On May 25, 2011, the SEC adopted final rules implementing the new whistleblower program that was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rules go into effect on August 12, 2011.
The whistleblower program is intended to encourage individuals to report securities law violations by paying to the whistleblower an award of between 10% and 30% of the monetary sanctions collected by the SEC or certain other agencies.
The whistleblower must be an individual or a group of individuals who provide the SEC with information that pertains to a possible violation of federal securities law. A whistleblower must voluntarily disclose information. This information must be “original” information, and it must not have already been known by the SEC. The information must lead to a successful enforcement action(s). The enforcement action(s) by the SEC or certain other agencies must result in a monetary sanction in excess of $1,000,000. Some of these rules are complex and may require a detailed analysis by the whistleblower or his attorney.
The law provides certain anti-retaliatory provisions that protect the whistleblower and give the whistleblower the right to bring a private cause of action if retaliation occurs.
The rules permit a whistleblower to bypass the company’s internal reporting obligations and report possible violations directly to the SEC. Most companies would prefer a whistleblower to report possible violations to appropriate company management. A whistleblower may still receive an award if he reports the possible violations to company management. In order to encourage a whistleblower to report possible violations to the company, and not to the SEC, top company management must establish policies and procedures that make the whistleblower believe that reports will be quickly and effectively addressed and that no retaliation will occur.
Wednesday, July 27, 2011
Thursday, June 23, 2011
SEC Issues Rules Related to the Implementation of Dodd-Frank by Investment Advisers, Hedge Funds, and Family Offices
President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21, 2010. Title IV of that Act imposed many changes on investment advisers and hedge funds and other pooled investment funds that are managed by advisers. Most of those new laws were scheduled to become effective on July 21, 2011. However, in April 2010, the SEC told state regulators this deadline for mid-sized advisers to register with the states may be extended because the SEC had not completed its rulemaking and the IARD system used by advisers to register would have to be re-programmed. On June 22, 2011, the SEC adopted several rules which extended the deadline for certain provisions in Dodd-Frank and gave advisers and hedge funds needed guidance in several areas.
Although I don’t yet have the final rules, I have included a summary of those rules from two press releases issued by the SEC.
In press release 2011-133, the SEC described rules that it adopted that included, but are not limited to, the following:
1. Private-fund advisers that must register as investment advisers with the SEC for the first time because of Dodd-Frank must be registered by March 30, 2012.
2. On their application for registration, Form ADV, private-fund advisers will have to provide the following: (a) basic organizational and operational information about each fund they manage, (b) general information about the size and ownership of the fund, (c) general fund data, (d) the adviser’s services to the fund, and (e) identification of the “gatekeepers” that assist the adviser and the private fund (i.e., auditors, prime brokers, custodians, administrators, and marketers).
3. Form ADV was amended (yes, again) to include information about (a) the types of clients advised,
(b) the adviser’s employees, (c) the adviser’s advisory activities, and (d) their business practices that may present significant conflicts of interest. (Some of this seems duplicative of the information already required. When we see the final rule, we may be able to make some distinctions.)
4. Although exempt from registration, the SEC imposes the following duties on advisers solely to venture capital funds and advisers solely to private funds with less than $150 million in assets under management in the U.S.
a. File and periodically update reports with the SEC using Form ADV. This information will be filed electronically on the IARD system and will be available to the public.
b. Instead of completing the entire Form ADV, these “exempt reporting advisers” will disclose (a) basic identifying information about the adviser, (b) the identity of its owners and affiliates, (c) information about the private funds the adviser manages, (d) information about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest, and (e) the disciplinary history of the adviser and its employees that may reflect on the integrity of the advisory firm.
5. Dodd-Frank requires that advisers who have assets under management of between $25 million and $100 million switch their registration from the SEC to the applicable state(s), if certain requirements are met. The new rule states that:
a. Advisers registered with the SEC will have to declare that they are permitted to remain SEC registered in a filing to be made in the first quarter of 2012.
b. Advisers who no longer are eligible for SEC registration will have until June 28, 2012, to complete the switch to state registration.
