A Comprehensive Overview of Registration Changes under the Advisers Act, including Amended Form ADV Part 2 and Proposed Changes to Part 1

Transcription

1 A Comprehensive Overview of Registration Changes under the Advisers Act, including Amended Form ADV Part 2 and Proposed Changes to Part 1 Alan Goldberg, Partner alan.goldberg@klgates.com Carolyn Jayne, Associate carolyn.jayne@klgates.com Don Weiss, Partner donald.weiss@klgates.com

2 Amendments to Form ADV Part 2 Overview The SEC adopted amendments to Form ADV Part 2 (ADV Part 2) on July 21, 2010 Rule and accompanying release (Release) published on July 28, 2010 Original proposal released in

3 Overview In adopting changes, SEC commissioners noted change was overdue Changes to ADV Part 2 largely were re-proposals of changes originally proposed in April 2000 The types of disclosures included in the new form evolved piecemeal over the years in response to SEC enforcement actions, no-action letters and guidance 4 Overview The amendments change the current ADV Part II s check the box format to a narrative format and break the ADV Part 2 into: Part 2A called the brochure contains 18 items (discussed below) an adviser must address filed electronically through the Investment Adviser Registration Depository (IARD) and is publicly accessible Part 2B called the brochure supplement requires the adviser to address six items (discussed below) is intended to provide a potential client or investor with specific information about the supervised persons that will provide the client with investment advice is NOT filed through the IARD 5

4 Compliance Dates Part 2A Each adviser registered with the SEC as of December 31, 2010: with a fiscal year ending December 31 will be required to file ADV Part 2A beginning with its annual amendment of ADV Part 1 for 2010, due by March 31, 2011 with a fiscal year ending other than December 31 will be required to file Part 2A with its next annual updating amendment made after December 31, 2010 Advisers registering after January 1, 2011 must file ADV Part 2A to become registered 6 Compliance Dates Part 2A After filing its first ADV Part 2A, an adviser must: immediately begin providing new clients and investors with ADV Part 2A provide existing clients and investors with ADV Part 2A within 60 days of first filing the Part 2A An adviser that has no clients to whom it needs to deliver a brochure or brochure supplement need not create one Surprising, given that in the Release the SEC states how valuable the Form ADV disclosure is to the SEC staff in its inspection and compliance review efforts As a result of the Dodd-Frank Act, many advisers that previously were unregistered must register by July 21, 2011, although many may elect to register earlier 7

5 Part 2A Delivery Requirements Previously an adviser was required: Initially to provide a client with a copy of the adviser s ADV Part II: At least 48 hours prior to entering into an advisory agreement with the adviser or On entering into the contract, so long as the client was permitted to rescind the agreement without penalty for five days after signing 8 Part 2A Delivery Requirements On an annual basis, either: Provide current clients or investors with an updated version of its ADV Part II or Offer current clients or investors an updated version of its ADV Part II and, upon request thereafter, provide an investor with an updated version 9

6 Part 2A Delivery Requirements Under the new rule, an adviser must: Initial Delivery Initially, provide a client or investor with an ADV Part 2A (and Part 2B) upon entering into an advisory agreement with that client Annual Delivery Within 120 days after the adviser s fiscal year end, either: Provide current clients with an amended Part 2A or Provide a summary of material changes to the Part 2A (see Item 2 of Part 2A, discussed above) with contact information permitting a client to request an amended version If the adviser has not made an interim amendment to the brochure and no material information has changed, no summary is required and no brochure is required to be delivered to existing clients that year 10 Part 2A Delivery Requirements Interim Delivery An adviser must deliver an updated brochure whenever the adviser amends its brochure to add a disciplinary event (or to change material information already disclosed) in Item 9 11

7 Part 2A Delivery Requirements Advisers need not deliver the brochure to: Advisory clients receiving only impersonal investment advice who pay the adviser less than $500 per year Investment companies registered under the 1940 Act, or Business development companies subject to Section 15(c) of the 1940 Act An adviser need not prepare a Form ADV Part 2A if all of its clients fall into one or more of these categories 12 Part 2A Delivery Requirements In a footnote to the Release, the SEC notes that an adviser is required to provide its ADV Part 2 to clients, and that, after the Goldstein decision, a private fund adviser s client is the private fund, not the investors therein Currently it does not appear that a private fund adviser must provide ADV Part 2A and 2B to investors in a private fund Providing the ADV Part 2 to fund investors is a common practice 13

8 Plain English and Concise Disclosure The Release and instructions for the new ADV Part 2 stress the importance of using plain English, including: using short sentences using definite, concrete, everyday words using active voice avoiding legal or technical jargon using examples where possible putting complex material into tables or bulleted lists 14 Plain English and Concise Disclosure The Release states that the disclosure must be succinct and readable To keep it succinct, disclosure should only discuss: practices the adviser engages in or is reasonably likely to engage in, or conflicts the adviser has or is reasonably likely to have There is an inherent tension between: plain English and precision in disclosure (has been problematic since the SEC s push toward plain English disclosure in the 1990s) goal of keeping disclosure succinct while ensuring it is complete 15

