June 28, 2022

Volume XII, Number 179


June 27, 2022

Subscribe to Latest Legal News and Analysis

SEC Amendments to Form ADV and Recordkeeping Rules Go into Effect on October 1

The amended Form ADV, which goes into effect October 1, 2017, will require investment advisers to expand the information they report on Form ADV about separately managed accounts and other important aspects of their advisory business. The SEC also adopted a number of other amendments to the Form ADV and certain rules under the Investment Advisers Act of 1940 that include permitting consolidated investment adviser registrations for certain private fund advisers that operate a single advisory business through multiple entities, amending the Advisers Act books and records rule to require investment advisers to maintain additional information supporting performance claims, and making certain other clarifying and technical amendments to the Form ADV and Advisers Act rules.

On August 25, 2016, the US Securities and Exchange Commission (SEC) announced the adoption of amendments to Form ADV and certain Investment Advisers Act of 1940 (“Advisers Act”) rules (collectively, the “amendments”).[1] The amendments substantially expand the information required by Form ADV Part 1A to include more detailed information regarding an investment adviser’s separately managed accounts (SMAs) and other aspects of an adviser’s business activities. The amendments also implement a number of other amendments to Part 1A, including (i) a new mechanism for certain private fund adviser entities (relying advisers) to make consolidated or “umbrella” registration filings, (ii) provisions requiring additional information about an adviser’s business activities and affiliations, and (iii) certain clarifying and technical amendments to existing items and instructions. The SEC indicated in its Adopting Release that the amendments to Form ADV are designed to improve the depth and quality of information that the staff collects on investment advisers, facilitate risk-monitoring initiatives, and assist in the SEC staff’s risk-based examination program. In addition to implementing changes to Form ADV, the amendments also modify the recordkeeping rules under the Advisers Act to require the maintenance of additional records supporting the calculation of performance claims and make certain clarifying and technical amendments to Advisers Act rules.

The amendments will greatly impact the disclosure requirements of investment advisers. As adopted, the amendments to Form ADV contain a number of modifications to those that were originally proposed on May 20, 2015 (the “Proposed Rules”)[2] in order to address concerns raised by commenters during the comment period. Below, we discuss key aspects of the Adopting Release and its significant implications for investment advisers.

Data Collection and Reporting of Separately Managed Accounts on Form ADV

The amendments modify existing Item 5 of Form ADV Part 1A, and Section 5 of Schedule D, to require advisers to report information on an aggregate level regarding the SMAs that they manage. For purposes of Form ADV reporting, the Securities and Exchange Commission (SEC) considers a “separately managed account” to be any investment advisory account other than pooled investment vehicles (i.e., registered investment companies, business development companies, and pooled investment vehicles that are not registered with the SEC, such as private funds). The stated rationale for the amendments to Form ADV is to collect detailed information for SMAs similar to that which the SEC already collects for pooled investment vehicles, in order to “better understand” how such assets are invested across the industry and enhance the SEC’s risk-monitoring and risk-based examination activities. The types of information that advisers will be required to report regarding SMAs include

  • the percentage of an adviser’s regulatory assets under management (RAUM) attributable to SMAs it manages in each of 12 broad asset class categories;

  • the RAUM, and use of derivatives and borrowings, for SMAs that it manages; and

  • information regarding the custodians who hold 10% or more of an adviser’s aggregate RAUM attributable to SMAs that it manages.

Similar to the existing reporting regime under Form PF relating to private funds, the amount of detail that an adviser will be required to report on amended Form ADV will be determined by the level of the adviser’s RAUM attributable to SMAs. The more SMA assets that the adviser manages, the more data and information it will be required to report regarding the holdings and exposure of such accounts:

  • Advisers with RAUM of up to $500 million attributable to SMAs – Advisers with up to $500 million of RAUM attributable to SMAs will be required to report, in new Section 5.K.(1) of Schedule D, the approximate percentage of RAUM that is attributable to SMAs across 12 broad asset categories, which reflects an increase from the 10 categories initially proposed. Such advisers will be required to report these percentages on an annual basis through the annual updating amendment to Form ADV.

