FPA Government Relations Office
1615 L Street, N.W., Suite 650
Washington, D.C. 20036
Web site: www.fpanet.org
By Electronic Mail
June 13, 2000
Jonathan G. Katz
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0609
Re: Release No. IA-1862; File No. S7-10-00; Electronic Filing by Investment Advisers; Proposed Amendments to Form ADV
Dear Mr. Katz:
The Financial Planning Association ("FPA")1 is pleased to provide comment on one of the most important rulemakings ever promulgated by the Securities and Exchange Commission (the "SEC" or "Commission") in connection with investment adviser regulation. Most of our 29,000 members would be affected directly, or indirectly, by the proposed rule. An estimated one-quarter of our members are principals in SEC-registered firms,2 while the majority of those engaged in comprehensive financial planning are registered investment advisers with state securities administrators. Many, however, are dually affiliated on both state and federal levels with investment advisers by maintaining an independent planning practice under a state registration, and acting as a supervised person of a broker-dealer's federally registered investment adviser. Even FPA members registered solely with state securities administrators have a strong interest in promulgation of Release No. IA-1862 (the "Release" or "Rule") simply because the states are expected to accept the new Form ADV and related amendments as their model disclosure and registration documents.
We begin with general comments on the proposed Rule, including remarks on IARD costs and administration; followed by comment on Rule amendments; and separate commentary on Part 1A, Part 2A, and Part 2B. As noted in the Release, Part 1B, Item 20 of Part 2A, and Item 8 of Part 2B of Form ADV apply only to state-registered investment advisers. FPA is submitting comment to NASAA on these requirements, and is copying both the SEC and NASAA on these separate comment letters to facilitate review with respect to the overall Form.
Uneven Disclosure for Investors under Current SEC Rulemakings. The Release requests comment on the proposed Rule as well as its effect "on the advisory profession as a whole."3 We begin with a general observation that, as encompassing as the proposed Rule is regarding investment adviser regulation, it should not be viewed in isolation with respect to other recent rulemakings of the Commission. Despite enhanced disclosure to investors under the proposed Rule, we note that the same benefits will not be available across the board to Americans with similar investment goals. Under SEC Release Nos. 34-42099 and IA-1845, Certain Broker-Dealers Deemed Not To Be Investment Advisers (the "BD Exception"), broker-dealers would generally be excepted from the disclosure requirements of this Rule and other investor protection requirements of the Investment Advisers Act of 1940 (the "Act").4 Unchecked by the paucity of disclosure requirements of NASD Rules, registered representatives have a greater financial incentive to promote certain transaction-based sales products as retirement planning solutions - sales recommendations that may pose significant conflicts with the investor's goals.
FPA members, including individual members who are registered representatives, are subject to the CFP Code of Ethics and Professional Responsibility (the "CFP Code") or the nearly identical FPA Code of Ethics, drawn directly from the CFP Code. The CFP Code requires full and effectual disclosure to all clients and prospective clients5 of the individual planner's professional background, conflicts of interest, and financial advisory services consistent with current federal disclosure requirements.
Form ADV Length. Form ADV has, of course, been an integral part of the financial planner's disclosure process for many years. It is also generally recognized that the existing Form ADV disclosure regimen is long overdue for change. Based on FPA members' own practical experience in working with Form ADV over the past 16 years, we agree with the Commission's introspective view that "the format of Part II does not lend itself to meaningful, clear disclosure." In addition to the Release's comments, financial planners would add that the sheer volume and length of the old Form ADV discourages any reading of the Brochure. FPA members have always felt compelled under their professional obligations, and in their duty as fiduciaries, to affirmatively communicate much of the information contained in Form ADV that otherwise would be ignored. Given client complaints of being overwhelmed with information, it would be erroneous to assume that the perfect disclosure format will be read if physical size discourages inspection.
As a result, the SEC must judiciously weigh the "volume" problem in connection with its new disclosure requirements. We make the observation here, and only once, those redundant reporting items appearing throughout Form ADV must be reduced and consolidated. We hope that the comment letters help to identify some of the biggest problems. For example, a single disciplinary action must be reported in at least four different places: Item 11 of Part 1A; in a criminal, judicial or regulatory DRP; in Item 8 of Part 2A; and in Item 3 of Part 2B.
The volume problem should be addressed in other ways to discourage lengthy narrative. In the case of Part 2B disclosure, while FPA strongly supports this section because it provides critical retail information concerning an adviser's qualifications, we have reservations that the average length can be held to one page, as assumed in the Release. With seven items requiring disclosure in Part 2B, and some advisers perhaps tempted to use Part 2B as a marketing tool to showcase their qualifications, limiting this section to one page may or may not be practical.
