SEC Proposes to Amend Form ADV and Investment Adviser Recordkeeping Rules

The U.S. Securities and Exchange Commission (SEC or Commission) recently proposed amendments to Form ADV and to Rule 204-2 (Recordkeeping Rule) and other rules under the Investment Advisers Act of 1940, as amended (Advisers Act).¹ The Proposal is designed to require investment advisers registering on Form ADV (advisers) to report additional information to the SEC to enhance the SEC staff’s ability to carry out its risk-based examination program and other risk assessment and monitoring activities, as well as to examine and evaluate adviser performance claims. As proposed, the information to be provided under the Proposal would be available to the general public—in contrast to similar private fund filing information on Form PF, which is filed confidentially. 

The Form ADV amendments would include: 

• Requirements for increased aggregate information on separately managed accounts managed by advisers. 
• Amendments to facilitate “umbrella registration” for eligible affiliated advisers. 
• Various technical amendments to items and instructions. 

The rule amendments, including the Recordkeeping Rule amendments, would consist of: 

• Requirements that advisers retain, in their books and records, materials demonstrating the calculation of the performance or rate of return presented either directly or indirectly to any person. 
• A requirement that advisers preserve original written correspondence received, and copies of written correspondence sent, relating to the performance or rate of return of any or all managed accounts or securities recommendations. 
• Several technical amendments to update the text of various rules in connection with the expiration of transition periods—including those provided in the implementation the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and recent amendments to Form ADV. 

This Dechert OnPoint summarizes these key components of the Proposal. 

Proposed Amendments to Form ADV 

Disclosures Regarding Separately Managed Accounts 

Currently, advisers must report a percentage breakdown of the types of clients they advise, by assets and number of clients. As part of the SEC’s efforts to enhance its risk-monitoring initiatives, the Proposal would require advisers to provide more specific information regarding separately managed accounts. 

First, the Proposal would require all advisers to annually report in Item 5 of Part 1A of Form ADV and Section 5 of Schedule D the percentage of separately managed account regulatory assets invested, across 10 broad asset categories.² 

In addition, the Proposal would require advisers with at least $150 million in regulatory assets under management (RAUM) attributable to separately managed accounts to report information on borrowings and derivatives attributable to separately managed accounts annually, when filing their updating amendment to Form ADV. Section 5.K. of Schedule D would require certain disclosures by advisers, based on their RAUM attributable to separately managed accounts as set forth below: 

• Advisers with more than $150 million. The Proposal would require these advisers to disclose the number of accounts (with a net asset value of at least $10 million) fitting within delineated categories of gross notional exposure, together with the weighted average amount of borrowings (as a percentage of net asset value) in those accounts.³ 
• Advisers with at least $10 billion. Advisers in this category would additionally be required to disclose the weighted gross notional value of six different types of derivatives (as a percentage of the net asset value).⁴ These advisers also would be required to report both mid-year and year-end derivatives and borrowings data in their annual filings. 

The SEC proposed an additional requirement that advisers identify any custodians that account for at least 10 percent of separately managed account RAUM, as well as disclose the amount of RAUM attributable to separately managed accounts held at such custodians. 

Additional Identifying Disclosures 

CIK Information 

Currently, Item 1.N. of Part 1A of Form ADV requires advisers that are public reporting companies under Sections 12 or 15(d) of the Securities Exchange Act of 1934, as amended, to report their Central Index Key number (CIK Number). The SEC proposed amendments that would remove the CIK Number question in Item 1.N. and replace that question with a new question in Item 1.D., which would require all advisers to report any CIK Numbers assigned to them. Advisers would thus be required to report their CIK Numbers regardless of public reporting company status. 

Social Media Sites 

To assist the SEC staff in preparing for examinations and comparing information that an adviser is circulating across various social media outlets, the Proposal would amend Item 1.I. to require disclosure of any social media accounts used by the adviser. Examples provided by the Commission included Twitter, Facebook and LinkedIn. However, no definition for “social media website” was proposed. 