  • Advisers with RAUM of at least $500 million but less than $10 billion attributable to SMAs – Advisers with at least $500 million but less than $10 billion of RAUM attributable to SMAs will be required to report the information above concerning the approximate percentages of their RAUM that is attributable to SMAs across the 12 asset categories on an annual basis. Such advisers will also be required to report on an annual basis, in new Section 5.K.(2) of Schedule D, certain information on the use of derivatives and borrowings by SMA accounts that they manage. This includes the amount of RAUM attributable to SMAs that correspond to three categories of gross notional exposure[3] to derivatives, and the total dollar amount of borrowings by such categories. Advisers falling into this category must calculate this information as of the same date used to calculate the adviser’s RAUM for its annual Form ADV updating amendment.

  • Advisers with RAUM of $10 billion or more attributable to SMAs – Advisers with $10 billion or more of RAUM attributable to SMAs will be required to report the information above concerning the approximate percentages of their RAUM that are attributable to SMAs across the 12 asset categories. However, such advisers will be required to report this information as of two points in time: midyear (defined as six months before the end of year date) and end of year.[4] In addition to having to report RAUM and borrowing figures for SMAs that correspond to the three categories of gross notional exposure (detailed above), advisers falling within this category must also report, on both a midyear and an end-of-year basis, the derivatives exposure for their SMAs that correspond to six categories of derivatives.[5]

The Adopting Release contains important guidance from the SEC on how the information regarding SMAs should be reported. With respect to reporting of derivatives and borrowing information for SMAs, an adviser that acts as a subadviser to an SMA should only include the portion of the account that it subadvises. Additionally, advisers may, but are not required to, only include those SMAs with $10 million or more under management when reporting information in new Section 5.K.(2) of Form ADV regarding the use of derivatives and borrowing. Note that all SMA accounts, including those under $10 million, must be included in the asset class percentage reporting of new Section 5.K.(1).

Additionally, for purposes of calculating the asset class percentage holdings of an adviser’s SMAs in Section 5.K.(1), the SEC indicated that advisers should not double count assets, and are not required to look through an SMA’s holdings in mutual funds or ETFs to the underlying asset classes. Acknowledging a number of commenters’ concerns regarding the methodology for attributing assets to the new asset class categories, and consistent with the approach taken for the Form PF, the SEC indicated that advisers may use their own methodologies, as well as the conventions of their service providers, in determining how to categorize SMA assets. The SEC stated that such methodologies or conventions must be “consistently applied” as well as “consistent with information the advisers report internally and to current and prospective clients.”

The amendments also contain a number of key modifications from the Proposed Rules with respect to reporting on the use of derivatives and borrowing in SMAs. Importantly, the Adopting Release raised the minimum threshold at which an adviser is required to report the use of derivatives and borrowing in its SMA accounts from $150 million to $500 million in RAUM attributable to SMAs. The SEC noted that its rationale for this change was a number of comment letters indicating that such a change would permit the SEC to collect 95% of the data it would collect using the $150 million threshold, as proposed, while relieving a reporting burden for 3,000 advisers. Additionally, the amendments added the requirement that advisers with RAUM of $10 billion or more report derivatives and borrowings information on their SMAs at both midyear and end of year as part of their annual amendments. The amendments also modify the basis on which derivatives and borrowing figures are reported. Under the Proposed Rules, advisers would have been required to base the reporting of derivatives and borrowing in SMAs that they manage on net asset value. The amendments, however, require advisers to base such reporting on RAUM and borrowings that correspond to ranges of gross notional exposure. Additionally, the amendments eliminate the proposed requirement that advisers report the actual number of SMA accounts that they manage.

