1 Investment Adviser Release No. IA-1862 (April 5, 2000) (the "Release").
[11792]
April 7, 2000
TO: INVESTMENT ADVISERS COMMITTEE No. 12-00
RE: SEC PROPOSES REVISIONS TO FORM ADV; ELECTRONIC FILING BY
ADVISERS
______________________________________________________________________________
The Securities and Exchange Commission has proposed substantial revisions to Form ADV and
new rules under the Advisers Act relating to the form.1 The Commission's proposal is intended to
facilitate the implementation an electronic filing system for investment advisers, the Investment Adviser
Registration Depository ("IARD"). The IARD will permit investment advisers to satisfy their initial and
continuing filing obligations with the SEC and state regulators through the submission of Internet
filings. In addition to revising Form ADV for its use with the IARD, the proposed revisions to the form
are intended to reflect regulatory changes since the form was last amended, and to improve the quality of
information advisers must provide to their clients and prospective clients. A copy of the Commission's
Release, which is summarized below, is attached.
Comments are due to the SEC on its proposal no later than June 13, 2000. If you have
comments you would like to be considered for the Institute's comment letter, please submit them to
Tamara Reed by phone (202-326-5825), fax (202-326-5839) or e-mail (tamara@ici.org) no later than
Monday, May 15th.
I. PROPOSED REVISIONS TO FORM ADV
As proposed by the SEC, Form ADV, which currently consists of only two parts, Part I and Part
II, would be divided into four parts: Parts 1A, 1B, 2A and 2B. Part 1A, which would be filed by all
advisers, would be similar to the current Part I of Form ADV, and would provide clients information
about the advisory firm. Part 1B would only be filed by state-registered advisers. Part 2A would specify
the information required to be included in the adviser's brochure that must be provided to clients. And
Part 2B would be a supplemental disclosure document containing information about the supervised
person(s) of the adviser who provide advisory services to that client. Importantly, the disclosure required by
Parts 2A and 2B of the revised form must be provided in a plain-English narrative format. Advisers would no longer be
permitted to satisfy the brochure rule under the Advisers Act by distributing a completed copy of Part 2 of the form.
Each of these proposed parts of Form ADV is discussed in detail below.
A. Part 1A
2 As proposed, each adviser: (1) would complete either a criminal, civil, or regulatory Disciplinary Reporting Page ("DRP") if
it responds affirmatively to a disciplinary question; (2) would report those disciplinary events occurring in the past ten years,
including actions of foreign courts and regulatory authorities and cease-and-desist orders issued by the SEC; and (3) would no
longer report an unsatisfied judgment or lien, bankruptcy, or bond denial, payout or revocation or disclose disciplinary
information for advisory affiliates no longer associated with the adviser.
Part 1A would be completed by all advisers (both federally-registered and state-registered). It
would require an adviser to provide information about its business through a series of fill-in-the-blank,
multiple-choice, and check-the-box questions. While the 12 items of information that would be required
to be disclosed by Part 1A are similar to the information disclosed in the current Part I of Form ADV,
Part 1A would require the following new disclosures: the adviser's CRD number (if it has one), its web
site address(es), an e-mail address of a person who could be contacted about the form, the adviser's fax
number and the information currently required on Schedule I of the form, which relates to the adviser's
eligibility for SEC registration. In addition, there have been substantial revisions to the disclosure
requirements relating to the adviser's disciplinary history.2
Also, this portion of the form would no longer include the education and business background
of the adviser's personnel -- this information would instead be moved to Part 2A of the form -- and
disclosure concerning the adviser's control persons would be revised. As a result, an adviser would
generally no longer be required to report an indirect owner unless the indirect owner owned 25% of a
direct owner.
B. Part IB
Part 1B has been prepared by the North American Securities Administrators Association
("NASAA") on behalf of the state securities authorities. Only state-registered advisers would be required to complete
Part 1B. It would require those advisers subject to state registration to provide information necessary to
obtaining such registration.
C. Part 2A -- The Firm Brochure
Some of the more significant changes proposed by the SEC are contained in Parts 2A and 2B of
the form. Proposed Part 2A would consist of nineteen disclosure items, though, with the exception of
the first two items, the adviser would not be required to present its disclosure in any particular order.