Further, we ask the Commission to review carefully the descriptions of disclosure requirements for the items in Part 2 so that the adviser is truly encouraged to follow the plain English narrative style referenced by the Release, and does not feel compelled to "over-disclose" because of ambiguity in the instructions. For example, Item 7 of Part 2A requires a narrative description if the adviser specializes in a particular kind of investment strategy. Many financial planners are strong proponents of modern portfolio theory. Is this a specialized strategy, and if so, do planners need to discuss risk factors such as Sharpe ratios and standard deviations (in plain English) to explain why they prefer portfolio diversification as a preferred investment strategy? On the other hand, can financial planners simply state that they generally recommend portfolio diversification? We believe Commission staff has offered superb clarity and guidance in many areas of the Form, and should take into consideration industry recommendations to build upon an excellent drafting foundation. In summary, we urge the Commission to carefully re-consider the size of Form ADV after reviewing all of the comment letters, and not be reluctant to make additional comprehensive changes where necessary.
Notwithstanding the prefatory comments that suggest substantive changes are required, the FPA strongly commends the Commission for the tremendous amount of research and thoughtful preparation that has gone into a revised Rule, a new disclosure model that will have considerable implications for the investing public, their public policy, and investment advisers. FPA also recognizes the Commission's commitment to assist "small" advisers with their new compliance requirements, even for those that come under direct state supervision. Re-drafting questions that are common interpretive problems for advisers, providing an on-line "help" button on the IARD, and providing question-and-answer formats, are features that will help assist the smaller firms that do not have the benefit of in-house compliance counsel. The FPA submits these technical comments with the goal of providing a perspective from an association of small financial planning firms that advise more than 4 million American households.
IARD Administration and Associated Costs
With respect to the electronic filing of Form ADV for registration and disclosure, the FPA strongly supports the creation of the Investment Adviser Registration Depository ("IARD"), a central electronic source of information on the investment adviser industry that benefits investors, regulators, and advisers. As investors increasingly rely on the Internet for important market information and for analytical tools in planning and implementing their own financial goals, it makes sense to provide readily accessible informational resources on the more traditional alternative -- the "human" advisers - including critical disciplinary history and professional qualifications. In connection with academic and regulatory surveys of the investment adviser industry, the IARD will serve as the single most comprehensive source of statistical information and the first central source since the National Securities Markets Improvement Act of 1996 ("NSMIA") divided oversight responsibilities between the states and the SEC. With full participation by the states, the IARD also will serve as a critical database identifying new marketing trends, investment styles, and firm organization within the entire advisory industry. A significant benefit for state-registered advisers who act as investment managers to pension plans is that filing through the IARD will automatically satisfy U.S. Department of Labor filing requirements for fiduciaries.
At the same time, there are significant costs associated with development and maintenance of such a complex system. The FPA appreciates the recognition of Commission staff that "large advisers, which typically will impose more costs on the system by submitting notice filings and paying fees in multiple states, will benefit the most," and therefore should pay higher costs. However, we disagree with the suggested narrow fee range of $200 between large and small advisers. We recognize that there are two major cost factors currently beyond the control of the SEC that will be needed to ultimately determine the average cost per adviser. The first is the absence of an accurate count of state-registered investment advisers who would participate in the system; current estimates are only approximate. The second is the number of states that will initially participate in the system, which has not yet been determined. As noted in the Release,6 a number of state securities administrators may have to submit proposals to individual state legislatures to receive the appropriate statutory authority delegating administration of adviser registration to the National Association of Securities Dealers Regulation, Inc. ("NASDR"). Based on the minimum $200 fee estimated by the SEC, however, we believe the cost for the small adviser is too high.
State-registered investment advisers ("RIAs") already pay registration fees of $100 to $240 per state while SEC advisers do not pay anything for registration with the Commission. Financial planners, whose multi-disciplinary approach to financial advisory services require a variety of registration, licensing and professional fees, may pay more than $1,000 a year for fees to do business in a single state - a far higher per capita cost than that for "pure" advisory firms registered with the SEC.
The benefits of a central, electronic filing system accrue primarily to the multi-state advisory firm, or one that is required to file multiple amendments. State RIAs do not generally derive a corresponding benefit from an electronic filing system, partly because their practices are focused within the local community, and also because they typically do not file more than one or two amendments to their Form ADV during a given year. In a 1996 survey of financial planners,7 only one-third were registered as investment advisers in more than one state, and half of those were registered in no more than two states. We therefore suggest a more proportionate fee scale reflecting the greater benefits to be derived from the system by the larger advisers. If the average user cost per adviser is indeed in a $200 to $400 range, then we recommend establishing a graduated fee scale so that state-registered advisers would pay a flat, minimum fee that is 25 percent of the highest cost, or a $100 fee. We also support a general scaled range of fees for SEC-registered advisers, based on assets under management ("AUM"). However, since the eventual cost to building the first phase could be much higher, we strongly urge the Commission and NASAA that state-registered adviser fees be capped at no more than $125, and the remaining costs allocated proportionately among the advisers who receive the most benefit.
We also support a fee calculation limited to assets under management. There is no need to factor in the number of states in which the adviser is registered (or makes a notice filing), which would make the formula more complicated.
In summary, fees for state-registered advisers should be at the lowest level, which should be no more than $125. Fees for federally registered advisers could be established at three higher, progressive levels. As an example, a graduated fee scale for federal advisers could be based on ranges of $25 to $100 million AUM; $100 to $200 million AUM; and with the highest fee capped at $200 million or more AUM.
