Are You Illegally Giving Financial Advice?

Abstract

“This is not financial advice” disclaimer.

What is the Investment Advisers Act?

Who is an "investment adviser?"

What is "investment advice?"

Exceptions

Punishments for violations.

“This Is Not Financial Advice” Disclaimer

TL;DR: these words mean nothing if someone is receiving compensation.

Oftentimes the “this is not financial advice” disclaimer is attached to financial advice, advice both advice offered up for free and advice given after receiving compensation, in an effort to act as a shield against the Investment Advisers Act ("IAA" or “the Act”).

Unless an individual is receiving compensation for financial advice, the IAA should not be of worry. If, however, an individual is offering up financial advice in exchange for some form of compensation, these 5 magical words cannot shield them from the IAA. The IAA lists specific exceptions to the act and nowhere under those exceptions are the “this is not financial advice” disclaimer. Contrary to common belief, you cannot waive federal law.

Let’s say, for example, an individual has 30 people paying them $50 a month for “stock market education,” or stock market watchlists, or other stock market related advice. Before providing their services, the individual announces that any information discussed or communicated in exchange for the compensation is not financial advice and should not be treated as such. As nice as those words sound, the IAA includes no such waivers or exceptions for individuals in violation of the Act that tell their clients they are not receiving financial advice. In that scenario, the individual is providing financial advice for compensation to 30 clients. In theory, that person could be fined $5,000 per client and sentenced to 5 years in federal prison per client. This totals $150,000 in fines and a sentence of 150 years in prison. This is not including the other potential SEC civil liability, or other personal liability claims that could be brought against them.

As just mentioned, personal liability claims are something that an unregistered financial adviser is at risk of. Think, a group of clients receiving financial advice or "education" in exchange for compensation. If any one of those client loses half of their portfolio (or any sort of loss) during an unexpected market crash or other event, they, and any other client affected, has the right to sue the unlicensed individual. In fact, the unlicensed individual that accepted the compensation runs the risk of a potential lawsuit from every single one of their unhappy customers. In some cases, those unhappy customers may even have the opportunity to file a class action lawsuit against the individual.

It is worth noting that mandatory "donations" in exchange for financial advice is no different than any other form of compensation. Changing the word assigned to the form of compensation does not change the illegality of the exchange.

At the end of the day, it is much safer to take the necessary tests and receive the required certifications to become a licensed financial adviser.

These scenarios are not to be taken lightly.

This article analyzes the IAA, who is considered an “investment adviser,” what is considered “financial advice,” and everything else an individual needs to know about financial coaching.

The Investment Advisers Act

The IAA was created by Congress to eliminate abuses in the securities industry that they believed contributed to the stock market crash of 1929 and the depression of the 1930s. The IAA's goal is to eliminate, or expose, all conflicts of interest that "might cause advisers either consciously or unconsciously, to render advice that is not disinterested.” In modern terms, the IAA was aimed at preventing biased advice. (1)

In its most basic form, the IAA requires that if you are considered an investment adviser, you must register as a legal financial adviser, or face legal consequences. There are very few exceptions, all of which will be detailed at the end of this article, and none of which contain the disclaimer "this is not financial advice." "This is not financial advice" should only come into play when the information given is free, and no compensation is required. There is no waiver to federal law. (1)

Who Is An "Investment Advisor?"

Under the IAA, an investment adviser is defined as any person or firm that meets the following elements (known as "the statutory test"): (2)

  • for compensation;
  • is engaged in the business of;
  • providing advice to others or issuing reports or analyses regarding securities.

Confused? Let's break it down.

Compensation ‍

This term has been broadly defined by the SEC and generally includes the receipt of any economic benefit, whether in the form of an advisory fee, some other fee relating to the total services rendered, a commission, or some combination, satisfies this element. (1)

Engaged in the Business

A person must be engaged in the business of providing advice. This does not have to be the sole or even the primary activity of the person. Generally, a person providing advice about specific securities will be “engaged in the business” unless specific advice is rendered only on a rare or isolated occasion. If there is any question, the following factors are considered:

  • whether the person holds himself out as an investment adviser;
  • whether the person receives compensation that represents a clearly definable charge for providing investment advice; and
  • the frequency and specificity of the investment advice provided. (1)

Advising Others about Securities

This brings us to our next hot button question...

What Is Considered Financial Advice?

TL;DR: almost everything.