9 Part 2A: The Brochure Part 2A: The Brochure Contains 18 separate items of disclosure Part 2A is filed with the IARD and is publicly available Filed through IARD as text-searchable.pdf Attached to IARD filing like an attachment to an An adviser can include a summary with its Part 2A if the brochure is long (recall the goal of succinct disclosure), with more detailed explanation in the body of Part 2A Next, we address certain key items and changes from the previous ADV Part II 17

10 Part 2A: The Brochure Cover Page Requirements Part 2A must include a cover page that provides certain basic information: Name Address Contact info Website Date of brochure 18 Part 2A: The Brochure The cover page must also include the following legend: This brochure provides information about the qualifications and business practices of [your name]. If you have any questions about the contents of this brochure, please contact us at [telephone number and/or address]. The information in this brochure has not been approved or verified by the U.S. Securities and Exchange Commission or by any state securities authority. Additional information about [your name] also is available on the SEC s website at 19

11 Part 2A: The Brochure If an adviser refers to itself as a registered adviser or otherwise as being registered, it must include a statement that registration does not imply a certain level of skill or training In the Release, the SEC expressed concern some advisers were misusing registration to imply a heightened level of prowess 20 Part 2A: The Brochure Item 2 Material Changes Adviser must include a summary of any material changes since its last annual Part 2A filing, if any This summary can be included: On the cover page On the following page, or In a separate document filed as an exhibit to Part 2A As discussed below, the summary can be used to satisfy the annual Part 2A delivery requirement 21

12 Part 2A: The Brochure Item 3 Table of Contents The brochure must provide a table of contents, indicating the page on which the response to each item can be found An adviser must use the headings and order of headings in Part 2A Where an item is not applicable, the heading must be included with a statement that the item is not applicable Cross-references are permitted among items Goal is to permit easy comparison of advisers 22 Part 2A: The Brochure Conflicts and Disclosure Generally ADV Part 2A generally calls for a succinct, easy-tounderstand narrative, in plain English, of: the conflicts of interest the adviser faces (or is reasonably likely to face) in its business and how the adviser addresses such conflicts Advisers must be cautious in selecting which conflicts to disclose Over-inclusion would be inconsistent with the succinct disclosure approach required by the SEC Omitting conflicts could violate the requirements of the new ADV Part 2A and expose an adviser to claims that it did not sufficiently disclose relevant conflicts 23

13 Part 2A: The Brochure Item 4 Advisory Business General information about the adviser s business, including: a description of the business and how long it has operated its principal owners (including persons owning 25% or more of business listed in Schedule A of ADV Part 1) Types of advisory services offered, including a more detailed description of: any area of specialization (e.g., financial planning, quantitative analysis, or market timing) limitations on types of investments for which the adviser provides advisory services 24 Part 2A: The Brochure Whether and how advisory services are tailored to individuals Whether the adviser participates in wrap programs and, if so, the adviser must disclose: how the adviser manages wrap fee accounts compared to other accounts that the adviser receives a portion of the wrap fee for its services 25

14 Part 2A: The Brochure Amount of client assets managed on a discretionary basis and on a non-discretionary basis, including an as-of date for the figure (no more than 90 days before the date of the filing or update) This amount may be calculated differently than AUM for purposes of Item 5 of the ADV Part 1A Adviser must keep documentation of how it computed client assets it manages Commissioner Aguilar expressed particular concern over an adviser s ability to calculate differently its client assets for this purpose, believing it could lead to confusion and prevent an apples-to-apples comparison by investors 26 Part 2A: The Brochure Item 5 Fees and Compensation Disclosure of Fees and Compensation As with previous ADV Part II, an adviser must disclose: its fee schedule whether fees are negotiable and how clients pay fees (i.e., whether fees are deducted directly from a client s account) The new Part 2A requires more specific information be provided, such as custodial and brokerage fees and fund expenses The Release anticipates the description of custodial and transaction fees will be simple and brief and states that the disclosure is not required to include the amount or range of the fees 27

15 Part 2A: The Brochure Exemption for Qualified Purchasers The new Part 2A also permits an adviser to omit disclosure of its fee schedule and other information under Item 5 if the brochure is delivered only to qualified purchasers under the Investment Company Act of 1940, as amended (1940 Act), and the rules thereunder 28 Part 2A: The Brochure Item 6 Performance Fees and Side-by-Side Management Item 6 requires an adviser to disclose whether it receives performance-based compensation from an account or fund If the adviser also manages accounts or funds that do not pay such compensation, the adviser must disclose the potential conflicts of interest the adviser faces that might cause it to favor the account paying a performance fee, which could include: Incentive to take more risk in accounts paying a performance fee Incentive to favor performance fee paying accounts in allocations (cherry-picking) 29