Office Location and Activity Disclosure 

Proposed amendments to Item 1.F. and Section 1.F. of Schedule D would require that advisers report the total number of offices in which they offer investment advisory services and provide information relating to their 25 largest offices by number of employees. Advisers would be required to report for each office: 

• CRD branch numbers (where applicable). 
• A count of employees serving in an advisory capacity. 
• The business activities that take place, based upon a list of activities provided by the Commission. 
• Any other investment activities conducted. 

Chief Compliance Officer Outsourcing 

To allow the SEC to better understand the use of outsourced chief compliance officers, the Proposal would amend Item I.J. of Part 1A to require an adviser to report whether or not its chief compliance officer is compensated or employed by a third-party service provider. If this is the case, the adviser would be required to disclose the name and IRS Employer Identification Number (if any) of that service provider. The SEC noted that identifying information for these third-party service providers would allow the SEC to identify all advisers relying on a particular service provider and could be helpful in improving the SEC’s ability to assess potential risks.⁵ 

Adviser Asset Approximation 

The Proposal would amend Item 1.O. of Part 1A, which currently requires an adviser to check a box if it has assets of $1 billion dollars or more. Item 1.O. would be amended to require advisers to report their own assets (i.e., balance sheet assets, not assets under management) within specified ranges. The SEC noted that this information would provide the SEC with more accurate data for use in rulemaking arising from Dodd-Frank Act implementation.⁶ 

Additional Information about Advisory Business 

The Proposal would amend Item 5 of Part 1A of Form ADV to require more specific information about the amount and proportion of an adviser’s RAUM for different client types. Under the Proposal, the current percentile ranges of RAUM would be replaced with a table requiring advisers to provide precise amounts of RAUM attributable to each specific category of clients. Advisers would also be required to disclose the number of clients to whom the adviser provided advisory services but for whom the adviser does not manage regulatory assets, such as a non-discretionary account or a one-time financial plan. 

Under the Proposal, Form ADV would require an adviser to indicate if it reported client assets in Part 2A of Form ADV in a different manner from the RAUM it reported in Part 1A.⁷ The SEC indicated that understanding which advisers make this election will help it clarify whether the differences in calculations require a regulatory response. 

The SEC proposed adding a requirement to Section 5.G.(3) of Schedule D that, in addition to the SEC File Number, an adviser report RAUM of all “parallel managed accounts” related to a registered investment company or business development company advised by the adviser.⁸ The SEC noted that this information would assist the SEC staff in assessing how an adviser manages conflicts of interest between parallel managed accounts and registered investment companies or business development companies advised by the adviser, as well as illustrate the extent of any changes in assets between parallel managed accounts and registered investment companies or business development companies.⁹ 

Section 5.I. of Part 1A obligates an adviser to disclose whether it services a wrap fee program as either a sponsor or a portfolio manager. In addition to disclosure of the name and sponsor of each wrap fee program the adviser manages, the amended Section 5.I.(2) would require disclosure of the SEC File Number and CRD Number for each sponsor of a wrap fee program, as well as disclosure of the aggregate value of RAUM attributable to the adviser’s role as a sponsor and/or portfolio manager of the wrap fee program. 

Financial Industry Affiliation and Private Fund Reporting Disclosures 

The Proposal would amend Sections 7.A. and 7.B.(1) of Schedule D to require disclosure of identifying numbers, registration numbers and CIK Numbers of financial service providers. The Commission has also proposed to add a question requiring advisers to report the percentage of a private fund owned by “qualified clients” as defined in Rule 205-3 of the Advisers Act. This may prove to be difficult for an adviser to ascertain with respect to offshore funds as well as funds where there is not a performance fee. 

Umbrella Registration 

Background 

The SEC recognized that certain tax, legal and regulatory motivations may prompt an adviser to private funds to organize as a group of related advisers that are separate legal entities, but which operate as a single advisory business. Because Form ADV is designed to accommodate registration by a single legal entity, many organizations that are constructively a single advisory service must register each of their advisers on separate Form ADVs. 

