CHARLES SCHWAB & CO., INC.
101 Montgomery Street
San Francisco, California 94104
June 13, 2000
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-10-00 -- Electronic Filing by Investment Advisers; Proposed Amendments to Form ADV
Dear Mr. Katz:
Charles Schwab & Co., Inc. ("CS&Co"), along with its affiliate Charles Schwab Investment Management, Inc. ("CSIM" and together with CS&Co, "Schwab")1, appreciates the opportunity to comment on the Securities and Exchange Commission's ("Commission" or "SEC") and state securities regulators' recent proposal to amend Form ADV and related rules under the Investment Advisers Act of 1940 (the "Advisers Act").2 The proposal would institute an Internet-based system of electronic integrated federal and state filing for investment advisers called the Investment Adviser Registration Depository ("IARD"), and would make significant changes to the format and content of information reported in Form ADV and disclosed to advisory clients.
Schwab Supports the Commission's Efforts to Modernize Adviser Registration and Disclosure
Schwab supports the establishment of the IARD and narrative adviser brochures in plain English. The intent of the Commission's proposal represents a significant step toward modernizing investment adviser registration and disclosure. Given the growing importance of advice to the investing public and the related growth in the number of investment advisers3, this modernization effort is badly needed. One-stop electronic filing (as opposed to the current paper-based and separate federal and state system) and narrative disclosure in plain English (as opposed to the current check-the-box and continuation sheet format of Form ADV) are good for both investors and their advisers.
The Requirements for Advisers' Disclosure Brochures Must Be Simplified and More Flexible
Schwab urges the Commission to simplify the proposed disclosure requirements for advisers' brochures and make them more flexible. As proposed, those requirements will result in long, complicated adviser brochures that include some redundant information also required to be disclosed elsewhere. This type of brochure will not achieve the Commission's objective of more meaningful disclosure to advisory clients, and it will unduly burden investment advisers. We believe a simpler, more flexible disclosure brochure is both less burdensome on advisers and more meaningful to advisory clients.
Schwab generally agrees with the overall comments on the proposal submitted by certain securities industry groups. As a dual registrant, CS&Co is represented on the Investment Adviser Committee of the Securities Industry Association ("SIA") and participated in the preparation of its comment letter. Many of CS&Co's independent investment adviser clients are members of the Investment Counsel Association of America ("ICAA"), and Schwab generally agrees with the overall comments submitted by ICAA. CSIM is a member of the Investment Company Institute ("ICI"), and Schwab generally agrees with the overall comments submitted by the ICI. We believe that the thrust of each of these groups' comments is consistent with Schwab's recommendation that requirements for adviser brochures be simplified and made more flexible. We also believe the alternatives proposed in the SIA, ICAA and ICI letters deserve serious consideration, and would generally be consistent with the simplification and flexibility Schwab believes is needed.
Schwab believes that some of the proposed changes to Form ADV expand current disclosure requirements and would make advisers' brochures longer and more complicated than they already are. This will make them less useful to investors. The proposal would require comprehensive disclosure of virtually all of the adviser's practices, policies and procedures. This detail may or may not be material to a particular advisory client or prospect depending on the nature of the advisory service offered to that client.
Optimally, an investor would receive only the information about the adviser that is material to the investor's decision to hire or terminate the adviser. Disclosure of the detail apparently required by the Commission's proposal would, in Schwab's estimation, result in brochures significantly longer than the ten or more single spaced typed pages typical of brochures complying with current rules. The brochure would look much like a mutual fund prospectus or the adviser's policies and procedures manual. Neither of those documents is likely to be read by an advisory client.
The Form ADV brochure is not the only, and may not always be the best, means for an adviser to disclose material information tailored to the particular client. Other means commonly used include advisory contracts and letters and reports to clients. These means are frequently used to make more detailed disclosure of the adviser's practices in a particular area (such as proxy voting) to clients for whom those practices are material. This current practice, coupled with an adviser's fiduciary duty to fully disclose to its clients all material facts and the broad antifraud provisions of the Advisers Act and state securities laws make it appropriate for the Commission to streamline the brochure disclosure requirements rather than expand them.
