SEC Approves Amendments to Form ADV Part 1A and Certain Additions

Matthew R. Silver

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SEC Approves Amendments to Form ADV Part 1A and Certain Additions to Investment Advisers Act Rules

by: Matthew R. Silver of Faegre Drinker - Publications

Thursday, September 8, 2016

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The Securities and Exchange Commission (SEC) has adopted amendments to Form ADV as well as certain rules under the Investment Advisers Act of 1940 (the “Advisers Act”) (collectively, the “Amendments), previously proposed in May 2015.^[1] The Amendments, adopted on August 25, will impact SEC-registered investment advisers and, indirectly, many state-registered advisers, largely because various states also employ Form ADV. The Amendments will likely have minimal practical effect on most SEC Exempt Reporting Advisers, except for certain additional reporting requirements, including those relating to social media applicable to such advisers.

As originally proposed, the Amendments will: (1) require investment advisers to provide information related to their separately managed account (SMA) business; (2) better enable private fund investment advisers to file an “umbrella registration” for separate investment advisers that operate as a single investment advisory business; (3) adjust Rule 204-2 under the Advisers Act to require investment advisers to maintain records that demonstrate performance calculations or rates of return in any written communications and maintain certain additional records; and (4) make certain clarifying, technical and other amendments. The Amendments also introduced a number of notable changes to the SEC’s original May 2015 proposal, including a higher “asset under management” threshold for some of the new SMA reporting requirements, a delayed compliance date of October 1, 2017, and a clarification that a firm’s Form ADV need not be adjusted to comply with the Amendments outside of the currently required amendment cycle (i.e., in connection with the firm’s annual or other than annual amendments to comply with the currently existing requirements).

The Amendments are intended to not only modernize and enhance disclosures for the investment management industry, but also to further the SEC’s use of technology. In part, the SEC hopes the changes will improve its ability to monitor various risks by taking advantage of technological advances in data collection and analysis—especially in light of the growth of new and increasingly complex investment products and strategies.

Amendments to Form ADV

Information Regarding SMAs

The Amendments enhance the SEC’s ability to collect information specific to investment advisers’ SMAs, which for the purposes of reporting on Form ADV include all advisory accounts other than registered investment companies, business development companies, and pooled investment vehicles that are not investment companies (i.e., private funds). The data collection focuses on types of assets held and the use of derivatives and borrowings in SMAs. For the most part, the SEC adopted its SMA-related changes as proposed except in select areas, such as adding a “fewer than five clients” column in place of a requirement that the actual number of clients be listed. Further, the Amendments require less information about separately managed accounts than what was originally proposed for investment advisers managing at least $150 and less than $500 million in regulatory assets, and no longer require investment advisers to report the number of SMAs managed by the advisers. The changes were made in response to many commenters opposing the public disclosure of SMA information, citing the potential cost of disclosure of confidential client information, particularly for advisers with a small number of SMAs, and the concerns with disclosing proprietary investment or trading strategies.

As adopted, key changes from existing standards are summarized below:

On an annual basis, investment advisers are obligated to indicate the percentage of SMA assets in 12 broad asset categories, including exchange-traded equities, U.S. government and agency bonds, securities issued by investment companies and derivatives.Investment advisers with SMA assets under management of $10 billion or more would be required to include both annual and semi-annual data in the annual filing.
All SMA investment advisers are required to report the percentage of SMA assets invested in derivatives and also provide certain information relating to their borrowings.Investment advisers with at least $500 million in SMA assets under management are required to report information on the use of borrowings and derivatives in SMA accounts and to update their borrowing and derivatives information annually when filing their annual updating amendment to Form ADV.Those with at least $10 billion in SMA assets under management would be required to report mid-year and annual borrowing and derivatives information as part of their annual filing:
- Investment advisers with $500 million but less than $10 billion in SMA assets under management would be required to report the number of accounts that correspond to certain categories of gross notional exposure in those accounts; and
- Investment advisers with $10 billion or more in SMA assets under management would be required to report the gross notional exposure in each of six specific derivatives categories. The calculations of gross notional exposure and gross notional value will rely on regulatory assets under management of an account; total amount of borrowings in an account; and the notional value of derivatives and are comparable to the information collected on Form PF regarding private funds.
Investment advisers are required to identify custodians that hold at least 10 percent of their SMA assets under management along with the amount of assets held at those custodians.

