The Consortium, Nancy Lininger
PO Box 2682, Camarillo, CA 93011-2682
June 12, 2000
Jonathan G. Katz, Secretary
450 Fifth St. NW
Washington DC 20549-0609
RE: File No. S7-10-00
Electronic Filing by Investment Advisers
I appreciate the opportunity to comment on the proposal. I am in support of the electronic filing system. As a compliance consultant I have hands-on experience with the Form ADV and registration process as it applies to a broad range of investment advisory operations. I have numerous comments with both the small and large investment adviser ("IA") in mind.
II.C. Transition: The SEC expects to publish a schedule by which IAs will resubmit Form ADV Part I through the IARD. Since implementation will begin late in the year, IAs will be gearing up for and busy with client year-end tax and financial planning and portfolio reporting. Therefore I recommend that the transition be allowed through year-end - including up to 90 days after the December 31 fiscal year end. This coincides with the time of year (normal deadline) most IAs know they have to review Form ADV for the annual updating. Assuming an August approval, I believe it is expecting too much of the industry (which includes numerous small firms) to absorb and implement such drastic changes before the end of the year. Also since a number of IAs already rely on consulting firms (filing services or service bureaus), the consulting firms could meet the demand if allocated enough time.
It is also my recommendation that Part 2A filings could commence as early as 1/1/01 and overlap the Part 1 filings. Those IAs who will have filed prior to 12/31/00 will have the ability to file Part 2A immediately after 1/1/01. Those IAs who will be making their first submission of Part 1 after 1/1/01 would have the ability to file Part 1 and Part 2A concurrently. Again because this is the time of year this task is usually focused on, it would not be burdensome to submit both Parts at one filing.
If Part 2A is first accepted by IARD on 1/1/01, per the proposal, the first annual update after that (ergo requirement to file Part 2A by) could be as late as 90 days after 12/31/01. Is that the intent to let the implementation go on that long? If the intent is to populate the database prior to that date, then I would recommend that IAs be allowed to file Part 2A within 180 days after the 12/31/00 fiscal year end. This would mean a second quarter end deadline.
Annual updating and offer: I do not think it is burdensome to require a reprint of a clean document annually. IAs are accustomed to this schedule and it would force a full review of the ADV on a timely basis. It is my understanding that the "annual offer" still stands as just an offer. The exception would be a new delivery requirement only if (and at the time of) material inaccuracies. It would be helpful if the SEC would publish a (non-inclusive) list of material changes that would prompt the delivery requirement.
Brochure cover page: To accommodate marketing design, I would like to see the cover page requirement allowing the option of being an inside cover page. The front cover can therefore have a design and color theme to tie into corporate literature. This would make the document less intimidating to investors and enhance the chances that they will open and read the booklet.
Material changes: It is unnecessary for new clients to receive a disclosure brochure that summarizes material changes, as this would actually be immaterial for new clients who would be reading current information for the first time. I also question the requirement of a separate cover letter that would go to existing clients summarizing the material changes. When a clean full disclosure document is being delivered, it is redundant to create yet another document with summary details. By virtue of the fact that this would be going to persons with an existing relationship, and they would be getting notice that changes have occurred by virtue of receiving the updated brochure, the client should then have sufficient notice and be able to decide for themselves if they want to read the new document. I really think what the IA should detail in the cover letter is more of a facts and circumstances situation. The IA should decide if the material changes warrant special attention in the cover letter.
I recommend that the SEC require a separate letter which explains that the brochure is being sent because of material changes and that certain changed items may need to be called out in the letter, but without requiring that all the material changes be summarized.
Fees and compensation: IAs should (as now required) provide full disclosure about their advisory fees, including that the client may bear other costs (brokerage commissions and other brokerage fees). Conflicts such as participation in commissions (transaction based compensation) also should be (and is currently) required to be disclosed. However it is impractical to require the disclosure of amounts (or ranges) of brokerage and other outside third party fees. There may be numerous relationships, changing relationships, and each of these outside firms may change their fee schedules at differing times during the year. It would be a burden for the IA to attempt to keep these fee schedules up to date, even by sticker. It would be too cumbersome for investor readability to wade through multiple outside entity fee structures. Clients will be made aware of the applicable outside fees by way of the commission schedules published by the BD, and the custodial fees published by the custodian - at the time those relationships are entered into by the client. It would not be meaningful disclosure to the client to know IRA custodial fees at the time of opening an individual account with the IA. But it would be meaningful down the road when the client opens that account and gets the information/new account package as published by the custodian.