In addition to the current requirements for advisers to amend their brochures to reflect material changes and annually offer to deliver their amended brochure to clients, the proposal would require that advisers also deliver the amended brochure or a "sticker" to every client and prospect every time the brochure is amended. Advisers would also have to summarize separately the material changes in the brochure and keep records of each summary and when it was delivered.
Schwab believes that the requirement to deliver brochure stickers undercuts the efficiency of a continuously updated and current adviser database publicly available through the Internet. Moreover, an adviser's fiduciary duty to fully disclose to its clients all material facts and the broad antifraud provisions of the Advisers Act and state securities laws currently require an adviser to timely disclose material changes to clients.
Schwab believes that the costs of the proposed requirement for individual brochure supplements, combined with the administrative complexity (including substantial enhancements and changes to advisers' computer systems) necessary to maintain the accuracy of the information would significantly outweigh the marginal utility of that information to investors. The Commission proposes to require advisers to provide each client with a brochure supplement describing each person who (a) regularly communicates investment advice to that particular client or (b) formulates investment advice for that particular client or (c) makes discretionary investment decisions on behalf of that particular client. Advisers would be required to deliver the brochure supplements for each of their personnel to each client before or at the time the supervised person starts to formulate or regularly communicate advice to the client.
The proposal would require Schwab to create and maintain thousands of individual brochure supplements for its personnel who communicate with clients about Schwab's advice. These persons are subject to extensive supervision as registered representatives of CS&Co under applicable self-regulatory organization rules. The advice they communicate is non-discretionary, non-supervisory and is formulated by other personnel on a centralized basis. Schwab's reputation and the nature of its services are the primary considerations of the investor in choosing Schwab's advisory services. It is unlikely that the biographical information of the person delivering the advice would be a material factor in the investor's decision to obtain advice from Schwab. Moreover, the one category of personal information that might be relevant is disciplinary history, and that information could be made available through other means, such as Form U-4. Finally, if the Commission does not eliminate the brochure supplement requirement, Schwab suggests that the Commission seriously consider limiting it to personnel who exercise investment discretion over client accounts.
The Exemption Under Proposed Rule 204-3(c)(1) Should Be Expanded to Include Certain Other Non-Individual Clients In Addition to Investment Companies
The Commission's proposed Rule 204-3(c)(1) would exempt investment advisers whose only clients are investment companies from the requirement to offer or deliver Part 2 of the proposed Form ADV. Schwab proposes that this exemption be expanded to include certain other non-individual clients. Specifically, new Rule 204-3(c)(1) should exempt from the brochure requirement: (1) charitable investment vehicles that are excluded from the definition of investment company; (2) foreign institutional investors and collective investment vehicles; and (3) affiliated persons of an adviser. Schwab proposes that Rule 204-3(c)(1) read as follows (added language is underlined):
You are not required to deliver a brochure or brochure supplement when you enter into (i) an investment company contract or (ii) a contract with any client (A) that is neither a natural person nor a resident of the United States, (B) that is excluded from the definition of "investment company" in section 3(c)(10) of the Investment Company Act of 1940, as amended (the "1940 Act"), or (C) of which you are an affiliated person, as defined in section 2(a)(3) of the 1940 Act.
CSIM believes that this expansion of the exemption to the brochure requirement would be consistent with public policy. There is already precedent for treating non-U.S. investors differently under the Advisers Act. For example, section 205(b)(5) of the Advisers Act reflects Congress' decision not to apply restrictions regarding performance-based fees to advisory contracts with non-U.S. clients. CSIM believes that the same rationale applies in the case of the brochure delivery requirement, especially if the delivery requirement would still apply to natural persons that are not U.S. residents (as it would in our proposed rule text).
Similarly, Congress' exclusion of certain charitable vehicles from the protection of the Investment Company Act of 1940, as amended, by section 3(c)(10) thereof, reflects the lower level of regulation that is appropriate for such entities.
Finally, affiliated persons of an adviser do not need the same degree of disclosure, in light of their close relationship with the adviser and the access to information that comes with such a relationship.
