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SEC Adopts New Form ADV, Part 2

September 24, 2010


Background. 

On July 21, 2010, the U. S. Securities and Exchange Commission (the “SEC”) unanimously adopted changes to Form ADV, Part II, a portion of the form used by investment advisers when registering with the SEC or the states.  These changes come a decade after the SEC amended and adopted changes calling for the electronic filing of Form ADV, Part I, and more than two years since the SEC proposed such changes to Form ADV, Part II.  This Alert seeks to highlight some changes to Form ADV, Part 2 (the new name for Form ADV, Part II) that will be of interest to our Investment Management clients engaged in the investment advisory industry.  The changes are significant, and the new Form comes with tight deadlines.  As a result, if you would like additional information on the matters discussed in this Alert, or need assistance in drafting your revised Form ADV, Part 2, please contact a member of our Investment Management group.

Form ADV, Part 2, commonly referred to as the “brochure,” explains to a client or potential client an investment adviser’s qualifications, investment strategies, and business practices.  The brochure in its current format requires investment advisers to respond to a series of multiple choice questions organized in a “check-the-box” format, supplemented in some cases with brief narrative responses that frequently do not correspond well to an investment adviser’s business.  In some cases, the required disclosure may not describe the investment adviser’s business or conflicts in a way that is truly meaningful to the investor.  For years, investment advisers have had the option of presenting the information required by Form ADV, Part II in a narrative brochure format, but few in the industry have actually used that format.  Under the new amendments, investment advisers are now required to prepare a narrative, “plain-English,” brochure, presented in a consistent, uniform manner that will make it easier for clients to compare different investment advisers’ disclosures.

Requirements for Filing and Delivery of New Form ADV, Part 2.

  • New Form ADV, Part 2 and its related amendments to certain rules under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) are effective on October 12, 2010.
  • Investment advisers are permitted, but not required, to use new Form ADV, Part 2 any time after October 12, 2010.
  • Investment advisers first registering with the SEC after December 31, 2010 must use new Form ADV, Part 2.
  • Each investment adviser currently registered with the SEC and whose fiscal year ends on or after December 31, 2010, must include in its next annual updating amendment to its Form ADV a brochure or brochures that meet the requirements of new Form ADV, Part 2. Annual updating amendments are due 90 days after an investment adviser’s fiscal year end. Since many in the industry use December 31 as their fiscal year end, the largest group of filers will be those filing by March 31, 2011.
  • State registered investment advisers must check with their appropriate state securities authorities to determine the implementation deadline for new Form ADV, Part 2 that is applicable to them.
  • Each investment adviser currently registered with the SEC must deliver to its existing clients a copy of its new Form ADV, Part 2 within 60 days of filing such amendment with the SEC (i.e., it must be delivered to existing clients by May 30, 2011).
  • New Form ADV, Part 2 must be filed electronically on the IARD system using the text-searchable Adobe Portable Document Format or “PDF” format. Documents filed on the IARD system are available to the general public.
  • If an investment adviser does not have any clients to whom a brochure must be delivered, the investment adviser will not be required to prepare or file a Form ADV, Part 2 with the SEC. This exemption also applies to the brochure supplements described below. For example, an investment adviser will not be required to deliver its brochure or brochure supplement to: (i) a client that is an investment company registered under the Investment Company Act of 1940, as amended (the “1940 Act”); (ii) a client that receives only impersonal investment advice for which the investment adviser charges less than $500 per year; and (iii) a business development company as defined in the 1940 Act that is subject to Section 15(c) of that Act. If the investment adviser’s clients are only in the categories listed above, the adviser will not be required to have a Form ADV, Part 2.
  • The delivery requirements have changed. Rule 204-3 under the Advisers Act now requires an investment adviser to deliver a current brochure before or at the time it enters into an advisory contract with the client. Previously, such delivery had to occur at least 48 hours before entering into the advisory contract, or at the time of entering into the contract if the client has the right to terminate the contract without penalty within five business days thereafter.
  • Investment advisers must annually provide to each client to whom they must deliver a brochure either: (i) a copy of their current (updated) Form ADV, Part 2 that includes or is accompanied by a summary of material changes; or (ii) a summary of material changes that includes an offer to provide a copy of the current Form ADV, Part 2. The offer also must be accompanied by a website address and a telephone number and e-mail address for obtaining the complete brochure, as well as the website address for obtaining information about the investment adviser through the IARD system. Each investment adviser must make this annual delivery no later than 120 days after the end of its fiscal year.
  • Investment advisers may deliver a Form ADV, Part 2 and summary of material changes, or a summary of material changes accompanied by an offer to provide the complete Form ADV, Part 2, to clients electronically in accordance with the SEC’s guidelines regarding the electronic delivery of information.