Disciplinary information: A full disclosure brochure should be a full disclosure brochure. Everything a client needs to read should be found in one source. (With the exception being Part 2B advisory affiliate supplement where there is a logical reason to give this data selectively.) Therefore disciplinary information should appear in the main brochure itself. The importance of this information is just as important as all the other full disclosure. Regulatory audits of IAs will comment on inadequate disclosure in the brochure of any required disclosure.
As proposed, an IA subject to an administrative order would require that the client/prospective client be provided with a copy of the order for a period of one year. I recommend that the ADV offer to deliver a copy of the order. The essence of the action taken should be properly disclosed in the ADV as should any disciplinary event. Many clients will not want to be burdened with a legalese document, while those clients who do want it should have the option. Since this is a material change to the ADV, it would trigger a new brochure update to be sent to existing clients. Prospects and clients will have adequate notice about the event.
I believe that as much as possible, that disclosure by federal covered IAs should mirror disclosure by state registered IAs. This will facilitate investor readability/comparison shopping. This will also facilitate ease of IAs understanding their disclosure responsibilities and making the seamless transition between state and federal registration. If state authorities require disclosure of arbitration claims in excess of $2,500, then that should be the SEC criteria.
Other financial industry activities/affiliations: If the IA selects or recommends other IAs for the clients, disclosure should be made (as currently required) of compensation arrangements, affiliations, and conflicts. Current solicitor rules/disclosure require that the exact amounts of compensation be made at the time the solicitation is made. It would be burdensome to disclose in the ADV the exact (or range of) compensation arrangements with numerous firms. Relationships change and the outside IA fee schedules change. This is similar to the objection on disclosing the amounts charged by BDs. I have seen ADVs where IAs attempt to in good faith disclose all these fee arrangements. It makes for a very unreadable ADV when there are multiple outside relationships. It is only meaningful for the client to see at the time a particular outside IA is recommended. Therefore the ADV should include disclosure that the IA may receive a portion of the account fee or commissions, and in these instances the IA will make available to the client a "Compensation Disclosure Statement" and the Form ADV for the other adviser. Current solicitor rules handle this task very nicely.
Custody (Item 13): A number of firms (especially those affiliated with accounting firms) may have inadvertent custody because the affiliated firm has checkwriting signatory authority. This should be another specified exception to the custody disclosure that most IAs do not impose custody and that clients face a greater risk than if an independent custodian held their assets.
Financial information: To promote uniformity and client understanding when comparing firms, all firms that have custody (including banks, insurance companies, and broker/dealers) should be required to provide audited balance sheets. The logic for the proposal to exclude certain types of companies is that these other firms have net capital requirements. This raises a comment on another matter outside of the proposal but that might have an effect on the proposal. There exists now a discrepancy between state registered IAs that have net capital requirements and federal covered IAs that do not. It seems counter to investor protection that the large IAs (those with more client assets) can get away with having no minimum net capital requirements. I recommend that the SEC consider net capital requirements similar to NASAA guidelines for the states. This would then put all IAs on a level playing field and put federal covered IAs on a level playing field with other financial services entities (specified above) that have net capital requirements.
Bankruptcy disclosure: This disclosure should be provided to clients for events during the past 10 years for the RIA, its officers/owners/directors, other control persons, and for Part 2B advisory affiliates.
Part 2A Appendix 1 (Wrap Fee Brochure): As is the case with current Schedule H, the proposal requires a separate wrap fee brochure. I recommend a revision from current and proposed practices that wrap fee programs be made by a separate brochure. It should be optional for those IAs who want to deliver a separate wrap fee brochure. However, some IAs would prefer one brochure that describes all programs, including the wrap programs. I am aware of firms who were interested in offering a wrap program, but so as to avoid the burden of creating yet another brochure, restructured the fees so the client would pay two costs.