NASDR Administration/Accountability. While FPA recognizes the practical reasons that led to selection of the NASDR as administrator of the new system, we nonetheless greatly appreciate the SEC's confirmation in the Release that the [NASDR] "will not, however, act as a self-regulatory organization for advisers."8 FPA strongly backs the SEC's traditional position supporting functional regulation of the financial services industries, including clear regulatory demarcations between the sales and advisory sides of the securities business.
Financial planners remain concerned, however, with the potential conflicts of interest with the NASDR acting as an administrator of the system, given its past interest in regulating investment advisers.9 Therefore, we support the Commission's determination to segregate IARD fee revenues collected by the NASDR from its other assets, and for these adviser fees to be retained for the exclusive benefit of the IARD.10 Further, we strongly support the annual, independent audit of the system noted in the Release and making available to the public copies of the report. In addition to segregating revenues, expenditures attributable solely to the IARD are an equally critical part of the accounting system. We request that the Commission include in the annual accounting report any shared personnel or other costs charged by the NASDR that inevitably arise in connecting and maintaining the interface with the Central Registration Depository ("CRD"). We ask that such overlapping costs in operating the IARD system be equitably apportioned, and that such expenditures be clearly identified in the audit report.
We also urge the Commission to do whatever possible to require the NASDR to hold down costs in building the other phases, and in maintaining the system. As stated in the Release, we strongly support adjusting fee levels "only if the proposed fees are reasonable and necessary to support proper operation of the IARD."11 We request that the industry advisory panel currently in place be retained to continue to provide comment to the SEC and NASAA and to monitor the ongoing costs of building and maintaining the system. And finally, because of previously mentioned concerns with the NASDR's expressed interest in regulating advisers, we ask that the NASDR be prohibited from generating any IARD data that could be directly or indirectly used to support advocating expansion of its regulatory oversight to investment advisers.
In summary, we are pleased with the SEC's intent to make the IARD a purely administrative, pay-as-you-go system whose technology will ultimately permit a more efficient compliance and registration system for investment advisers.
Transition to State Registration. Proposed Rule 203A-1(b)(2)(ii)
The FPA supports the proposed rule to permit transition for investment advisers from federal to state registration by temporarily suspending preemption of a state's registration requirements for federal advisers. The proposal allows an adviser to continue to maintain its federal registration during the time that it applies for state registration and permitting it to file Form ADV-W after the state registration becomes effective. We anticipate that participation by a state in the IARD would allow this transition to take place more quickly.
Hardship Exemptions. Proposed Rules 203-3(a)(1) and (3).
The FPA is pleased that the Rule provides for temporary and continuing hardship exemptions for certain investment advisers. Our initial reaction is similar to the Release commentary that such a continuing exemption will be rarely needed, even for small advisers. We are aware, though, at least anecdotally in comments by regulators and compliance experts, that many small advisers often have more advanced software and hardware upgrades than institutional advisers. So in some cases it may be the large, institutional adviser that may need to rely on a temporary hardship exemption, not the small adviser. A 1999 survey by one of our predecessor organizations, the Institute of Certified Financial Planners, and cited by the Release, determined that nearly 100 percent of state-registered investment advisers have access to the Internet.
In response to the SEC query to whether a continuing hardship exemption is needed for federal advisers, we support such an exemption. Again, we believe such cases will be rare, but nonetheless the rule permits flexibility in situations where an exemption may be appropriate. For example, a federally registered adviser may retire a short time after the Rule's effective date and not wish to make a capital investment in new hardware or conversion to an electronic form. Or, a continuing hardship exemption may be useful in situations where a financial planner is semi-retired, or for other reasons maintains a part-time practice by occasionally writing a few plans or continuing to monitor a limited number of clients' financial plans. In these instances, the sole proprietor would be considered to be "in the business" of providing investment advice under the Act or state investment adviser statute and therefore also required to maintain an investment adviser registration.12 In connection with temporary hardship exemptions, we prefer to see the deadline extended from seven to 10 business days, or two full weeks, to permit adequate time to review various computer consultant fees and services.
Transition Period for Rule Implementation. Proposed Rule 204-3(i)(1) and (2).
Although the effective dates for transition to electronic filing of Part 1 and Part 2 are not known and therefore not indicated in the proposed Rule, it is our understanding that the Commission wishes to propose a first phase filing of Part 1 in the fall of this year. After reviewing the proposed Rule requirement and timetable for effectiveness, we strongly urge the Commission to move the startup of the first phase to January 1, 2001. We believe that at least that much time will be required for the larger firms, of which FPA has a number of members,13 to convert data and new narrative disclosure information from the old Form ADV to the new one. We also believe that the additional 30-day transition period for advisers to provide new brochures and supplements to existing clients should be doubled to 60 days for the same reason.
Delivery Requirements for Amendments. Proposed Rule 204-3(f).
Specifically, with respect to updating the firm brochure as required in Part 2A, the proposed rule would require written updates to take the form of either a reprinted brochure or a "sticker" to be inserted in an existing brochure.
