The proposed rules would require expanded reporting about separately managed accounts and other aspects of an adviser’s business, allow consolidated registrations for certain private fund advisers that operate a single advisory business through multiple entities, and amend the record-keeping rules affecting investment advisers.
On May 20, 2015 the US Securities and Exchange Commission (SEC) proposed to expand substantially Form ADV Part 1A to capture more detailed information about separately managed accounts, as well as other aspects of an adviser’s business, and to provide a mechanism for certain advisers to make consolidated or “umbrella” registration filings (Proposing Release). The proposal represents the most significant changes to Form ADV since 2011, when the SEC added Item 7.B. to collect detailed information about private funds managed by registered advisers. The proposed amendments are designed to provide information about separately managed accounts (SMAs) similar to that which is already required for private funds. The SEC indicated in the Proposing Release that the proposals are motivated, at least in part, by the desire to collect more detailed quantitative information that the examination staff can use to run risk analytics and design examination initiatives. The request for information about SMAs is also presumably a response to the Financial Stability Oversight Council (FSOC), which recently noted that because information about SMA portfolio positions is not collected on a systematic, industrywide basis, information about the assets held in these accounts, their counterparty and other exposures, and amounts of leverage are not routinely available to regulators for assessment and monitoring purposes.
In addition to facilitating data collection about SMAs, the proposed changes would also
- enhance the disclosure requirements of Form ADV Part 1A to include additional questions regarding the adviser and certain aspects of its business;
- modify Form ADV to allow for consolidated or “umbrella registrations” for private fund advisers that operate a single advisory business through multiple entities and satisfy certain other conditions;
- enhance the record-keeping requirements concerning performance information; and
- make certain technical amendments to Form ADV and Advisers Act rules.
The SEC simultaneously issued a companion release proposing to enhance the reporting requirements applicable to registered investment companies. The SEC unanimously approved both proposals, which it noted were intended to further “modernize and enhance” its monitoring and regulation of the asset management industry. In addition to providing more accurate and up-to-date information for investors, the SEC indicated that the proposed forms, rules, and other actions would facilitate its risk monitoring objectives.
The following is a summary of the Proposing Release, including some key points to note and significant implications for investment advisers. We encourage investment advisers to carefully consider how these proposals could affect their business and whether they want to provide their perspectives to the SEC through the comment process.
Data Collection and Reporting of Separately Managed Accounts
Under the proposal. Part 1A of Form ADV would require advisers to provide detailed information about the types of assets, derivatives positions, and borrowings associated with SMAs. Similar to the reporting regime under Form PF relating to private funds, the amount of detail required to be reported would be driven by the level of an adviser’s regulatory assets under management (RAUM) attributable to SMAs. The more SMA assets an adviser has, the more data it would need to provide under the proposal.
- Advisers with RAUM of up to $150 million attributable to SMAs—Under the proposal, any adviser that indicates that it has RAUM attributable to SMAs in response to Item 5.K.(1) would need to report the approximate percentage of SMA assets invested in each of 10 broad asset categories. Such information would need to be provided annually as of the end of the adviser’s fiscal year.
- Advisers with RAUM of at least $150 million but less than $10 billion attributable to SMAs—Advisers with at least $150 million but less than $10 billion of RAUM attributable to SMAs would have to provide the information above, as well as to identify the use of derivatives and borrowings in SMAs. Further, such advisers would have to report the number of accounts that correspond to certain categories of gross notional exposure and the weighted average amount of borrowings (as a percentage of net asset value) in accounts with a net asset value of at least $10 million. Such information would need to be provided annually as of the end of the adviser’s fiscal year.
- Advisers with RAUM of $10 billion or more attributable to SMAs—Advisers with $10 billion or more in RAUM attributable to SMAs would have to provide all of the same information required for advisers in the two categories described above, as well as the weighted average gross notional value of derivatives (as a percentage of the net asset value) in six different categories of derivatives. These advisers would be required to annually report the foregoing information as of the end of the adviser’s fiscal year, as well as its mid-year point.
It is important to note that—in all cases—the SMA information would only need to be filed once a year as part of an adviser’s annual amendment.