6. The relatively new pay-to-play rule was amended to allow an adviser to pay a registered municipal advisor to act as a placement agent to solicit government entities on its behalf, if the municipal advisor is subject to a pay-to-play rule adopted by the MSRB that is at least as stringent as the investment adviser pay-to-play rule.
7. The SEC defined “venture capital fund,” which was undefined in Dodd-Frank.
In press release 2011-134, the SEC defined “family offices,” which was also left undefined by Dodd-Frank. Family offices are entities established by wealthy families to manage their wealth and provide other services to family members. Historically, family offices used the private adviser exemption to avoid registration as an investment adviser, but Dodd-Frank eliminated the private adviser exemption. Dodd-Frank exempted family offices from registration as an investment adviser and left the definition up to the SEC.
According to the new rule, a family office that is exempt from registration is any company that:
1. Provides investment advice only to “family clients,” as defined in the rule;
2. Is wholly owned by family clients and is exclusively controlled by family members and/or family entities, as defined by the rule; and
3. Does not hold itself out to the public as an investment adviser.
Family offices that do not meet this definition must register with the SEC or with the applicable state(s) by March 30, 2012.
The new rule states that existing exemptive orders from the SEC remain effective and that certain family offices may be deemed to meet the new definition under a grandfathering provision.
Although I don’t yet have the final rules, I have included a summary of those rules from two press releases issued by the SEC.
In press release 2011-133, the SEC described rules that it adopted that included, but are not limited to, the following:
1. Private-fund advisers that must register as investment advisers with the SEC for the first time because of Dodd-Frank must be registered by March 30, 2012.
2. On their application for registration, Form ADV, private-fund advisers will have to provide the following: (a) basic organizational and operational information about each fund they manage, (b) general information about the size and ownership of the fund, (c) general fund data, (d) the adviser’s services to the fund, and (e) identification of the “gatekeepers” that assist the adviser and the private fund (i.e., auditors, prime brokers, custodians, administrators, and marketers).
3. Form ADV was amended (yes, again) to include information about (a) the types of clients advised,
(b) the adviser’s employees, (c) the adviser’s advisory activities, and (d) their business practices that may present significant conflicts of interest. (Some of this seems duplicative of the information already required. When we see the final rule, we may be able to make some distinctions.)
4. Although exempt from registration, the SEC imposes the following duties on advisers solely to venture capital funds and advisers solely to private funds with less than $150 million in assets under management in the U.S.
a. File and periodically update reports with the SEC using Form ADV. This information will be filed electronically on the IARD system and will be available to the public.
b. Instead of completing the entire Form ADV, these “exempt reporting advisers” will disclose (a) basic identifying information about the adviser, (b) the identity of its owners and affiliates, (c) information about the private funds the adviser manages, (d) information about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest, and (e) the disciplinary history of the adviser and its employees that may reflect on the integrity of the advisory firm.
5. Dodd-Frank requires that advisers who have assets under management of between $25 million and $100 million switch their registration from the SEC to the applicable state(s), if certain requirements are met. The new rule states that:
a. Advisers registered with the SEC will have to declare that they are permitted to remain SEC registered in a filing to be made in the first quarter of 2012.
b. Advisers who no longer are eligible for SEC registration will have until June 28, 2012, to complete the switch to state registration.
6. The relatively new pay-to-play rule was amended to allow an adviser to pay a registered municipal advisor to act as a placement agent to solicit government entities on its behalf, if the municipal advisor is subject to a pay-to-play rule adopted by the MSRB that is at least as stringent as the investment adviser pay-to-play rule.
7. The SEC defined “venture capital fund,” which was undefined in Dodd-Frank.
In press release 2011-134, the SEC defined “family offices,” which was also left undefined by Dodd-Frank. Family offices are entities established by wealthy families to manage their wealth and provide other services to family members. Historically, family offices used the private adviser exemption to avoid registration as an investment adviser, but Dodd-Frank eliminated the private adviser exemption. Dodd-Frank exempted family offices from registration as an investment adviser and left the definition up to the SEC.
According to the new rule, a family office that is exempt from registration is any company that:
1. Provides investment advice only to “family clients,” as defined in the rule;
2. Is wholly owned by family clients and is exclusively controlled by family members and/or family entities, as defined by the rule; and
3. Does not hold itself out to the public as an investment adviser.
Family offices that do not meet this definition must register with the SEC or with the applicable state(s) by March 30, 2012.