Additional Information Regarding Investment Adviser and Advisory Business

The next set of Form ADV amendments is designed to elicit information regarding the investment adviser and its business operations and affiliations in order to enhance the SEC’s ability to conduct risk-based examinations. The SEC generally adopted these amendments as proposed except for minor modifications and clarifications, such as clarifying that social media website reporting should be limited to external facing accounts on social media platforms where the adviser controls the content (and not the accounts of employees or internal-access-only sites). In addition, Amendments require the information concerning an adviser’s 25 largest offices to only be updated in annual amendments, on a less frequent basis than originally proposed. Finally, contrary to the original proposal, the Amendments do not require that chief compliance officers compensated or employed by an investment company registered under the Investment Company Act of 1940 and advised by the registrant be listed in Form ADV as having “outside” employment.

As adopted, the additional information that the SEC will collect includes:

The addresses of the investment adviser’s website(s) and all social media accounts and marketing platforms, including Twitter, Facebook and LinkedIn;
The total number of offices at which the investment adviser’s advisory business is conducted, along with the locations of the investment adviser’s 25 largest offices and their respective CRD branch numbers;
The number of employees who performed advisory functions from the investment adviser’s 25 largest offices, and an indication of each of the 25 largest offices’ other investment-related business operations;
Whether the investment adviser’s Chief Compliance Officer (CCO) is compensated or employed by any person other than the investment adviser or a related person of the investment adviser (e.g., outsourced CCO services);
An indication, within a range, of the investment adviser’s own proprietary balance sheet assets (with the required categories being $0-1 billion, $1-10 billion, $10-50 billion and $50 billion or more);
Information related to the number of the investment adviser’s clients and the amount of regulatory assets attributable to regulatory accounts (e.g., registered investment companies, business development companies and all parallel managed accounts), and such items as the number clients that are sovereign wealth funds and/or foreign official institutions (and the applicable AUM derived from such clients).In addition, there is a new question asking the approximate amount of an adviser’s total regulatory assets under management that is attributable to clients that are non-United States persons to complement the current requirement that each adviser report the percentage of its clients that are non-United States persons (as the SEC believes that the number of clients is not always a reliable indicator of an adviser’s relationships with non-U.S. clients);
Detailed information regarding the total amount of regulatory assets under management attributable to acting as a sponsor and/or portfolio manager of a wrap fee program, and the name, SEC file number and CRD number of sponsors of wrap fee programs for which the investment adviser serves as portfolio manager;
The percentage of each private fund owned by qualified clients, as defined in Rule 205-3 under the Advisers Act; and
The identifying numbers of financial industry affiliates of the investment adviser (e.g., Public Company Accounting Oversight Board (PCAOB) registration numbers and CIK numbers).

Umbrella Registration

Currently, advisers seeking to bank on a single registration in order to register multiple affiliated private fund investment advisers rely on the guidance in the SEC no-action letter to the American Bar Association (the “ABA Letter”), which imposes a number of conditions on investment advisers wishing to rely on the registration of an affiliated investment adviser. As adopted, the Amendments are designed to codify the relief granted in the ABA Letter, make the filing procedures more efficient, and provide greater certainty and clarity on the availability or absence of availability of umbrella registration for certain filers. For the most part, the Amendments concerning umbrella registration generally accord with the provisions of the ABA Letter.

The conditions for umbrella registration were adopted as proposed, and include the following:

The filing investment adviser and one or more relying investment advisers conduct a single private fund advisory business and each relying adviser is controlled by or under common control with the filing investment adviser;
The filing investment adviser and each relying investment adviser advise only private funds and clients in separately managed accounts that are qualified clients (as defined in Rule 205-3 under the Advisers Act) and are otherwise eligible to invest in the private funds advised by the filing investment adviser or a relying investment adviser and whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to those private funds;
The filing investment adviser has its principal office and place of business in the United States;
Any relying investment adviser and its employees are supervised and controlled by the filing investment adviser, such that the relying investment adviser and its employees are “persons associated with” the filing investment adviser as defined in the Advisers Act;
The advisory activities of each relying investment adviser are subject to the Advisers Act and the rules thereunder, and each relying investment adviser is subject to examination by the SEC; and
The filing investment adviser and each relying investment adviser operate under a single code of ethics adopted in accordance with rule 204A-1 under the Advisers Act, and a single set of written policies and procedures adopted and implemented in accordance with rule 206(4)-(7) under the Advisers Act, administered by a single chief compliance officer in accordance with that rule.