The SEC staff provided no-action relief that allowed an adviser to file a single Form ADV on behalf of itself and other advisers that are controlled by or under common control with that adviser, provided they conduct a single advisory business, which is referred to as “Umbrella Registration.”¹⁰ The Proposal would extend this relief by formalizing Umbrella Registration under Form ADV.¹¹ 

Process 

A “Filing Adviser” seeking to satisfy the requirements of Form ADV while using Umbrella Registration would be required to file Parts 1 and 2 of a single Form ADV that includes all required information about the Filing Adviser and each “Relying Adviser.”¹² 

Qualifying for Umbrella Registration 

Under the Proposal, Form ADV would allow a group of related advisers operating a single advisory business to rely on Umbrella Registration when each of the Relying Advisers is controlled by or under common control with the Filing Adviser, and: 

• All of the Relying Advisers and the Filing Adviser advise only private funds and clients in separately managed accounts that are qualified clients eligible to invest in the private funds advised by the Filing Adviser or a Relying Adviser. The accounts of the advisers must pursue substantially similar investment objectives and strategies as those private funds. 
• The principal office and place of business of the Filing Adviser is in the United States.¹³ 
• Each Relying Adviser, its employees and those acting on the Relying Adviser’s behalf are “persons associated with” the Filing Adviser, and thus under the supervision and control of the Filing Adviser.¹⁴ 
• The advisory activities of all of the Relying Advisers are governed by the Advisers Act and its accompanying rules, subjecting the Relying Advisers to examination by the SEC. 
• The Filing Adviser and all Relying Advisers operate under a single code of ethics and a single set of written policies and procedures and have the same chief compliance officer. 

Schedule R and Amendments to Schedule D 

To clarify and supplement disclosures already provided by groups relying on the ABA Letter for Umbrella Registration, the Proposal would add Schedule R to Part 1A of Form ADV. Schedule R would require certain identifying information, including organizational form, ownership and control persons for each Relying Adviser. The Proposal would also amend Schedule D to include a new question that would require each adviser relying on Umbrella Registration to identify the Filing Adviser and Relying Advisers that manage or sponsor private funds reported on Form ADV. 

Clarifying and Technical Amendments to Form ADV 

Based on frequently asked questions received by the SEC staff and in order to encourage more reliable and consistent disclosures, the SEC proposed several minor amendments to various parts of Form ADV. These proposed amendments included a number of clarifications such as technical amendments to titles, questions, instructions and the glossary. 

For example, the SEC proposed to amend:

• Item 8.H. of Part 1A to break that item into two parts—Item 8.H.(1) to request disclosure of compensation paid to individuals not employed by the adviser for client referrals and Item 8.H.(2) to request details regarding compensation paid to employees above their normal salary for soliciting clients. 
• Section 9.C. of Schedule D to request that an adviser report the PCAOB registration number of its independent public accountant and to indicate whether all reports prepared by the independent public accountant since the date of the last annual updating amendment have contained unqualified opinions. 

Proposed Amendments to Rules under the Investment Advisers Act 

Proposed Amendments to Recordkeeping Rule 

The Proposal included two amendments to the Recordkeeping Rule. First, the SEC proposed amending Rule 204-2(a)(16) to require advisers to document and preserve calculations supporting performance claims made in materials distributed directly or indirectly to any person. Currently, Rule 204-2(a)(16) requires advisers to retain records supporting performance information only in communications that are distributed to 10 or more persons. Second, the SEC proposed amending Rule 204-2(a)(7) to add a requirement that advisers 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. 

Proposed Technical Amendments to Advisers Act Rules 

The SEC proposed the withdrawal of the following rule provisions under the Advisers Act containing lapsed transition periods from the Dodd-Frank Act and recent amendments to Form ADV: 

• Rule 202(a)(11)(G)-1(e) (expired transition periods for family offices relying on the “private adviser” exemption). 
• Rule 203A-5 (expired exemption period for “mid-sized” advisers). 
• Rule 203-1(e) (expired transition period for companies relying on the “private adviser” exemption). 
• Rule 203-1(b) (expired transition period for electronic filing). Rule 204-1(c) (expired transition period to electronically file a Part 2A brochure). 