All advisers to SMAs would also be required to identify each custodian that holds 10% or more of an adviser’s RAUM attributable to SMAs, as well as the amount of SMA assets held by each such custodian. These proposed changes align with the more detailed disclosure currently required by private fund advisers in Item 7.B. of the current Form ADV Part 1A and the corresponding sections of Schedule D.
Expanded Information About an Adviser’s Business
In addition to the SMA data, the proposal would also amend Part 1A to collect additional information about an adviser and its clients. Below are some of the more notable proposed changes.
- Social Media—Under the proposal, advisers would be required to disclose whether they maintain a presence on social media and to identify their specific social media addresses (e.g., the firm’s Facebook, Twitter, or LinkedIn addresses). Although the SEC stopped short of proposing that an adviser report information about individual employee use of social media for business purposes, it did ask for comment as to whether such disclosure should be required. This is an interesting area of focus that could suggest an increase in interest by the examination staff on the use of social media by advisers and their employees, including the degree to which information that is made available through social media complies with applicable advertising restrictions under the Advisers Act and is consistent with the adviser’s Form ADV and other marketing materials.
- Offices—The proposal would require advisers to identify and disclose the location of their 25 largest offices (measured by number of employees). Advisers would also have to provide information about the advisory, securities-related, and investment-related activities conducted from each office. Currently, an adviser must disclose its top five office locations. This change is notable in light of the examination staff’s interest in the supervision of registered representatives and financial advisor representatives in branch offices. For most advisers, disclosure of the “largest 25 offices” would effectively require disclosure of all offices.
- Chief Compliance Officer Disclosure—Under the proposal, Form ADV would require an adviser to disclose whether its Chief Compliance Officer (CCO) is compensated or employed by any person other than the adviser, and if so, the name and IRS Employer Identification Number (if any) of that person or firm. This line of disclosure may imply that the examination staff is noticing a disparity between the compliance programs of firms with full-time CCOs and those with outsourced CCOs. The SEC specifically noted in the Proposing Release that its examination staff has “observed a wide spectrum of both quality and effectiveness of outsourced chief compliance officers and firms.”
- Adviser Assets—Currently under Form ADV, advisers are only required to indicate if their balance sheet assets (as opposed to regulatory assets under management) exceed $1 billion. Under the proposal, the information would be further segmented and advisers would have to disclose whether their own assets fall into ranges between $1 billion and $10 billion, $10 billion and $50 billion, or $50 billion or more. This proposed change is intended to assist the SEC in implementing 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 would be amended to require advisers to provide the number of advisory clients and the RAUM attributable to each specific type of client, as opposed to just providing percentage ranges as is currently required. The SEC is also proposing to add two new categories of clients—“sovereign wealth funds” and “foreign official institutions”—and has clarified that government pension plans should be counted as state or municipal government entities, not pension and profit-sharing plans.
- Wrap Program Disclosure—Although advisers already disclose whether they act as a sponsor or portfolio manager for wrap fee programs, the amended Form ADV, Part 1A would also require disclosure of the total amount of RAUM attributable to an adviser acting as sponsor and/or portfolio manager of a wrap fee program. Further, advisers would have to provide the SEC file number and CRD number for sponsors to each wrap fee program for which the adviser serves as portfolio manager. It is notable that the explanation the SEC provided for this request was to make it easier for the staff to identify whether a particular adviser acts as sponsor or portfolio manager and to “collect information across investment advisers involved in a particular wrap fee program.” During its most recent sweep of wrap sponsors and mangers, the examination staff may have found it challenging to sort out which wrap programs particular advisers were participating in and whether they were serving as sponsor or portfolio manager. Further, as with much of the other data that would be collected through the updated Part 1A, the staff would have the ability to run analytics against the data and quickly identify and evaluate the relevant relationships among advisers participating in a single wrap program.
