National Regulatory Services
a Division of Thomson Financial
323 A Main Street
Lakeville, CT 06039
June 12, 2000
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609
Dear Mr. Katz-
This comment letter is submitted on behalf of National Regulatory Services ("NRS"). NRS, the nation's leading registration and compliance consulting firm, was founded in Lakeville, Connecticut in 1983. Today, NRS is a division of Thomson Financial, part of the Thomson Corporation.
NRS offers registration and compliance consulting services and related products to investment advisers, broker-dealers, investment companies and insurance firms. The NRS client base of over 6000 investment advisers in six countries includes a wide range of advisory firms from small mom-and-pop advisers and start-ups to the largest money managers and dually registered wire houses. Of these, more than 4000 advisers used NRS' E-Z Registration software. In addition to its consulting practice, NRS provided initial registration services for more than 300 advisers last year.
The proposed rules presented in IA Release IA-1862 (the "Release") will, upon effectiveness, indisputably usher in a new era in investment adviser regulation. NRS commends the Division of Investment Management of the Securities and Exchange Commission (the "Commission") on the effort put forth to craft what is clearly a thoughtful and comprehensive framework for the implementation of an electronic filing system and the unprecedented revision of the Form ADV.
As a provider of compliance services and solutions to investment advisers and other regulated entities under the securities laws, NRS places a premium on clarity and precision in the regulatory environment that promotes transparency regarding the expectations of the regulator as well as the concomitant obligations of the regulated. It is in this spirit that we are pleased submit the following comments. Please note that the order of our comments corresponds to the Release's treatment of these issues and is not indicative of NRS' assessment of their relative importance.
I. THE IARD
Interface for Filer Internal Systems
NRS strongly recommends that the Commission ensure that filings can be delivered to the IARD by using alternate systems that provide advisers with functionality that would be unavailable from the standard web-based interface. The NASDR's web-based Central Registration Depository ("WebCRD") system has this limitation; consequently, many NASD member firms have requested that the WebCRD be reconfigured to allow other systems to send information directly to the WebCRD in order to bypass the perceived inefficient and slow web-based interface. This capability would allow filers to maintain local databases of information as sent to the IARD without the need to duplicate entry tasks. It is NRS' belief that this feature will be critically important in allowing advisers to print high quality documents as needed, maintain an archive of documents submitted to the IARD, and develop automated systems for complying with the new brochure delivery rule without compromising system security.
We believe that there is a need for a universal identifier for both state and federal registered advisers. Prior to the enactment of the National Securities Market Improvement Act of 1996 ("NSMIA"), all registered advisers received a SEC number that could be used to identify the registrant universally in order to access all records regarding the entity. In the wake of NSMIA, a state-registered adviser no longer receives a SEC number and, in fact, may receive an identification number from each state in which it is registered. Thus, there is a persistent problem with not being able to access all historical information for an adviser across multiple jurisdictions. This problem is compounded when, for instance, a state-registered adviser qualifies for SEC registration, is subsequently de-registered, and once again becomes registered with the states. New state identification numbers are usually assigned to the adviser in each jurisdiction resulting in a potential brake in the historical chain of regulatory information. While IARD numbers will presumably be assigned to IARD system filers, we are concerned that the incremental and uncertain entry of state-registered advisers on to the IARD will perpetuate this hallmark of regulatory inefficiency. While we appreciate the fact that resolution of this problem may not be fully within the Commission's power to rectify, we hope that the Commission can use its good offices to eradicate this barrier to public disclosure.
Archiving/Public Reference Room Access
The Release, at footnote 49, indicates that all historical IARD filings will remain accessible, but not through the public disclosure system. The Release, unfortunately, provides no guidance as to the protocol or methodology that would be employed for obtaining historical information. This concern regarding access reinforces the importance of providing a mechanism for system-to-system electronic filing that would enable IARD filers to build or buy systems that can provide this archiving function.
The Release suggests that the only avenue for accessing the public disclosure system will be through the Internet. Thus, we are seeking guidance as to whether the public reference room will continue to provide record access to persons at minimal cost who do not use the Internet and whether pre-IARD records will continue to be available.
