Changes to Form ADV Take Effect October 1, 2017

09.25.2017

On August 25 of last year, the U.S. Securities and Exchange Commission (the SEC) adopted final rules and amendments to Form ADV,[1] requiring greater specificity from advisers regarding key aspects of their advisory business.  Among the many changes, the new Form ADV: (a) requires detailed information regarding separately managed accounts (SMAs) managed by an adviser; (b) provides for “umbrella registration” for private fund sponsors to register multiple affiliates to an investment adviser on one Form ADV; and (c) requires identification of and information about any persons to whom the adviser outsources the role of chief compliance officer.  Additionally, the SEC adopted amendments to several rules under the Investment Advisers Act of 1940 (the Advisers Act), including the Books and Records Rule (i.e., Rule 204-2), to “modernize” and enhance data reporting by registered advisers, especially with respect to performance information. 

Collectively, these amendments are intended to assist the SEC in its assessment of risk and comparison of information across SEC data sets (e.g., Form ADV and Form PF data) and to provide the SEC with a greater understanding of registered advisers, their client relationships, and their management of client assets.  Since the release of the final rules last August, the SEC has received several requests for clarification about the new requirements in Form ADV, and the staff of the SEC has responded by updating the Frequently Asked Questions (FAQs) on Form ADV to provide additional guidance.[2]

Although the amendments became effective on October 31, 2016, the compliance date for the amendments was set for October 1, 2017.  Accordingly, any adviser filing an initial registration, or an annual or updating amendment to its current Form ADV after October 1 will need to complete the amended form.  To prepare for these changes, we recommend clients begin collecting the newly required information immediately.

Form ADV – Separately Managed Account Disclosure

Several of the more significant changes in Form ADV require specific information about SMAs managed by an adviser.  According to the new instructions, an SMA is any account other than pooled investment vehicle managed by the adviser (e.g., registered investment companies, BDCs or private investment funds).  Advisers will need to analyze their client accounts to determine whether such accounts are SMAs and, therefore, subject to these additional information requirements.

Information provided on adviser’s SMA will depend, in part, on the amount of regulatory assets under management managed through such accounts (“SMA-AUM”).  The greater the SMA-AUM, the more detail the adviser will have to disclose – all of which will be publicly available on the SEC online database (IARD).  Required information will include the following:

• Asset Allocation.  An adviser will need to provide the aggregate amount of SMA-AUM and an approximate percentage breakdown of how such SMA-AUM is invested across twelve pre-defined categories.[3]  For advisers with less than $10 billion in SMA-AUM, the new rules require such adviser to report the breakdown as of year end, as part of their annual update.  However, for advisers with more than $10 billion in SMA-AUM, the new rules require such adviser to provide both the mid-year and year-end breakdown in their annual update.
• Use of Borrowings and Derivatives. [4]  Advisers will need to provide information on the use of borrowings[5] and derivatives[6] in the SMAs, including the “gross notional exposure” of such borrowings and the “gross notional value” of the derivatives held in such accounts. 
  • Advisers with at least $500 million but less than $10 billion in SMA-AUM are required to report the dollar amount of SMA-AUM that, at year-end, falls within three categories of gross notional exposure: (a) less than 10%, (b) 10-149% or (c) 150% or more; and
  • Advisers with at least $10 billion in SMA-AUM are required to report, in addition to the information required above, both the mid-year and end-of-year gross notional value of derivative exposure across six categories:interest rate, foreign exchange, credit, equity, commodity and “other” derivative exposures.

In both cases an adviser may, but is not required to, exclude reporting on SMA accounts with AUM of less than $10 million.  Also, an adviser may include a narrative description of the way in which borrowings and derivatives are used in its strategies if it believes that the gross notional metrics reported in Section 5.K., by themselves, would be misleading without further explanation.

• Custodians.  Any custodian (and the location of such custodian’s office) that holds at least 10% of an adviser’s SMA-AUM must be identified in Form ADV, as well as the amount of SMA-AUM held by such custodian.[7]

It should be noted that registered advisers managing SMAs for clients outside the United States are required to include such SMAs in the aggregate information provided in Section 5.K., even if the adviser’s principal offices and places of business are also outside of the United States. 

Although not discussed in detail in the adopting release, we can expect the SEC to look for descriptions of an adviser’s management of SMAs in Part 2 of Form ADV consistent with the information provided in the amended Part 1A.