Umbrella Form ADV Registration
The SEC also seeks to amend Form ADV to better facilitate consolidated or “umbrella registrations” through which private fund advisers that operate a single advisory business through multiple entities could register by filing a single Form ADV. The SEC staff first permitted private fund advisers to take advantage of consolidated registrations in certain contexts in a 2012 No-Action Letter issued to the American Bar Association (ABA). Although that guidance provided a practical method for streamlining the registration process for certain private fund advisers, Form ADV’s structure did not provide the flexibility necessary to support such a consolidated filing. In the Proposing Release, the SEC acknowledges the difficulties associated with relying on the 2012 ABA Letter in light of the current version of Form ADV and the resulting inconsistencies in Form ADV disclosure among advisers seeking to rely on that no-action position. The amendments would allow one adviser (the “filing adviser”) to file a single Form ADV (an “umbrella registration”) on behalf of itself and other advisers that are controlled by, or under common control with, the filing adviser (each, a “relying adviser”), provided that they operate a single advisory business and satisfy the following conditions:
- The filing adviser and each relying adviser can only advise private funds and clients in separately managed accounts that are “qualified clients” and otherwise are eligible to invest in the private funds advised by the adviser and whose accounts pursue strategies substantially similar or otherwise related to the private funds managed by the adviser. This condition would limit the universe of advisers able to file an umbrella registration to those managing private funds and certain separate accounts of sophisticated investors. Notably, as proposed, this would largely preclude advisers with multiple lines of business from filing an umbrella registration.
- 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 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, non-US advisers may be unwilling to take advantage of an umbrella registration, given that the Advisers Act would apply to their dealings with their non-US clients.
- Each relying adviser, its employees, and the persons acting on its behalf are subject to the filing adviser’s supervision and control.
- The advisory activities of each relying adviser are subject to the Advisers Act and subject to examination by the SEC.
- The filing adviser and each relying adviser operates 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.
Advisers filing an umbrella registration would need to complete new Schedule R, which would provide a mechanism for the filing adviser to report the requisite information for each relying adviser. Schedule R would not necessarily require any additional information but would provide more uniformity in the disclosure of information regarding relying advisers than under the current Form ADV.
Note that that advisers qualifying for umbrella registration would be permitted, but not required, to file umbrella registrations. In addition, the SEC explicitly stated that umbrella registration is not available for exempt reporting advisers (ERAs). The SEC’s rationale for excluding ERAs from the proposed umbrella registration is that ERAs would not meet the condition of a single advisory business given that such advisers are not required to adopt policies and procedures and a code of ethics in accordance with Rule 206(4)-7 and Rule 204A-1. Depending on the outcome of the final rules, any advisers currently filing consolidated ERA filings may need to reconsider their filings.
In addition, as noted above, the proposed approach would effectively preclude advisers with a variety of business lines and advisers that provide advice outside of the private fund context from relying on an umbrella registration. The SEC, however, requested comment as to whether the umbrella registration provisions should be expanded to permit registrants with broader business lines to benefit from a consolidated registration.
Proposed Amendments to the Books and Records Rule Concerning Performance
The SEC is proposing to amend the books and records rule on the retention of records relating to advertisements and other written communications. Both proposed changes reflect the examination staff’s continued focus on reviewing and evaluating adviser performance claims.
Advisers Act Rule 204-2(a)(16) currently requires advisers to retain 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, directly or indirectly, to 10 or more persons. The proposal would remove the “10 or more persons” condition and instead require that advisers retain the requisite performance records for communications that are distributed to any person. Although we generally believe that, as a best practice, most advisers retain the relevant records for communications provided to any number of clients and prospective clients (including one-on-one presentations), if adopted, this proposal would make any failure to maintain such records a regulatory infraction.
The SEC also proposes to amend rule 204-2(a)(7) to require advisers to maintain originals of all written communications received and copies of written communications sent relating to the performance or rate of return of any or all managed accounts or securities recommendations. This proposed change was precipitated by, among other things, a recent enforcement action wherein the evidentiary record prevented the action from moving forward.
Technical Amendments to Form ADV and Advisers Act Rules
Finally, the SEC also proposes numerous minor amendments to Form ADV to clarify areas where it received numerous requests to remove expired provisions and provide further instruction. In addition, the SEC proposes to amend certain Advisers Act rules to remove transition provisions that are no longer applicable.