June 13, 2000
BY HAND AND ELECTRONIC FILING
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Release Nos. IA-1862, 34-42620; File No. S7-10-00; Electronic Filing by Investment Advisers; Proposed Amendments to Form ADV
Dear Mr. Katz:
The Investment Counsel Association of America1 appreciates the opportunity to provide these comments regarding the Commission's proposed rules related to electronic filing by investment advisers and revisions to Form ADV.2
Introduction and Summary
On April 5, 2000, the Commission announced the development of an electronic filing system for investment advisers, the Investment Adviser Registration Depository (IARD). The Commission also proposed substantial amendments to Form ADV, designed to modernize the registration process and enhance information that investment advisers provide to their existing and prospective clients. As part of this enhanced disclosure, a firm would be required to provide clients with a narrative brochure in plain English describing its practices, policies, and procedures, along with brochure supplements providing additional information regarding specific employees of the firm.
The ICAA applauds the Commission for establishing the IARD. This electronic filing system will permit federally registered advisers to make "one-stop" filings with both the Commission and with states in which they are required to notice file.3 It will provide the Commission with a powerful tool to monitor advisers and gather useful data about the profession. Most important, the database will provide clients around the world with easy access through the Internet to significant information about investment advisers, including disciplinary history.
The ICAA also supports the Commission's goal of making advisory firm brochures more useful to clients. Form ADV has not been substantially amended since 1985 and is in need of modernization. We support the new requirement of a narrative brochure written in plain English as a logical and meaningful step toward improving disclosure for clients.
While agreeing with the Commission's investor protection goals, the ICAA has a number of comments regarding electronic filing and the new structure and substance of Form ADV. Following is a summary of our principal concerns:
We discuss below: (1) electronic filing through the IARD; (2) the Release and Form ADV generally; (3) Part 1A generally; (4) the proposed delivery requirements for Part 2; (5) Part 2A generally; and (6) Part 2B generally. For ease of reference, we have set forth our specific item-by-item comments with respect to Part 1A, Part 2A, and Part 2B in separate appendices that should be considered as part of this comment letter.
I. Electronic Filing through IARD
A. Transition timing
The Commission requests comment on the transition process and the timing of filing Form ADV and delivering the brochure to clients.4 Gathering the information for Part 1 alone will involve significant time and effort. We believe advisers will need at least 60 days to complete Part 1. In addition, if the Commission does not narrow the scope and extent of the brochure and brochure supplements, drafting such documents will be an enormous undertaking. Advisers will need at least 180 days to gather the necessary information and create these documents and an additional 60 days to deliver new brochures and supplements to all clients.
In addition, we understand that filings with the states through IARD for investment adviser representatives may overlap with the schedule for filing Part 1A and/or Part 2A. We hope the Commission and the states will work together in the transition schedule to avoid overlapping or impractical requirements.
B. Paper filing of the brochure with the states
The SEC proposes to "roll out" Part 1 of Form ADV on the new IARD approximately one year before Part 2A is filed electronically.5 In the interim, the Commission will not require SEC-registered advisers to file Part 2A with the Commission, but simply to provide Part 2A to their clients.6 Because the Commission will not require the filing of Part 2A during this period, states would not be permitted to require Part 2A in notice filings by SEC-registered advisers.7
The SEC has proposed to "accommodate" the states' desire to receive Part 2A by "deeming" Part 2A to be filed with the Commission.8 Thus, during the initial one-year roll-out period, advisers would be required to file Part 1 electronically with the SEC and the relevant states, while notice filing Part 2A on paper by mail with the various states that so require.
We strongly oppose this proposal. Requiring Part 2A on paper would be unnecessarily burdensome for firms already completely revising their Form ADVs and becoming familiar with the IARD. Further, Part 2A already must be provided to clients and prospective clients, so there is no investor protection rationale for the requirement. States will have all of the regulatory information they need in Part 1, including disciplinary history. We see no legitimate "notice filing" need for states to require advisers manually to file a copy of Part 2A, particularly where it is a stop-gap measure until the IARD is completed.9
C. Completeness check
The Commission notes that the system "will prevent an adviser from submitting an incomplete form or from entering inconsistent information at different places on the form."10 We understand that broker-dealer firms have had problems with the CRD's completeness checks, especially with errors in the system that prevent timely filing by firms. Apparently, the system sometimes rejects forms that are correctly completed because of assumptions made in the system that do not apply to all firms. It is important that the Commission control the completeness check function of IARD for Form ADV, not NASDR or the states, and that the system is flexible enough to be quickly adapted if errors are discovered in how the checks operate.