16 Part 2A: The Brochure The adviser must disclose how it addresses these conflicts of interest The Release notes that, as of May 3, 2010, 28% of registered advisers reported charging performance fees to some accounts but not others 30 Part 2A: The Brochure Item 7 Types of Clients Item 7 requires the adviser to disclose: The types of clients it serves, and Any minimum investment amount or other requirements for opening an account A private fund adviser would have to disclose that it manages private funds 31

17 Part 2A: The Brochure This disclosure is part of a larger problem in the narrative form for private fund managers A private fund adviser cannot engage in a general solicitation or general advertising of its funds because private funds generally rely on a private offering exemption from registration of the offer and sale of the funds securities Normally a private fund adviser is very limited in what it can say about the funds it manages, but the narrative disclosure of the new ADV Part 2 requires significant public disclosure in Part 2A 32 Part 2A: The Brochure In the Release, the SEC staff acknowledges that overdisclosure could constitute a general solicitation for purposes of the private offering exemptions, but says that it believe[s] registrants can provide information required by [ADV Part 2A] without jeopardizing reliance on those exemptions Private fund advisers must take great care in drafting disclosure regarding private funds in the ADV Part 2A 33

18 Part 2A: The Brochure Item 8 Methods of Analysis, Investment Strategies and Risk of Loss Significant Methods of Analysis or Strategies Must disclose methods of analysis and investment strategies and, for each significant strategy, explain the material risks involved 2008 proposing release required only discussion of primary investment strategies; significant would seem broader In the Release, the SEC notes that the brochure may not be the appropriate place for a multi-strategy adviser to describe all the risks of its methods of analysis or strategies If the method of analysis or strategy involves significant or unusual risks, these must be discussed in detail Difficult to balance goal of succinct disclosure with detailed discussion of risks; for a private fund, an adviser likely would not want to include all the risks from its offering memorandum The Release states that significant or unusual risks would be those that otherwise would not be apparent to the client from reading the adviser s brochure 34 Part 2A: The Brochure Frequent Trading If an adviser s primary strategy involves frequent trading of securities, the adviser must disclose how frequent trading can affect investment performance, particularly through increased transaction fees and costs SEC declined to define frequent trading (and noted that comment letters criticizing the lack of a definition did not suggest one) but said in the Release that it expects advisers would provide the disclosure if their intended investment strategies involved frequent trading of securities that a reasonable client would otherwise not expect in light of the other disclosures contained in the brochure 35

19 Part 2A: The Brochure Particular Securities If an adviser recommends primarily a particular type of security, it must explain the material risks involved with such security and, if the security involves significant or unusual risks, these must be discussed in detail An adviser must also explain in Item 8 that investing in securities involves risk of loss that clients or investors should be prepared to bear 36 Part 2A: The Brochure Item 9 Disciplinary Information Item 9 requires disclosure of certain legal and disciplinary events regarding the adviser and its management persons (defined below) that would be material to a client s evaluation of an adviser This item incorporates the disclosure of disciplinary information required by Rule 206(4)-4 under the Investment Advisers Act of 1940, as amended (Advisers Act) Rule is being rescinded as superfluous The Release notes that, even if an adviser is not required to provide a brochure to a client (such as a brochure intended only for qualified purchasers), the adviser s fiduciary duty requires [it] to continue to disclose to all of [its] clients material disciplinary and legal events and [its] inability to meet [its] contractual commitments to [its] clients 37

20 Part 2A: The Brochure A disciplinary action is presumptively material if it occurred within the past 10 years Presumption can be rebutted If rebutting presumption, an adviser must document its determination in a memorandum and retain the memorandum 38 Part 2A: The Brochure Beyond 10 years, disciplinary events only need to be disclosed if they are so serious that they would remain material to a client s assessment The Release places a great deal of the burden in determining what must be disclosed on adviser s determination of materiality This could include sanction of a supervised person by a professional organization, such as the CFA Institute, or arbitration proceedings that otherwise are not expressly required to be disclosed The Release stresses that the adviser s fiduciary duty may require disclosure even if Item 9 does not; Item 9 is not a safe harbor 39

21 Part 2A: The Brochure If an employee resigns to avoid a sanction, and the adviser knew or should have known this was the reason for the resignation, the adviser must disclose this fact 40 Part 2A: The Brochure Item 10 Other Financial Activities and Affiliations Material Relationships Item 10 requires an adviser to identify and discuss, among other things: Material relationships the adviser or its management persons have with related financial industry participants (similar to the list in Item 7 of Form ADV Part 1A) that are material to its advisory business Any conflicts arising from these relationships, and How the adviser deals with those conflicts Provision is very similar to Item 8 of old ADV Part II 41