These nineteen items are as follows:
! Item 1 -- Cover Page. This page would require identifying information about the advisory firm (e.g.,
address, telephone number), the date of the brochure, and the name of a person who could be
contacted for additional information.
! Item 2 -- Material Changes. The brochure would be required to include a summary of material
changes since the last annual update in order to help clients identify new or revised information.
This summary would be required to appear on the cover page of the brochure or immediately
thereafter.
! Item 3 -- Table of Contents. A table of contents must be included in each brochure.
! Item 4 -- Advisory Business. The brochure would be required to provide information about the
firm, including how long it has been in business, the names of its principal owners, and a description
of the firm's advisory business, including information relating to any areas of specialization, amount
of assets subject to the adviser's investment discretion, and information relating to wrap-fee
arrangements.
! Item 5 -- Fees and Compensation. The brochure would describe how the adviser is paid for its
services including any fee tables, whether fees are negotiable, billing procedures, and frequency of
fee assessment. Also, any fees the client may incur in addition to advisory fees (e.g., brokerage
commissions, custody fees, etc.), must be disclosed. Advisers who receive transaction-based
compensation must also disclose this practice, any conflicts of interest arising from it, and the firm's
procedure for addressing such conflicts.
! Item 6 -- Types of Clients. The adviser must describe the types of advisory clients the firm
generally has, as well as any minimum account requirements.
! Item 7 -- Methods of Analysis, Investment Strategies and Risk of Loss. In addition to describing
in narrative form the adviser's methods of analysis and investment strategies, disclosure would be
required of the risks a client faces in following the adviser's advice or in permitting the adviser to
manage assets. It would not, however, require advisers that offer a wide variety of advisory services
to list the risks involved in each type of security or trading strategy.
! Item 8 -- Disciplinary Information. An adviser would be required to disclosure information about
the firm's disciplinary history that is material to a client's or prospective client's evaluation of the
adviser's business and the integrity of its management.
! Item 9 -- Other Financial Industry Activities and Affiliations. The brochure would be required to
disclose information about the adviser's other financial industry activities and affiliations (e.g.,
registration as a broker or commodities professional); any material conflicts of interest that the
relationship or arrangement might create; and, the restrictions or other control procedures the
adviser uses to address any such conflict. Also, if the adviser refers clients to another adviser, it
must disclose any compensation or business arrangements with such other adviser and any conflicts
created thereby.
! Item 10 -- Participation or Interest in Client Transactions; Personal Trading. The adviser would
be required to discuss any conflicts of interest the adviser faces when the advisory firm or a "related
person" has a financial interest in, or trades in, securities the adviser recommends to clients.
Procedures and controls designed to address such conflicts must also be disclosed.
! Item 11 -- Brokerage Practices. The brochure would be required to describe the adviser's policies
and practices in selecting brokers for client transactions and in determining the reasonableness of
brokers' compensation. In particular, the brochure would have to provide specific disclosure in the
following areas: the adviser's soft dollar practices; client referrals; transaction costs; directed
brokerage; and commission recapture. In each of these areas, the brochure must discuss any
conflicts of interest created by the arrangement and any procedures the adviser uses to address such
conflict. The specific disclosures required in these areas as follows:
! Soft Dollars. The brochure would disclose any policies and practices with respect to the
adviser's use of soft dollars, including any conflicts of interest that result. The description
of an adviser's soft dollar practices must be specific enough for clients to understand the
types of products or services the adviser is acquiring and to permit the client to evaluate any
conflicts. Disclosure must be more detailed for products or services not used in the
adviser's investment decision-making process. Also, the adviser would be required to
disclose: whether all -- or only certain -- clients benefit from soft dollars and how the
adviser allocates such benefits, and whether it "pays up" for soft dollar benefits.
! Client Referrals. The brochure would discuss the adviser's practices in using client
brokerage to reward brokers that refer clients to the adviser.
! Transaction Costs. The adviser would discuss any benefits it receives from negotiating
lower commissions or from bunching trades to obtain volume discounts. If applicable, the
brochure must also explain that clients may pay higher commissions if the adviser either
does not bunch trades when it has the opportunity to do so or does not negotiate or limits
the extent to which it negotiates commissions.
