JANE KATZ CRIST
A PROFESSIONAL CORPORATION
ATTORNEY AT LAW
12400 WILSHIRE BOULEVARD, SUITE 400
LOS ANGELES, CALIFORNIA 90025
TELEPHONE: (310) 207-9818
FAX: (310) 207-8361
E-MAIL: JANECRIST @USA.NET
June 12, 2000
Via e-mail rule-comments@sec.gov
Jonathan G. Katz,
Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Comments on File No. S7-10-00
Dear Mr. Katz:
I appreciate the opportunity to respond to the Commission's request for comments on proposed amendments to rules regarding Form ADV filings by investment advisers.
I am an attorney in private practice.1 I have advised numerous investment advisory firms on, among other matters, preparation of their initial Form ADV and amendments thereto. My clients have included investment management firms, pension consultants, financial planners, third-party solicitor firms and an internet advisory firm.
I commend the Commission's effort to revise the structure of Form ADV to make it a more readable and understandable disclosure document and to accommodate the many varieties of investment advisory businesses. I support the change to electronic filing of Form ADV and amendments to the Form as well as the one-stop electronic notice filings to the states.
My comments address: the transition process to the new Form and electronic filing; delivery of updates of the firm brochure and individual supplements; the number of permitted stickers; the requirement for summary of material changes; disciplinary information; revisions to Form ADV-W; proposed Part 1A of Form ADV; proposed Part 2A of Form ADV; and proposed Part 2B of Form ADV.
1. Transition Process to New Form and Electronic Filing.
In order to complete the new Form investment advisers will need a substantial amount of time to review carefully all aspects of their business and to prepare the proposed Part 2A (the "Firm Brochure") in plain English. Therefore, the Commission should allow advisers at least 90 days after the new rules and Form have been adopted to file the new form and then an additional 30 days to deliver the Firm Brochure and any required individual supplements to existing clients.
2. Delivery of Updates to the Firm Brochure and Individual Supplements.
The proposed requirement to deliver updates or even a "sticker" to all existing clients would be extremely burdensome for large firms that have thousands of existing clients.2 Although electronic delivery has the potential of lessening the burden, in order to take advantage of this option, an adviser would have to obtain written consents from numerous clients. There is no assurance that such an effort would produce sufficient consents to make the effort worthwhile. Equally importantly, the electronic delivery requirements require electronic confirmation of receipt of delivery. The availability of electronic confirmation of receipt of delivery is dependent upon whether the receiving party agrees to provide confirmation of delivery. If a client or prospective client of an investment adviser does not consent to providing confirmation of receipt of delivery, an adviser would be unable to rely on electronic delivery. Therefore, electronic delivery of the Firm Brochure may not be a feasible option for many advisory firms.
Instead, the Commission could accomplish the same objective of having an adviser keep its clients apprised of material changes in its operation in a much less burdensome manner. The Commission should allow an investment adviser to post its updated brochure on its website as long as the investment adviser notifies its clients of this practice in the first firm brochure it sends to a client and allows clients who want to receive a hard copy the ability of opting out of the website procedure by so notifying the adviser in writing. In this manner, those clients who want to receive a hard copy of the firm brochure would receive it.3
Those advisers who do not have a website are likely to be small firms. Such advisers could mail the updates or stickers to existing clients, or could petition the Commission for a temporary or permanent hardship exemption in the same manner they would petition with respect to the electronicfiling requirement.
3. Number of Permitted Stickers.
It is difficult to estimate the number of stickers an investment adviser would accumulate in one year. My experience with amending Part II of Form ADV and Schedule F is that there can be as many as five amendments in a year. The number of stickers is not merely a function of how many changes there are in an investment adviser's operations, but is also a function of new interpretations by the Commission either in an interpretive release, no-action letter, open letter to investment advisers or enforcement action. If the Commission permits delivery of updates by posting them on an investment adviser's website, it would not be that burdensome to require a clean firm brochure each year.
4. Requirement for Summary of Material Changes.
The requirement for a summary of material changes may result in a lengthy list that is not particularly helpful to clients and increases the preparation burden on investment advisers. It is difficult to understand any rationale for requiring this summary in each update to an investment adviser's firm brochure, but not in each updated mutual fund prospectus.
5. Disciplinary Information.
I support the change in the reporting of disciplinary events to limiting the reportable events to those that occurred in the last ten years. This change would eliminate the current inconsistency of having to report criminal events and injunctive actions only if they occurred in the last ten years, but other events without any limit.
