The Securities and Exchange Commission (SEC) is considering reclassifying more advisory firms as “small entities” in order to better understand how they may be disproportionately impacted by new regulatory burdens.
The Proposed Rule Amendment
A rule amendment proposed by the SEC aims to redefine a “small entity” among investment advisors as firms with less than $1 billion in assets under management, with adjustments for inflation every 10 years. The current threshold, set in 1998, is significantly lower at $25 million.
The definition is crucial as it determines the scope of the RIA industry that the SEC evaluates when assessing the potential impact of new regulations on small firms. The Regulatory Flexibility Act of 1980 mandates the SEC to estimate the number of small RIAs affected by any proposed regulation and explore alternative approaches to achieve the same goals.
For example, in a cybersecurity proposal introduced in 2023, the SEC projected that 522 registered advisors would be affected by the new requirements, potentially leading to increased compliance costs for some firms.
Challenges Faced by Small RIAs
Industry groups have highlighted that the absence of inflation adjustments for the current threshold has resulted in almost no SEC-registered firms meeting the definition of a small entity. Currently, only about 3% of the 15,909 advisory firms registered with the SEC have less than $25 million in AUM, a significant decline from the 20% figure in 1998.
If the threshold were raised to $1 billion, the SEC estimates that 75% of firms would fall under the small entity definition. However, due to the concentration of assets managed by larger firms, small entities would only oversee 3% of the total $152.9 trillion AUM in the industry.
The SEC considered setting the threshold even higher but recognized the risk of shifting focus away from issues specific to smaller entities, which the Regulatory Flexibility Act aims to protect.
Efforts Towards Modernization
The proposed amendment to the definition of a small firm aligns with a broader deregulatory push under President Donald Trump’s administration. SEC Chair Paul Atkins, appointed during Trump’s tenure, emphasized the SEC’s commitment to understanding and addressing the concerns of small entities.
Various industry groups, including the Investment Adviser Association (IAA), welcomed the SEC’s proposal to raise the AUM threshold for small advisory firms. The IAA, representing around 600 advisory firms, emphasized the importance of recognizing the industry’s composition dominated by small businesses with distinct resource constraints.
The IAA’s Advocacy
The IAA has long advocated for an updated threshold to address the challenges faced by small advisory firms. It noted that SEC registration rules often exclude smaller firms, with most federal level registrants having assets exceeding $100 million.
Instead of relying solely on AUM thresholds, the IAA suggested defining small firms based on the number of employees. The organization looks forward to engaging with the SEC to ensure that the final rule accurately reflects the adviser industry’s diversity.
Advisors will have a 60-day window to provide feedback on the rule amendment once it is published in the Federal Register.
Sources: Financial Planning