! Directed Brokerage. If an adviser permits clients to direct brokerage, the brochure would
explain that the adviser may not be able to obtain best execution and the arrangement may
cost clients more money. If, however, the adviser routinely requests or requires clients to
direct brokerage, the brochure must describe the adviser's policies in this area, including any
conflicts of interest.
! Commission Recapture. An adviser that utilizes commission recapture would describe
how this works, explain its benefits, and explain how a client may participate in recapture
programs.
! Item 12 -- Review of Accounts. The brochure would be required to disclosure whether, and how
often, the adviser reviews clients' accounts or financial plans and identify who conducts such review.
Advisers that do not regularly review accounts must explain what circumstances would trigger a
review.
! Item 13 -- Payment for Client Referrals. The brochure would describe any payment -- in cash or
otherwise -- the adviser or a related person makes for client referrals and whether the adviser
receives any benefit from a non-client for providing advisory services to clients.
! Item 14 -- Custody. Advisers that accept custody would disclose this in their brochure and describe
any special reports they give to their custodial clients. Advisers that require custody of client assets
must also explain that most advisers do not impose this requirement and disclose that clients face
greater risk than if an independent custodian held the assets.
! Item 15 -- Investment Discretion. Advisers with discretionary authority over client accounts would
be required to disclose that fact in their brochure as well as any limitations clients may place on this
authority.
! Item 16 -- Proxy Voting Policies. Disclosure of the adviser's proxy voting policies would be
required.
! Item 17 -- Investment Performance. Advisers that advertise or report their investment
performance would be required to describe any standards they use to calculate or present such
performance, and any third-party review of such performance information.
! Item 18 -- Financial Information. While the SEC proposes to continue requiring advisers who
have custody of client assets or who require the prepayment of fees to provide clients an audited
balance sheet, excluded from this requirement would be banks, insurance companies, and federally-
registered broker-dealers. Also, advisers with discretionary authority over client assets would
disclose any financial condition reasonably likely to impair the adviser's ability to meet contractual
commitments to clients.
! Item 19 -- Index. Part 2A requires that the adviser provide to SEC staff -- but not to clients -- an index
of the Items required by Part 2A, to facilitate the staff's review of the adviser's compliance with this
part.
! Appendix 1 -- Wrap Fee Program Brochures. Those advisers that sponsor wrap fee programs
would be required to prepare a separate, specialized firm brochure, which would be provided to
clients of the wrap fee program in lieu of the adviser's standard advisory firm brochure. The
contents of the wrap fee brochure are set forth in Appendix 1 to Part 2A.
D. Part 2B -- The Brochure Supplement
As proposed by the SEC, advisers would be required to prepare and provide to clients a
supplementary brochure on those supervised persons of the adviser who provide advisory services to
that client (even if the supervised person does not have any direct contact with the client). Each
supplement would contain seven items of background information about an individual or group. An
adviser would be generally free to structure the disclosure of these items in a manner that best conveys
the information. (A smaller advisory firm that chooses to include information about all advisory
personnel in its firm brochure would not need to use any supplements.) The items that must be
included in a brochure supplement are as follows:
! Item 1 -- Cover Page. This would identify the subject(s) of the disclosure.
! Item 2 -- Educational Background and Business Experience. The supplement would disclose the
formal education and business experience for the past five years of the supervised person(s), as well
as any professional designations or attainments.
! Item 3 -- Disciplinary Information. The supervised person's disciplinary history would be
disclosed, including any proceeding revoking or suspending a professional attainment, designation,
or license.
! Item 4 -- Other Business Activities. In addition to disclosing the supervised person's other
business activities, the supplement would describe the nature of any conflicts resulting from such
other activities and the procedures the adviser uses to address such conflicts. The supplement
would also disclose whether the supervised person receives any transaction-based compensation,
including bonuses and non-cash compensation.
! Item 5 -- Additional Compensation. The supplement would describe arrangements in which
someone other than a client gives the supervised person an economic benefit (e.g., a sales award or
prize) for providing advisory services.
! Item 6 -- Investment Advice and Supervision. The supplement would disclose who formulates the
advice given to clients and how the firm monitors the advice provided. In addition, the name, title,
and telephone number of the person who supervises the supervised person would be included in the
supplement.