22 Part 2A: The Brochure Broker-Dealer or Commodities-Related Licenses An adviser is also required to disclose whether it or any of its management persons are registered or have an application to register pending as: A broker-dealer or registered representative of a broker-dealer, or A futures commission merchant, commodity pool operator, a commodity trading advisor, or an associated person of the foregoing entities Manager of Managers A manager of managers is expressly required to describe: Any compensation received from managers to which it refers clients, and Any other conflicts its relationships or agreements with other managers raise 42 Part 2A: The Brochure Management person is defined to mean [a]nyone with the power to exercise, directly or indirectly, a controlling influence over [a] firm s management or policies, or to determine the general investment advice given to the clients of [the] firm The definition provides that the following are presumed to be management persons : An adviser s principal executive officers, such as the chief executive officer, chief financial officer, chief operations officer, chief legal officer, and chief compliance officer; an adviser s directors, general partners, or trustees; and other individuals with similar status or performing similar functions The members of an adviser s investment committee or group that determines general investment advice to be given to clients and If an adviser does not have an investment committee or group, the individuals who determine general investment advice provided to clients (if there are more than five people, an adviser may limit its response to their supervisors) 43

23 Part 2A: The Brochure Item 11 Code of Ethics, Participation in Client Transactions and Personal Trading This item is similar to the prior Item 9 of the old ADV Part II It requires an adviser to: Describe its code of ethics and personal trading policy for personnel and State that a copy of the code is available to clients upon request 44 Part 2A: The Brochure Also requires adviser to discuss whether it engages in certain kinds of trades that could result in a conflict of interest with clients, including when and if the adviser or a related person: Buys or sells, for client accounts, securities in which the adviser or a related person has a material financial interest As principal, buys securities from (or sells securities to) its clients (principal trades) 45

24 Part 2A: The Brochure Acts as general partner in a partnership in which the adviser solicits client investments Acts as an investment adviser to an investment company that the adviser recommends to clients Invests in the same securities (or related securities, e.g., warrants, options or futures) that the adviser or a related person recommends to clients Recommends securities to clients, or buys or sells securities for client accounts, at or about the same time that the adviser or a related person buys or sells the same securities for the adviser s own (or the related person s own) account If the adviser engages in one of the foregoing transactions, it must describe its practice, the conflicts that arise and how it deals with those conflicts 46 Part 2A: The Brochure Item 12 Brokerage Practices An adviser must disclose factors considered in selecting or recommending brokers and determining the reasonableness of the brokers compensation Soft Dollars An adviser must include a great deal of disclosure regarding its use of soft dollars, including: Whether the adviser uses soft dollar benefits to service all of its clients accounts or only those that paid for the benefits Whether the adviser seeks to allocate soft dollar benefits to client accounts proportionately to the soft dollar credits the accounts generate 47

25 Part 2A: The Brochure The types of products and services the adviser or any of its related persons acquired with client brokerage commissions (or markups or markdowns) within the adviser s last fiscal year The Release notes that this description must be specific enough for clients to understand the types of products or services that the adviser is acquiring and to permit them to evaluate possible conflicts of interest The adviser s description must be more detailed for products or services that do not qualify for the safe harbor in Section 28(e) of the Securities Exchange Act of 1934, such as those services that do not aid in investment decision-making or trade execution The Release states that merely disclosing that you obtain various research reports and products is not specific enough 48 Part 2A: The Brochure If the broker uses soft dollars, the adviser must also disclose to investors: That the adviser may have an incentive to select or recommend a broker-dealer based on the adviser s interest in receiving the research or other products or services, rather than based on its clients interest in receiving most favorable execution, and Whether clients may pay commissions (or markups or markdowns) higher than those charged by other broker-dealers in return for soft dollar benefits (known as paying up) 49

26 Part 2A: The Brochure Brokerage for Referrals An adviser must disclose whether it considers client referrals from a broker in selecting brokers for clients accounts If so, the adviser must also disclose: The conflicts this creates, and The procedures it has used to allocate client trades to brokers in exchange for referrals in the adviser s last fiscal year Previous Item 13.B required disclosure regarding payment for client referrals, but did not require discussion of the conflict the practice can create 50 Part 2A: The Brochure Directed Brokerage If the adviser routinely recommends, requests or requires that a client direct the adviser to execute transactions through a specified brokerdealer, the adviser must describe its practice or policy The adviser must explain that not all advisers require their clients to direct brokerage If the adviser and the broker-dealer are affiliates or have another economic relationship that creates a material conflict of interest, the adviser must describe the relationship and discuss the conflicts of interest it presents The adviser must also explain that, by directing brokerage, the adviser may be unable to achieve most favorable execution of client transactions, and that this practice may cost clients more money If the adviser permits a client to direct brokerage, it must describe its practice and note that under such circumstances: The adviser will be unable to ensure most favorable execution of trades and The practice may cost the client more money The adviser need not include this warning regarding favorable execution if client-directed brokerage is permitted only subject to the adviser s ability to obtain best execution 51