The Release draws on an "apples and oranges" comparison by assuming that the practice of requiring stickers used to update mutual fund prospectuses would be appropriate for the advisory industry. The former method is needed for timely disclosure of investment styles, securities holdings and costs of an investment product that changes daily in value; the other is disclosure of advisory services, which is a completely different business operation altogether. Many mutual funds have 100 percent-plus turnover rates annually of their holdings. The investor needs to be aware of style drift, portfolio manager changes, etc., that may affect an investment. With respect to investment advisers, it is clearly in the interest of the adviser and generally basic common business sense to disclose firm changes that may affect its relationship with clients, whether it's a change in contact information or in services offered. Particularly for small advisers, there is no need for additional regulatory requirements where no substantive evidence of investor fraud or abuse has been offered.
The basis for determining how firm changes automatically trigger amendments is complex. Advisers must keep in mind 13 different disclosure categories from Part 1, and use their subjective judgment for Part 2, in determining which changes to the firm business have risen to the level of public disclosure. They must be aware of changes involving three separate levels of activity: first, when information from eight different items of Part 1 become inaccurate "in any way;"14 second, when information from five other separate items of Part 1 become materially inaccurate; and third, any information from Part 2 that becomes "materially" inaccurate. Further, advisers are reminded that they are not required to make changes to six other items of Part 1, even if these items have become inaccurate, until the annual updating amendment is made. In summary, it is indeed complicated for a sole proprietor or other small firm without full-time compliance assistance to keep track of the various items that may or may not have changed; and that may or may not require immediate or annual updating.
We believe that the proposed rule should continue to require prompt submission of amendments to the IARD as required. But we also believe that investment advisers should have greater latitude in how they disseminate amendments to clients, including the use of alternate methods to satisfy the delivery requirements. Item 2 of Part 1 proposes requiring investment advisers to list in detail material changes made since the last annual update. Advisers should be permitted to take advantage of this summary of changes in Item 2 to satisfy the disclosure and delivery requirement by including in this section prominent notice that information on new changes to the firm may be accessed through its Internet site or the IARD. Also, for those clients not wishing or unable to rely on Internet communications, prominent notice could be made in the initial brochure delivery that the adviser is required to deliver the same information of material changes by mail if requested to do so. FPA of course supports the Commission's determination that delivery of such information may be made over the Internet, consistent with its earlier interpretive guidelines for advisers' delivery of disclosure information through electronic media. In addition, we believe that other options for delivery should be permitted in lieu of stickers, such as notifying clients of material changes in quarterly billing/account statements and referencing where to find the information on the Internet, or offering to mail the changes. Many investment advisers currently offer the annual brochure four times a year, not just once, through billing statements. We believe such a method should be permitted as well for privacy notices required under the Gramm-Leach-Bliley Act. And we support the proposed Rule requirement that the adviser must revise and reprint the brochure annually, and to incorporate all amendments into the new brochure at that time, instead of permitting the accumulation of stickers over a period of several years before reprinting the Form.
In summary, we believe that the Commission should continue to rely on the anti-fraud provisions of the Investment Advisers Act of 1940 (the "Act") that require the adviser to fully disclose material conflicts to clients without requiring delivery of the amendments as detailed in the Form ADV general instructions. It should be assumed that once investors become familiar with the IARD, they would rely on it as an important disclosure medium. The Commission and NASAA can encourage investor participation by prominently posting notices on the IARD home page where investors enter the web site, and stating that federal rules require prompt posting of ADV amendments on the system.
Form ADV Glossary.
Discretionary Authority. We believe it would be helpful to replace "investment advisers" on line 3 of the definition with "portfolio managers," since this is the term commonly used by an investment management consultant who has discretionary authority in these situations.
Part 1A of Form ADV.
Item 1.F. Principal Office and Place of Business. FPA strongly supports the efforts of the Commission to maintain privacy of an investment adviser's personal data, including social security numbers and most residential addresses. However, we have concerns with the way two other items of confidential information may be handled. First, it is unclear from reading footnote 77 of the Release whether the IARD would publicly disclose the date of birth and IRS tax numbers of control persons reported on a Disciplinary Reporting Page ("DRP") or on schedules A, B and C. We oppose any public disclosure of dates of birth or IRS tax numbers. Secondly, footnote 77 makes clear that Item 1.F.would publicly disclose on the IARD the residential address of an adviser who is a sole proprietor, and whose home is also his or her principal office and place of business. We assume that the same information required on Form ADV-H also would be posted on the IARD. Similarly, we presume that if an adviser affiliate maintained a satellite office at his or her residence, the home address also would be publicly disclosed on Schedule D. We take strong exception as well to these public disclosures of personal information.
