Investment Advisers Act of 1940

The Investment Advisers Act of 1940 (often called the 'Advisers Act') is a cornerstone of U.S. investor protection. Passed in the wake of the devastating stock market crash of 1929, this federal law was designed to regulate the activities of investment advisers. Think of it as the rulebook for people and firms who get paid to give you financial advice. Its primary goal is to eliminate, or at least expose, the conflicts of interest that can arise when someone is managing your money. The Act is administered and enforced by the Securities and Exchange Commission (SEC). For any investor, but especially for a value investor who relies on trust and long-term partnerships, understanding this Act is like learning the rules of the road before you start a cross-country trip. It helps you identify who you can trust to navigate the market with your best interests at heart.

At its core, the Advisers Act is all about transparency and accountability. It sets up a framework to ensure that the advice you receive is both competent and ethical. While the full text is dense, its mission can be boiled down to a few key functions.

• Registration and Regulation: It requires individuals or firms who meet the definition of an investment adviser to register with the SEC (or state securities authorities, depending on the size of the assets they manage). This registration subjects them to a host of rules and oversight.
• Anti-Fraud Provisions: The Act makes it illegal for an adviser to defraud, deceive, or mislead clients. This is the legal muscle that protects investors from dishonest schemes and misrepresentation.
• Fiduciary Duty: This is perhaps the most important concept for investors. Advisers registered under the Act are held to a fiduciary duty. This is a legal standard that obligates them to act solely in the best interest of their clients, even if it means putting the client's interests ahead of their own. This is a much higher standard than the suitability standard, which merely requires that an investment is “suitable” for a client, not necessarily that it's the absolute best option.
• Disclosure and Record-Keeping: Registered advisers must provide clients with a written disclosure statement (Form ADV) detailing their business practices, fees, conflicts of interest, and educational and professional background. They must also maintain extensive records, which allows the SEC to conduct examinations and ensure compliance.

The law uses a simple three-part test (often called the “ABC test”) to define an investment adviser. You are an adviser if you are:

1. providing Advice about securities,
2. as part of a Business, and
3. receiving Compensation for it.

However, the Act includes several important exemptions. The following are generally not considered investment advisers under the Act, as long as their advice is solely incidental to their main profession:

• Banks and bank holding companies.
• Lawyers, accountants, engineers, and teachers.
• Broker-dealers whose advisory services are incidental to their brokerage business and for which they receive no special compensation.
• Publishers of bona fide newspapers or financial publications with a general and regular circulation. This is why a value investing newsletter you subscribe to doesn't have to register.

For the patient, diligent value investor, the Advisers Act isn't just legalese—it's a powerful tool for finding the right partners and avoiding pitfalls.

Value investing is built on a foundation of trust. You are entrusting your capital to a business, and if you use an adviser, you are entrusting them to help you make sound decisions. The Act helps you find advisers who are legally bound to be on your side of the table. By specifically seeking out a registered investment adviser (RIA), you ensure your adviser operates under a fiduciary duty. This aligns perfectly with the value investor's ethos of seeking long-term, trustworthy relationships rather than chasing short-term “hot tips” from a salesperson.

The law mandates the use of Form ADV, which is a goldmine for due diligence. Before you ever hand over a dollar, you can look up an adviser's Form ADV for free on the SEC's website. In it, you'll find:

• Fee Structure: How do they get paid? Are there hidden fees?
• Investment Strategy: Do they follow a philosophy that aligns with your own, like value investing?
• Conflicts of Interest: What potential conflicts does the adviser have?
• Disciplinary History: Have they ever been in trouble with regulators?

Reviewing this document is a critical step in vetting a potential adviser, much like you would scrutinize a company's annual report before investing. It empowers you to make an informed choice, a hallmark of the value investing approach.