27 Part 2A: The Brochure Trade Aggregation Adviser must disclose whether and under what conditions it aggregates trades If the adviser does not aggregate when it could do so, the adviser must disclose that clients may pay higher brokerage costs as a result 52 Part 2A: The Brochure Item 13 Review of Accounts Periodic Review Adviser must disclose whether accounts are reviewed on a periodic basis and provide: Frequency of review Nature of review, and Title of reviewing persons Other Review If reviews are conducted on an other than periodic basis, adviser must describe factors that trigger a review The requirement to disclose these items with greater specificity than in old ADV Part II may lead to more formalized review processes 53

28 Part 2A: The Brochure Item 14 Client Referrals and Other Compensation An adviser must describe any arrangements in which the adviser pays compensation of any kind to another party (other than an employee) for client referrals Must describe the conflict created, and How that conflict is addressed Unlike the old ADV Part II, this Item 14 includes not just cash compensation, but any compensation whether cash or non-cash 54 Part 2A: The Brochure Advisers will need to consider their current practices to determine whether any could be deemed paying compensation for referrals There is no de minimis exception 55

29 Part 2A: The Brochure Item 15 Custody Adviser with custody must: Explain that clients will receive account statements directly from a qualified custodian State that the client should carefully review the account statements If the adviser sends out its own account statements in addition to those sent by the qualified custodian, the adviser must include a statement urging clients to compare the two statements The SEC recently amended the custody rule requirements applicable to investment advisers 56 Part 2A: The Brochure Item 16 Investment Discretion If an adviser has discretion over client accounts, it must disclose: The fact that it has discretionary authority, and Any limitations clients may (or customarily do) place upon the adviser s discretion The Release notes this may be duplicative with Item 4, and states that a cross-reference could be used in such a circumstance 57

30 Part 2A: The Brochure Item 17 Voting Client Securities Adviser must disclose: Whether it has or will accept authority to vote, and if so, what policies it has in place to vote proxies Whether and how clients can direct the adviser to vote in a particular solicitation How the adviser addresses conflicts of interest when it votes securities, and How a client can obtain information on how the adviser voted its securities 58 Part 2A: The Brochure Release notes that this requirement parallels Rule 206(4)-6 under the Advisers Act Release states that Rule 206(4)-6 independently would require the same disclosure even if it were not required in the brochure 59

31 Part 2A: The Brochure Item 18 Financial Information If an adviser requires or solicits prepayment of more than $1,200 in fees per client six months or more in advance, it must provide a GAAP-audited balance sheet Not required if the adviser is a qualified custodian under Rule 206(4)- 2 or similar state laws or an insurance company An adviser must disclose any financial condition that is reasonably likely to impair its ability to meet contractual commitments to clients if the adviser: Has custody of client assets Has discretionary authority over client assets, or Requires or solicits prepayment of more than $1,200 in fees per client six months or more in advance 60 Part 2A: The Brochure If the adviser has been the subject of a bankruptcy petition in the past ten years, it must disclose: The fact of the petition The date the petition was brought, and The current status 61

32 Part 2A: The Brochure Appendix 1 to Part 2A Wrap Fee Programs Appendix 1 includes 10 items and is similar in form to Part 2A Appendix 1 takes the place of the full Part 2A for wrap fee clients of wrap programs the adviser sponsors Sponsor means a person who sponsors, organizes or administers a wrap fee program or selects, or provides advice to clients regarding the selection of, other investment advisers in the program The adviser must deliver its full Part 2A for wrap fee clients of wrap programs it does not sponsor Sponsoring adviser must create an Appendix 1 for each wrap program it sponsors or create an Appendix 1 that describes more than one of its wrap programs If a wrap program has more than one sponsor, another sponsor may provide the Appendix 1 to the program clients on behalf of an adviser so long as the Appendix 1 contains all information that would be required in the adviser s own Appendix 1 62 Part 2A: The Brochure An adviser must disclose: Whether any of its related persons is a portfolio manager in the wrap fee program and If so, the related conflicts, including whether related person portfolio managers are subject to the same review and screening as other managers 63

33 Part 2B The Brochure Supplement Part 2B The Brochure Supplement Part 2B is a significant aspect of the new ADV Part 2 Each item of Part 2B must be answered for each supervised person of the adviser that either: Formulates investment advice for client assets and has direct client contact or Makes discretionary investment decisions for client assets, even if there is no direct client contact (each, a covered supervised person ) If investment advice is provided by a team comprised of more than five supervised persons, the brochure supplement need only be provided for the five supervised persons with the most significant day-to-day responsibility If an adviser has no clients to whom a brochure supplement must be delivered, then it need not prepare a brochure supplement 65