! Item 7 -- Financial Information. The supplement would disclose whether the supervised person
was the subject of a bankruptcy petition within the past ten years.
II. The IARD
A. Generally; Use of the System will be Mandatory
As mentioned above, the Form ADV is being revised, in large part, in order to facilitate
implementation of the IARD system, the SEC's proposed electronic filing system for investment
advisers. The IARD will be an Internet-based system that an adviser will use to apply for registration,
amend its registration, and withdraw from registration. An SEC-registered adviser will also be able to
submit its state notice filings through the IARD. Advisers will be able to complete their Form ADV,
and any amendments thereto, on-line and immediately transmit the form electronically to the SEC.
Once the revised Form ADV is adopted and the IARD becomes operational, all SEC-registered advisers
would be required to file a revised Form ADV with the SEC through the IARD. With respect to
amendments to its Form ADV, an adviser would access its form through the IARD, type the new
information over the old, and electronically transmit the information to the SEC. The IARD would
replace the stale information with the new information and record the date of the change.
Information contained in filings made through the IARD will be stored in a database that
members of the public will be able to access free of charge through the Internet. Once it becomes
operational, SEC-registered advisers will be required to make all Form ADV filings through the IARD. The only
exceptions will be in the event of hardship -- either temporary hardship due to, for example, computer
malfunction or electrical outage; or a continuing hardship, in the event use of the IARD would create an
undue hardship on the adviser.
B. Proposed IARD Roll Out
The SEC proposes to roll out the IARD in the following order:
! Release 1 -- SEC-registered advisers and applicants for SEC registration will begin using the IARD
to file Part 1A of Form ADV with the SEC and to submit notice filings to the states. The SEC
expects that the IARD will begin to receive filings pursuant to Release 1 later this year;
! Release 2 -- Public access would be provided via the Internet to the IARD database. This is
expected to occur a few months after the first filings are made on the system.
! Release 3 -- Investment adviser representatives could electronically submit their state registration
applications via the system once Release 3 is rolled out.
! Release 4 -- The IARD will begin to accept Part 2 of Form ADV.
C. Fees
While the SEC has paid for the development of the system, which is being built and will be
operated and maintained by NASDR, Inc., filing fees will be assessed to pay for the system's operation
and maintenance. NASDR will charge fees based upon an adviser's assets under management and the
number of states to which notice filings are submitted, for initial applications and annual updating
amendments. The SEC expects the annual filing fee to run $200-$400. IARD filing fees and state notice
filing fees, which would also be paid through the system, would be paid by NASDR debiting the
adviser's NASDR account, which the adviser would be required to establish and maintain in connection
with using the IARD.
III. Proposed Revisions to the "Brochure Rule" Under the Advisers Act
As discussed above, the SEC has proposed to require all advisers to provide clients with a plain
English narrative brochure and supplemental brochure containing disclosure about the advisory firm and
its supervised persons. In addition to offering to clients at least annually a copy of the adviser's current
brochure and supplemental brochure, the SEC has proposed to amend the brochure rule (i.e., Rule 204-3
under the Advisers Act) to require an adviser to provide its clients with a written brochure update, which
may take the form of a reprinted brochure or a sticker, whenever information in such brochures
becomes materially incorrect.
IV. Miscellaneous
A. Transition Issues
Once the SEC adopts its proposed amendments, it will publish a schedule by which all advisers
will be required to re-submit their registration forms to the SEC through the IARD. The SEC does not
expect to require advisers to file their brochures with the SEC until such time as the adviser makes its
first annual update after the IARD begins to accept Part 2A (which is not expected to be until 2002). In the
meantime, in lieu of filing brochures in hardcopy with the SEC, advisers will be required to maintain
them (as part of the adviser's recordkeeping requirements pursuant to Rule 204-2 under the Advisers
Act) and make them available to SEC staff upon request.
B. Form ADV-W
The SEC has proposed revisions to Form ADV-W, Notice of Withdrawal from Registration as
an Investment Adviser, and to require it that it be filed through the IARD. In addition, the SEC has
proposed to make such withdrawal effective upon filing, rather than 60 days after filing, which is the
current procedure.
* * * *
Tamara K. Reed
Associate Counsel
Attachment