Umbrella Registration

When the Dodd-Frank Act repealed the private adviser exemption[8] from SEC registration, many private investment fund advisers were forced to register with the SEC for the first time.  What became unclear, however, was whether private fund advisers should also register separate but affiliated legal entities that essentially operated with the adviser as a single advisory business (e.g., general partners and limited partnerships).  Adding to the uncertainty was the fact that Form ADV was designed only to accommodate the registration of a single legal entity.  Thus, a private fund adviser operating several separate legal entities may have had to file multiple registrations on multiple Form ADVs, even though the registrations were in essence for the same advisory business.

In 2012 the SEC issued guidance in the form of a no-action letter to the American Bar Association,[9] allowing certain advisers to file Form ADV on their own behalf and on behalf of other “relying advisers” (i.e., advisers that are controlled by or under common control with the filing adviser), if they conducted a single advisory business.  Unfortunately, the problems with Form ADV remained, and this created additional confusion and inconsistencies around this new “umbrella” registration process. 

Through these amendments, the SEC seeks to codify the “umbrella” registration concept and simplify the process by providing applicable new sections in the Form ADV. Though not required, umbrella registration will provide more reliable information about private fund advisers and affiliated “relying advisers” that operate a single advisory business through multiple entities.

Conditions for Umbrella Registration

The amendments to Form ADV’s General Instructions establish conditions for umbrella registration that are substantially similar to the conditions established in the SEC’s ABA No-Action Letter:

1.  The filing adviser and each relying adviser advise only private funds and SMAs that include investors that are “qualified clients” (as defined in Advisers Act Rule 205-3) and are otherwise qualified to invest in such private funds and SMAs; and the private funds and SMAs advised by each relying adviser pursue investment objectives and strategies that are substantially similar to the private funds and SMAs advised by the filing adviser;

2.  The filing adviser’s principal office and place of business is in the United States;

3.  The filing adviser supervises and controls each relying adviser, its employees and the persons acting on its behalf, and each relying adviser, its employee and person acting on its behalf are “persons associated with” the filing adviser, as defined in the Advisers Act;[10]

4.  Each relying adviser’s advisory activities are be subject to the Advisers Act, and each relying adviser is subject to examination by the SEC; and

5.  The filing adviser and each relying adviser operate under a single code of ethics[11] and a single set of written policies and procedures,[12] which are overseen by the same chief compliance officer.

Umbrella registration is available only to registered investment advisers and not to exempt reporting advisers (ERAs).

Schedule R – Relying Adviser Information for Umbrella Registration 

A new schedule is being added to Form ADV where advisers will list information about each relying adviser in an umbrella registration.  Schedule R discloses certain information about each relying adviser, such as identifying information, the basis for SEC registration and separate reporting of indirect and direct ownership.  Advisers will also need to disclose in Schedule R any relying advisers that manage or sponsor the private funds reported in Section 7.B.(1) of Schedule D.

Umbrella Registration Reporting Information

The Form ADV General Instructions[13] are being amended to include details on filing umbrella registration requests, the timing of filings and umbrella registration amendments.  The filing adviser is required to file (and update, as necessary) a single Form ADV that includes all information regarding the filing adviser and each relying adviser.  The filing adviser must also include this same information in any other reports or filings (e.g., Form PF)  it must make under the Advisers Act.

Additional Investment Adviser Disclosures

In addition to the new information required for SMAs and relying advisers, the SEC has added several new questions to the Form ADV and revised several existing questions relating to an advisers’ identifying information, advisory business, and affiliations. 

Identification and Operations Information 

Included in the amendments are the following notable changes regarding the identity and operations of an adviser:

• CIK information:  Currently, Form ADV Part 1 requires an adviser to provide a Central Index Key Number (“CIK Number”) if the company is a public reporting company.  This section was revised to require an adviser to provide CIK Numbers for any affiliate that has a CIK Number,[14] regardless of its status as a public reporting company.[15]
• Social Media Sites:  An adviser is currently required to disclose whether it has one or more websites and the addresses of each such site.  The amended Form ADV requires an adviser also to list any social media accounts where the adviser controls the content (such as Twitter, Facebook or LinkedIn) and the address of each social media website or page.
• Office Location and Business Activity.  Currently, advisers are required to provide their principal office address and place of business.  The amendments requires information for the largest 25 offices (according to number of employees), each such office’s FINRA CRD branch number (if any), the number of employees who are involved in the advisory business at such location and outside business activities conducted there, including any other investment-related activities.  Advisers associated with banks, insurance companies, brokerage firms and CPAs and which share offices with such entities, will need to pay particular attention to accurately describing the other business activities that occur at those locations.
• Chief Compliance Officer Outsourcing.  Form ADV currently requires each adviser to provide the name and contact information of its CCO.  The amendments require an adviser to also report whether its CCO is employed or compensated by (a) any person other than the adviser (or one of its related persons) or (b) a registered investment company managed by the adviser.  If compensated by another person, the name and IRS Employer Identification Number of that person must be provided.