Insufficient Funds to Pay Fees
The Release states that the IARD will not accept a filing if insufficient funds are on account to pay any fees that are due. In such situations, will the adviser's filing be lost or deleted, thereby requiring that the information be re-entered after the funds deficiency is cured, or will the filing be stored in a deficiency queue for a designated period of time?
With reference to the proposed transition to the IARD system, the Commission is seeking feedback as to the estimated length of time, following adoption of the proposed rules and revised Form ADV, that advisers will need in order to re-submit Part 1A of Form ADV through the IARD. This query seemingly presupposes that the only obstacle that comes into play regarding adviser preparedness is the somewhat mechanical and perfunctory process of filling out a form consisting of rather rudimentary fill-in-the-blank, multiple-choice, and check-the-box questions. However, it should not be forgotten that the IARD system and its attendant functionality would be utterly foreign to many advisers, especially those that are not acquainted with the CRD. While an IARD "help" function that can answer frequently asked questions should be helpful, this may not suffice in the short term for assisting advisers in becoming sufficiently conversant with the IARD's functionality. We respectfully suggest that the Commission's transition schedule should accommodate a reasonable orientation period which will afford advisers the opportunity to acquire a complete working knowledge of the IARD or, in the alternative, to retain and consult with a service provider who in turn would assume this responsibility.
The answer to the Commission's "how soon" question must also be colored by the answer to another closely related question: Can advisers be reasonably expected to prepare, deliver and offer to deliver the new Part 2 brochure and brochure supplement, in accordance with amended rule 204-3, by no later than the date that all advisers have been required to re-submit Part 1A to the IARD, plus a 30-day transition period? The transition schedule, as determined by the Commission, regarding the electronic filing of Part 1A will effectively act as a trip wire for the offer and/or delivery of the new brochure and brochure supplement. Accordingly, we respectfully urge the Commission to design a transition schedule that will provide advisers with a generous amount of lead-time to cope with the labor and resource intensive preparation and delivery of the new brochure and brochure supplement. In hindsight, advisers would have been better served had the Release shed more light on the Commission's thinking as to the projected time frame for transition filings. We further note that the imposition of a highly compressed transition schedule, which follows hard on the heels of the adoption of the proposed rules, may work a hardship on advisers with regard to the timely preparation and delivery of the new brochure and brochure supplement.
The Release, consistent with earlier reports, indicates that the IARD will be "rolled out" in four separate releases. At footnote 29 of the release, the Commission, while acknowledging its preference for having all components of the IARD in place when the system goes active, maintains that implementing the system in stages will permit NASDR to reduce its programming costs, thereby avoiding higher filing fees. We must point out that many advisers fear that a staggered phase-in of the system means that they would be living in the worst of all worlds: a regulatory filing environment that is part electronic and part paper. Upon implementation of electronic filing of Part 1, SEC-registered advisers, for example, will still have to contend with submitting hard copy filings to the states in connection with agent registration and anticipated state requests for filing of Part 2. Delaying implementation of phase one of the IARD in favor of a contemporaneous activation of the entire system would permit advisers to seamlessly transition to a paperless filing environment. Moreover, this additional lead-time may permit the states to complete the process of amending the appropriate statutes and regulations to ensure uniform and total acceptance of IARD filings.
As state-registered advisers review the Release, they are understandably concerned about the lack of state guidance with respect to electronic filing requirements or the possibility of voluntary use of the IARD. The evident lack of SEC/state coordination with regard to the implementation of the IARD, including the question of filing fees, regrettably casts a disquieting pall over this endeavor at its very outset.
II. BROCHURE DELIVERY
We next turn to the proposal that, if adopted, would require updates to the brochure to be delivered to clients whenever information in the brochure becomes "materially inaccurate." It is indeed axiomatic that an adviser, consistent with the anti-fraud provisions of the Investment Advisers Act of 1940, must disclose all material conflicts to clients. From our perspective, the dilemma presented by the "materially inaccurate" standard is one of intent; namely, the Commission's intent. Is it the Commission's intent that a material inaccuracy is synonymous with an undisclosed conflict? Are they one and the same? If so, the final release should so state. If not, it would seem incumbent upon the Commission to provide guidance on the breadth and scope of this new standard.