Part 2B: Supplement information about advisory personnel is a valuable way to cut down unnecessary text in the main brochure that go to all clients, but that the client gets information on the applicable affiliate none-the-less. I am also in favor that IAs would have the option of using the main brochure for this information should it fit.
I support the conclusion that filing the supplements would be costly and burdensome both on the IARD/SEC and the IA. These supplements will be available for regulatory review during audits of the IA. I know from experience that this is a practical solution. Since the ADV does not currently require a complete listing of all affiliates for large firms, it is a procedure that I have recommended and implemented as a consultant, so that clients may get full disclosure.
Part 2B item 6 (investment advice): I have found that when supervised persons in a large firm formulate the advice that their services may differ from that of a different supervised person. "Who" formulates the advice is not sufficient detail. Part 2A main brochure may not be able to provide the necessary level of detail when there are multiple supervised persons each formulating advice to their own clientele. Therefore when broad umbrella disclosure is found in Part 2A because of these situations, then 2A type information may need to be repeated in more detail in Part 2B. This would include: services offered, fee arrangements, whether fees are negotiable, types of investments, methods of analysis, sources of information, investment strategies, other business activities, other financial industry activities or affiliations, conditions for managing accounts, frequency of reviews and reports, and any other material disclosures.
Revisions: The IARD will pre-populate "most" of the items from the previous filing. To avoid inadvertent revisions and to promote consistency, I question which items will not be populated? Should not all data be pre-populated?
PROPOSED FORM ADV
Schedules A, B, C: I'm in favor of having one consolidated schedule of direct owners/officers, and a separate consolidated schedule of indirect owners regardless of the type of legal entity. While I understand that Schedule C for amendments to Schedule A or B mirrors Form BD, I propose that it is confusing. Schedule C only reflects piecemeal changes. Therefore when the firm is relying on paper copies for historical documentation, over the years it requires piecing together information to try to get a complete picture. If the new Schedule A and B were like other pages of the current Form ADV, an amendment would require a complete filing of that page showing all current information (a complete snapshot in time). It would be easier for revisions if the Schedule A would be pre-populated with the information, and then changes could be made on that same page.
Since very often there may be more than 5 owners/officers, I would like more room on Schedule A (and B) to fill in actual data. This can be accomplished by extending the bottom margin. While additional Schedule A's or B's can be added if needed, there is no reason not to accommodate more names on one page.
Schedule D: I will assume that this is a page that would not be pre-populated for revisions. How would old data from areas such as Section 1.B or 1.I be deleted?
Since Section 1.B only allows for 2 entries (and Section 1.F one entry), additional information would need additional pages. This gets very lengthy for the historical paper trail for firms with 20, 200, or 2,000 affiliates/individual branch offices. Although for Section 1.F for SEC firms, only the 5 largest offices need be listed, for state IAs, all would need be listed. (There are some large financial planning type firms that are state registered.) I am aware of at least one firm that is federal registered with 20 plus one-person offices. Therefore there would be no 5 largest in terms of employees.
If more room is needed, I would like to see Schedule D supplemented with a more open format page similar to the current Schedule E. This accommodates the listing of many offices on one page versus virtually one page for each office. This would also allow information to be tied together so that the local area business name can be tied to the applicable office address which is tied to the applicable web address. Under the proposed Schedule D it is unknown if the data in Section 1.B relates to the office in Section 1.F and if that relates to the web address in Section 1.I.
Filing Services: It is important to accommodate filing services/service bureaus (compliance consultants) to assist firms in completing Form ADVs. These firms are familiar with the SEC and state rules, regulations, and disclosure requirements. The filing service should be able to draft the on-line ADV, send it to the IA for review, back to the filing services for revisions, and finally to the IA for final review/acceptance and electronic signature/submission. In an ideal world this process may take 30 - 60 days. Sometimes less, and sometimes it takes longer. Therefore the draft of the ADV should have a 90 day life on-line. I also think it is important to be able to download the ADV draft so that these draft revisions can go back and forth between the IA and the filing service without being subject to on-line scrutiny by the regulators. Finally, the filing service should have access to the filed form to prepare revisions.
Thank you for your consideration of these suggestions.