Many small and mid-sized advisers use compliance consultants or lawyers to provide outsourced CCO services.  These Form ADV changes will require transparency with respect to that relationship, and provide the SEC greater opportunity to scrutinize the qualifications of the outsourced CCO and the firm providing the services.

Range of Asset Amount.  Form ADV Part A presently asks whether an adviser has $1 billion or more in AUM at the end of the most recent fiscal year.  The amendments require more specificity by adding 3 more identifying categories:  $1 billion to less than $10 billion; $10 billion to less than $50 billion; or $50 billion or more.

Additional Information About Advisory Business

The amended Form ADV will require the following additional information about the adviser’s business:

• Currently, an adviser is required to indicate an approximate range for the number of advisory clients, the type of advisory clients, and AUM attributable to those categories.The amendments now require an adviser to report the number of clients and amount of AUM with respect to each category of clients, as of the date the adviser determines its AUM for the filing.
• The amendments also require advisers to report the number of clients for whom they provided advisory services but do not have AUM. This is applicable to advisers who produce research and marketing industry reports for clients and other advisers.
• An adviser will now have to provide the approximate amount total AUM attributable to clients that are non-United States persons.
• Section 5.G.(3) of Schedule D currently requires an adviser to report the SEC File Number for these registered investment companies and business development companies to which it serves as an investment adviser. The amendments will require an adviser to report the AUM of all “parallel managed accounts”[16] related to such registered investment companies (or series thereof) or business development companies.
• Item 5.I currently requires an adviser to specify whether it acts as a sponsor of, or portfolio manager for, a wrap fee program. The amendments now require the adviser to indicate whether it participates in such wrap fee program and the total amount of AUM attributable to such program.

Section 5.I.(2) of Schedule D currently requires an adviser to list the name and sponsor of each wrap fee program for which the adviser serves as portfolio manager. The amendments now require an adviser to also provide any SEC File Number and CRD Number for sponsors to those wrap fee programs.

Additional Information About Financial Industry Affiliations and Private Fund Reporting

• Questions are being added to Section 7.A. and 7.B of Schedule D requiring disclosure of an adviser’s related persons’[17] CIK number, if any, and financial service providers’ Public Company Accounting Oversight Board (“PCAOB”) or registration numbers.
• A question is also being added to Section 7.B.(1) of Schedule Dto require an adviser to a private fund that is excluded from the definition of investment company under section 3(c)(1) of the Investment Company Act of 1940 to report whether it limits sales of the fund to “qualified clients,” as defined in Rule 205-3 of the Advisers Act.

Clarifying, Technical and Other Amendments to Form ADV

The SEC is adopting other minor amendments throughout the Form ADV instructions, Glossary of Terms,[18] titles and questions for clarification and to make the information reported on Form ADV more consistent.  Certain conforming Amendments to the General Instructions and Glossary of Terms are also being adopted with respect to umbrella registration.

Amendments to Investment Advisers Act Books and Records Rule (Rule 204-2)

The SEC is adopting two amendments to the Advisers Act Books and Records Rule (Rule 204-2) that will require advisers to retain certain materials relating to the calculation and distribution of performance information in an effort to protect investors from misleading or fraudulent performance claims:

Removal of Ten Person Minimum for Communication Retention

Rule 204-2(a)(16) currently requires registered advisers to maintain records supporting performance claims in communications that are distributed or circulated to ten or more persons.[19] This Rule is being amended to state that advisers will be required to maintain materials that demonstrate the calculation of the performance or rate of return in any communication that the adviser circulates or distributes to any person.

Advisers that circulate or distribute communications regarding performance after October 1, 2017 (including information on performance that predates October 1, 2017) will be required to maintain the materials listed in Rule 204-2(a)(16) that demonstrate performance calculation.

Retention of Written Performance Communications

Rule 204-2(a)(7) currently requires registered advisers to maintain certain categories of written communications it sends and receives.[20]  The amendments will require that advisers  also maintain originals of all written communications received and copies of written communications sent by an adviser relating to securities recommendations or the performance of managed accounts.

Conclusion

The increased specificity reflected in the SEC’s amendments to the Form ADV demonstrate that the agency is looking for more information from registered advisers for not only disclosure purposes and conducting exams, but to populate their data sets and continue their development of risk analysis and algorithms.

As with all disclosures in Form ADV, advisers will need to scrutinize their contracts, compliance manuals, internal documentation and marketing materials to make sure they are consistent with this new information.

