On July 28, 2010, the Securities and Exchange Commission (the SEC) published amendments to Part 2 of Form ADV and related rules under the Investment Advisers Act of 1940 (the Advisers Act). As detailed in the adopting release, the amendments are designed to require registered investment advisers to provide new and prospective clients with a brochure and brochure supplements written in “plain English” providing disclosure about the business practices, conflicts of interest and background of the investment adviser and its advisory personnel. These amendments convert Part 2 of Form ADV into a narrative disclosure document required to cover a number of disclosure items in a free-form approach. While advisers are required to provide all disclosure items in the order they appear in the form, the SEC does not proscribe a specific format. Below is a summary of the key amendments and requirements of new Part 2:
- Part 2A Disclosure Items. The core disclosures in Part 2 are in a new Part A, which includes 18 separate disclosure items, each of which must be addressed by the adviser in the following order:
- Cover Page;
- Material Changes;
- Table of Contents;
- Advisory Business;
- Fees and Compensation;
- Performance-Based Fees and Side-by-Side Management;
- Types of Clients;
- Methods of Analysis, Investment Strategies and Risk of Loss;
- Disciplinary Information;
- Other Financial Industry Activities and Affiliations;
- Code of Ethics, Participation or Interest in Client Transactions and Personal Trading;
- Brokerage Practices;
- Review of Accounts;
- Client Referrals and Other Compensation;
- Investment Discretion;
- Voting Client Securities; and
- Financial Information.
Additional Disclosures for State-Registered Advisers . Advisors who are registering or are registered with one or more state securities authorities must make additional disclosures in response to special “Requirements for State-Registered Advisers”. These disclosures generally involve information about the principal executive officers and management personnel of the adviser.
Part 2B Disclosures . A new Part 2B is required that provides information about the advisory personnel managing client accounts. Part 2B requires a narrative disclosure by all advisers (state and federally-registered) regarding the qualifications and disciplinary history of the specific advisory employees who give advice to the particular client to whom the Form ADV Part 2 is delivered. Part 2B disclosures must address the following items in the following order:
- Cover Page;
- Educational Background and Business Experience;
- Disciplinary Information;
- Other Business Activities;
- Additional Compensation; and
- Use of “Plain English” . One key requirement of amended Form ADV, Part 2 is that the narrative disclosures have to be written in “plain English”. The SEC has applied “plain English” requirements to a number of SEC filings (e.g., prospectuses and certain corporate reports) for a number of years. In general, “plain English” writing focuses on using short sentences; using definitive, concrete and everyday words; using active voice; using tables or bullet lists for complex material, whenever possible; generally avoiding legal or business jargon; and avoiding multiple negatives.
- Wrap Fee Programs. Advisers who sponsor wrap fee programs must prepare a separate, specialized brochure for wrap fee program clients. The required disclosures for wrap fee brochures have been revised to incorporate many of the new disclosures required in Part 2 generally. Wrap fee program sponsors also must disclose whether any of their related persons are portfolio managers in their wrap fee program and, if so, the related conflicts of interest.
- Initial and Annual Delivery . As was the case before the amendments, advisers continue to be required to deliver a current brochure at or before entering into an advisory contract with a client. In addition, however, the new amendments require annual delivery (within 120 days after fiscal year end) of either:
- a current updated brochure including or accompanied by a summary of material changes; or
- a summary of material changes including an offer to provide the current brochure.
- Updates Requiring Interim Delivery . While changes to an advisor’s ADV Part 2 will generally only require annual delivery, advisers are required to notify clients when the adviser amends its brochure to include a disciplinary event or to change any material disclosures related to disciplinary events. In these cases, advisers may deliver to clients an updated brochure or a document describing the material facts related to the disciplinary event in accordance with Rule 204-3 of Advisers Act.
- Updates to Part 2B Disclosure Items. Advisers are required to amend their Part 2B disclosures if they become materially inaccurate, and to update clients about the changes by delivering the revised supplement or the old version with a sticker explaining the changes of such event.
- Compliance Date . While new Form ADV, Part 2 was effective October 12, 2010, the compliance dates are as follows:
New Investment Advisers . An adviser that applies for registration with the SEC after January 1, 2011, will be required to file a brochure that complies with the amended Part 2A as part of its application for registration on Form ADV. Upon registration, the adviser must begin delivering to its prospective and existing clients a brochure and brochure supplement that meet the amended requirements.
Registered Investment Advisers . An adviser who is already registered with the SEC, and whose fiscal year ends on or after December 31, 2010, must include a brochure that meets the amended requirements for Part 2A with its next annual updating amendment to Form ADV. Therefore, advisers with fiscal year ends of December 31, 2010, must file compliant brochures by March 31, 2011, and must deliver those brochures, along with brochure supplements, to existing clients within 60 days of their being filed.