A New Part 2: Amendments to Form ADV Bring Significant Changes to Investment Adviser Registration and Disclosure Requirements (Part 1)

 
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After significant effort and time, the Securities and Exchange Commission ("SEC") finally has adopted amendments to Form ADV and related brochure filing and delivery requirements ("Part 2 Amendments").1 Form ADV Part II, currently a "check-the-box" form supported by a disclosure schedule, will now be replaced with Form ADV Part 2, which in most cases will require each SEC-registered investment adviser ("RIA") to produce a narrative, plain English disclosure document, sequenced in a specified order to promote comparability among registrants. Form ADV Part 2 will be required to be (i) provided to clients and prospects, (ii) filed with regulators and (iii) made available to the general public through the SEC-sponsored Investment Adviser Public Disclosure website ("IAPD") (http//www.adviserinfo.sec.gov). The Part 2 Amendments are intended to ensure that current and prospective clients receive clear, meaningful and useful information about the RIA and relevant personnel who provide advice to and/or interface with clients.

The Part 2 Amendments will significantly change the manner in which RIAs describe to clients, the RIA's business, investment practices and potential conflicts of interest and will result in greater transparency about the approximately 11,000 RIAs currently registered with the SEC – as well as the significant number of new registrants expected to register with the SEC as a result of the provisions of the Private Fund Investment Advisers Registration Act of 2010, enacted as Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank").2 Many of these new registrants, including in particular a large number of private equity and hedge fund managers in the United States and abroad, which previously relied on the "Private Adviser Exemption" provided by Section 203(b)(3) of the Investment Advisers Act of 1940, as amended ("Advisers Act"), are likely to face particular challenges in responding to the disclosure requirements imposed by the Part 2 Amendments.

Background

In 2000, the SEC proposed amendments to the entire Form ADV.3 At that time, only the amended Form ADV Part 1 (and related electronic filing requirement for that portion of the Form ADV) was adopted, leaving the revisions to Part II of Form ADV in a state of limbo for eight years. In 2008, the SEC re-proposed amendments to Part II of Form ADV,4 which have been adopted, with some modification, as the Part 2 Amendments. While the Part 2 Amendments are clearly based on the portions of 2000 Proposal (and related comments), the Part 2 Amendments also reflect many of the "hot issues" of the past ten years.

The "New Part 2" includes:

Part 2A, which replaces the existing Part II and Schedule F (referred to herein as the "Brochure"); Part 2A, Appendix 1, which replaces the existing Part II, Schedule H and must be completed by sponsors of wrap fee programs (referred to herein as the "Wrap Fee Brochure"); and Part 2B, the Brochure supplement, which provides clients with biographical and disciplinary information about relevant personnel of the RIA (referred to herein as the "Supplement").5 Changes to General Delivery and Filing Requirements

Current Requirements for RIAs

Currently, each RIA must: (i) prepare and maintain Form ADV Part II or a brochure containing all the information in Form ADV Part II ("Part II Brochure"); (ii) provide the Part II Brochure to each prospective client not later than the time when an advisory relationship has been created; (iii) update the Part II Brochure promptly if information in the Part II Brochure becomes materially inaccurate; (iv) offer to provide an updated Part II Brochure to each client annually; and (v) hold within the RIA's records and make available to the SEC staff a copy of each such Part II Brochure (in lieu of filing a Part II Brochure directly with the SEC).6 Additionally, certain states have required that paper versions of the Part II Brochure of each RIA that makes a notice filing in that state (as well as State-Only RIAs registered in the state) be filed with the relevant state official or agency.