In addition to the reporting requirements above, the amendments also create new Item 5.K.(4) of Part 1A and Section 5.K.(3) of Schedule D to Form ADV. Advisers will be required to identify any custodians that custody at least 10% of RAUM that is attributable to the advisers’ SMAs under management, and will also need to disclose the amount of the advisers’ RAUM attributable to SMAs held at such custodians. The SEC stated that this new information mirrors the existing disclosure regime for private funds and registered investment companies, and will allow the SEC’s examination staff to identify advisers whose clients use the same custodian in the event that concerns are raised about a particular custodian.

Expanded Information About an Adviser’s Business

In addition to the SMA reporting discussed above, the amended Form ADV will require additional disclosure in Part 1A about an adviser’s business activities, affiliations, and clients. Below we discuss some of the most notable changes to Part 1A adopted by the SEC:

  • Wrap Program Disclosure – Form ADV, Part 1A currently requires that an adviser indicate whether it serves as a sponsor of, or portfolio manager for, a wrap fee program. As amended, Form ADV will require an adviser who participates in wrap programs to report the total amount of RAUM attributable to its acting as sponsor or portfolio manager to a wrap fee program. Additionally, Schedule D of Part 1A has been amended to require the adviser to provide any SEC File Number and CRD Number for sponsors to the wrap fee programs for which the adviser serves as portfolio manager.

  • Social Media – The amended Form ADV, Part 1A will require an adviser to disclose whether it maintains a presence on social media, and to identify the specific addresses of its accounts on such social media platforms (such as Twitter, Facebook, or LinkedIn). In contrast to the proposal, the adviser will only be required to report accounts on social media platforms for which the adviser controls the content. The SEC clarified that accounts used solely to promote the business of an affiliate, or affiliates that are not advisers registered with the SEC, would not implicate the reporting requirements. Although the SEC asked for comment in its Proposing Release as to whether information about the social media accounts of employees should be reported on Form ADV, such a requirement was not adopted.

  • Offices – As adopted, advisers will be required to report the total number of offices at which they conduct investment advisory business, and information about such offices, including the number of employees performing investment advisory functions from the location, any other business activities conducted at the location, and a description of other investment-related business activities at the location. In addition, advisers will be required to provide information regarding its 25 largest offices (measured by number of employees), as opposed to only the five largest offices, as required under the current Form ADV. The staff stated that such information will be used to identify locations to conduct examinations.

  • Chief Compliance Officer Disclosure – Under the amended Form ADV, Part 1A, an adviser will be required to disclose whether its chief compliance officer (CCO) is compensated or employed by any person other than the adviser, a related person of the adviser, or a registered investment company advised by the adviser for providing CCO services to the adviser. Advisers will be required to report the name and IRS Employer Identification Number (if any) of any such other persons. The SEC reiterated its position from its Proposing Release that its examination staff “has observed a wide spectrum of both quality and effectiveness of outsourced chief compliance officers and firms,” and that this new information will allow the staff to identify all advisers that rely on a particular service provider and could be used to improve the SEC’s ability to assess potential risks. The SEC had asked for comment in its Proposing Release about whether it should require information on Form ADV about an adviser’s use of third-party compliance auditors, and in response to commenters’ concerns about the utility of such disclosure, it did not amend Form ADV to require such information.

  • Adviser Assets – Under the current Form ADV, an adviser is only required to indicate if its balance sheet assets (as opposed to regulatory assets under management) exceed $1 billion. The amended Form ADV further segments this information and will require an adviser whose balance sheet assets exceed $1 billion to disclose whether its assets fall into the following three ranges: between $1 billion and $10 billion, between $10 billion and $50 billion, or $50 billion or more. This amendment is intended to assist the SEC in rulemaking on methodologies for stress testing financial risk, as required by Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

  • Types of Clients – Item 5.C. and Item 5.D. have been amended to require advisers to provide the number of advisory clients and amount of RAUM attributable to each specific type of client, as opposed to only providing percentage ranges as is currently required. The SEC stated that replacing the ranges with more precise information will enhance the staff’s ability to see the scale and concentration of assets by client type and analyze data across investment advisers. Additionally, the amended Form ADV will require an adviser to provide information on the approximate amount of its RAUM attributable to clients that are non–United States Persons.