Disclosure Requirements for New Brochure. 

  • New Form ADV, Part 2 now consists of three separate sections: (i) Part 2A (the “Brochure”); (ii) Appendix 1 to Part 2A (the “Wrap Fee Program Brochure”); and (iii) Part 2B (the “Brochure Supplement”).
  • The Brochure has 18 separate items to address, each of which requires disclosure on a distinct topic, and answers must be presented in the order of the items in the form, using the headings in the form. If an item is inapplicable to an investment adviser, the investment adviser must include the heading and an explanation that the information is inapplicable. Drafting a new Form ADV, Part 2 should not be intimidating as many of these 18 items are drawn from the information currently required in Form ADV, Part II.
  • Answers should be in “plain-English,” which means that they should be should be in short sentences, using definite, concrete, everyday words, and using the active voice.
  • A new item of note, Item No. 2, requires that an investment adviser amending its Brochure identify and discuss the material changes since the last annual update. Investment advisers may include the summary in their Brochure or in a separate document. A summary prepared as a separate document can be used to satisfy an investment adviser’s annual client delivery obligations. Summaries provided as a separate document must be filed with the SEC as an exhibit to Form ADV, Part 2.
  • Other changes include increased disclosure concerning possible conflicts of interest between the investment adviser and client, and how the investment adviser deals with such conflicts, and disclosure concerning material facts about any legal or disciplinary event that is material to a client’s or potential client’s evaluation of the integrity of the investment adviser or its management personnel.

Wrap Fee Program Brochure. 

  • Investment advisers that sponsor wrap fee programs continue to be required to prepare a separate, specialized firm brochure, a Wrap Fee Program Brochure, for clients of the wrap fee program in lieu of the sponsor’s standard Brochure. The items in a Wrap Fee Program Brochure are substantially similar to those currently contained in Schedule H to Form ADV, Part II. Many of the changes are just conforming changes to the information now required by the 18 items in the Brochure.
  • One new requirement to the Wrap Fee Program Brochure requires that an investment adviser must identify whether any of its related persons is a portfolio manager in the wrap fee program and, if so, describe the associated conflicts.

New Required Brochure Supplement.

  • Each firm Brochure must be accompanied by a Brochure Supplement providing information about the advisory personnel on whom the particular client receiving the Brochure relies for investment advice.
  • Among other things, the Brochure Supplement will contain information about the educational background, business experience, and disciplinary history (if any) of the supervised persons who provide advisory services to the client. The Brochure Supplement thus includes information that would not necessarily be included in the firm’s Brochure about supervised persons of the investment adviser who actually provide the investment advice and interact with the client.
  • The Brochure Supplement must also be written in “plain-English” and the information must be organized in the same order and contain the same headings as provided in the form. There is some leeway with how the information is presented. For example, the information can be included in a firm’s Brochure, which may be an attractive format to smaller investment advisory firms. Another method is to have one large Brochure Supplement covering all of an investment adviser’s supervised persons. Alternatively, a firm can have separate Brochure Supplements for each supervised person.
  • As with the Brochure, an investment adviser will be required to amend a Brochure Supplement promptly if it becomes materially inaccurate, but will not be required to update the Brochure Supplement on an annual basis. Neither the Brochure Supplement nor any amendments to the Brochure Supplement will be required to be filed with the SEC, and neither will be publicly available.

Investment advisers are encouraged to begin the drafting process as soon as possible because of the impending compliance deadline and the numbers of investment advisers facing the same deadline (i.e., March 31, 2011).  If you have any questions concerning this Alert, or need help in drafting your Form ADV, Part 2, please do not hesitate to contact one of the attorneys in our Investment Management group.