D. Commercial use
The Commission notes that IARD data will be available for commercial use.11 We believe such commercial use of regulatory information is highly unusual in any profession, particularly given that personal information about certain advisory personnel is included. For example, we understand that CRD data is not similarly available. At a minimum, the Commission should ensure that private information, such as social security numbers and home addresses or telephone numbers, is not provided to commercial users.
II. General Comments on Form ADV
A. The IARD Should Be Tailored to Investment Advisers
NASDR is building the IARD for the Commission and the North American Securities Administrators Association (NASAA). We appreciate Chairman Levitt's statement that "NASDR will be operating in this venture as a contractor for [the SEC] and not as a self-regulatory organization for investment advisers."12 We are nonetheless concerned that certain portions of the Release appear to focus more on attempting to conform Form ADV to Form BD and to accommodate dually registered entities than on establishing requirements that reflect characteristics of the advisory profession.
As we have stated consistently,13 there are significant differences between the investment adviser profession and the broker-dealer industry. Nevertheless, the Commission appears to have used Form BD and its accompanying definitions as the model for Form ADV. For example, the Regulatory DRP (Disciplinary Reporting Page) contains questions completely unrelated to the investment advisory profession, referring to products, sales practices, and SRO-type sanctions. Similarly, the form includes questions about registered representatives and "minor rule violations."14 This approach is not appropriate for advisers. To the extent questions relate to dual registrants, the Commission should already have access to such information through broker-dealer filings.
We understand that the SEC hopes to achieve "synergies" in filing for dual registrants. But we believe that an accurate and appropriate form for advisers should not be sacrificed in the name of easing filing requirements for dual registrants. Historically, "true" dual registrants - that is, one entity registered as both an investment adviser and broker-dealer - are principally broker-dealers who decide to enter the investment advisory profession. Traditional investment advisers who register as broker-dealers do so, for the most part, to distribute proprietary mutual funds and create an affiliate or subsidiary to do so. We understand, however, that only "true" dual registrants will benefit from the synergies of linking the IARD with the CRD. Thus, aspects of this proposal that make Form ADV more consistent with Form BD primarily will benefit the broker-dealer industry, not traditional investment advisers.15
We are also concerned that the Release appears to indicate that NASDR has authority to set fees for various filings and to issue future releases.16 Only the SEC and the states have such authority. The Release and proposed Form ADV are sprinkled with references to CRD numbers throughout, when there should be a separate IARD number for this separate system.
B. The Paper Version of Form ADV
We are disappointed that the Commission chose to release only the paper version of proposed Form ADV, which is not relevant to the vast majority of advisers. Few, if any, federally registered advisers will apply for hardship exemptions to use the paper form. It is clear that the on-line version of the form will not be identical to the paper version. For example, while the Release mentions electronic signatures, the proposed form does not. In addition, we understand that Schedule C will not exist on-line, but the Release does not make that clear. Similarly, Schedule D may not appear in the same manner on-line as it does in the proposal. The Commission should make clear which items, if any, may be amended directly on-line, without accessing various schedules.
Further, advisers need to see the instructions that will be available on-line in order to provide relevant comments. The ease with which the form can be completed on-line is critical to the success of the new system. We are concerned that firms will have to expend additional resources if the paper form does not match up with the on-line version. We understand that with respect to the current Form BD in the CRD system, the two versions (paper and electronic) are not identical, which is a source of confusion and lack of consistency in firm information and filing. We believe the Commission should identify and clarify any discrepancies between the paper and electronic versions of Form ADV.
C. Disciplinary History
We commend the Commission for incorporating requirements of Rule 206(4)-4 into the brochure. Clients generally consider disciplinary history in making decisions about their adviser and clients should have access to this information. We are concerned, however, that the disciplinary history required is unnecessarily detailed and repetitive across various parts of the form. We do not believe that Form BD and its accompanying DRPs should be used as models for investment adviser disclosure. Further, some questions are overly intrusive and irrelevant, particularly those requesting information about charges that did not result in findings of guilt or liability. Our item-by-item commentary on these questions is provided in the relevant appendices.
