The
Securities and Exchange Commission has voted unanimously to adopt changes to
the principal disclosure document that SEC-registered investment advisers must
provide to their clients and prospective clients.
Form
ADV, Part 2, commonly referred to as the ‘brochure,’ includes an investment
adviser’s qualifications, investment strategies, and business practices.
Amendments
The
amendments to form ADV, Part 2 address the following issues:
Narrative Format and Updating Requirements
An
investment adviser is required to prepare a narrative, plain English, brochure,
presented in a consistent, uniform manner, with particular focus on conflicts
of interest the firm and its personnel face, the effects of those conflicts on
firm services, and steps the adviser takes to address the conflicts.
An
investment adviser must deliver the brochure to a client before or at the time
the adviser enters into an advisory contract with the client. In addition, an adviser must provide each
client with an annual summary of material changes to the brochure and either
deliver a complete updated brochure or offer to provide the client with the
updated brochure.
Expanded Content
The
new brochure addresses the following topics:
• Advisory Business - An investment
adviser must describe its advisory business, including the types of advisory
services offered, state whether it holds itself out as specializing in a
particular type of advisory service, and disclose the amount of client assets
that it manages.
• Fees
and Compensation - An investment adviser must describe how it is
compensated for its advisory services, provide a fee schedule, and disclose
whether fees are negotiable. The
investment adviser must also describe the types of other fees or expenses, such
as brokerage fees, custody fees, and fund expenses that clients may pay in
connection with the services provided.
• Performance-Based
Fees and Side-by-Side Management - An investment adviser that accepts
performance-based fees, or that supervises an individual who accepts such fees,
is required to disclose this fact. If
the investment adviser also manages accounts that are not charged a performance
fee, the adviser must explain the conflicts of interest that arise from the
simultaneous management of these accounts and must describe how it addresses
those conflicts.
• Methods of Analysis, Investment strategies,
and Risk of Loss - An investment adviser must describe its methods of
analysis and investment strategies and explain that investing in securities
involves risk of loss. Investment
advisers who use a particular method of analysis or strategy or who recommend a
particular type of security are required to explain the material risks involved
and discuss the risks in detail, if those risks are unusual.
• Disciplinary
Information - An investment adviser is required to disclose in its brochure
material facts about any legal or disciplinary event that is material to a
client’s evaluation of the advisory business or to the integrity of its
management personnel. An investment
adviser must deliver promptly to clients updated information when there is new
disclosure of a disciplinary event or a material change to an existing
disciplinary event.
• Code of Ethics, Participation or Interest
in Client Transactions, and Personal Trading - An investment adviser is
required to describe briefly its code of ethics and state that a copy is available
upon request. The adviser must also
disclose whether it or an affiliate recommends to clients, or buys or sells for
client accounts, securities in which the adviser or an affiliate has a material
financial interest and, if so, the conflicts of interest associated with that
practice. The adviser also must disclose
whether it or an affiliate invests (or is allowed to invest) in the same
securities that it recommends to clients or in related securities, such as
options or other derivatives, and must explain the conflicts involved and how
it addresses those conflicts. In
addition, an investment adviser that trades in the recommended securities at or
around the same time as the client has to explain the specific conflicts
inherent in that practice and how it addresses them.
• Brokerage
Practices - An investment adviser is required to describe the factors
considered in selecting or recommending broker-dealers for client transactions
and determining the reasonableness of brokers’ compensation. Investment advisers also must disclose soft
dollar practices (research or other products or services, other than execution,
provided by brokers or a third party to the investment adviser in connection
with client transactions); client referrals (using client brokerage to
compensate brokers for client referrals); directed brokerage (asking or
permitting clients to send trades to a specific broker for execution); and
trade aggregation (bundling trades to obtain volume discounts on execution
costs). Investment advisers must explain
how they address the various conflicts of interest associated with these
practices.
Supplements
An
adviser is required to deliver “brochure supplements” to new and prospective
clients, providing them with information about the specific individuals who
will provide services to the clients. The supplement will contain brief résumé-like disclosure about the
educational background, business experience, other business activities, and
disciplinary history of the individual. It
will also include contact information for the individual’s supervisor.
Electronic Filing
Advisers
are now required to electronically file Form ADV, Part 2. The filings will be publicly available on the
SEC’s website.
Compliance Dates
The
amended rules and forms will be effective 60 days after publication in the
Federal Register.
Most
investment advisers will begin distributing and publicly posting new brochures
in the first quarter of 2011.*
Form ADV is divided
into two parts, and is required to register as an investment adviser with the
SEC. This article, and the amendments
described herein, relate solely to Form ADV, Part 2. Form ADV, Part 1 requires the disclosure of
information that is mostly within the purview of the SEC or state securities
authorities, as opposed to investors.
Specifically, Form ADV, Part 1 covers aspects of an investor adviser’s
business, such as name, number of employees, form of organization, and nature
of business, as well as disciplinary history within the last ten years.
* * *
Robert Kiggins, Esq. of McCarthy Fingar LLP, is author of the blog, and may be reached at (914) 385-1024 or rkiggins@mccarthyfingar.com.
