SEC proposes new ‘small firm’ definition

The SEC is looking to reclassify more advisory firms as “small entities” in an attempt to better understand how they might be disproportionately harmed by new regulatory burdens.

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A rule amendment proposed by the Securities and Exchange Commission on Thursday would change the definition of a “small entity” among investment advisors to firms with less than $1 billion in assets under management, a figure that would be adjusted for inflation every 10 years. The current threshold, unchanged since 1998, is 40 times smaller: $25 million.

The definition is important because it determines how broad a swath of the RIA industry the SEC looks at when considering the burdens new rules could impose on small firms. The Regulatory Flexibility Act of 1980 requires the SEC to provide an estimate of how many small RIAs will be affected by any newly contemplated regulation and to consider alternative means of attaining the same objectives.

For instance, as part of a cybersecurity proposal put forward in 2023 (and since adopted) the SEC predicted the new requirements would affect 522 registered advisors and that some of those firms “would be likely to experience some increase in costs to comply with the proposed amendments if they are adopted.”

Where did all the small RIAs go?

Industry groups have long pointed out that the lack of inflation adjustments for the current threshold has meant that almost no SEC-registered firms now meet the definition of a small firm. Only about 3% of the 15,909 advisory firms now registered with the SEC have less than $25 million in AUM. That’s down from about 20% when the SEC adopted that threshold in 1998.

If the limit were raised to $1 billion, the SEC estimates the definition would apply to 75% of firms. But because the largest firms also manage a disproportionate share of assets, firms falling under the definition of small entities would still oversee only 3% of the total $152.9 trillion AUM in the industry, according to the SEC.

The SEC said it had originally considered setting the threshold even higher than $1 billion.

“However, a size standard threshold that is set too high could inadvertently cause the Commission’s attempts to tailor its rules for small entities to focus on issues of more general concern to the industry, instead of on issues that particularly impact smaller entities, which the [Regulatory Flexibility] was designed to protect,” according to the proposal.

The proposed amended definition of a small firm comes amid a general deregulatory push ushered in under President Donald Trump. SEC Chair Paul Atkins, appointed last year by Trump, said in a statement that, “The Commission has a longstanding commitment to understanding and addressing the concerns of small entities.

“Today’s proposal — consistent with the SEC’s intent to modernize regulatory requirements — would further this commitment by more accurately capturing the types and numbers of investment advisers and investment companies that are ‘small.'”  

The IAA’s long campaign for a more up-to-date threshold

Various industry groups praised the SEC’s proposal to raise its AUM threshold for small advisory firms. The Investment Adviser Association, which represents roughly 600 advisory firms and related entities, said in a statement that, “The proposal is an important step towards recognizing that the investment adviser industry is largely made up of small businesses that face different resource constraints from larger firms and that regulation should more appropriately take these factors into consideration.”

The IAA has long noted that a quirk in SEC registration rules for advisory firms renders regulators’ requirement to figure out how a new rule will affect small firms almost meaningless.  In general, the SEC allows only firms with $100 million or more in assets to register with it at the federal level; outfits with anything less must register with state regulators.

One of the exceptions to that rule is for firms in New York, which doesn’t conduct regular examinations of investment advisors. In that state alone, firms with $25 million or more in AUM can register with the SEC. Those complex registration requirements mean most firms registered at the federal level were excluded from the small-entity definition by default.

Rather than using an AUM threshold to determine which firms count as “small,” the IAA has contended in the past that the label should apply to advisories with 100 or fewer employees. Now, though, it says it’s looking forward to reviewing the new proposal and “engaging with the SEC to ensure that the final rule accurately reflects the makeup of the adviser industry.”

Advisors will have 60 days to submit comments on the rule amendment after it’s published in the Federal Register.