The SEC has requested comment regarding whether disciplinary information should appear in a separate document.17 We strongly believe this information should not be required in a separate document. The logistics involved in delivering three or more documents (brochure, disciplinary history, one or more supplements) as well as the recordkeeping requirements would be extremely complicated. In addition, clients know to look for disciplinary history. The table of contents required by the proposal would immediately direct clients' attention to the correct location.
The Commission has also requested comment on whether SEC-registered advisers should be required to report arbitration liability in excess of $2,500.18 We believe that requiring disclosure of arbitration claims or awards would be inappropriate. As the Commission points out, it is not always possible to identify arbitrations that reflect upon the integrity of the adviser, as opposed to arbitrations of commercial matters to which a large adviser, like any other corporation, may be subject. In any event, if such a disclosure requirement were adopted, the proposed disclosure threshold of "in excess of $2,500" whether that is the amount of the claim or the amount of the award, is too low. This de minimis amount may not be material even for a small state-registered adviser, much less a large adviser with substantial staff, clients, and assets under management.
D. State-related issues
In its description of the electronic filing system, the Commission implies that many states require an SEC-registered adviser "doing business" in the state to provide a notice filing.19 In fact, however, all but four states require notice filings only if an adviser has a place of business in the state or more than five clients in that state.20 We believe that the Coordination Act was intended to and did codify that de minimis requirement for notice filing. In any event, we anticipate that federal legislation currently under consideration will confirm that intent. We respectfully request that the final release correctly describe the states' notice filing requirements.
In the General Instructions for Part 2 of Form ADV, instruction number 5, the Commission asserts that for notice-filers, the "state securities authorities require you to send them paper copies of your brochure until the IARD system is capable of accepting these filings." This explanation should read that states "may require" such filings. Under the Commission's proposal, each state may determine whether or not to require paper filings during this period.21
In addition, the Commission proposes a rule amendment that would suspend preemption of a state's laws when the adviser registers with that state.22 We understand the Commission's rationale for this proposal but caution against unintended consequences. Currently, some SEC-registered advisers may voluntarily register with a state because anachronistic pension laws in certain states require advisers to be registered with both authorities, despite the passage of the Coordination Act, and clients insist on complying with the letter of state law.23 These advisers should not be subject to state regulation.
Finally, the Commission should note in Item 9 of the General Instructions that once an adviser registers with the SEC, it may withdraw its registration(s) from the state(s).
III. Part 1A
Part 1A will be the principal regulatory information-gathering form for the SEC. This part of the form has been greatly expanded. It incorporates most of the information requested in current Part I and also includes some information that is currently in Part II. The information requested in Part 1A is, for the most part, straightforward, and the Commission has included helpful instructions and a glossary of terms. Several questions, however, still ask for excessive or unnecessary detail, and the purpose of gathering the information in this document is unclear. Our item-by-item commentary discussing these issues appears in Appendix A.
Further, proposed Form ADV frequently requests the same or similar information in multiple questions. For example, disciplinary history for certain personnel is disclosed in Part 1A and the DRPs and is repeated in the brochure and/or brochure supplement. The same wrap fee information requested in Part 1A is repeated in the brochure. This repetition is burdensome to the adviser and makes the disclosure documents too complex and unwieldy for clients. The SEC ultimately will receive both Part 1A and the brochure, and therefore should eliminate the duplication.
The Commission estimates that the average time an adviser will spend on creating Form ADV is 22 hours. We believe this estimate is low even for small firms and it is not remotely realistic for large advisers with a broad client base, expanded product lines, numerous affiliates, and complex policies and procedures. The required disclosures in both Part 1A and Part 2 regarding products, people, and policies per product will be proportionately greater the larger and more complex the organization. Particularly given the consequences of "inadequate" or inaccurate disclosure that could result in enforcement actions, any large complex organization will expend substantial resources on multiple layers of review and information-gathering, including review by outside counsel.
IV. Part 2: Delivery Requirements
Currently, each adviser must deliver its brochure or Part II of Form ADV at the inception of the advisory relationship and offer to deliver the brochure or Part II annually. At the same time, an adviser is required to update Form ADV either promptly or annually depending on the item to be amended. The updated Form need only be sent to clients that request the Form pursuant to the adviser's annual offer. We agree that the current system is ineffective, particularly because the vast majority of clients do not request the updated Form pursuant to the annual offer.