The Commission estimates that advisers will spend, on average, 22 hours preparing their new ADVs to comply with the proposal. Schwab believes that this is a materially low estimate. Small firms, which the Commission acknowledges do not have in-house or full-time legal or compliance staff, will have two choices. The y will either expend substantially more time than the Commission estimates getting up to speed on the new requirements and preparing new ADVs, or they will spend the dollar equivalent of substantially more than the 22 hours of an employee's time on outside counsel or compliance consultants who are familiar with the requirements. Larger advisers with broader ranges of advisory services and more complex operations frequently spend substantially more than the Commission's estimated time annually amending their ADVs. Overhauling their ADVs as required by the proposal will take much longer. Schwab believes that the simpler, more flexible brochure requirements it recommends would reduce advisers' compliance burden to a level closer to that estimated by the Commission.
The Commission should not include solicitors, especially unaffiliated third-party solicitors within the definitions of "related person" and "advisory affiliate." The Commission has set forth two conflicting definitions of each of these terms in the proposed Form. The first definition of the terms, appearing in the Glossary of Terms, includes solicitors. The second set of definitions, which appear at Item 7 (related persons) and Item 11 (advisory affiliate) of Part 1A, do not. The Commission as has included no discussion of why these terms have been expanded in the release to include solicitors. We hope that indicates an inadvertent drafting error. Significant disclosure outside the Form ADV is already required of both advisors and solicitors with regard to their activities via the requirements of Advisers Act Rule 206(4)-3. This includes information about the solicitor's disciplinary history. Additionally, Part 2A, Item 13 of the proposed Form ADV (as well as Part II, Item 13 in the current Form ADV) contain a specific inquiry about an adviser's direct and indirect referral arrangements. Based on these existing disclosure requirements, Schwab strongly believes that there is no need for advisers to repeat similar information elsewhere in the Form ADV.
Schwab applauds the Commission's proposal to exclude advisers that have custody and are banks, insurance companies or SEC-registered broker-dealers from the requirement that clients be provided with an audited balance sheet as of its most recent fiscal year end. As an SEC-registered broker-dealer, CS&Co, like other dual registrants, already must provide financial statements to all brokerage customers under the Securities Exchange Act of 1934, and also is subject to substantive regulation of its financial condition under that Act and self-regulatory organizations requirements. There is no need for this information to be provided to a client twice.
Schwab commends the Commission and its staff for undertaking this huge effort to modernize investment adviser registration and disclosure. We strongly support the establishment of the IARD and narrative adviser brochures in plain English. We believe, however, that the proposed brochure requirements must be simplified and made more flexible if they are to achieve the Commission's objective of more meaningful disclosure to advisory clients and not unduly burden investment advisers.
If you have questions about this letter, please contact the undersigned at 415-636-1064 or at firstname.lastname@example.org.
CHARLES SCHWAB & CO., INC.
Vice President and
Associate General Counsel
cc: Paul F. Roye, Director, Division of Investment Management
Cynthia M. Fornelli, Senior Adviser to the Director, Division of Investment Management
Robert E. Plaze, Associate Director, Division of Investment Management
J. David Fielder, Senior Counsel, Task Force on Investment Adviser Regulation
1 CS&Co and CSIM are under common control. CS&Co is registered with the Commission as both a broker-dealer and an investment adviser. Schwab serves 7.1 million active accounts with nearly $775 billion in customer assets. Through its Schwab Institutional Services for Investment Managers enterprise, CS&Co renders brokerage, custody, back office, and related services to over 5600 independent investment advisers whose clients' accounts with Schwab total approximately $250 billion. Schwab is the market leader is providing these services to independent investment advisers. CSIM is registered with the Commission as an investment adviser. CSIM is an investment adviser and administrator for over 40 mutual funds, with more than $107 billion in assets under management. CSIM serves as an investment adviser to the SchwabFunds, a family of investment companies also registered with the Commission.
2 Investment Advisers Act Release No. 1862 (April 5, 2000) (the "Proposing Release")
3 See, e.g., Investment Adviser Year 2000 Reports, SEC Release No. IA-1728; IC-23293; File No. S7-20-98 (June 30, 1998) ("Investment advisers play a key role in the economic life of America today.")