While some of this information may be available currently by requesting it directly from the SEC, it is a far different disclosure standard to permit access through the World Wide Web. Although specific data on the number of advisers or supervised persons affected by this proposal is unknown, some financial planners do work out of their homes. We have heard from a number of FPA members expressing concern with Internet access to their personal information. Several women practitioners in particular have commented to us on this issue. Because one in five CFP practitioners are women,15 this issue is important to the home-based planner concerned with personal and family safety. One FPA member in this situation tells us she has never had a complaint from a client in using a post office box for her business address. This planner does not meet clients in her own home. To meet with clients, she travels to the client's home or office, or uses a conference room of a colleague. If a comfortable client relationship has been established, the planner will give the client her residential address for parcel deliveries or to drop off documents. If potential clients are uncomfortable with an adviser disclosing only a mailing address, and not a physical business, they can easily find other advisers.
The popularity of the Internet as a business medium is increasing the likelihood that, as the number of home-based businesses continues to grow, there will be more, not fewer, sole proprietor/advisers working out of their homes. The Release has not cited any enforcement problems or sweep data as a basis for this requirement separate from the need to have such data available on a non-public basis for examinations. If the disclosure requirement is based on a heightened concern with Internet fraud, Form ADV can be revised to shed light on an adviser's use of the Internet. For example, to permit more effective deployment of enforcement resources to this potential problem, an "early warning" disclosure requirement could be added to Item 5 of Part 1A requiring the adviser to indicate if advisory services are provided to clients primarily or exclusively through the Internet. If the firm lists a postal address and indicates that it is engaged primarily in Internet-based advisory services, but its DRPs confirm an active disciplinary history, we believe that such information would enable the Commission to respond appropriately.
Item 5. Information About Your Advisory Business. Item 5.B.(3) of Part 1A requires the advisor to list employees and independent contractors of the firm who solicit advisory clients. We are unsure of the reason for this question. If it is to determine how many persons affiliated with a firm act only as "solicitors" who refer clients to the firm, then the question is too general to be useful. Most supervised persons of the firm dealing with the public could be considered to be soliciting clients in various ways. Because the SEC and the states do not license solicitors per se, we would recommend that the item be removed.
Item G.(1) of Part 1A requires notification if the adviser provides financial planning services. Item G.(2) requires notification if the adviser provides personalized portfolio management. Many financial planners consider portfolio management to be an integral part of their financial planning practices.16 Others view it as a separate activity. As a result, we believe that subsequent Item H may be misinterpreted by financial planners. Item H asks how many clients received financial planning services during the last fiscal year. Planners who consider their asset management services to be part of an implementation of the clients' financial goals may consider such services to be part of their financial planing services, while others who may not have developed a comprehensive plan for a client may view asset management as a separate service.17 If the Commission is interested in how many clients received financial planning services exclusive of portfolio management services, Item H. should be clarified.
Item 6. Other Business Activities. Item 6.A. of Part 1A is missing a conspicuous newcomer to the adviser industry, and that is the accountant. Members of this professional group are increasingly registering as investment advisers and also affiliating with broker-dealers. The "other" category under A.(7) ("Other financial product salesperson") would not appear to apply to accountants if they did not maintain a securities or insurance sales license. We believe that it would be appropriate to add a separate listing for accountants to monitor this new trend in the consolidation of financial services industries, similar to the listing requirement for accountants in Item 7 of Part 1 A for financial industry affiliations.
Item 8. Participation or Interest in Client Transactions. The FPA welcomes the Commission's increased emphasis on potential conflicts of interest in various activities of an investment adviser firm. We support the areas focused upon by the Release - proprietary and sales interests in client transactions, investment or brokerage discretion, client referrals - and strongly support greater transparency of these adviser activities to the consumer.
Form ADV Schedule D.
Section 1.F. Other Offices. We believe the instructions for completing this section could be simplified by basically stating that a SEC- or state-registered adviser list the largest five branch offices, instead of an initial comment that requires the listing of "each office." Secondly, for the small number of state-registered investment advisers with more than five branch offices, the instructions are unclear whether the firm would have to list all branch offices. We request clarification from the SEC and NASAA, and ask that a uniform standard be applied to both. Inconsistent disclosure requirements also would require certain SEC-registered institutional advisers to maintain separate branch office lists if they advise state or local public pension plans and are required by state law to register there (and not merely notice file). Finally, we ask that the instructions clarify that this is an annual reporting event, given the fact that the branch offices of larger firms may fluctuate frequently in terms of numbers of employees, and amending Schedule D for this reason would be burdensome.
Section 1.K. Location of Books and Records. The requirement to list each location at which books and records of the firm are kept seems to obviate the need for a Section 1.F., unless the assumption is that all records would be maintained electronically at a separate location from the branch office. As mentioned in our comments on privacy matters, we strongly support restricting this information from public access if the records are maintained on the personal premises of the adviser or supervised person.
Part 1 of Form ADV; Disclosure Reporting Pages.
Civil Judicial Action DRP. In instances where there are inconsistent reporting standards between federal and state-registered investment advisers, we ask the SEC and NASAA to come to agreement on uniform standards. A case in point would be on the Civil Judicial Action page, which requires state- registered advisers to respond to eight additional events that occurred more than 10 years ago than for SEC-registered advisers. If the NASAA response is that state laws or rules vary, then we encourage NASAA to aggressively advocate uniform disclosure standards to be supported by its members in rule or legislation.
