On August 25, 2016, the Securities and Exchange Commission (SEC) adopted final rules designed to enhance and modernize reporting by investment advisers (the Adopted Rules) registered with the SEC.1 The Adopted Rules—which amend Form ADV to require additional disclosure regarding separately managed accounts (SMAs) and permit relying advisers to formally register with the SEC under an "umbrella registration"—provide the SEC with the ability to gather additional information to better understand investment advisory businesses. The Adopted Rules also amend Rule 204-2 under the Investment Advisers Act of 1940 (the Advisers Act) to require increased recordkeeping of communications regarding performance and rate of return calculations.
The Adopted Rules (originally proposed in May 20152) provide the SEC with additional means to better understand market characteristics that may affect adviser risk and performance, and are a step in the SEC’s continued efforts to mine and monitor data as a means to regulate funds and advisers. As noted by SEC Chair Mary Jo White, the SEC intends to use the additional data it collects as a result of the Adopted Rules to assess the risk profile of individual advisers within the industry and the industry as a whole.3
The Adopted Rules amend Form ADV to: (i) enhance disclosure regarding SMAs, (ii) formally adopt "umbrella" registration for private fund advisers, and (iii) enhance disclosure about other client types. Rule 204-2 under the Advisers Act is also amended to specifically include recordkeeping requirements for performance and rate of return calculations provided to any person. Despite significant participation from members of the industry in the comment process, the Adopted Rules largely mirror the proposed rule. Below we have set out brief summaries of the significant aspects of the Adopted Rules.
1. Form ADV Amendments to Enhance Reporting for SMAs (applicable to all registered advisers). The Adopted Rules impose a new requirement on advisers to provide disclosure regarding SMAs, which are defined as advisory accounts other than pooled investment vehicles. This newly required information includes disclosure about the types of assets held and the use of derivatives and borrowings by SMAs.
Advisers will be required to annually report the approximate percentage of regulatory assets under management (RAUM) attributable to SMAs invested in 12 asset categories (e.g., exchange-traded equity securities, sovereign bonds, and derivatives)—although advisers will be able to use their internal, consistently applied methodologies in categorizing assets. Those advisers with at least $10 billion in RAUM attributable to SMAs will be required to report this information for both mid-year and year-end in the annual Form ADV filing.
Those advisers with at least $500 million but less than $10 billion in RAUM attributable to SMAs will be required to report RAUM and the dollar amount of borrowings attributable to those assets that correspond to three levels of gross notional exposures (i.e., less than 10%, 10%-149%, and 150% or more). Advisers with at least $10 billion in RAUM attributable to SMAs will be required to report the same information on gross notional exposure for RAUM and the dollar amount of borrowings, and will also be required to report the gross notional exposure for six specific types of derivatives—each item at both mid-year and year-end. Advisers may, but are not required to, exclude from this requirement any SMA with RAUM of less than $10 million. All advisers will be required to identify any custodians accounting for at least 10% of RAUM attributable to SMAs and provide information on the amount of such RAUM held by the custodian.
The new reporting requirements for SMAs may require investment advisers to aggregate and report information that their current operating systems may not be equipped to generate. As a result, advisers should consider how their systems could be updated to comply with the Adopted Rules by the time they come into effect.
2. Umbrella Registration for U.S.-based Advisers. The Adopted Rules allow related, but legally distinct, investment advisers to private funds (and certain SMAs) operating as a single advisory business to file an "umbrella registration," whereby a single Form ADV serves to register a primary adviser (the Filing Adviser) and each related adviser (the Relying Adviser). This change codifies the SEC’s position in the 2012 SEC staff no-action letter to the American Bar Association.4 Under the Adopted Rules, each Relying Adviser must file the new Schedule R to the Filing Adviser’s Form ADV, which requires identifying organizational form and ownership information, and information on the Relying Advisers’ ability to register. The new Schedule R requires Relying Advisers to disclose more information about their business than the current Form ADV, which is based on the 2012 SEC staff no-action letter. Relying Advisers should consequently plan to allocate more time and resources to completing the form.
Notably, the SEC declined to permit a non-U.S. adviser (i.e., an adviser with a principal office or place of business located outside the United States) to be a Filing Adviser under an umbrella registration, although a non-U.S. adviser may be a Relying Adviser under an umbrella registration. As proposed, the SEC also did not make umbrella registration available to exempt reporting advisers.
3. Additional Enhanced Reporting Requirements. Advisers will also be required to provide additional information regarding the number and location of branch offices and the use of social media. Additional disclosure requirements include information on the RAUM under each category of client, approximate RAUM attributable to non-U.S. clients, and the total RAUM attributable to affiliations with wrap fee programs.
4. Advisers Act Amendments on Maintenance of Performance Records. The Adopted Rules add requirements under Rule 204-2 of the Advisers Act (the books and records rule) to maintain materials supporting performance or rate of return calculations that are distributed, directly or indirectly, to any person in written communications. These records are only required to be maintained under the current rule for distributions to 10 or more people. Additionally, the Adopted Rules require advisers to maintain, for communications related to performance or rate of return, originals of all written communications received and copies of written communications sent by the adviser.
Advisers filing an initial Form ADV or an amendment to an existing Form ADV on or after October 1, 2017 will be required to use the Form ADV as modified by the Adopted Rules. The amendments to the recordkeeping requirements will apply to communications circulated or distributed after October 1, 2017.