34 Part 2B The Brochure Supplement An adviser can create a brochure supplement for each covered supervised person or for a group As with the brochure, the brochure supplement must use headings, ordering and format of the brochure supplement form Brochure supplement can be folded into brochure with disclosure in appropriate places Release notes this may be easier for the 81% of SEC-registered advisers with fewer than 10 persons providing investment advice Advisers are not required to file brochure supplements on IARD The brochure supplement must be retained in an adviser s files 66 Part 2B - Multiple Brochure Supplements Multiple brochure supplements An adviser can group its personnel into separate brochure supplements and provide a client only the brochure supplement that is relevant for the services that client receives The ability to use multiple brochure supplements is useful for an organization with many investment strategies, but will require care in ensuring all relevant information is provided to the appropriate clients and to ensure consistency among different brochure supplements 67

35 Part 2B The Brochure Supplement A covered supervised person s brochure supplement initially must be given to each client at or before the time when that specific supervised person begins to provide advisory services to that specific client An adviser is not required to deliver a brochure supplement to a client: to whom delivery of the firm brochure is not required or to certain qualified clients who are also officers, directors, employees and other persons related to the adviser Advisers are permitted to deliver the brochure supplement electronically In this case, advisers may disclose that a covered supervised person has a disciplinary event and provide links to BrokerCheck and the Investment Adviser Public Disclosure (IAPD) website 68 Part 2B The Brochure Supplement Item 1 Cover Page Must include information identifying the supervised person(s) covered by the supplement as well as the advisory firm (e.g., name, business address, contact information, website and date of the Supplement) Information required by this item may be presented either on a separate cover page or at the top of the first page of the brochure supplement Must include required legend 69

36 Part 2B The Brochure Supplement Item 2 Education and Business Background An adviser must disclose information about the supervised person s formal education and business background for the past five years If the supervised person has no high school degree, no formal education after high school or no business experience, adviser must state this fact Business background disclosure must discuss positions at prior employers 70 Part 2B The Brochure Supplement If an adviser chooses to include information about a supervised person s professional designation, it must provide a sufficient explanation of the minimum qualifications required for the designation so that the value of the designation might be understood Unclear if large professional organizations such as CFA Institute will publish standard disclosure language 71

37 Part 2B The Brochure Supplement Item 3 Disciplinary Information Advisers must disclose legal and disciplinary events that are material to a client s evaluation of the integrity of the covered supervised person As with brochure, certain disciplinary actions deemed presumptively material Adviser required to disclose if covered supervised person has relinquished a designation or license in anticipation of its being suspended if the adviser knew or should have known that the designation or license was relinquished for such reason 72 Part 2B The Brochure Supplement Item 4 Other Business Activities Must disclose other capacities in which manager serves and conflicts this might create Must include disclosure on compensation, including bonuses and non-cash compensation, manager receives for sales of securities or other products and conflicts this creates Adviser also must disclose material non-investmentrelated business in which the covered supervised person engages If the other business activity represents less than 10% of the portfolio manager s time and income, it is presumptively nonmaterial 73

38 Part 2B The Brochure Supplement Item 5 Additional Compensation Brochure supplement must describe any arrangement in which someone other than a client gives the covered supervised person an economic benefit (such as a sales award or other prize) for providing advisory services 74 Part 2B The Brochure Supplement Item 6 Supervision Requires adviser to explain how it monitors a covered supervised person s advice Creates public accountability for the named supervisors May also create compliance burdens if the supervisory chain changes frequently or is ambiguous, as is the case with many smaller advisers 75

39 Part 2B The Brochure Supplement Updating and Interim Delivery An adviser must amend a brochure supplement to reflect any changes that render it materially inaccurate An adviser need only make an interim delivery to existing clients when there is a new disclosure of a disciplinary event or a material change to disciplinary information already disclosed Advisers who provide the brochure supplement electronically and provide links to BrokerCheck and IAPD cannot rely on the link alone to meet the delivery-of-updates requirement (e.g., when there is a new disciplinary event) 76 Part 2B The Brochure Supplement Advisers are required to deliver an updated supplement or sticker to clients Will create compliance challenges since only certain clients will receive certain supplements, depending on which covered supervised person is advising them Advisers will have to track carefully which supplements have been sent to which clients in order to provide them with appropriate updates 77

