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Amendments to Form ADV

A Small Entity Compliance Guide¹

Overview:

On July 28, 2010 the Commission adopted amendments to Part 2 of Form ADV and related rules that will substantially improve the quality of disclosure advisers provide to their clients. These changes require that advisers provide new and prospective clients with narrative “brochures” organized in a consistent, uniform manner that include plain English disclosures of the adviser’s business practices, fees, conflicts of interest, and disciplinary information. Advisers also must provide “brochure supplements” to clients that contain information about the advisory employees that will provide advisory services to that client.

The amendments include:

Improved Format and Updating Requirements. Advisers are required to prepare a narrative plain English brochure, presented in a consistent, uniform manner that will facilitate clients’ comparison of different advisers’ disclosures. The clear and concise narrative descriptions provided in the brochure will improve the ability of clients and prospective clients to evaluate advisers and to understand relevant conflicts of interest that the firms and their personnel face, the effects of those conflicts on the firms’ services, and the steps the adviser takes to address the conflicts.

Advisers must deliver the brochure to a client before or at the time the adviser enters into an advisory contract with the client. In addition, advisers must provide each client annually with a summary of material changes to the brochure and either deliver an updated brochure or offer to provide the client with a copy of the updated brochure.
Expanded Content. The new brochure includes the following topics:
- Advisory business — An investment adviser must describe its advisory business, including the types of advisory services offered, whether it holds itself out as specializing in a particular type of advisory service, and the amount of client assets that it manages.
- Fees and compensation — An investment adviser must describe in its brochure how it is compensated for its advisory services, provide a fee schedule, and disclose whether fees are negotiable. The investment adviser must also describe the types of other fees or expenses, such as brokerage, custody fees, and fund expenses that clients may pay in connection with the advisory services provided to them by the investment adviser.
- Performance-based fees and side-by-side management — An investment adviser that accepts performance-based fees or that supervises an individual who accepts such fees is required to disclose this fact. If the investment adviser also manages accounts that are not charged a performance fee, the adviser must explain the conflicts of interest that arise from the simultaneous management of these accounts and must describe how it addresses those conflicts.
- Methods of analysis, investment strategies, and risk of loss — An investment adviser must describe its methods of analysis and investment strategies and explain that investing in securities involves risk of loss which clients should be prepared to bear. Investment advisers must also explain the material risks involved for each significant method of analysis or strategy and particular type of security they recommend and must explain the risks in greater detail if those risks are unusual.
- Disciplinary information — An investment adviser is required to disclose in its brochure material facts about any legal or disciplinary event that is material to a client’s evaluation of the advisory business or of the integrity of its management personnel. An investment adviser must deliver promptly to clients updated information when there is new disclosure of a disciplinary event or a material change to an existing disciplinary event.
- Code of ethics, participation or interest in client transactions, and personal trading — An investment adviser is required to describe briefly its code of ethics and state that a copy is available upon request. The adviser must also disclose whether it or an affiliate recommends to clients, or buys or sells for client accounts, securities in which the adviser or an affiliate has a material financial interest and, if so, the conflicts of interest associated with that practice. The adviser also must disclose whether it or an affiliate invests (or is allowed to invest) in the same securities that it recommends to clients or in related securities, such as options or other derivatives, and will have to explain the conflicts involved and how it addresses those conflicts. In addition, an investment adviser that trades in the recommended securities at or around the same time as the client has to explain the specific conflicts inherent in that practice and how it addresses them.
- Brokerage practices — An investment adviser is required to describe the factors that it considers in selecting or recommending broker-dealers for client transactions and determining the reasonableness of brokers’ compensation. Investment advisers also must disclose soft dollar practices (research or other products or services, other than execution, provided by brokers or a third party to the investment adviser in connection with client transactions); client referrals (using client brokerage to compensate brokers for client referrals); directed brokerage (asking or permitting clients to send trades to a specific broker for execution); and trade aggregation (bundling trades to obtain volume discounts on execution costs). Investment advisers must explain how they address the various conflicts of interest associated with these practices.
Supplements. An adviser is required to deliver “brochure supplements” to clients providing them with information about the specific individuals who will provide advisory services to them before or at the time the specific individuals begin to provide advisory services. The supplement will contain brief resume-like disclosure about the educational background, business experience, other business activities, and disciplinary history of the individual so that the client can assess the person’s background and qualifications. It will also include contact information for the person’s supervisor in case the client has a concern about the person.
Internet Availability. Advisers are required to electronically file brochures at the Investment Adviser Registration Depository (IARD), which will be publicly available on the SEC’s web site. The new public access to adviser brochures will make it easier for the public to obtain information regarding investment advisers they may be interested in hiring, and permit advisory clients to compare and contrast their advisers’ business practices and conflicts with other advisers.

Implementation

Update — On December 8, 2010, the Commission issued a release extending the compliance date generally for four months for investment advisers to prepare and deliver brochure supplements (Part 2B of Form ADV).

The amended rules and forms are effective on October 12, 2010. Compliance of the new forms and amended rules is as follows:

New Advisers. Each adviser applying for registration with the Commission after January 1, 2011 must file a brochure or brochures that meet the requirements of amended Part 2A as part of the application for registration on Form ADV. Such adviser must, upon registering, begin to deliver to their clients and prospective clients a brochure or brochures and brochure supplements that meet the requirements of the amended Form ADV.
Registered Advisers. Each adviser that is currently registered with the Commission 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 the amended Form ADV and upon filing such new brochure, begin to deliver to their new clients and prospective clients the new brochure and brochure supplements that meet the requirements of the amended Form ADV. In addition, within 60 days of filing the new brochure, the adviser must deliver to its existing clients the new brochure and brochure supplements that meet the requirements of the amended Form ADV.

Other Resources

The final adopting release for amendments to Form ADV, Part 2 and related rules can be found on the SEC's website at http://www.sec.gov/rules/final/2010/ia-3060.pdf. The proposing release can be found on the SEC's website at http://www.sec.gov/rules/proposed/2008/ia-2711.pdf.

The final adopting release extending the compliance date for brochure supplements can be found on the SEC’s website at http://www.sec.gov/rules/final/2010/ia-3129.pdf.

The text of the amended rules can be accessed through the "Laws and Rules" section of the Division of Investment Management page of the SEC's website at http://www.sec.gov/divisions/investment.shtml. The instructions for amended Form ADV, Part 2 can be accessed at http://www.sec.gov/divisions/investment/iard/iastuff.shtml.

Contacting the SEC

The SEC's Division of Investment Management is happy to assist small investment advisers with questions regarding amended Form ADV, Part 2 and related rules. The Division's Office of Investment Adviser Regulation answers questions submitted by e-mail and telephone. You can submit a question by e-mail to iarules@sec.gov and a staff member of the office will call you to discuss your question. In addition, you can contact the Office of Investment Adviser Regulation at (202) 551-6787. Questions on other investment management matters concerning small companies may be directed to the Division's Office of Chief Counsel by e-mail at IMOCC@sec.gov, or by telephone at (202) 551-6825.

Endnotes

¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.

http://www.sec.gov/rules/final/2010/ia-3060-secg.htm