On July 21, 2010, the same day the Dodd-Frank Wall Street Reform
and Consumer Protection Act was signed into law, the SEC quietly
released the long-anticipated new Form ADV, Part 2, otherwise known
as the registered investment adviser brochure.
Background
Registered investment advisers are required to make certain
disclosures to their clients. Historically they could do so by
either preparing a glossy brochure containing the required
information, or alternatively by simply delivering to their clients
and prospective clients a copy of the Form ADV Part 2 which was a
required paper filing with the SEC from 1979 until 2000. In 2000
the SEC adopted an electronic filing system for investment advisers
known as IARD ("Investment Adviser Registration
Depository"). The IARD system included an online version of
Form ADV Part 1 but not Part 2. Advisers were instructed to
continue using the old Part 2 paper format for client disclosure
purposes, but the requirement to file Part 2 with the SEC was
waived until an electronic version could be developed.
At about the same time in 2000, the SEC issued a release proposing
the new Part 2 format and requesting comments. The comment period
passed and nothing happened; the SEC appeared to lose interest in
the matter until 2008, when they issued a revised proposed new Part
2 and requested more comments. Finally, a mere ten years after
first raising the issue, they have completed work on the new Form
ADV Part 2.
The New Part 2
The old Part 2 was a fill-in-the-blanks form, with numerous check
boxes and yes or no questions, with supplemental sheets at the back
of the document for elaboration on the answers given in the
questionnaire portion of the document. It was not a particularly
user-friendly document.
The new Part 2 takes a completely new approach. It consists of 19
"items," general topics really, which the adviser is
required to address in a narrative format. And not only are
narrative answers required, but they must be written in "plain
English." In the SEC's world, "plain English" is
a writing style adopted by the agency in the 1990s for use in
prospectuses, proxy statements and the like which public companies
are required to file. The SEC has some very specific requirements
in mind when they refer to plain English – first person
narrative ("we," "ours," etc.), short
sentences, simple words whenever possible, avoidance of defined
terms, avoidance of passive voice, and more. It has become
something of an art form for SEC practitioners.
The 19 required headings may not be altered, and all must appear in
the document, even if not applicable to a particular adviser. The
topics include:
- Business description and identity of owners.
- All aspects of fees and compensation, including identification of potential conflicts of interest if advisers personally receive payments from third parties such as mutual funds or brokers, performance fee arrangements, and referral fees.
- Types of clients.
- Detailed description of investment strategies used and related risks.
- Information about any disciplinary problems the adviser may have had in the past.
- Adviser's relationships with other firms, including affiliated companies.
- Code of Ethics.
- Brokerage practices, including broker-dealer best execution practices and directed brokerage requirements.
- Client account review practices and reporting frequency.
A brochure appendix is required if the adviser participates in any
wrap fee programs, and a "brochure supplement" is
required for all advisers, providing individualized information
about all "supervised persons" who actually provide
investment advice or otherwise have direct contact with
clients.
Compliance Timing
The new Part 2 rules become effective 60 days after their
publication, in the Federal Register, around September 21, 2010,
applicable the next time after that an adviser is required to
update its Part 2. In almost all cases that means Part 2 must be
updated and filed with the SEC via IARD by March 31, 2011.
It is not too early to start working on your new Part 2!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.