To address this problem, the Commission's proposal would require that advisers not only amend their brochures to reflect material changes, but also deliver a reprinted brochure or "sticker" to every client and prospective client every time the brochure is amended. Under the proposal, firms would also have to summarize separately the material changes in the brochure for clients and keep records of each summary and when it was delivered to clients. The proposal would also retain the current requirement of an annual offer.
We believe that public access via the Internet to the adviser's most up-to-date and complete Form ADV goes a long way toward improving the current situation. In lieu of the Commission's delivery/stickering proposal, we strongly recommend that Rule 204-3 be amended to require the annual delivery, not offer, of an adviser's current brochure to existing clients.24 Delivery should be accompanied by prominent language disclosing that the brochure may be amended from time to time during the year, and that clients are advised periodically to check the listed website for any changes. We are confident that clients sophisticated enough to retain the services of a federally registered investment adviser have ready access to the Internet. The brochure could also be accompanied by a summary of material changes made to the brochure since the last delivery. The concept of an "offer" is no longer useful and should be eliminated. Of course, as is currently required, an adviser must provide prospective clients with its most current brochure filed with the SEC. Our proposal addresses only delivery, not filing requirements.
We understand and support the Commission's desire to keep clients apprised of material developments related to their advisers. We believe, however, that the Commission's proposals related to "stickering" and "summaries of material changes"25 will be confusing to clients and overly burdensome for advisers. These proposals defeat the purpose of creating a continuously current electronic database available to the public. Our proposal of delivering a clean updated brochure to clients on an annual basis will accomplish the Commission's goals while improving the clarity of disclosure.
V. Part 2A
A. The Brochure Will Be Too Long and Dense
Part 2A requires all investment advisers to draft a firm brochure in a plain English, narrative format. In essence, it replaces information currently provided in Schedule F, the continuation page for current Part II of Form ADV. Advisers will provide narrative disclosure on 19 separate items. While the nature of the disclosure has been specified in the proposal, advisers generally will be free to structure the disclosure and order the topics so that it best conveys the required information.
We agree that the current "check-the-box" format is not user-friendly to clients. However, the proposed brochure is not merely reformatted but also requires a much higher level of detail regarding more topics than the current version. The brochure would have to include a firm's policies, practices, and procedures regarding the firm's business activities, ownership, fees, compensation, types of clients, methods of analysis, investment strategies, risks of loss, disciplinary information, financial industry affiliations and activities, personal trading, brokerage practices, soft dollars, commission recapture, allocation, account review, custody, wrap fee programs, investment discretion, proxy voting, performance advertising, and other financial information. While each item alone may sound reasonable, taken as a whole the rule appears to require advisers to prepare quite a substantial and detailed document that will be more than a "brochure." The requirements are even further complicated for large firms, where, for example, there may be different policies and procedures in various areas for each investment strategy.
Moreover, proposed Form ADV appears to require disclosure and delivery most relevant to financial planners and large wirehouses serving individual retail clients. Unfortunately, these retail clients have no reliable way to assess whether the policies and procedures disclosed by advisers are effective or consistent with legal or professional standards.26 Conversely, many of the proposed changes have limited relevance to the vast majority of institutional clients that typically are represented by sophisticated consultants. Through the RFP process, due diligence meetings, and the assistance of consultants, institutional clients are able to obtain as much detailed information about an adviser that they feel is necessary, including information about the individuals who will be managing their assets.
While we support the concept of a plain English brochure for clients, we believe the scope and extent of disclosure requested is excessive. The proposed brochure will be too lengthy and complicated for clients, particularly the type of retail client the Commission targets. Currently, without the additional items and detail proposed in the Release, many firms' Part II disclosure exceeds 10 or 20 single-spaced pages. The possibly unintended consequence of the proposal (especially with the "stickering" concept) is to transform the brochure into a mutual fund-like prospectus, which many investors will not read.27 A narrative brochure that is likely to be in excess of 20 or 30 pages will not achieve its intended goal of providing clients with important information in an easy-to-read format.