Part 2A of Form ADV; General Instructions
Instruction 5. Instruction 5 seems to assume that states will immediately participate in the IARD system. The instruction states that "You will file your brochure with your Form ADV on the IARD system, starting when the IARD system is capable of accepting these filings." Although it is hoped that all states will eventually participate in the IARD system, some initially may require additional time to secure appropriate statutory authority and therefore not be prepared to accept such filings at the time the IARD system begins accepting such filings. We recommend amending the instructions with a comment such as "You will file with the Commission and most or all states your Form ADV and brochure on the IARD system..."
In connection with the bullet points in Instruction 5 noting that federal and state-registered advisers must file paper copies of the brochure with state securities authorities, we would suggest amending the state filing requirement to "may be required." Although most states appear likely to insist on the paper filing of Part 2 even though Part 1 will be filed electronically, we believe that certain states may adopt the SEC policy that the brochure is deemed to be filed until the IARD system is capable of accepting Part 2.
Instruction 8.(a). We raise the same question mentioned immediately above in connection with Instruction 8.(a), which requires the paper filing of the brochure and brochure amendments with state authorities by SEC-registered advisers. What if a state adopts the SEC "deemed to be filed" policy? Also, Instruction 8.(a) instructions are not clear with respect to the filing methods of state-registered investment advisers during the phase-in period. Elaboration on their alternative filing methods is requested. For example, the instructions should note one of the following actions might be required: the state may require a combined electronic-and-paper filing; paper-only filings of the entire Form; or electronic filing of Part 1 with Part 2 deemed to be filed at the same time.
Instruction 8.(b). Instruction 8.(b) seems to imply that the states also require delivery of amendments to clients. We are uncertain whether the states have uniform rules in connection with the delivery of amendments. Some states may have adopted the SEC disclosure rules by reference; others may have specific requirements. We ask that the final Rule note that the delivery requirements apply only to SEC-registered investment advisers, and that state-registered advisers should check with the appropriate state authority. Our comment letter to NASAA on the Rule encourages uniform application of such delivery rules to state-registered investment advisers.
Part 2A of Form ADV: Firm Brochure.
Item 1. Cover Page. We have two comments in connection with the cover page. First, Item 1.B. requires that the firm brochure's cover page identify "the name of a person who can be contacted for further information." While it may be easy for small firms to identify a particular individual, it is not practical for large firms. To provide more flexibility while still adhering to the apparent purpose behind this requirement, investment advisers should be permitted to identify contact persons in other ways. As an example, an investment adviser should be able to list on the brochure's cover page a toll-free telephone number to a call service center that would direct calls to an individual capable of responding to inquiries.
Secondly, Item 1.C. requires a disclaimer that a firm referring to itself as a "registered investment adviser" cannot imply a certain level of skill or training. We agree with this statement to the extent that the SEC and a small number of states do not require minimum competency standards. Since most states now mandate passage of the Series 65 exam or a professional waiver as a licensing requirement for investment adviser representatives ("IARs") of state- and certain federally registered advisers, then Item 1.C. is not accurate. We suggest adding the word "may" to reflect the uneven standards of investment adviser qualification based on SEC or certain state requirements.
We make the further observation that qualifications are indeed important to the selection of an investment adviser. FPA recommends that the cover page instructions also require a sentence suggesting that the investor review Item 2 of Part 2B of the supplement, if offered separately, to examine in detail any professional qualifications of the person who is offering advisory services to the client.
Item 6. Types of Clients. Helping the investor screen the IARD list of thousands of prospective advisers based in part on the types of clients with whom the adviser works is important to both parties. Often, persons who need debt management assistance initially contact a financial planner. Most planners are not trained as debt counselors, or do not provide that level of service. FPA supports requiring the adviser to disclose a minimum account size to assist the prospective client in making an educated choice.
Item 8. Disciplinary Information. With respect to disciplinary information, Item 8.A.(2.) requires disclosure of a pending, investment-related criminal proceeding. The FPA supports full and effective disclosure of all criminal convictions, findings, and enforcement actions as described in Item 8 and acted upon in a court of law. We believe that disclosure, however, should be based on actual conviction, adjudication, or enforcement action, as embodied in the fundamental concept of "innocent until proven guilty." The consumer media serves an important First Amendment role of publicly disclosing pending criminal proceedings, complementing the regulatory authorities that issue advisories or press releases on their enforcement activities.
