SEC Amends Part 2 of Form ADV to Create New Disclosure Regime for RIAs
December 2, 2010
By Craig Foster
The SEC recently amended the requirements for the principal disclosure document that SEC-registered advisers provide to their clients and prospective clients. Under the previous Form ADV Part II, advisers were required to respond to a series of multiple-choice and fill-in-the blank questions, supplemented with narrative descriptions expanding on certain responses. The amended rules are contained in Form ADV Part 2 ("Part 2") and require an adviser to describe its business practices, conflicts of interest and background in a completely narrative-style format.
. Part 2 is divided into Part 2A (the "brochure") and Part 2B (the "brochure supplement").
- Brochure. The brochure requirements include 18 separate disclosure items concerning all aspects of the adviser's business, in some cases significantly expanding on the scope of disclosures formerly required by Form ADV Part II. (The brochure requirements contain an additional disclosure item for advisers registering with one or more state securities authorities.)
- Brochure Supplement. A brochure supplement generally is required for each of the firm's supervised persons who: (a) formulates investment advice for clients and has direct client contact; or (b) provides investment advice to clients even if the supervised person has no client contact. The brochure supplement requirements include six disclosure items about the supervised person's background, experience, disciplinary history, other business activities, compensation and supervision. Brochure supplements may be separate documents or the required information may be included in the firm brochure, at the adviser's option.
. All of Part 2's narrative disclosures must be addressed in the order specified by the amended rules and be in "plain English," meaning that, to the extent possible, the disclosures should use short sentences, everyday words, tables, lists and the active voice. More information on how to incorporate plain English may be found in the SEC's "A Plain English Handbook," available by clicking here
. Advisers must file the brochure (and subsequent amendments to the brochure) electronically through the Investment Adviser Registration Depository ("IARD") system. The brochure will then be publicly available on the IARD website. Brochure supplements do not need to be filed, but must be preserved and made available to the SEC upon request.
. The amended rules require an adviser to deliver a current brochure to a client before or at the time the adviser enters into an advisory contract with the client. Advisers are no longer required to deliver the brochure to a prospective client at least 48 hours before entering into an advisory contract or grant a five-day cancellation right. Advisers must deliver to a client a brochure supplement for each supervised person providing advisory services to that client, before or at the time the supervised person begins providing advisory services to the client. Advisers are not required to deliver the brochure or brochure supplements to clients that receive only impersonal advice and pay the adviser less than $500 per year, clients that are registered investment companies or business development companies, or investors in private investment funds advised by the adviser.
. Under the amended rules, an adviser generally must update its brochure annually, and also must promptly update its brochure when any information in it becomes materially inaccurate. However, in some cases, an adviser filing an annual amendment may not have any material changes to make to its brochure. If an adviser has not filed any interim amendments to its brochure and the brochure continues to be accurate in all material respects, the adviser need not (a) prepare or file an updated firm brochure as part of its annual updating amendment or (b) deliver a summary of material changes to clients, as described below. Brochure supplements must only be amended if any information becomes materially inaccurate.
. The new rules became effective on October 12, 2010. Advisers applying for registration with the SEC after January 1, 2011 must file brochures that meet the new requirements as part of their registration on Form ADV. Such advisers must, upon registration, begin to deliver to clients and prospective clients brochures and brochure supplements that comply with the amended rules. Advisers currently registered with the SEC with fiscal years ending on or after December 31, 2010 must file an annual updating amendment to Form ADV that includes the new brochure no later than 90 days after the end of the firm's fiscal year. Upon filing the brochure, the brochure and brochure supplements must be used with new and prospective clients. Within 60 days of an adviser's deadline for filing the brochure, the adviser must deliver to existing clients a brochure and brochure supplements that comply with the amended rules. Firms with a December 31 fiscal year end must file their initial brochures by March 31, 2011 and deliver the brochure and brochure supplements to existing clients by May 31, 2011.
. Most state securities authorities, including those of Oregon and Washington, require advisers registering with such authorities to follow the new requirements for Part 2.
Subsequent Annual Delivery
. If there have been any material changes since the last annual amendment, an adviser must deliver to each client, annually within 120 days of the end of the adviser's fiscal year, either (a) an updated brochure that includes or is accompanied by a summary of material changes or (b) a summary of material changes that includes an offer to provide a copy of the updated brochure. While there is no annual delivery requirement for brochure supplements, updated brochure supplements must be delivered to clients when there is new disclosure of a disciplinary event, or a material change to disciplinary information already disclosed.
More information about the content, format, filing, updating and delivery requirements of Part 2 is available by accessing the SEC's general instructions for Part 2, available by clicking here
. Because completing Part 2 will require a substantial amount of work, we suggest that advisers start the process as soon as possible to meet compliance deadlines. To assist in the process, we suggest that advisers:
- Discuss brochure disclosure items internally to ensure thoroughness and accuracy, including such topics as current business practices, investment strategies (and risk factors related to such strategies), conflicts of interest (and how the adviser addresses such conflicts), services offered, fees, disciplinary information, code of ethics, and brokerage and custody practices.
- Involve persons in charge of different areas of the firm in providing input for the brochure and consider creating a "time and responsibility" table to ensure timely delivery of information.
- Determine which employees will need a brochure supplement and start compiling the required information. Advisers may list a supervised person's professional designations, but if they do, they must provide a sufficient explanation of the qualifications required for each designation to allow clients to understand the value of the designation. The Financial Industry Regulatory Authority (FINRA) has established an online guide providing certain professional designation qualifications, available by clicking here.
- Determine how the brochure and brochure supplements will be delivered. If they will be delivered by email, consider whether the client has consented to receive notices by email. Sending clients an email containing a link to a website where the documents have been posted is not considered sufficient delivery.
- Once the brochure and brochure supplements have been drafted, review the adviser's Form ADV Part 1, website, client agreements, compliance policies and procedures, and private fund documents (if applicable) to ensure consistency with brochure disclosures. Revise the documents as necessary to be consistent.
- Consider testing a draft brochure on a few clients and requesting feedback on the brochure's readability and incorporation of plain English.
For further questions about your firm's brochure or brochure supplements, or for assistance in preparing these new documents, please contact our Financial Services practice group