Comment Period 

Comments on the Proposal are due by August 11, 2015.

Footnotes 

_{1) Amendments to Form ADV and Investment Advisers Act Rules, Rel. No. IA-4091 (May 20, 2015) (Proposing Release or Proposal). At the meeting during which the Proposal was adopted, the SEC also unanimously approved a proposal to modernize the reporting of information provided by registered investment companies. See Investment Company Reporting Modernization, Rel. No. IC-31610 (May 20, 2015). For additional information relating to the latter proposal, please see Dechert OnPoint, U.S. SEC Approves Proposal to Modernize Investment Company Reporting Regime.
2) The categories are: (i) exchange-traded equity securities; (ii) U.S. Government/agency bonds; (iii) U.S. state and local bonds; (iv) sovereign bonds; (v) corporate bonds-investment grade; (vi) corporate bonds-non investment grade; (vii) derivatives; (viii) securities issued by registered investment companies or business development companies; (ix) securities issued by pooled investment vehicles (other than registered investment companies); and (x) other. A similar data collection with respect to private funds is included in Form PF, and the SEC has proposed to define the categories consistently with Form PF.
3) The Proposal would define gross notional exposure as “the percentage obtained by dividing (i) the sum of (a) the dollar amount of any borrowings and (b) the gross notional value of all derivatives by (ii) the net asset value of the account.”
4) The six types of derivatives are: (i) interest rate derivatives; (ii) foreign exchange derivatives; (iii) credit derivatives; (iv) equity derivatives; (v) commodity derivatives; and (vi) other derivatives.
5) In proposing this Item, the SEC noted that the “examination staff has observed a wide spectrum of both quality and effectiveness of outsourced chief compliance officers and [compliance] firms.”
6) In particular, Section 165(i) of the Dodd-Frank Act requires the SEC and other financial regulators to establish methodologies for conducting stress tests required by Section 165 of the Dodd-Frank Act.
7) The Proposal noted that Form ADV, Part 2A, Item 4.E. requires an adviser to disclose the amount of client assets it manages on a discretionary basis and on a non-discretionary basis. The method used to calculate this number can be different from the method that the adviser uses to calculate RAUM in Item 5.F. in Part 1A. Advisers using a different method of calculation must keep documentation describing the method used for Item 4.E. of Part 2A.
8) The proposed Form ADV glossary would define a “parallel managed account” as “any managed account or other pool of assets that you advise and that pursues substantially the same investment objective and strategy and invests side-by-side in substantially the same positions as the identified investment company or business-development company that you advise.”
9) Because a registered investment company with multiple series is issued a single SEC File Number, it is unclear whether the SEC staff would be able to determine the particular series that is being identified as a parallel managed account.
10) American Bar Association, Business Law Section, SEC No-Action Letter (Jan. 18, 2012) at Question 4 (ABA Letter).
11) “Umbrella Registration” would be defined in the proposed Form ADV glossary as “a single registration by a [F]iling [A]dviser and one or more [R]elying [A]dvisers who collectively conduct a single advisory business and that meet the conditions set forth in General Instruction 5.”
12) “Filing Adviser” would be defined in the proposed Form ADV glossary as “[a]n investment adviser eligible to register with the SEC that files a single [U]mbrella [R]egistration on behalf of itself and each of its [R]elying [A]dvisers.” “Relying Adviser” would be defined in the proposed Form ADV glossary as “[a]n investment adviser eligible to register with the SEC that relies on a [F]iling [A]dviser to file a single [U]mbrella [R]egistration on its behalf.”
13) Therefore, all of the Advisers Act requirements must apply to the Filing Adviser’s and all of the Relying Advisers’ dealings with each of their clients, whether or not a client is a U.S. person.
14) “Persons Associated with” is defined in Section 202(a)(17) of the Advisers Act.}