The new rule states that existing exemptive orders from the SEC remain effective and that certain family offices may be deemed to meet the new definition under a grandfathering provision.
Thursday, May 5, 2011
SEC to Focus on Nine Areas when Examining Investment Advisers
On March 21, 2011, Carlo V. di Florio, the SEC’s Director of the Office of Compliance Inspections and Examinations, gave a speech in which he indicated that the SEC would focus on the following nine areas in examinations of investment advisers:
1. Valuation – a top priority, particularly when the IA manages assets that are difficult to value (e.g., alternative investments that do not routinely trade on exchanges or other established markets). SEC will review the IA’s policies and procedures regarding valuation of managed assets.
2. Conflicts of Interest – SEC will review procedures used by an IA to identify, disclose, and manage conflicts. Conflicts mentioned included allocations, analysis of insider trading, side letters, best execution, directed brokerage, and soft dollar issues.
3. Portfolio Management – SEC will test whether the strategy presented to investors is actually being carried out by the advisers.
4. Performance and Advertising Issues – If applicable, SEC will review any performance calculation and the presentation of that performance in any offering materials.
5. Asset Verification – If an adviser has custody, SEC may verify assets and controls for safeguarding assets. This analysis may include a determination of whether an adviser who says it does not have custody actually does have custody (e.g., check writing authority, power of attorney, and/or general partner to a hedge fund).
6. Risk Management – how the adviser takes and manages risk.
7. Business Continuity/Disaster Recovery – This is an item that should be in every SEC-registered adviser’s policies and procedures manual. The Director cited the recent natural disasters in Japan and New Zealand.
8. Use of Social Media – The use of social media, including websites, blogs, twitter, etc., may increase an adviser’s compliance risks. The Director cited stock picks, links to other products and services, and the difficulty in providing proper disclosures as areas that may be problematic.
9. Small Niche Mutual Funds or ETFs – These investments are subject to unusual or obscure risks where small events can have huge effects. Again the SEC will consider an adviser’s risk management procedures.
If an IA is not an SEC-registered IA, it is must be subject to an examination program conducted by your state securities regulator; therefore, a state-registered IA should also be preparing for an examination by considering the above items.
Many of the above items should be considered and/or included in an adviser’s policies and procedures manual or the new narrative version of Part 2 of Form ADV.
1. Valuation – a top priority, particularly when the IA manages assets that are difficult to value (e.g., alternative investments that do not routinely trade on exchanges or other established markets). SEC will review the IA’s policies and procedures regarding valuation of managed assets.
2. Conflicts of Interest – SEC will review procedures used by an IA to identify, disclose, and manage conflicts. Conflicts mentioned included allocations, analysis of insider trading, side letters, best execution, directed brokerage, and soft dollar issues.
3. Portfolio Management – SEC will test whether the strategy presented to investors is actually being carried out by the advisers.
4. Performance and Advertising Issues – If applicable, SEC will review any performance calculation and the presentation of that performance in any offering materials.
5. Asset Verification – If an adviser has custody, SEC may verify assets and controls for safeguarding assets. This analysis may include a determination of whether an adviser who says it does not have custody actually does have custody (e.g., check writing authority, power of attorney, and/or general partner to a hedge fund).
6. Risk Management – how the adviser takes and manages risk.
7. Business Continuity/Disaster Recovery – This is an item that should be in every SEC-registered adviser’s policies and procedures manual. The Director cited the recent natural disasters in Japan and New Zealand.
8. Use of Social Media – The use of social media, including websites, blogs, twitter, etc., may increase an adviser’s compliance risks. The Director cited stock picks, links to other products and services, and the difficulty in providing proper disclosures as areas that may be problematic.
9. Small Niche Mutual Funds or ETFs – These investments are subject to unusual or obscure risks where small events can have huge effects. Again the SEC will consider an adviser’s risk management procedures.
If an IA is not an SEC-registered IA, it is must be subject to an examination program conducted by your state securities regulator; therefore, a state-registered IA should also be preparing for an examination by considering the above items.