I urge the Commission to limit arbitration disclosures to those arbitration awards in which the arbitrator finds a violation of an investment-related statute. Unfortunately, some advisory clients who lose money due to market action may file frivolous arbitration claims. In addition, investment advisers may be forced to settle a claim because their professional liability insurance carriers may require such a settlement by refusing to provide coverage if the claim is litigated. Disclosure of such claims would not be meaningful to clients. I also believe $2,500 is not a meaningful award. I think the amount should be at least $10,000.
6. Revisions to Form ADV-W.
I support the changes clearly allowing for withdrawals from some jurisdictions and not others. Under the present system, there is a danger that filing a Form ADV-W in one jurisdiction could be misinterpreted as a filing for all jurisdictions.
7. Proposed Part 1A of Form ADV.
A. Instruction 2.d. for Item 2.A.(6). The last sentence of this instruction states: "You are not eligible for this exemption if you only advise clients on allocating their investments within their pension plans." This sentence may cause confusion because an adviser that advises employee benefit plans, governmental plans, or church plans solely on allocating their investments is entitled to the pension consultant exemption from the prohibition on registration as long as the assets of the plans on which the adviser provides advice satisfies the minimum asset test. I believe the issue to which the instruction is aimed is that advisers who advise clients who are plan participants, as opposed to the plans, solely on allocating their investments within their pension plans are not eligible for the exemption.
B. Item 5.I. (2). The proposed item states: "If you are a portfolio manager for a wrap fee program, list the names of the programs and their sponsors in Section 5.I.(2) of Schedule D." Advisers who are portfolio managers for a wrap fee program often have contracts to act as portfolio managers for numerous wrap fee programs and enter into new agreements frequently. Thus, any information an adviser provides may become inaccurate shortly after the information is filed. Because the answer to this proposed question merely needs to be updated annually, it is difficult to understand how such out-of-date information is useful to the Commission.
In addition, if the question is to be retained, the instructions should clarify that an adviser is a portfolio manager for a wrap fee program only in the circumstance when the adviser has a contract with the wrap fee program sponsor. Many brokerage firms sponsor multiple programs that meet the definition of a wrap fee program. In many of these programs, there is no contract between the sponsor and the portfolio management firm. In this situation, the portfolio manager may not know it is a portfolio manager for a wrap fee program and thus would be unable to provide an accurate response to this item.
Under all of these circumstances, I recommend that an adviser not be required to list the wrap fee programs for which it is a portfolio manager, but the question should ask merely if an adviser is a portfolio manager in a wrap fee program, and if necessary, how many accounts it manages as a portfolio manager for wrap fee programs in which the adviser has a contract with the wrap fee program sponsor. If the Commission needs to know the names of the wrap fee programs in which investment advisers participate, it should obtain this information solely from the wrap fee program sponsors.
C. Item 6. The proposed question appears not to seek information about Advisory Affiliates whereas Part II of the current Form ADV requests information about Advisory Affiliates. To eliminate confusion, this question should also seek information about Advisory Affiliates because, for example, the investment advisory firm itself is not likely to be a registered representative, but an Advisory Affiliate would be.
D. Item 7.B. This question should be expanded or another question added concerning whether the adviser or a related person is a managing member of any limited liability company. Schedule D should be similarly expanded.
E. Item 8.B.(3). Please clarify if "other sales interest" also includes 12b-1 distribution fees or shareholder servicing fees received from a mutual fund or a mutual fund adviser.
8. Proposed Part 2A of Form ADV.
A. General Instructions.
If the objective of the firm brochure is for an adviser to disclose clearly to prospective and existing clients the nature of its business, conflicts of interest and related matters, then an adviser should have to respond only to those items that are applicable to its business and the General Instructions should so state. For example, an investment adviser whose sole business is to act as a solicitor should not have to reply to Item 7A which asks for a description of the methods of analysis and investment strategies used in formulating investment advice.
B. Item 4.E. Advisory Business Disclosure.
Please clarify if the periodic reports to which you refer include quarterly or other periodic economic or market reports or newsletters that an adviser provides free of charge to its clients.