  • Clients with No RAUM – Item 5.C. has been amended to require disclosure of the number of clients for whom an adviser provides advisory services but does not have correlating RAUM. The SEC noted that this disclosure would provide a more complete understanding of the adviser’s advisory business and will assist in the SEC staff’s risk assessment and examination process.

  • Parallel Managed Accounts – The SEC has added the requirement, as proposed, that advisers disclose the RAUM of all parallel managed accounts related to registered investment companies (or series thereof) or business development companies advised by the adviser. For these purposes, a “parallel managed account” will include any managed account advised by an adviser that “pursues substantially the same investment objective and strategy and invests side by side in substantially the same positions” as the investment company (or series thereof) or business development company advised by the adviser. The SEC stated that advisers should use their best judgment and make a good-faith determination when determining whether the investment objectives and strategies in question for a managed account are “substantially the same,” as many private fund advisers currently do when completing Form PF.

  • Private Fund Sales Practice Reporting – The SEC has amended the questions accompanying private fund reporting on Schedule D to require an adviser to a private fund relying on an exemption from the definition of “investment company” under Section 3(c)(1) of the Investment Company Act of 1940 (the “Company Act”) to report whether it limits sales of the fund to “qualified clients,” as such term is defined in Advisers Act Rule 205-3. This is a modification from the Proposed Rules, which would have required an adviser to report, for each private fund that it advises (including those relying on Section 3(c)(7) of the Company Act), the approximate percentage of the private fund beneficially owned (in the aggregate) by qualified clients.

Umbrella Form ADV Registration

The SEC has also amended Form ADV to codify “umbrella registration” through which private fund advisers that operate a single advisory business through multiple legal entities may register with the SEC by filing a single Form ADV. The SEC staff first provided guidance permitting private fund advisers to take advantage of consolidated registrations in a 2012 no-action letter issued to the American Bar Association.[6] While the SEC noted in the Adopting Release that most advisers that can rely on umbrella registration consistent with the SEC staff’s guidance in the 2012 ABA Letter are doing so, the SEC acknowledged that the current structure of Form ADV does not lend itself to a consolidated filing. Consequently, the amendments modify the Form ADV instructions to establish conditions under which umbrella registration is available, and add a new Schedule R to Form ADV that must be filed for each adviser other than the filing adviser that is relying on umbrella registration. The conditions for umbrella registration (which will be added to the Form ADV instructions) are consistent with those in the 2012 ABA Letter and, as proposed, and require the following:

  1. The filing adviser and each relying adviser must only advise private funds and clients in separately managed accounts that are “qualified clients” (as defined in Advisers Act Rule 205-3) and are otherwise eligible to invest in the private funds advised by the adviser and whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to the private funds managed by the adviser. Importantly, this condition limits the universe of advisers able to file an umbrella registration to those that manage only private funds and certain separate accounts of sophisticated investors. It also precludes advisers who have multiple lines of business from relying on umbrella registration.

  2. The filing adviser must have its principal office and place of business in the United States, and therefore, all of the substantive provisions of the Advisers Act and its rules must apply not only to the filing adviser but also to each relying adviser’s dealings with each of its clients, regardless of whether the relying adviser or the client is a US person. As a result of this condition, non-US advisers may be unwilling to take advantage of umbrella registration, given that the Advisers Act would apply to their dealings with their non-US clients.

  3. Each relying adviser, its employees, and the persons acting on its behalf are subject to the filing adviser’s supervision and control, and therefore each are “persons associated with” the filing adviser (as defined in Section 202(a)(17) of the Advisers Act).

  4. The advisory activities of each relying adviser are subject to the Advisers Act and the rules thereunder, and each relying adviser is subject to examination by the SEC.

  5. The filing adviser and each relying adviser operate under a single code of ethics and written policies and procedures, in accordance with Advisers Act Rule 204A-1 and Rule 206(4)-7, respectively, administered by a single CCO.