The SEC has also adopted a new Schedule R to Form ADV, which requires detailed information regarding the ownership structure of each relying investment adviser. Additional amendments to the instructions and Glossary of Form ADV have also been made to reflect the umbrella registration amendment. Umbrella registration remains unavailable for exempt reporting investment advisers, non-US investment advisers or advisers to other types of clients (e.g., registered investment companies and business development companies).

Amendments to Advisers Act Rules

Amendments to Books and Records Rules

Previously, investment advisers were required to maintain records supporting performance claims in communications distributed or circulated to 10 or more persons. Amendments tighten certain recordkeeping obligations under Advisers Act Rule 204-2 and require an investment adviser to maintain these records in communications that are distributed or circulated to even a single person. The changes were adopted as proposed.

Adjustments to Rule 204-2(a)(7) impose additional recordkeeping obligations on investment advisers to maintain original records of all written communications received and copies of all written communications sent related to the performance or rate of return of any or all managed accounts or investment recommendations. Investment advisers were previously only required to maintain records of correspondence that fall into certain categories. The SEC noted that most investment advisers already maintain the information that will be required to be maintained under amended rule 204-2, and the rule change does not require advisers to print out and retain hard copy “originals” just for the sake of having an ink version “original.”

Certain Other Advisers Act Rules

The SEC also adopted certain technical amendments to several rules, removing transition provisions adopted in conjunction with previous rulemaking initiatives that are no longer necessary due to the passage of time.

Practice Points

As noted above, the Amendments generally require investment advisers to disclose significant and, occasionally, sensitive additional information not previously provided by investment advisers through Form ADV. For example, advisers will be required to supply each of their social media URLs (specifically including Twitter, Facebook and LinkedIn) in the event the adviser controls the content and this content is available outside the firm (i.e. not limited to an intranet). Furthermore, if an investment adviser’s chief compliance officer is compensated or employed by any entity or person other than the adviser in question (with the exception of a registered investment company advised by the adviser), that too will be required to be listed on Form ADV—alongside the names and EINs of the other employing entities and persons (we would hope that the SEC may consider redacting part of applicable supplied EINs on Form ADVs made available via its website).

The SEC has acknowledged that identifying outsourced chief compliance officers may invite additional scrutiny about an adviser’s judgment in hiring externally versus internally. Advisers that advise registered investment companies or business development companies, and at the same time advise parallel managed accounts, will also be required to provide additional information to better assist SEC staff in assessing how the advisers manage conflicts of interest.

The SEC recognizes that the burden of reporting of additional information on some large advisers might be significant, especially in the initial reporting cycle when they are required to report the additional information for the first time. This burden may include additional legal costs as such advisers may feel the need to consult with their legal counsel in connection with some of the newly required disclosures. However, the SEC believes that the burden will decrease after the initial filing because in subsequent filings, advisers will only be reporting changes to their previously reported information. The SEC also stated that it will utilize all this newly available information to identify specific advisers for examinations.

Any 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 on the updated form. In many cases for advisers with a December 31 fiscal year, this will result in their first direct exposure to the new form taking place in connection with their annual Form ADV updates due at the end of March, 2018. Amendments to the Advisers Act books and records rule will apply to communications circulated or distributed after October 1, 2017. Advisers that circulate or distribute communications after October 1, 2017, that include performance information, including information on performance that predates that date, will be required to maintain the materials required by the Amendments that demonstrate the calculation of the performance.

^{[1] See Form ADV and Investment Advisers Act Rules, Investment Advisers Act Release No. IA-4509 (August 25, 2016), https://www.sec.gov/rules/final/2016/ia-4509.pdf. The following are paper copies of the new form and instructions thereto: https://www.sec.gov/rules/final/2016/ia-4509-appendix-d.pdf; https://www.sec.gov/rules/final/2016/ia-4509-appendix-a.pdf; https://www.sec.gov/rules/final/2016/ia-4509-appendix-b.pdf; and https://www.sec.gov/rules/final/2016/ia-4509-appendix-c.pdf}