B. The Brochure May Create New Legal Obligations
Investment advisers already make disclosures regarding many of the topics listed in proposed Part 2A. The Release, however, requires a new level of detail for each topic, as well as repeated requests for descriptions of policies and procedures. We are concerned that the requirement of policies and procedures for every potential issue that may conceivably arise implies a new regulatory regime that has never been properly proposed, reviewed, and approved. If so, this relatively short comment period is not sufficient to respond. Previously, the Office of Compliance Inspections and Examinations has urged investment advisers to adopt internal controls to give examiners confidence in the adviser and to streamline examinations (so-called "smart" exams).28 It has not previously been suggested that advisers must have these policies and procedures in place as a matter of law. We are aware of no violation of law that would occur, absent other specific violations, based on lack of policies and procedures alone regarding any particular topic (other than insider trading).29 Should the Commission desire advisers to have such policies and procedures - for example, to adopt a code of ethics, a requirement the ICAA strongly supports30 - it should propose regulations for comment in due course.
C. The ICAA Proposes An Alternative Approach
We propose an alternative approach to improve disclosure to clients. As is currently the rule, the Commission should require investment advisers to succinctly discuss potential conflicts of interest and certain other items listed in proposed Part 2A, but should not require details regarding the firms' policies and procedures for each topic. Instead, the adviser should prominently and explicitly offer to provide further information about the firm's policies and procedures to any client upon request. We believe that a simple, clear 10-page document is all that a client would or should be expected to read. In our item-by-item comments listed in Appendix B, we discuss areas in which disclosure could be streamlined.
To supplement and explain the information presented in firm brochures, the Commission could prepare an educational brochure for advisory clients, discussing in plain English potential conflicts of interest and suggesting questions to ask advisers or prospective advisers. The Commission recently issued such a booklet explaining variable annuities and suggesting questions to ask before investing.31 The Commission has also created a web page entitled Protect Your Money, which advises prospective clients to obtain advisers' and brokers' disciplinary history and to ask advisers to deliver both Part I and Part II of current Form ADV.
We understand that the Commission believes that conflict of interest information is specific to each firm and hopes that disclosure will not be boilerplate. But realistically, some boilerplate is inevitable because certain potential conflicts of interest and policies are fairly common across the profession, necessitating similar disclosure.32 Common issues that could be explained in the SEC's brochure include soft dollars, directed brokerage, commission recapture, fees, compensation, personal trading, risk of loss, and custody.
Advisers could be required to provide the SEC's educational brochure to each prospective client. Or the Commission could display the brochure on its website and direct firms to alert clients to it. The ICAA would be pleased to assist the Commission in drafting such a booklet. The Commission's explanation of Part 2A in the Release already is a significant step in that direction.
VI. Part 2B
Part 2B is a newly required "brochure supplement." The Commission proposes to eliminate current Schedule D and instead require firms to provide each client with a supplement that describes the advisory personnel who (a) regularly communicate investment advice to that client or (b) formulate investment advice for that client (unless part of a team or committee) or (c) make discretionary investment decisions for the client's assets.33 The intent is to provide a client with useful information about the employees relevant to that client, rather than general information about the executive officers or members of an investment committee of the firm. While this intent is laudable, we describe below its logistical difficulties, as well as alternative approaches. An item-by-item discussion of Part 2B as currently proposed is located in Appendix C.
A. Part 2B is not feasible
The brochure supplement concept may be well-tailored to small advisory firms, but is unrealistic and unworkable when applied to large organizations. In small advisory firms with only a handful of supervised persons, drafting, reviewing, delivering, and amending brochure supplements for a finite number of persons may be feasible. In larger organizations, however, it would be an administrative hardship to draft, deliver, and update brochure supplements for hundreds or even thousands of supervised persons, not to mention the obligation to track delivery of the supplements. For example, one client of a large investment adviser could have several portfolio managers for different market sectors providing advisory services to the account, several individuals communicating the portfolio managers' actions or investment advice to the client, and a marketing or relationship employee also in contact with the client. Thus, a firm could be required to send close to a dozen brochure supplements, in addition to a lengthy brochure, to one client.
Not only will large advisers have difficulty complying with the initial drafting and delivery requirements, but also with the continuing obligations proposed. Advisers will be obligated to send supplements for new employees servicing an account, sticker existing supplements, and to maintain books and records to track delivery, offers, and amendments. The relatively frequent addition of a new portfolio manager or internal reorganization of staff will trigger several mailings. The administrative obligations alone would force extensive system changes to track which clients get which brochure supplements, when an offer to deliver was made, and when and which subsequent amendments or stickers were mailed - all on a client-by-client and employee-by-employee basis.