The SEC also requests comment on whether an investment adviser should be required to disclose disputes resolved through arbitration or other alternative dispute resolution. Unlike civil or criminal proceedings, arbitrations do not include findings of guilt. Frequently such records, including settlements, are not publicly available. FPA believes that only those arbitration proceedings that have resulted in actual awards (not merely claims) should be required disclosure. Additionally, because of the sometimes frivolous nature of arbitration claims, the minimum threshold for reporting claims should be at least $10,000, consistent with the threshold in Form U-4, Uniform Application for Securities Industry Registration or Transfer.18
Item 9. Other Financial Industry Activities and Affiliations. FPA supports the proposed requirements to disclose all professional or other material affiliations to clients that may create conflicts of interest.19 However, Item 9.D. needs further clarification to avoid repeating information that might be disclosed in Item 13.B. ("Payment for Client Referrals"). Item 9.D. requires advisers to explain why they recommend or select other advisers for their clients if they receive compensation directly or indirectly as a result. In other words, we assume Item 9 involves disclosure of advisory service fees exchanged between advisers, and Item 13 involves disclosure of solicitor or referral fees between advisers and a third party that may also be an adviser. Compensation exchanged between advisers is probably increasing. With the recent changes to state accountancy laws permitting CPAs to broaden their compensation arrangements, accountants and broker-dealers are now entering into joint marketing and client referral programs. It may not be clear which Item is appropriate for disclosing these compensation-sharing arrangements. An example of what we believe is appropriate disclosure under Item 9 is when an adviser, on behalf of its client, selects a portfolio manager or managers and oversees their portfolio management work as an investment management consultant. A single asset management fee may be collected by one party to avoid multiple billings to the client for the same service. The fee would then be distributed to the respective advisers per the client agreement. If the general intent of Item 9.D. were to disclose the sharing of advisory fees as in this situation, it would be helpful to clarify that referral fees are separately reported in Item 13.B.
In addition to disclosing compensation arrangements, Item 9.D. also requires disclosure and/or discussion of a business association between two advisers in which no compensation is received, but one adviser selects or recommends the other adviser to the client. Does "business relationship" mean a "mutual proprietary interest" in another business, or can it also mean mutual referrals between two professionals? If it can be applied to either relationship, we are concerned that the required disclosure slips into a gray ethical area where there is no clear conflict of interest.20 Although professional referral arrangements vary widely, a common practice of financial planners is to offer a client several professional referrals, and not just one. We ask the Commission to clarify what it means by "business relationship."
Item 12. Review of Accounts. Item 12 requires a financial planner to indicate who in the firm periodically reviews financial plans, and the frequency and nature of the review. Because of the complexity of services and products that may be offered in such an arrangement, CFP practitioners are already required to define the scope of the financial planning engagement as part of their practice standards. As a practical business matter, a financial planning agreement typically defines the scope of services offered, including the "shelf life of the financial plan." Implementation and periodic review to "fine tune" the plan when needed are also critical parts of the comprehensive financial planning process. FPA supports Item 12. Effective disclosure should assist prospective clients in better understanding the financial planning process.
Item 15. Investment Discretion. FPA supports the requirement in Item 15 to explain to a client if it offers different kinds of discretionary services. One of the more common practices is known as "limited trading authority." In this situation, the financial planner has a power of attorney to execute trades with a discount broker on behalf of the client, but is limited in a secondary agreement with the client to execute trades only with the client's permission.
Item 17. Investment Performance. Because of a generally conservative approach to retirement planning and investments in general, most financial planners do not emphasize investment performance in their marketing materials, unlike mutual fund prospectuses or advisers who market services based on model portfolio performance. However, we believe that a uniform standard would be helpful and support adoption of the AIMR-established guidelines as an acceptable model. With respect to model portfolio performance, the mere disclosure of a standard used to calculate investment performance would not necessarily provide the public with a useful means of comparing investment performance among several advisers.
Item 18. Financial Information. Item 18.C. requires disclosure of bankruptcy activity within the past 10 years. We suggest that the disclosure in this item be clarified to include bankruptcy petitions involving management persons, firms under common control if not disclosed separately, and on predecessor advisers.
Item 20. Disclosure of Performance Fees. Item 20.C. requires further discussion of performance-based fee compensation, and associated investment risks. We believe that this is an important disclosure item that should be included as a separate disclosure to clients of SEC-registered advisers under Item 5 of Part 2A. If included there as a uniform disclosure item for clients of both state and federal advisers, then we would recommend that Item 20.C. be eliminated.
Part 2B of Form ADV
General Comment. The FPA strongly supports the addition of Part 2B to the Brochure as a highly practical disclosure piece, or resume, of the individual adviser's qualifications. Consistent with our previously mentioned concerns with the overall size of Form ADV, we believe that a Part 2B supplement may be the most widely read component of the Rule, and thus a critical factor in the selection of an investment adviser.
Instructions. Instruction 7.(a) notes that state-registered advisers must file all supplement amendments with the appropriate state securities authority. As mentioned previously, we recommend inserting "may be required," since not all states may require the filing of supplements. We also strongly urge the Commission and NASAA to build into the IARD system an electronic filing option for Part 2B supplements. Otherwise, the system would never be fully automated, and would require state-registered advisers to permanently rely on a part electronic, part paper filing system.
Item 1. Cover Page. Similar to comments made earlier with respect to privacy concerns, we oppose disclosure under Item 1A.(1.) and (2.) of the business address of sole proprietors if it is the same as their home address. We support disclosure only of a post office address.
Under Item 1B., similar to our comments on the cover page for Part 2A, we suggest that large corporate firms be allowed the flexibility to list a toll-free number and not an individual contact name.
