The Securities and Exchange Commission has set the timetable and ground rules for when and how some mid-sized investment advisers can deregister with the federal regulatory agency and be overseen by state regulators.

On Nov. 19, the SEC said investment advisers have until Oct. 19, 2011 to register with a state and withdraw from SEC oversight. The process is commonly referred to by the securities industry as “the switch.”

As required under the Dodd-Frank financial reform bill, mid-sized investment advisers with less than $100 million in assets under management will be required to withdraw their registration with the SEC and transfer to state supervision provided that they will be required to be registered and examined in the state where they maintain their principal office and place of business. The current threshold for SEC registration is $25 million.

Shifting mid-sized investment advisers from SEC oversight to the states is designed to free up the commission to better monitor larger advisers, such as hedge funds and private equity funds with over $150 million in assets. The SEC has issued a draft regulation implementing a provision of the Dodd-Frank reform bill which requires many advisers to hedge funds and private equity funds to register with the SEC by July 2011.

The SEC estimates that about 4,100 of the agency’s 11,850 registered advisers will be required to switch to state oversight but the ultimate number will depend on how advisers calculate the value of their assets under management and are regulated by state authorities.

As part of the SEC’s proposal, investment advisers are being provided with a less flexible method of calculating their assets under management that requires that they include proprietary assets, assets managed without receiving compensation, assets of foreign clients and accrued unpaid liabilities in their calculations of assets under management for certain regulatory purposes, such as qualifying for SEC registration.

“We are proposing these changes in order to preclude some advisers from excluding certain assets from their calculation and thus remaining below the new assets threshold for registration with the commission,” said the SEC in the rule proposal

It remains to be seen whether it will cost small to mid-sized investment advisers more to comply with state instead of federal regulations. It depends on the number of states in which it must register as well as the size of the investment adviser. Generally, the more offices and employees that an adviser has, the more states it will be required to register in. Advisers that are required to register in 15 states will also be eligible to register with the SEC.

“Some states such as Massachussetts and Texas are more proactive about enforcing their regulations,” says Robert Boresta , an attorney with the New York law firm of Winston and Strawn. “That means they will conduct more audits and levy more financial penalties if a violation is found.”

Those violations can range from mistakes with registation to a breach of fiduciary duty.

Regardless of whether the investment adviser is registered with the SEC or a state regulatory agency, it must still complete a form ADV which describes its business operations, disciplinary history and information about its organization. Under the SEC proposals, certain advisers such as venture capital funds, though exempted from SEC registration, will still be required to submit reports to the SEC that consists of a subset of the items in Form ADV.