40 Proposed Changes to Part 1 of Form ADV Private Fund Reporting (Item 7.B. of Form ADV, Part 1) The SEC has proposed to expand information advisers provide about private funds they advise by modifying the scope of Item 7 of Part 1 of Form ADV: complete Section 7.B. only for a private fund that the adviser (and not a related person) advises To avoid multiple reporting for each private fund, the rule proposal would permit: a sub-adviser to exclude disclosing information on private funds for which an adviser already is reporting on its Schedule D an adviser sponsoring a master-feeder arrangement to submit a single Schedule D for the master fund and all of the feeder funds that would otherwise be submitting substantially identical data an adviser with a principal office and place of business outside the U.S. would be able to omit a Schedule D for a private fund that is not organized in the U.S. and that is not offered to, or owned by, U.S. persons 79

41 Private Fund Reporting (Item 7.B. of Form ADV, Part 1) (Cont d) The SEC also proposed new Section 7.B.1.to Schedule D. Part A of this new section would require: identifying information of the private fund an adviser to identify the state or country where the private fund is organized, and the name of its general partner, directors, trustees or persons occupying similar positions 80 Private Fund Reporting (Item 7.B. of Form ADV, Part 1) (Cont d) information about the organization of the fund, including: whether it is a master or a feeder fund information about regulatory status of fund and its adviser, including exclusion from the Investment Company Act upon which the fund relies whether adviser is subject to a foreign regulatory authority whether the fund relies on an exemption from registration of its securities under the Securities Act of

42 Private Fund Reporting (Item 7.B. of Form ADV, Part 1) (Cont d) The item also would: ask whether the adviser is a subadviser to the private fund and would require the adviser to identify by name and SEC file number any other advisers to the fund elicit information to help the SEC understand the private fund s investment activities, including: size of the fund, including both its gross and net assets type of investment strategy employed by the adviser assets and liabilities held by the fund by class and a categorization of the fair value hierarchy established under GAAP number and the types of investors in the fund, as well as the minimum amounts required to be invested information about the characteristics of the fund that may present the fund manager with conflicts of interest with fund investors whether clients of the adviser are solicited to invest in the fund and what percentage of the other clients have invested in the fund 82 Private Fund Reporting (Item 7.B. of Form ADV, Part 1) (Cont d) In Part B of new Section 7.B. of Schedule D, the SEC proposes to require advisers to report information concerning five types of service providers that generally perform important roles as gatekeepers for private funds: Auditors Prime brokers Custodians Administrators Marketers An adviser would identify the gatekeepers, provide their location, and state whether they are related persons 83

43 Private Fund Reporting (Item 7.B. of Form ADV, Part 1) (Cont d) for each such service provider, the SEC would require specific information that would clarify the services they provide and include the following information: auditors -- whether they are independent, registered with the Public Company Accounting Oversight Board and subject to its regular inspection, and whether audited statements are distributed to fund investors prime broker -- whether it is SEC-registered and whether it acts as custodian for the private fund custodian -- whether it is a related person of the adviser administrator -- whether it prepares and sends to investors account statements and what percentage of the fund s assets are valued by the administrator or another person that is not a related person of the adviser marketers -- whether they are related persons of the adviser, their SEC file number (if any), and the address of any website they use to market the fund 84 Advisory Business Information: Employees, Clients and Advisory Activities (Item 5 of Form ADV, Part 1) The SEC proposed to amend Item 5 of Part l of Form ADV to require an adviser to provide basic information regarding the adviser s business to enable the SEC to identify the scope of the adviser s business, the types of services it provides, and the types of clients to whom it provides those services, including: additional information about the adviser s employees, including the number of employees that are registered representatives of a broker-dealer and the number of employees that are registered as investment adviser representatives or insurance agents 85

44 Advisory Business Information: Employees, Clients and Advisory Activities (Item 5 of Form ADV, Part 1) (Cont d) a single numerical response to the question about the number of employees instead of a range an expansion of types of clients to include business development and insurance companies, and other investment advisers, as well as to distinguish pension and profit-sharing plans subject to ERISA from those that are not; as amended, would require an adviser to indicate the approximate amount of its regulatory assets under management attributable to each client type the percentage of the adviser s clients that are not U.S. persons 86 Advisory Business Information: Employees, Clients and Advisory Activities (Item 5 of Form ADV, Part 1) (Cont d) an expansion of the list of advisory activities to include portfolio management for pooled investment vehicles, other than registered investment companies, and educational seminars or workshops the SEC file number for a registered investment company if the adviser checks the box for portfolio management for an investment company (to allow SEC s examination staff to link information reported on Form ADV to information reported on forms filed through EDGAR) a requirement for advisers to select from a list the types of investments about which they provided advice during the fiscal year for which they are reporting 87

