for insider trading, ensures fair allocation of investment opportunities across clients, and serves as the point of contact during regulatory examinations.

Recordkeeping requirements are extensive. Advisers must maintain journals, ledgers, transaction memoranda, bank statements, client communications, written agreements, and financial statements. Every written communication related to a recommendation, a transaction, or the handling of client money must be preserved. Records must be kept for at least five years from the end of the fiscal year in which the last entry was made, with the first two years in an accessible office location.¹¹ These are the first things examination staff will request.

Custody of Client Funds

Advisers who hold client money or securities, or who have the authority to withdraw them, face additional safeguards under the custody rule. “Custody” includes obvious situations like physically holding client assets, but it also covers arrangements like a general power of attorney or serving as general partner of a fund, both of which give the adviser access to client assets.¹²

An adviser with custody must keep client assets with a qualified custodian, typically a bank or broker-dealer, notify clients in writing of where their assets are held, and ensure the custodian sends account statements at least quarterly. An independent public accountant must also conduct a surprise examination of client assets at least once per calendar year, at a time chosen by the accountant without advance notice.¹² If the accountant discovers material discrepancies, the SEC must be notified within one business day. Narrower forms of custody, such as authority only to deduct advisory fees, carry lighter requirements.

Marketing and Political Contributions

The SEC’s modernized marketing rule allows advisers to use client testimonials and third-party endorsements, but only with specific disclosures and oversight measures in place.¹³ Every advertisement, regardless of format, is prohibited from making untrue statements of material fact, omitting facts that would make a statement misleading, or discussing potential benefits without fairly addressing risks and limitations. Cherry-picking favorable performance periods while hiding poor ones violates the rule.

When an adviser uses a testimonial or endorsement, the ad must clearly disclose whether the person is a current client, whether they received compensation, and any material conflicts of interest arising from the relationship. If compensation exceeds $1,000, the adviser must maintain a written agreement with the person providing the testimonial. Advisers also cannot pay anyone to endorse them if that person has been subject to certain disqualifying SEC actions.¹⁴ Performance advertising carries its own requirements around net-of-fee presentation and standardized time periods.¹³

A separate rule targets political contributions. If an adviser or any “covered associate” makes a political contribution to an official who could influence the awarding of advisory contracts, the firm is banned from receiving compensation for advisory services to that government entity for two years, subject to narrow de minimis exceptions.¹⁵ The two-year timeout has ended government advisory relationships when a junior employee made a contribution nobody tracked.

What SEC Examinations Look For

SEC examination staff select advisers for review based on risk factors including tips and complaints, unusual patterns in reported data, prior examination findings, and significant changes in a firm’s business activities.¹⁶ Newly registered firms frequently receive an examination within their first year or two.

During an examination, staff will request books and records, interview management and employees, and analyze operations. The core questions are whether the firm is complying with federal securities laws and whether client assets are safe. Examiners look at how trades are allocated across client accounts, whether portfolio management decisions match client mandates, whether performance information presented to clients is accurate, and whether the firm’s compliance culture is genuine or just paperwork.¹⁶

Penalties for Violations

The SEC has broad authority to enforce the Act through civil and administrative proceedings. It can seek injunctions in federal court to stop ongoing violations, and courts can order disgorgement of profits earned through misconduct.¹⁷ The SEC can also censure advisers, suspend their registration, or revoke it entirely.⁶

Civil monetary penalties follow a three-tier structure. Per the 2025 inflation-adjusted amounts, which remain in effect for 2026:

Tier 1, for any violation: up to $11,823 per violation for an individual, or $118,225 for a firm.¹⁸
Tier 2, for fraud or reckless disregard: up to $118,225 per violation for an individual, or $591,127 for a firm.¹⁸
Tier 3, for fraud causing substantial losses: up to $236,451 per violation for an individual, or $1,182,251 for a firm.¹⁸

At every tier, the penalty can instead be the gross amount of the violator’s financial gain from the misconduct, if that amount exceeds the per-violation cap.¹⁷ For large-scale fraud, this alternative measure can dwarf the statutory caps.

Criminal prosecution is reserved for willful violations. A person convicted faces up to five years in prison and a fine of up to $10,000.¹⁹ The statutory fine is low because it hasn’t been updated since the Act’s original passage, but criminal cases involving investment adviser fraud are often prosecuted under broader federal fraud statutes that carry significantly higher penalties.

1
Office of the Law Revision Counsel. 15 U.S. Code 80b-2 – Definitions
2
eCFR. 17 CFR 275.203(m)-1 – Private Fund Adviser Exemption
3
Office of the Law Revision Counsel. 15 USC 80b-3a – State and Federal Responsibilities
4
Investment Adviser Registration Depository. Form ADV – General Instructions
5
U.S. Securities and Exchange Commission. Electronic Filing for Investment Advisers on IARD
6
Office of the Law Revision Counsel. 15 USC 80b-3 – Registration of Investment Advisers
7
U.S. Securities and Exchange Commission. Form ADV – General Instructions
8
Justia U.S. Supreme Court. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963)
9
U.S. Securities and Exchange Commission. SEC v. Capital Gains Research Bureau, Inc.
10
eCFR. 17 CFR 275.206(4)-7 – Compliance Procedures and Practices
11
eCFR. 17 CFR 275.204-2 – Books and Records To Be Maintained by Investment Advisers
12
eCFR. 17 CFR 275.206(4)-2 – Custody of Funds or Securities of Clients by Investment Advisers
13
eCFR. 17 CFR 275.206(4)-1 – Investment Adviser Marketing
14
U.S. Securities and Exchange Commission. Risk Alert – Investment Adviser Marketing Rule
15
eCFR. 17 CFR 275.206(4)-5 – Political Contributions by Certain Investment Advisers
16
U.S. Securities and Exchange Commission. Examinations by the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations
17
Office of the Law Revision Counsel. 15 U.S. Code 80b-9 – Enforcement of Subchapter
18
U.S. Securities and Exchange Commission. Civil Penalties Inflation Adjustments – January 15, 2025
19
GovInfo. 15 U.S. Code 80b-17 – Penalties