B. Alternative approaches are preferable
In support of the Commission's investor protection mandate, we suggest two alternative approaches to brochure supplements. We believe both of these approaches are more in line with operational realities than the current proposal, yet will still provide comparable investor protections and meet client needs. First, we recommend that investment advisers provide disciplinary information for all management and investment personnel in the brochure, proposed Part 2A. In the alternative, though less preferable, we suggest that the rule require investment advisers to deliver brochure supplements only to retail clients.
1. Expanded Part 2A
As an alternative to brochure supplements, the Commission should require important information be provided to clients about firm personnel in Part 2A rather than in a separate brochure supplement. Part 2A could be expanded to include disciplinary history for all employees who formulate advice for clients, not just for "management persons" as currently proposed.34 The disciplinary history of other employees will already be available through the Internet both in Part 1A and in the Forms U-4 filed by "investment adviser representatives" with the states. The expanded disclosure in Part 2A could be coupled with a prominent offer to provide additional information not only about the persons formulating advice, but also about any employee involved in the advisory process. This could yield more information about more employees than is currently proposed.35
Of the seven disclosure items in the brochure supplements, disciplinary information is by far the most important to advisory clients, a position with which the Commission concurs.36 Indeed, we believe that disciplinary history is more important and understandable to clients than the detailed policies and procedures proposed to be disclosed in the brochure. Under our proposal, the revised Part 2A disciplinary information disclosure item would require disclosure for all persons who determine or formulate general or specific investment advice, regardless of whether they are part of an investment committee. If disciplinary information for management and persons who formulate advice is included in the brochure along with a prominent offer to provide additional information upon request, we believe that clients will have the most vital information disclosed to them and access to any other information they deem necessary.37
The prominent offer of identified additional information could state in plain English:
Additional information on any employee of the firm involved in the advisory process is available, including educational background, business experience, additional business activities, and general compensation policies other than salaries. This additional information is available upon request by calling ( ) ___-____, emailing a request to ___@___ or by mailing a request to ____.
Under this alternative, an advisory client would have immediate access to the most important disclosures - disciplinary information - for the most important advisory personnel - those persons deciding how to invest the client's assets. The client would also have available, upon request, additional information regarding employees involved in the advisory process.38
2. Brochure Supplements for Retail Clients
An alternative, though much less preferable, approach would be a requirement that brochure supplements be delivered only to retail clients - the type of client targeted by the Commission with the brochure supplement concept. Mandated disclosures are not necessary for sophisticated clientele, who often request specific information from investment advisers regarding advisory personnel. Providing brochure supplements to sophisticated clients will not significantly decrease the number and type of inquiries such clients pose to advisers, while greatly increasing the burden on advisers.
The ICAA strongly suggests that the Commission define retail clients as natural persons other than "qualified clients" as defined in Rule 205-3 under the Advisers Act. Thus, in general, retail clients would be natural persons who do not have a net worth of $1.5 million or $750,000 in assets under management of the adviser. Creating a dual standard for sophisticated clients and retail clients is consistent with other Commission rulemakings, such as the definition of "investment adviser representative" issued to implement the Coordination Act39 and the rules governing performance fees.40
Similar to our first suggested approach, the brochure supplements should be prepared only for persons who actually formulate advice, including those who make discretionary investment decisions for clients. Many of these employees serving a retail clientele will fall under the definition of investment adviser representative and will be registered with the state securities commissions. Firms already have to prepare filings (Form U-4) for such individuals with the states. These filings include much of the same information that would be required in the brochure supplement. The Commission could permit firms to deliver Form U-4 to clients voluntarily in lieu of the supplement, so as not to require duplicative efforts.41 This approach will provide retail clients with significant information about the persons providing them counsel.
In closing, we commend the Commission for issuing this historic proposal. This rulemaking encompasses perhaps the most significant changes in the investment adviser registration and disclosure regime since enactment of the Investment Advisers Act of 1940. With appropriate modifications, we are confident that the Commission's proposal will significantly enhance the level of relevant and useful information for investors, provide the Commission and the states with an unprecedented amount of data regarding individual advisers and the advisory profession, and allow investment advisers to achieve efficiencies in meeting their registration and notice filing obligations. We would be pleased to work with the Commission's staff in drafting language to modify appropriately the proposed revisions to Form ADV. Please do not hesitate to contact us if we may provide additional information or clarification to the Commission regarding any of these matters.
KAREN L. BARR
Cc: The Honorable Arthur Levitt
The Honorable Norman S. Johnson
The Honorable Isaac C. Hunt, Jr.
