Securities Law Blog

The SEC's comment period for its proposed new Form ADV Part II recently ended. It is expected that the SEC will move quickly to finalize a new rule requiring that Form ADV Part II be in a narrative brochure written in plain English rather than the current check-the-box format. The brochure would consist of Parts 2A and 2B, which describe the Adviser's services, fees, business practices, and conflicts of interest with clients. Advisers would file their brochures electronically through the IARD system and the public would benefit by having access to these brochures through the SEC's Web site.

Brochure Items in Part 2A:
The SEC proposed 19 separate items, each covering a different disclosure topic. Much of the information that would be required in the brochure concerns conflicts between an Adviser's own interests and those of its clients. This is disclosure the Adviser already must make to clients, as a fiduciary, under the Investment Advisers Act's anti-fraud provisions. Thus, many of the proposed disclosure requirements are designed to give Advisers guidance on fulfilling their statutory disclosure obligations to clients. Part 2A would clarify that an Adviser must respond only to the items that apply to its business. The 19 items are summarized as follows:

Item 1. Cover Page - Advisers would need to disclose on the cover page of its brochure the name of the firm, its business address, telephone number, and the date of the brochure. The cover page also would include a statement that the brochure has not been approved by the SEC or any state securities authority.

Item 2. Material Changes - Advisers would need to provide clients with a summary of any material changes to their brochures since their last annual update.

Item 3. Table of Contents - The SEC is proposing a requirement that Advisers include in their brochures a table of contents detailed enough to permit clients and prospective clients to locate topics easily.

Item 4. Advisory Business - Advisers would be required to describe their advisory business, including the types of advisory services offered, whether they hold themselves out as specializing in a particular type of advisory service, and the amount of client assets that they manage.

Item 5. Fees and Compensation - Advisers would need to describe how they are compensated for providing advisory services and describe the types of other client costs, such as brokerage charges, custody fees, and fund expenses that clients may pay in connection with the advisory services provided to them by the Adviser.

Item 6. Performance Fees and Side-By-Side Management - Advisers that charge performance fees (or who have a supervised person who manages an account which charges such fees) would need to disclose this fact.

Item 7. Types of Clients - The brochure would need to describe the types of advisory clients an Adviser generally has, as well as the firm's requirements for opening or maintaining an account, such as minimum account size.

Item 8. Methods of Analysis, Investment Strategies, and Risk of Loss - Firms would need to describe their methods of analysis and investment strategies. In addition, Advisers would be required to discuss the risks clients face in following the Adviser's advice or permitting the Adviser to manage assets. Item 8 also would require specific disclosure of how strategies involving frequent trading can affect investment performance. Finally, Item 8 would require Advisers to discuss their practices regarding cash balances in client accounts.

Item 9. Disciplinary Information - Material facts about any legal or disciplinary event that is relevant to a client's evaluation of the integrity of the Adviser or its management practices would need to be disclosed.

Item 10. Other Financial Industry Activities and Affiliations - Advisers would be required to describe material relationships or arrangements they (or any of its management persons) have with related financial industry participants, any material conflict of interest that the relationships or arrangements create, and how Adviser would address the conflict. In addition, if an Adviser selects or recommends other advisers for clients, this proposed item would require Adviser to disclose any compensation arrangements or other business relationships between the two advisory firms, as well as the conflicts created.

Item 11. Code of Ethics, Participation or Interest in Client Transactions and Personal Trading - Advisers would need to describe briefly their code of ethics and to state that a copy is available upon request.

Item 12. Brokerage Practices - Advisers would be required to describe how they select brokers for client transactions and determine the reasonableness of brokers' compensation. This item also would require Advisers to disclose how they address conflicts arising from their receipt of "soft dollars," i.e., the receipt of benefits such as research in connection with the client brokerage.

Item 13. Review of Accounts - Advisers who review accounts would need to disclose how often, they review clients' accounts or financial plans and identify who conducts the review. Advisers who do not review accounts would need to disclose such. An Adviser that reviews accounts, but not regularly, would explain what circumstances trigger an account review.

Item 14. Payment for Client Referrals - Firms would be required to describe any cash or other payment that it or a related person makes for client referrals. The brochure also would disclose whether the Adviser receives any benefit, including sales awards or prizes, from a non-client for providing advisory services to clients.

Item 15. Custody - This item would reflect amendments to rule 206(4)-2 made several years ago (the investment Adviser custody rule).

Item 16. Investment Discretion - Firms with discretionary authority over client accounts would need to disclose these arrangements in their brochure, and any limitations clients may (or customarily do) place on this authority.

Item 17. Voting Client Securities - Advisers would be required to disclose their proxy voting practices.

Item 18. Financial Information - This item would require disclosure of certain financial information about the Adviser when the information is material to clients.

For more information on this subject contact securities attorneys, Michaels, Ward & Rabinovitz, LLP.