C. Item 4.F. Advisory Business Disclosure.
The requirement in proposed Item 4F that wrap fee portfolio managers explain any differences in their portfolio management for wrap fee and non-wrap fee clients is helpful to prospective clients. However, the list of wrap fee programs in which an investment adviser participates is not particularly useful and under present circumstances, could require weekly updates to the firm brochure.4 There is an argument that information about the names of the wrap fee programs in which a portfolio manager participates is meaningless, or even misleading, to a prospective wrap fee client. If an investment adviser participates in fifty wrap fee programs, but has only one client in each of forty-five programs, and has a hundred clients in the other five wrap fee programs, a prospective client could infer that the investment adviser is a much larger firm than it is. If the purpose of this requirement is to let clients know that the investment adviser serves a number of wrap fee clients, then disclosure of the number of wrap fee clients as of the end of theinvestment adviser's most recent fiscal year is more meaningful disclosure than the list of the wrap fee programs in which the investment adviser participates. See also my comments under Part IA, item 5.I.(2) above.
D. Item 5.C. Fees and Compensation.
It is useful for a client to understand that he is subject to additional costs such as custodial fees, brokerage costs and mutual fund fees. However, it may be very difficult or impossible for an investment adviser to determine the amount or range of all such costs. An investment adviser may not have access to information about the amount of custody fees, particularly if these costs or fees change over time. Frequently, investment advisers are not informed in advance of the costs of any particular custodian, nor are they notified of any changes in fees. The only time an investment adviser will learn of this information is if the custodial fee is deducted from the client's custodial account and the investment adviser has discretionary authority and therefore must reconcile its portfolio accounting system to the client's custodial statements.
In addition, those financial planners who do not have any responsibility for selection of brokerage firms or for placing orders for clients' transactions may not have access to information about brokerage costs or custodial fees. Similarly, advisers who act as solicitors may not have access to this information.
E. Item 11.A.1. Soft Dollar Practices.
It would be helpful if the Commission would define the term "paying up" for soft dollar benefits. Although the Commission's most recent interpretive release concerning soft dollars, issued in 1986, referred to the term "paying up," "paying up" has not been interpreted in the light of current internet brokerage pricing for execution of individual transactions at a minimal flat charge. Please clarify if an adviser would be "paying up" because the adviser pays more than the least expensive internet brokerage firm will charge.5 Proposed Part 2A also asks for a description of the procedures an adviser used during the last fiscal year to direct transactions. Please clarify what is meant by "procedures;" perhaps, an example would be helpful.
F. Item 11.A.2. Brokerage for client referrals.
Proposed Part 2A asks for a description of the procedures an adviser used during its last fiscal year to direct brokerage for client referrals. Please clarify what is meant by "procedures;" an example would be helpful.
G. Item 14.B. Custody.
The directions to this item state that if an adviser has custody solely because the adviser is a general partner to limited partnerships, the adviser does not need to respond to item 14B. The directions should be revised to state that if an adviser has custody solely because the adviser is a general partner to limited partnerships and/or acts as a manager of limited liability companies, the adviser does not need to respond to this item.
9. Proposed Part 2B.
A. Proposed item 1.B. requests that a supervised person's CRD number be included. Not all supervised persons of investment advisory firms have CRD numbers if they have not been employed in the brokerage industry or have not been required to take any examination sponsored by the NASD Regulation, Inc. Will each supervised person be given a CRD number? If not, should an adviser eliminate the reference to availability of additional information?
B. Because the intent of the individual supplements is provide information to prospective and existing clients about the person who will be advising them, a firm that acts solely as a solicitor (and therefore may be deemed to be offering investment advice), should not have to prepare and distribute individual supplements. The General Instructions should so state.
Thank you for the opportunity to comment on the proposed rule. Please do not hesitate to contact me at (310) 207-9818 if you have any questions or would like to discuss my comments.
Respectfully submitted,
Jane Katz Crist
1 Prior to entering private practice in 1985, I was the Chief of the Investment Adviser/Investment Company Examination branch in the Los Angeles (now Pacific) Regional Office of the Securities and Exchange Commission for three years.
2 Some of my investment advisory firm clients have in excess of 20,000 clients.
3 It has been my experience that many clients of investment advisers do not want to receive any additional paperwork and in some cases, have requested not to receive any confirmations or statements. Moreover, many of my advisory firm clients report that fewer than 1% of their clients ever request a copy of Part II of Form ADV after receiving the adviser's annual offer as required by Rule 204-3(c).
4 Many wrap fee sponsors also "private label" their wrap fee program and allow their introducing brokerage firms to sponsor such programs by providing them with all the necessary agreements and documentation. In this circumstance, some of my advisory firm clients are solicited almost weekly to participate in new wrap fee programs.
5 There are very good reasons an investment adviser might determine that the limitations on internet executions combined with the inability to bunch orders are such that the adviser in good faith determines not to place orders with such internet brokerage firms.