The Honorable Laura Unger
The Honorable Paul R. Carey
Paul F. Roye, Esq.
Robert E. Plaze, Esq.
Marc D. Beauchamp
Specific Comments on Part 1A
Item 1 Identifying information
Item 4 Successions
Item 5 Information about your advisory business
Item 6 Other business activities
Item 7 Financial industry affiliations
Item 9 Custody
Item 11 Disciplinary information
Schedules A and B Direct owners and executive officers/Indirect owners
Specific Comments on Part 2A
Item 1 Cover Page
Item 2 Material Changes
Item 4 Advisory Business
Item 5 Fees and Compensation
Item 7 Methods of Analysis, Investment Strategies and Risk of Loss
Item 8 Disciplinary Information
Item 9 Other Financial Industry Activities and Affiliations
Item 10 Participation or Interest in Client Transactions and Personal Trading
Item 11 Brokerage Practices
Item 14 Custody
Item 16 Proxy Voting Policies
Item 17 Investment Performance
Specific Comments on Part 2B
Instructions to Part 2B
Item 1 Cover Page
Item 3 Disciplinary Information
Item 4 Other Business Activities
Item 6 Investment Advice and Supervision
Item 7 Financial Information
1 The ICAA is a not-for-profit association that exclusively represents the interests of SEC-registered investment advisers. Founded in 1937, the Association's membership today consists of more than 250 investment advisory firms that collectively manage in excess of $2 trillion for a wide variety of institutional and individual clients. For additional information, please consult our web site at http://www.icaa.org.
2 Electronic Filing by Investment Advisers; Proposed Amendments to Form ADV, Release Nos. IA-1862, 34-42620, April 5, 2000 ("Release").
3 This anticipated benefit of the system would be achieved only if all states accept notice filings electronically.
4 E.g., Release at 22.
5 Release at 23.
6 The Commission does not intend to require advisers to file brochure supplements. Release at 68.
7 The Investment Adviser Supervision Coordination Act (Coordination Act) preempts states from regulating investment advisers registered with the SEC. Section 307(a) of the Act, however, provides: "Nothing in this title or any amendment made by this title prohibits the securities commission . . . of any state from requiring the filing of any documents filed with the Commission pursuant to the securities laws solely for notice purposes ...." (emphasis added).
8 Release at 23 n.68.
9 The concept of notice filing is that SEC-registered firms should provide relevant states with copies of documents as notice of what they have filed with the SEC. Most states have been requiring investment advisers to file a copy of their registration document, Form ADV, and any amendments as notice. Some states require only page 1 of Form ADV as notice, along with a fee.
10 Release at 10-11.
11 Release at 12 n.26.
12 Opening Statement of Chairman Arthur Levitt, U.S. Securities and Exchange Commission, Amendments to Form ADV (April 5, 2000).
13 E.g., Letter from ICAA Executive Director David G. Tittsworth to Jonathan G. Katz, Secretary, Securities and Exchange Commission (Jan. 12, 2000); ICAA Report on Pay-to-Play and Investment Advisory Profession (May 15, 2000); Statement of David G. Tittsworth, Executive Director, ICAA, Roundtable on Investment Adviser Regulatory Issues, SEC (May 23, 2000).
14 E.g. Proposed ADV Part 1A, Item 5.B.2 and Item 11.E.2.
15 Interestingly, information disclosed by investment advisers about their firms and their employees is much more extensive and accessible to the public than the information clients receive from broker-dealers and their agents. Broker-dealers are not required to disclose fully all conflicts of interest, business practices, and policies and procedures on Form BD and are not required to provide Form BD to clients.
16 See Release at 14.
17 Release at 48.
18 Release at 51.
19 Release at 9 n.14; General Instructions, Item 8 at pp. 4-5.
20 The definition of "notice filing" in the glossary and the description in Item 2B of Part 1A provide a more accurate statement of law and practice.
21 21 Similarly, in item 8(a) to the Instructions for Part 2A, the Commission asserts that "State laws require you to file paper copies of all brochure amendments with the state securities authorities to which you make notice filings." This statement is inaccurate. Some state laws, for example, currently require notice filers to file only page 1 of Form ADV annually.