Most obvious, a person clearly meets the third element of the statutory test if he provides advice to others about securities. The IAA defines securities as stocks, bonds, variable annuities, mutual funds, ETFs, and everything else you can invest in other than owning the actual tangible asset (such as a bar of gold or a house). (1)

Regarding less specific advice, the SEC has stated advice about the following topics IS considered to be investment advice:

  • Market trends – this includes thoughts on the overall trend of the stock market, thoughts on the future of the economy, the likelihood of recession, whether or not the US stock market is a better place to invest than foreign markets or other forms of investment;
  • The selection and retention of other advisers – this includes accepting compensation from a licensed financial adviser in exchange for a client referral;
  • The advantages of investing in securities versus other types of investments – this includes suggesting a client invest in the stock market over things such as coins or real estate;
  • Providing a selective list of securities – this includes offering a list of securities a client should choose from even if advice on specific securities is not offered; and
  • Asset allocation – this includes discussions surrounding how much a person’s portfolio should be invested in each asset class (for example, suggesting 60% stocks and 40% bonds, or investing in a certain number of growth mutual funds). (1)

It is worth noting that the SEC explicitly states there is no exemption for non-United States advisers. So long as the non-US person is advising a US person, they are subject to the IAA and must register with the SEC. Further, the SEC has stated it does not accept “home state registration” of non-U.S. advisers in lieu of SEC registration. (1)

Are There Exceptions?

The IAA does include written exceptions, however the exceptions listed most likely don’t apply to most individuals that are giving financial advice to clients without a license. (1)

Exceptions for the Press

The IAA carves out an exception when the advice is distributed solely through a “publication of regular and general circulation.” Media megastars and various kneepad magazines rely on this exception and it is mostly why they are not charged when the advice given is ridiculously bad or dangerous. The press, however, is not the average individual. If the advice Dave Ramsey gave on the radio was given in groups or individually with clients, he would not fall under this exception. Most likely, this does not apply to you.

Exceptions for Teachers

When financial advice is given as part of a teaching activity, the IAA says you are exempt. “I don’t offer advice; I just offer education!” This doesn’t quite cut it. For this exception to apply to you, the advice must be given “solely incidental to the practice of his profession.” In plain English, teaching must be your main employment and most likely needs to be by an accredited educational institution. Not only that, but the advice must be incidental to the teaching. Teaching clients about investments, by its literal definition, would not be considered incidental since investments are the sole reason for the education and the client is paying you for the financial advice. Self-designated [insert various social media platforms here] University teachers don’t fit the bill.

Exceptions for Professionals

Other professions, such as lawyers, accountants, engineers, or brokers/dealers, also get an exception to the IAA requirement, but identical to teachers, the advice must be given “solely incidental to the practice of his profession.” For example, a divorce attorney could advise a client to switch retirement finds out of stocks and into money market funds during the divorce proceedings and be covered under this exception. Why? Because the attorney is giving advice in their capacity, and duty, to protect their client legally during the divorce. This same advice given to the same client outside of the divorce context could theoretically be considered illegal investment advice because it is now no longer incidental to the legal advice.

When do these exclusions not apply? If the professional advertises themselves out as providing financial planning. The SEC has stated the exceptions are not available to professionals who “hold himself out to the public as providing financial planning, pension consulting, or other financial advisory services.” (1)

Punishments and Liability

If an individual meets the criteria to be considered a financial adviser and doesn't register with the SEC, they could face serious penalties such as fines, civil liability, and/or prison time. (2)

Fines and Prison Time

Offering financial advice illegally can get you fined for up to $10,000 and up to 5 years in federal prison. The IAA connects the two punishments with “and” instead of “or,” meaning a person in violation can get fined and sentenced to jail. (2)

$5,000 and 5 years might sound small to some, but this is the fine and prison sentence per violation. Think, for example, a person giving advice to 20 clients could, in theory, be fined $100,000 and receive a 100-year federal prison sentence. Those numbers don’t sound small.

SEC Civil Liability

If the above fines and prison time penalties weren’t enough, the SEC has the right to bring a court case against those who violate the IAA. These damages again start small, at $5,000 for natural persons and $50,000 for other persons. Other persons means a business operating under an LLC, S-Corp, or other business entity.

These numbers get a bit higher if the individual in violation of the IAA is operating under a business entity. When evaluating damages figures under civil liability, the individual would fall under the natural persons category and their business would fall under the other persons category. Depending on the facts and circumstances surrounding the violation, the damages can get as high as $100,000 for the natural person and $500,000 for the business entity.

Damages for this type of civil liability are theoretically unlimited however, and the damage cap can be increased to include whatever pecuniary gain (compensation or business profit) the person violating the act received through the offering of the advice. The damages sky is truly the limit depending upon how lucrative the individual has become through the offered services.

Personal Civil Liability

In addition to the above liabilities, the individual in violation may also be liable for civil penalties if a court case is brought against them by their clients, their client’s children, or anyone else that had legal standing to bring suit. Standing in this case means anyone that could have had a right or future interest in the monies involved. (2)

A person could sue the individual illegally receiving compensation for financial advice under any one of the following scenarios:

  • the portfolio was wiped out during a market crash;
  • the portfolio was lost during a lawsuit because the shoddy advice left more money open to creditors;
  • the assets were transferred to someone other than who was intended for the service;
  • a multitude of other possible scenarios that are often given as advice on podcasts, radio shows, and social media.

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SOURCES:

(1) REGULATION OF INVESTMENT ADVISERS BY THE U.S. SECURITIES AND EXCHANGE COMMISSION

(2) INVESTMENT ADVISERS ACT OF 1940

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