Significant Changes

The Part 2 Amendments significantly alter certain of the delivery and filing requirements:

Brochures and Wrap Fee Brochures must be Filed and Available to All Online. Perhaps the most significant change to the filing and delivery requirements is that every RIA that is required to maintain a Brochure will be required to file that Brochure through the Investment Adviser Registration Depository system ("IARD") in PDF format. 7 Current Brochures will be publicly available online and can be viewed by any interested person through the IAPD.8 Because Brochures will be posted in PDF format, they will be searchable using full text search features included in widely available PDF software.9 Not All Clients Must Receive a Brochure and Not All RIAs Must Maintain a Brochure. The SEC has slightly expanded the types of clients to which an RIA need not provide a Brochure ("Excepted Clients") to include: (i) registered investment companies; (ii) persons receiving only impersonal advisory services; and (iii) any business development company ("BDC") whose contract with the RIA is subject to the contract approval provisions contained in Section 15 of the Investment Company Act of 1940, as amended ("1940 Act").10 Significantly, an RIA that has only Excepted Clients will not be required to maintain or file a Brochure.11 Note, however, that requirements may vary for State-Only RIAs. Annual Delivery of Substantive Disclosure Information Is Now Mandated. Currently, every RIA is required to offer each of its non-Excepted Clients a revised Part II Brochure, within 90 days after the end of its fiscal year, but is not required to: (i) notify its non-Excepted Clients about changes to its Brochure or (ii) highlight or specifically clarify the information in the Part II Brochure that has changed (even if an updated Brochure is provided to its non-Excepted Clients). Citing concern that non-Excepted Clients may be relying on "stale" Part II Brochures, the SEC determined to require RIAs to provide substantive disclosure summarizing any material changes to a Brochure since the previous annual updating amendment ("Material Changes Summary")12 to any client that has received a prior version of the relevant Brochure.13 Thus, in contrast to current requirements for the Part II Brochure, the Part 2 Amendments require an RIA whose Brochure has materially changed since the RIA's last annual updating amendment to deliver to each of its non-Excepted Clients, within 120 days after the end of its fiscal year,14 either: (i) a current amended Brochure (which includes a Material Changes Summary) or (ii) a separate document containing (a) the Material Changes Summary and (b) an offer to provide the relevant current relevant Brochure without charge.15 Interim delivery of a Brochure or notification of changes to disclosure information will be mandated only with respect to changes in disclosure related to disciplinary events.16 As is currently the case with a Part II Brochure, delivery of a Brochure (including a Wrap Fee Brochure or Supplement) can be made in paper form or, assuming compliance with relevant law and guidance, electronically. 17 Five-Day Termination Provision Is Rescinded. Although the initial delivery requirement remains the same, RIAs will no longer be required to offer their clients a five day termination right if the Brochure was not delivered at least 48 hours prior to entering into the investment advisory agreement.18 Thus, RIAs will now be obligated to provide a current Brochure to any client (other than an Excepted Client) "before or at the time [the RIA] enter[s] into an investment advisory agreement with that client."19 Supplements. RIAs must prepare and provide Supplements with respect to each supervised person who: (i) formulates investment advice for and has direct contact with the client or (ii) makes discretionary investment decisions for the client, even if the person will have no direct client contact.20 Updating would be required only if a Supplement becomes materially inaccurate. While new clients would be provided with the most current version of each relevant Supplement, those clients that previously received a Supplement need not be provided with an updated Supplement unless there have been material changes to relevant disciplinary information. 21 Unlike the Brochure and the Wrap Fee Brochure, SEC-registered advisers need not file Supplements through the IARD system and, thus, Supplements will not be publicly available through IAPD. Instead, as is currently the case for Part II Brochures, such Supplements would be maintained by each RIA in its records and available to the SEC or its staff upon request. However, State- Only RIAs will generally be required to file on the IARD a copy of the Supplement for each supervised person doing business in the relevant state.22 Phase-In and Transition to New Form ADV Part 2. To allow advisers sufficient time to prepare a Brochure: (i) those advisers that apply for registration after January 1, 2011, must file Brochure(s) meeting the requirements of the Part 2 Amendments as part of their applications for registration on Form ADV; and (ii) existing RIAs whose fiscal year ends on or after December 31, 2010, must include a Brochure that complies with the Part 2 Amendments in their next annual updating amendment to Form ADV (e.g., March 31, 2011, for an RIA with a December 31 fiscal year end). Delivery of a new Brochure to all current Non-Excepted Clients is required during the initial period (as discussed later), with delivery required to be made not later than 60 days after filing the Brochure through the IARD system.23 As such, filings are required within 90 days after the end of the RIA's fiscal year and an existing RIA will have 150 days following the end of its fiscal year that began in 2010 to deliver the...

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