The SEC stated that these conditions are designed to limit eligibility for umbrella registration to private fund advisers that operate as a single advisory business, and that the following are indicia of a single advisory business: commonality of advisory services and clients; consistent application of the Advisers Act and the rules thereunder to all advisers in the business; and a unified compliance program. The single Form ADV filed by the filing adviser in an umbrella registration meeting these conditions must include all information relating to both the filing adviser and each relying adviser, and must include this same information in any other reports or filings it is required to make under the Advisers Act or the rules thereunder. In addition to new Schedule R, the SEC is also amending the private fund reporting requirements of Schedule D to require advisers to identify the filing advisers and relying advisers that manage or sponsor private funds.

Notably, the SEC acknowledged in the Adopting Release that several commenters urged the Commission to expand the eligibility of umbrella registration to additional types of advisers, including non-US advisers and exempt reporting advisers. The SEC chose to adopt the amendments as proposed, without modification, despite some acknowledgment as to the legitimacy of the requests. The SEC noted that it did not extend umbrella registration to non-US filing advisers, based on its concern that a group of related advisers based within and outside the United States could cause a non-US adviser to file as “filing adviser” and assert, based on the theory of operating a single advisory business, that the Advisers Act’s substantive provisions largely would not apply to the non-US clients of the US-based relying advisers. Additionally, the SEC chose not to extend umbrella registration to exempt reporting advisers “at this time” but acknowledged a set of Frequently Asked Questions (FAQs) that permit certain exempt reporting advisers to file a single Form ADV on behalf of multiple special purpose entities.[7] Notably, the SEC stated that the views expressed in such FAQs are not being withdrawn as a result of the amendments.

Amendments to the Books and Records Rule Concerning Performance

In addition to the amendments to Form ADV, the SEC also adopted amendments to Advisers Act Rule 204-2, the books and records rule, that will require advisers to maintain additional materials related to the calculation and distribution of performance information. The rule amendment reflects the SEC’s stated belief that requiring the retention of additional records will “better protect investors from fraudulent performance claims.”

Advisers Act Rule 204-2(a)(16) currently requires advisers to maintain all documents or records 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 communication that an adviser distributes or circulates to 10 or more persons. Consistent with the proposed rules, the SEC is amending Rule 204-2(a)(16) to remove the “10 or more persons” condition and will instead require that advisers maintain records to support performance claims in communications that are distributed to any person.

Additionally, the SEC has amended Rule 204-2(a)(7) to require advisers to maintain originals of all written communications received and copies of written communications sent by an adviser relating to the performance or rate of return of any or all managed accounts or securities recommendations. Rule 204-2(a)(7) currently requires advisers to keep originals of written communications relating to securities recommendations, advice, and transactions. As noted in the Proposing Release, the amendment was motivated by, among other things, a recent enforcement action where the lack of evidentiary record prevented the action from moving forward.[8] The SEC further stated that it believed these records will be useful for the SEC examination staff in reviewing and evaluating adviser performance claims.

Technical Amendments to Form ADV and Advisers Act Rules

Finally, the SEC also adopted a number of minor amendments to Form ADV to clarify areas where it has received requests to remove expired provisions or provide further instruction. In addition, the SEC amended certain Advisers Act rules to remove transition provisions that are no longer applicable.

Implementation of the Amendments

The SEC stated in the Adopting Release that it is currently working with the Financial Industry Regulatory Authority (FINRA) to reprogram the IARD system to implement these amendments to Form ADV, and that the IARD system is expected to be able to accept filings of revised Form ADV by October 1, 2017. Any investment adviser filing an initial Form ADV or an amendment to an existing Form ADV on or after October 1, 2017 will be required to provide responses to the amended Form ADV, Part 1A. The SEC acknowledged that in most cases, advisers will not be filing on the amended Form ADV, Part 1A until their annual updating amendments, which (for most) will occur in March 2018. The SEC further stated that the amendments to Advisers Act Rule 204-2, the books and records rule, will apply to communications circulated or distributed after October 1, 2017.