Item 2. Educational Background. Item 2 requires the listing, among other things, of professional designations. There are a confusing variety of accreditations in today's marketplace. We encourage the SEC and NASAA to provide either web links or contact numbers of the sponsoring organizations on the IARD, as well as on the agencies' consumer toll-free number. This will help investors independently verify the adviser's standing with a professional organization, or assist them in learning more about the accreditation.
Item 3. Disciplinary Information. Consistent with comments on Item 8 of Part 2A, we support disclosure of felony convictions, not pending proceedings. We also strongly support mandatory disclosure of actions taken to revoke or suspend professional designations. The CFP Board of Standards currently discloses to news media and to regulatory agencies all disciplinary proceedings in connection with CFP licensees.
Form ADV-H. Hardship Exemption.
Item 5. On the back page, at the bottom, the "SEC's Collection of Information" policy is re-printed and references withdrawal activities associated with Form ADV-W. We assume the intention was to reference the collection of information in connection with Form ADV-H.
We would be pleased to respond to any questions in connection with these comments. Please do not hesitate to contact the undersigned at 202.626.8770.
Duane R. Thompson
Director of Government Relations
Cc: Marc D. Beauchamp
NASAA Executive Director
|1||The Financial Planning Association is the largest organization in the United States representing financial planners and affiliated firms. FPA was formed on January 1, 2000, as a result of the combination of two existing non-profit financial planning associations, the Institute of Certified Financial Planners and the International Association for Financial Planning. FPA maintains administrative offices in Atlanta and Denver, and a government relations office in Washington, D.C.|
|2||FPA members, including those registered as investment advisers on both state and federal levels, generally are sole proprietors or principals in financial planning firms of one to four advisers.|
|3||SEC Release, page 85.|
|4||See January 14, 2000, FPA comment letter to the SEC.|
|5||Rule 401 of the CFP Code states that, in addition to compliance with applicable laws in connection with the financial planning engagement, a CFP designee shall disclose to the client "material information relevant to the professional relationship, including but not limited to conflict(s) of interest(s), changes in the CFP designee's business affiliation, address, telephone number, credentials, qualifications, licenses, compensation structure and any agency relationships, and the scope of the CFP designee's authority in that capacity." Rule 402 requires "timely written disclosure of all material information relative to the relationship."|
|6||SEC Release, supra, at 13.|
|7||Survey of 800 members of the Institute of Certified Financial Planners, January 1996.|
|8||SEC Release, supra, at 9.|
|9||In fall 1998, the chairman of the NASD, Frank Zarb, in remarks at a broker-dealers conference, called for the SRO to oversee investment adviser activities. See "Top NASD Officials Call for Adviser Regulation," IA Week, October 19, 1998.|
|10||SEC Release, supra, at 15. Consistent with the Rule proposal, Senate securities reform legislation also proposes funding the IARD by requiring advisers to "pay the reasonable costs associated with such filing and the establishment and maintenance of the systems." See S. 2107, page 13, lines 1-3.|
|11||SEC Release, supra, at 14.|
|12||A reasonable reaction to this scenario may be that this person would probably be registered on the state level so that a continuing hardship exemption for federal advisers is unnecessary. However, average client net worth and investable assets vary greatly among planners. CFP practitioners estimate the median net worth of their clients... ...at the lower range to be $50,000 (4 percent) to more than $100 million (2 percent) at the higher end. Source: First Annual CFP Practitioner Survey, conducted in summer 1999 by the CFP Board of Standards.|
|13||FPA has 121 member broker-dealer/registered investment advisers with approximately 115,000 registered representatives and/or investment adviser representatives whose compliance systems will require more time to "convert" than for a small advisory firm.|
|14||Form ADV: General Instructions, page 2.|
|15||First Annual CFP Practitioner Survey, supra. The survey indicates 21 percent of CFP practitioners are female.|
|16||Sixty-seven percent of CFP practitioners offer portfolio management services. Source: First Annual CFP Board Survey, supra.|
|17||Id. Slightly more than one-half of CFP practitioners feel that asset management is not a part of financial planning, and 42 percent say that it is part of financial planning.|
|18||Notwithstanding public disclosure requirements under federal or state securities laws, CFP licensees are required under the CFP Code to disclose to clients "material information relevant to the professional relationship." This may include arbitration or other proceedings relevant to the client engagement. See CFP Code, Rule 401(a).|
|19||Rule 402(e) of the CFP Code requires timely written disclosure of a "statement describing material agency or employment relationships a CFP designee (or firm) has with third parties and the fees or commissions resulting from such relationships." Rule 403 requires a CFP licensee, in a financial planning engagement, to "disclose in writing, prior to establishing a client relationship, relationships which reasonably may compromise the CFP designee's objectivity or independence."|
|20||Rule 301 of the CFP Code requires a CFP practitioner to offer advice only in those areas in which the planner has competence. He or she must seek counsel from qualified specialists or refer clients to such parties. The referral obligation is, of course, viewed as being in the best interest of the client. The SEC disclosure requirement is equally concerned that such referrals could be disadvantageous to the client.|