45 Other Business Activities and Financial Industry Affiliations (Items 6 and 7 of Form ADV, Part 1) Proposed amendments to Items 6 and 7 of Part la would require advisers, including exempt reporting advisers, to report on those financial services the adviser or a related person is actively engaged in from lists of financial services. The SEC proposed several changes to that list to provide a more complete picture of the activities of an adviser and its related persons, as follows: expand the lists in both Items 6 and 7 to include business as a trust company, registered municipal advisor, registered securitybased swap dealer, and major security-based swap participant, the latter three of which are new SEC-registrants under Dodd- Frank Act 88 Other Business Activities and Financial Industry Affiliations (Items 6 and 7 of Form ADV, Part 1) (Cont d) add accountants (or accounting firms) and lawyers (or law firms) to the list in Item 6 move from Item 7.B. to Item 7.A. - the question that asks whether a related person is a sponsor or the general partner or managing member of a pooled investment vehicle require additional reporting in the corresponding sections of Schedule D for Items 6 and 7 new Section 6.A. of Schedule D would require an adviser that checks the box that it is engaged in another business under a different name to list those other business names and the other lines of business in which the adviser engages using that name similar modification to Item 6.B. to require advisers primarily engaged in another business under a different name to also provide that name in Section 6.B. of Schedule D 89

46 Other Business Activities and Financial Industry Affiliations (Items 6 and 7 of Form ADV, Part 1) (Cont d) amend Section 7.A. (see previous discussion) require advisers to provide this same information with respect to any type of related person listed in Item 7.A. expand the information regarding related persons to include more details about the relationship between adviser and the person, whether related person is registered with a foreign financial regulatory authority, and how they share personnel and confidential information relocate to this section a question currently under Section 9 that requires reporting of whether a related person bank or futures commission merchant is a qualified custodian for client assets under the adviser custody rule, and to ask, if the adviser is reporting a related person investment adviser, whether the related person is exempt from registration 90 Participation in Client Transactions (Item 8 of Form ADV, Part 1) Item 8 of Form ADV, Part 1 requires an adviser to report information about its transactions, if any, with clients, including whether the adviser or a related person engages in transactions with clients as a principal, sells securities to clients, or has discretionary authority over client assets Currently requires an adviser to indicate if it has discretionary authority to determine the brokers or dealers for client transactions and if it recommends brokers or dealers to clients The SEC proposes to supplement this information by asking whether any of the brokers or dealers are related persons of the adviser or an adviser that indicates that it receives soft dollar benefits would also report whether all those benefits qualify for the safe harbor under section 28(e) of the Exchange Act for eligible research or brokerage services The rule also proposes to add a new question requiring an adviser to indicate whether it or its related person receives direct or indirect compensation for client referrals to complement the existing question concerning whether the adviser compensates any person for client referrals. 91

47 Reporting $1 Billion in Assets (Item 1 of Form ADV, Part 1) Section 956 of the Dodd-Frank Act requires the SEC, jointly with certain other federal regulators, to adopt rules or guidelines addressing certain excessive incentive-based compensation arrangements, including those of investment advisers with $1 billion or more in assets To enable the SEC to identify those advisers that would be subject to section 956, the SEC proposes to require each adviser to indicate in Item 1 whether or not the adviser had $1 billion or more in assets as of the last day of the adviser s most recent fiscal year For purposes of this reporting requirement, the amount of assets would be the adviser s total assets determined in the same manner as the amount of total assets is determined on the adviser s balance sheet for its most recent fiscal year end 92 Other Amendments to Form ADV The proposed amendments also include a number of additional changes unrelated to the Dodd-Frank Act that are intended to improve the SEC s ability to assess compliance risks, including: changes to improve certain identifying information the SEC obtains from other items of Part la of Form ADV, including requiring an adviser to provide contact information for its chief compliance officer to give the SEC direct access to the person designated to be in charge of its compliance program advisers would have the option, in Item 1.K., to provide an additional regulatory contact for Form ADV, neither of which would be viewable by the public on the SEC s website 93

48 Other Amendments to Form ADV (Cont d) amend Item 1 to require an adviser to indicate whether it or any of its control persons is a public reporting company under the Exchange Act add Limited Partnership as another choice advisers may select to indicate how their organization is legally formed an additional custody question to Item 9 to require advisers to indicate total number of persons that act as qualified custodians for adviser s clients in connection with advisory services adviser provides to its clients 94 Other Amendments to Form ADV (Cont d) three technical changes with respect to the reporting of disciplinary events: add a box to Item 11 for advisers to check if any disciplinary information reported in that item and the corresponding disclosure reporting pages is being reported about the adviser or any of its supervised persons add a third reason to each disclosure reporting page (DRP) that permits an adviser to remove the DRP from its filing by adding a box an adviser could check if it was filed in error amend Item 3.D. of Part 2B, the brochure supplement, to correct a drafting error regarding when a brochure supplement would need to include disclosure regarding the revocation or suspension of a professional attainment, designation, or license by replacing proceeding in that item with hearing or formal adjudication 95