As adopted, the amendments to Form ADV present a wide range of new disclosure requirements that investment adviser firms should review and begin to prepare for well in advance of October 2017. In particular, the new SMA reporting requirements will require firms to evaluate their methodologies, and the conventions of their service providers, with respect to how they categorize client holdings into different asset classes and how they calculate derivatives and borrowing exposure. Additionally, any private fund adviser currently filing a single Form ADV for itself and its affiliated relying advisers should review the new Form ADV, Part 1A in preparation for the new form. Moreover, any affiliated exempt reporting adviser filing on a single Form ADV and any adviser filing on behalf of itself and its non-US affiliates should consider the availability of umbrella registration going forward. Finally, the amendments to the books and records rule relating to the calculation and distribution of performance information represent the SEC staff’s continued focus on reviewing and evaluating advisers’ performance claims. Advisers who currently advertise performance should ensure that they are maintaining documentation that supports all advertised performance claims or figures, including underlying assumptions and calculation methodologies.

[1] Form ADV and Investment Advisers Act Rules, SEC Release No. IA-4509 (Aug. 25, 2016) (hereinafter, the “Adopting Release”).

[2] Amendments to Form ADV and Investment Advisers Act Rules, SEC Release No. IA-4091 (May 20, 2015) (hereinafter, the “Proposing Release”).

[3] As amended, the three categories of gross notional exposure that certain advisers will be required to report RAUM, borrowings, and derivatives exposure for are (i) less than 10%, (ii) 10-149%, and (iii) 150% or more. This is a modification from the Proposing Release, which had four categories with the highest threshold set at 200%.

[4] The SEC staff recently issued an IM Information Update clarifying that advisers that do not have enough data to provide a complete response to a new or amended question in Item 5, or the corresponding sections of Schedule D, could insert a “0” as a placeholder in order to submit their Form ADV, along with a corresponding note in the Miscellaneous section of Schedule D. This guidance applies only to interim filings submitted between October 1, 2017 and the adviser’s next annual amendment.

[5] These categories include interest rate derivatives, equity derivatives, foreign exchange derivatives, credit derivatives, commodity derivatives, and others.

[6] See American Bar Association, Business Law Section, SEC Staff Letter (Jan. 18, 2012) (hereinafter, the “2012 ABA Letter”).

[7] See Frequently Asked Questions on Form ADV and IARDReporting to the SEC as an Exempt Reporting Adviser (Mar. 2012).

[8] In the Matter of Michael R. Pelosi, Investment Advisers Act Release No. 3141 (Jan. 14, 2011); Initial Decision Release No. 448 (Jan. 5, 2012); Investment Advisers Act Release No. 3805 (Mar. 27, 2014) (Commission opinion dismissing proceeding against associated person of registered investment adviser charged with providing false and misleading performance information because the record lacked an evidentiary basis from which to determine that the performance information was materially false or misleading).

Copyright © 2022 by Morgan, Lewis & Bockius LLP. All Rights Reserved.National Law Review, Volume VII, Number 257

About this Author

Jennifer Klass, Morgan Lewis, Financial services attorney

Jennifer L. Klass is a regulatory counseling lawyer with a broad background in investment management regulation. She advises clients on a wide range of investment advisory matters, including investment adviser registration and interpretive guidance, disclosure and internal controls, regulatory examinations, and enforcement actions. Her clients include major investment banks, investment advisers, broker-dealers, and the sponsors of private investment funds and mutual funds. Previously vice president and associate general counsel at Goldman, Sachs & Co., Jen’s practice...

Christine M. Lombardo, Morgan Lewis, Investment Lawyer, Finance Attorney

Christine M. Lombardo advises investment managers and broker-dealers on financial regulatory matters. She concentrates her practice on securities regulations for hedge funds, private equity firms, family offices, broker-dealers, other professional traders, and high-net-worth individuals. Christine also counsels compliance and business personnel on the structure and operations of hedge funds, private equity funds, and other alternative investment products. Before joining Morgan Lewis, Christine was an associate at a national law firm in New York and worked for the...

212.309.6629 #sthash.lERkMf02.d