Aided by the Commission's long history of articulating in specific terms the array of conflicts or potential conflicts that require disclosure, a broad consensus has emerged over time as to the breadth and scope of required disclosure of conflicts. However, in a document as laden with text as the new brochure promises to be, it is foreseeable that material inaccuracies may surface that do not pertain to or embody conflicts as such. If the Commission, when the day is done, views this distinction as purely semantical, it should so indicate. If, however, the intent behind the proposal is to capture disclosure of any information deemed materially inaccurate, as opposed to information that rises to the level of an actual or potential conflict, the Commission should not be unmindful of the veritable avalanche of brochure amendments and stickers that such a broad interpretation would inflict on advisers and their clients.
We are concerned that the current proposal will replace a prophylactic rule (the annual offer) with a vague trigger mechanism that may result in clients becoming awash in brochure amendments, thereby undermining the laudable goal of enhancing meaningful disclosure. Accordingly, NRS recommends, as an alternative to the requirement that advisers send clients the entire amended or stickered brochure whenever a material change occurs, that advisers deliver to clients a summary of material changes, as presently envisioned in Item 2 of proposed Part 2A, on a periodic basis (e.g., quarterly or semi-annually) accompanied by an offer of the complete brochure. Clients who require disclosure within the context of the full brochure may request delivery of such, while clients who are not so inclined will not be subjected to what they may well perceive as yet another bundle of disposable paper.
III. PART 2A
As a preface to the comments that follow in this section, we note that, without taking specific issue with the Commission's estimate that the task of preparing the new Form ADV would require an estimated 22 hours per adviser, that many advisers we have talked to question this estimate in light of the personnel and resources available to assume this responsibility, especially in light of the current state of their Form ADV Part II disclosures.
NRS is concerned that complete abandonment of the check-the-box disclosure regime presently contained in Part II of Form ADV may be tantamount to the proverbial throwing out of the baby with the bath water. The Commission will be compromised in its ability to search Form ADV filings to ascertain how many advisers engage in certain practices. Under the current format, it is easy to detect how many advisers pay finder's fees, are registered as broker-dealers, have discretion to determine securities to be bought or sold but not the broker-dealer to be used, and so on. This information can be important in enabling the Commission to spot and track trends and determine which advisers engage in practices that warrant greater scrutiny. This information may not be as readily available or transparent through the process of reviewing narrative disclosures that are contemplated in proposed Part 2A.
Likewise, consumers, who are interested in identifying advisers who provide certain services, such as financial planning, or, on the other hand, avoiding advisers who engage in certain practices, such as receiving commissions for advisory services, can locate this information quickly and easily under the current disclosure format.
NRS therefore recommends that the Commission consider incorporating several of the present Part II check-the-box questions into the new Part 1. While these additions to new Part 1 do not constitute brochure disclosure, they will provide the Commission and users of the public disclosure system with a wealth of useful information.
With reference to proposed Item 5 of new Part 2A, the Commission is proposing that the brochure describe the types and amounts (or ranges) of other costs, such as brokerage, custody fees and fund expenses, that clients may pay in connection with advisory services. To our knowledge, many advisers routinely disclose in the brochure, as they should, the existence of these other fees. To also require brochure disclosure of actual fee amounts would force advisers to constantly monitor the fee scales of third-party service providers and amend or sticker the brochure whenever the service provider unilaterally elects to revise its fee structure. This requirement, simply put, appears to be both onerous and unnecessary. The Commission may wish to explore the alternative of requiring advisers to disclose that this fee information is available upon request and may be obtained from either the adviser or the service provider.
With reference to Item 11 as proposed, we note that the Commission is seeking comment on the feasibility of including commission recapture as a disclosure item. As a general rule, institutional investors, such as ERISA plans and public pension funds, are the primary users of commission recapture programs based on the recommendations of outside pension consultants or in-house investment staff. Advisers, who merely comply with the client's direction to place brokerage with a designated recapture broker, ought not be placed in the awkward position of explaining within the confines of the brochure the somewhat arcane features of these programs when the best and most expert source of this information is the third-party service provider.
Again, we commend the Commission for the initiative and innovation that has been applied to the daunting process of effecting the most far-reaching and comprehensive restructuring of investment adviser regulation in a generation.
If we may assist further or provide additional information or background on our comments, please let us know. We at NRS look forward to working with the Commission during the coming months on this historic initiative.
Richard S. Cortese