22 Release at 19-20.
23 E.g., Michigan Public Employees Retirement System Act, section 13(8)(a); Senate Bill 902, Oklahoma 2nd Session of the 47th Legislative Session (version date May 25, 2000) (to require advisers providing advice to school districts to be registered with the state).
24 We understand that some firms already deliver the brochure annually to all clients for better client relations and ease of recordkeeping.
25 E.g., Release at 39, 129-130.
26 Clients' traditional lack of response to firms' annual offers may be evidence that clients do not feel this type of information is helpful.
27 Indeed, the Commission created the concept of a "profile" prospectus for this very reason, and is in the process of deciding whether to eliminate the requirement that funds regularly deliver an updated prospectus to existing shareholders. E.g. Success and Survival of the Mutual Fund Industry in a Changing World, Remarks by Paul Roye, Director, SEC Division of Investment Management (May 19, 2000).
28 The Commission has frequently accomplished "rulemaking" by inspection or enforcement actions. We oppose this method of regulation. For example, a few years ago, advisers did not describe their allocation or "bunching" policies in their Form ADV. We understand that the inspection staff at that time essentially "forced" advisers to start doing so through a wave of deficiency letters. This is not an appropriate means of informing the profession of new requirements.
29 The only policy explicitly and affirmatively required of advisers by current law is an insider trading policy. Policies and procedures can constitute a safe harbor to a failure to supervise charge pursuant to Section 203(e)(5) of the Advisers Act. Many policies and procedures have implicitly been required or encouraged by no-action letters, interpretive releases, speeches by Commission staff, examinations, and enforcement actions. For example, while we support the Commission's proposed change to Rule 204-3 in the release at n.116, we note the apparently new announcement that a client can terminate the advisory relationship "at any time." Many advisers, however, have client contracts that currently provide for termination by either party upon 10 days or as many as 60 days written notice.
30 See Letter of David G. Tittsworth, ICAA Executive Director, to Arthur Levitt, Chairman, Securities and Exchange Commission (May 16, 2000).
31 Variable Annuities: What You Should Know (SEC web version dated June 5, 2000). See also Mutual Fund Investing: Look at More Than a Fund's Past Performance (SEC web version dated Jan. 24, 2000).
32 The Commission implicitly recognizes this fact, by stating in the instructions to Part 2A exactly what the disclosure should include for certain topics.
33 Before the Coordination Act, advisers were required to provide information on Schedule D not only for management, investment committee members, and persons with disciplinary history, but also for persons "giving investment advice" on behalf of the adviser in particular states (item G). The latter requirement for Schedule D existed only for states' purposes. After the Coordination Act, advisers were no longer required to provide Schedule D information for persons only "giving advice" who did not fit any other category of required Schedule D filers.
34 If this approach is taken, the requirement to disclose general educational standards should be re-inserted into the brochure. That disclosure is currently required in Item 5 of Part II.
35 For example, we understand that some sophisticated clients are requesting and receiving information about trading personnel of an investment adviser.
36 "The most important information in the supplements - the supervised person's disciplinary history - would be reported in the DRP Schedules in Part 1 of Form ADV and available through the IARD." Release at p. 68.
37 If the Commission chooses to make available an educational brochure for investors, as discussed above, it could emphasize the ability of clients to require and obtain information about any employee of the investment adviser involved in the advisory process.
38 This system would work well for the vast majority of investment advisers that employ few, if any, persons with material disciplinary history. Perhaps firms that have a large number of disciplinary disclosures could have the alternative of using the Commission's proposed brochure supplement system so as not to render the brochure too lengthy.
39 Rules Implementing Amendments to the Investment Advisers Act of 1940, Rel. No. IA-1633 (May 15, 1997).
40 Exemption to Allow Investment Advisers to Charge Fees Based Upon a Share of Capital Gains Upon or Capital Appreciation of a Client's Account, Rel. No. IA-1731 (July 15, 1998).
41 Of course, certain private information about the individual filing the U-4 would have to be blocked or deleted, such as any residential addresses or phone numbers, social security numbers, birth dates, and similar personal information.
42 The same issue occurs with proposed Schedule W1 of Form ADV-W
43 Release at 45.
44 Release at 50 and n.156.
45 See Release at 51 (requesting comment on arbitration disclosure).
46 Release at n.160.
47 See Release at 60 (requesting comment on the commission disclosure requirement).
48 Release at 64.
49 Release at 69.
50 Part 2B of Form ADV: Instructions for Preparing a Brochure Supplement.