Compliance Solutions for Investment Advisers

Compliance Alert! ADV Part 2A

Dear Compliance Professional,

While the SEC has provided detailed instructions regarding the new ADV Part 2, there are many open questions – as there typically are with new requirements – as to the practical implications of these instructions.  Many of these questions will only be answered, and ambiguities clarified, in the crucible of an SEC audit.

Advisory firms should give thoughtful consideration to all potential ambiguities, and have a clear reason for handling a requirement in a particular manner. The new Form ADV raises questions to be considered, regarding both disclosures and the content provided.  Some of the issues raised are enumerated here.

………………………..

Potential Disclosure Issues

Additional Disclosure Items

The ADV 2 contains 18 items (19 for state-registered advisers), but to satisfy your disclosure obligations as a fiduciary, you may have to disclose to clients information not specifically required by Part 2 or in more detail than the Part 2 items might otherwise require.

Financial Sophistication

You are required to write your ADV 2 in plain English, taking into consideration your clients’ level of financial sophistication.

Potential Issues:

  • How do you determine your clients’ level of financial sophistication?
  • What level of due diligence are you required to undertake?
  • How diverse is your client base? Do you need multiple versions for client’s of differing sophistication?
  • Do you need to draft for the lowest common denominator?

Potential Issues with Required Content

Item 1 – Cover Page

If you refer to yourself as a “registered investment adviser” or describe yourself as being “registered” do not forget to include the following statement:

“Registration with the SEC does not imply that ____________ or any individual providing investment advisory services on behalf of _______________ possess a certain level of skill or training.”

Item 4 – Advisory Business

If you hold yourself out as specializing in a particular type of advisory service (e.g., financial planning) do not forget to explain the nature of that service in detail.

Need to explain whether (and, if so, how) you tailor your advisory services to the individual needs of clients.

Item 5 – Fees and Compensation

Do not forget to disclose all other types of fees (e.g., those above and beyond what you charge for your advisory services) that clients may pay, including:

  • Brokerage Fees and Expenses
  • Custody Fees and Expenses
  • Mutual Fund Fees and Expenses

Item 8 – Methods of Analysis, Investment Strategies and Risk of Loss

You are required to explain material risks involved with either a particular type of security or a particular type of investment strategy. For example, if you recommend the use of options, you should have disclosure information regarding the risks involved. The same goes for margin transactions, private placement investments and just about any other type of investment outside of mutual funds. The problem is that there is no standard disclosure language and the SEC has not provided guidance. Also, you are not permitted to use legalese so any risk must be described in “plain English”.

Though not specifically required in the rule, it is suggested that in light of recent money market issues that you disclose your cash management practices including whether you charge on cash balances and if/how cash is invested in cash equivalents.

Item 9 – Disciplinary Information

Generally, you are required to disclose certain disciplinary events for a period of ten years following the date of the event. However, even if more than ten years have passed since the date of the event, you must disclose the event if it is so serious that it remains material to a client’s or perspective client’s evaluation of your firm or its management.  The SEC has not provided guidance about what is serious enough to warrant disclosure.

Item 15 – Custody

If you send account statement to your clients, you must include a statement urging clients to compare the account statement they receive from you with the one they receive from the qualified custodian.

line