If you have any questions or require assistance with the completion of your initial or next update and filing of the Form ADV, please contact one of the partners in our Investment Management Group.  For your convenience, we are including a link to the redline comparison of the changes to the Form ADV provided by the SEC and available at https://www.sec.gov/rules/final/2016/ia-4509-form-adv-summary-of-changes.pdf.

[1] SEC Release No. IA-4509; File No. S7-09-15 (Aug. 25, 2016), available at: https://www.sec.gov/rules/final/2016/ia-4509.pdf (the “Adopting Release”). 

[2] FAQs on Form ADV and IARD are available at:  https://www.sec.gov/divisions/investment/iard/iardfaq.shtml. 

[3] Section 5.K.(1) of Schedule D.  The 12 categories are: Exchange-Traded Equity Securities; Non-Exchange-Traded Equity Securities; U.S. Government/Agency Bonds; U.S. State and Local Bonds; Sovereign Bonds; Investment Grade Corporate Bonds; Non-Investment Grade Corporate Bonds; Derivatives; Securities Issued by Registered Investment Companies or Business Development Companies; Securities Issued by Pooled Investment Vehicles (other than Registered Investment Companies or Business Development Companies); Cash and Cash Equivalents; and Other.

[4] Section 5.K.(2) of Schedule D.

[5] According to the SEC Staff, a “borrowing” for purposes of Section 5.K. includes “traditional lending activities such as client bank loans and margin accounts, other secured borrowings and unsecured borrowings, synthetic borrowings and transactions involving synthetic borrowings (e.g., total return swaps that meet the failed sale accounting requirements), transactions selling securities short, and transactions in which variation margin is owed, but as a result of not reaching a certain set threshold, has not been paid by the client,” but does not include leverage embedded through the use of derivatives, securities lending or repurchase agreements.  FAQ, Q. Item 5.K.(2).

[6] “Derivatives” is not defined in the instructions to Form ADV, but the SEC takes the position that it has the same meaning as used in Form PF and should be interpreted consistently with any reporting on that form.  See Release No. IA-4509, p. 21.

[7] Section 5.K.(3) of Schedule D.

[8] Section 203(b)(3) of the Advisers Act (the “private adviser exemption”) previously exempted any investment adviser from registration if the investment adviser (i) had fewer than 15 clients in the preceding 12 months, (ii) did not hold itself out to the public as an investment adviser and (iii) did not act as an investment adviser to a registered investment company or a company that elected to be a business development company.

[9] See American Bar Association, Business Law Section, SEC No-Action Letter (June 18, 2012), available at https://www.sec.gov/divisions/investment/noaction/2012/aba011812.htm.

[10] See Section 202(a)(17) of the Advisers Act.

[11] As adopted in accordance with SEC Rule 204A-1.

[12] As implemented in accordance with SEC Rule 206(4)-7.

[13] The revised General Instructions can be viewed here:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-a.pdf.

[14] The SEC assigns CIK numbers in EDGAR to identify a public reporting company and other purposes, such as if the entity is a transfer agent.

[15] As defined in Sections 12 or 15(d) of the Securities Exchange Act of 1934, as amended.

[16] “Parallel managed account” is defined in the Form ADV Glossary as: “With respect to any registered investment company or series thereof or business development company, a parallel managed account is any managed account or other pool of assets that you advise and that pursues substantially the same investment objective and strategy and invests side by side in substantially the same positions as the identified investment company or series thereof or business development company that you advise.”

[17] “Related Persons” is defined in the Form ADV Glossary as: “Any advisory affiliate and any person that is under common control with your firm.”

[18] The revised Glossary of Terms can be viewed here:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-c.pdf.

[19] Rule 204-2(a)(16) requires advisers to make and keep “All accounts, books, internal working papers, and any other records or documents that are necessary to form the basis for or demonstrate the calculation of the performance or rate of return of any or all managed accounts or securities recommendations in any notice, circular, advertisement, newspaper article, investment letter, bulletin or other communication that the investment adviser circulates or distributes, directly or indirectly, to 10 or more persons (other than persons connected with such investment adviser); provided, however, that, with respect to the performance of managed accounts, “the retention of all account statements, if they reflect all debits, credits, and other transactions in a client's account for the period of the statement, and all worksheets necessary to demonstrate the calculation of the performance or rate of return of all managed accounts shall be deemed to satisfy the requirements of this paragraph.”

[20] Rule 204-2(a)(7) requires advisers to make and keep: “Originals of all written communications  received and copies of all written communications sent by such investment adviser relating to (i) any recommendation made or proposed to be made and any advice given or proposed to be given, (ii) any receipt, disbursement or delivery of funds or securities, or (iii) the placing or execution of any order to purchase or sell any security.”