Many of the above items should be considered and/or included in an adviser’s policies and procedures manual or the new narrative version of Part 2 of Form ADV.
Tuesday, May 3, 2011
Are You or Your Firm Listed on BrightScope?
A new website allows investors, plan sponsors, and others to search for and find information on investment advisers. That website is http://www.brightscope.com/.
BrightScope states, “BrightScope®, Inc. is a financial information company that brings transparency to opaque markets. Delivered through web-based software, BrightScope data drives better decision-making for individual investors, corporate plan sponsors, asset managers, broker-dealers, and financial advisors. BrightScope primarily operates in two major segments: Retirement Plans and Wealth Management.”
Regarding retirement plans, BrightScope states that it provides ratings and analysis for participants, plan sponsors, and advisors. Regarding wealth management, BrightScope states that it presents information on financial advisors that can be used by investors to perform due diligence on their current or prospective advisor.
Reliable and timely information is always useful, so BrightScope’s service may be needed. However, a recent article states that many advisers claim that information presented by BrightScope about investment advisers is not accurate, especially information about an adviser’s assets under management. That article also states that an adviser can correct - for a fee - certain information displayed by BrightScope.
All investment advisers and brokers may want to determine whether information about them or their firm appears on BrightScope and, if so, verify that information.
BrightScope states, “BrightScope®, Inc. is a financial information company that brings transparency to opaque markets. Delivered through web-based software, BrightScope data drives better decision-making for individual investors, corporate plan sponsors, asset managers, broker-dealers, and financial advisors. BrightScope primarily operates in two major segments: Retirement Plans and Wealth Management.”
Regarding retirement plans, BrightScope states that it provides ratings and analysis for participants, plan sponsors, and advisors. Regarding wealth management, BrightScope states that it presents information on financial advisors that can be used by investors to perform due diligence on their current or prospective advisor.
Reliable and timely information is always useful, so BrightScope’s service may be needed. However, a recent article states that many advisers claim that information presented by BrightScope about investment advisers is not accurate, especially information about an adviser’s assets under management. That article also states that an adviser can correct - for a fee - certain information displayed by BrightScope.
All investment advisers and brokers may want to determine whether information about them or their firm appears on BrightScope and, if so, verify that information.
Friday, April 1, 2011
Now that your Brochure is filed . . . What is an Investment Adviser to do?
Most investment advisers had to electronically file the new narrative, plain English brochure (Form ADV, Part 2A) by March 31, 2011. I hope that everyone met this deadline. But what is an investment adviser to do now that its brochure has been filed? Is this regulatory burden over? Can you just file it away and glide until your annual updating amendment is due in March, 2012?
As lawyers like to say, it depends. I have gathered some thoughts and information below that may assist you regarding your additional responsibilities. (These responsibilities come from federal law, but state securities regulators are likely to apply the same laws.)
First, what should you do with the new brochure?
If you are an SEC-registered adviser, you must “deliver” a brochure and a brochure supplement(s) to each client or prospective client that contains all information required by Part 2 of Form ADV. 17 C.F.R. § 275.204-3(a).
Please note that the statute says “deliver,” not offer. For more detail on the delivery requirements, see below and/or seek legal advice.
Second, when do I start using the new brochure and brochure supplement?
An SEC-registered investment adviser must begin using the new brochure and brochure supplement by the date that the adviser was required to first electronically file its new brochure. 17 C.F.R. § 275.204-3(g)(2). Therefore, registered advisers with a December 31, 2010 year-end must start using the new brochure and brochure supplement by March 31, 2011. (Note that this is a transition rule.)
When using the new brochure and brochure supplement, an adviser must be using the “current” version. 17 C.F.R. § 275.204-3(g)(2). Therefore, advisers should control all amendments to the brochure and brochure supplement to ensure that only the current versions are being used.
Finally, an adviser must comply with the delivery requirements. See 17 C.F.R. § 275.204-3(g)(2).
Third, in this period of transitioning to the new narrative brochure, when must I provide existing clients with a copy of the new brochure and brochure supplement?
An SEC-registered investment adviser must deliver its current brochure and brochure supplement to its existing clients within 60 days after the date that the adviser was required to electronically file its new brochure. 17 C.F.R. § 275.204-3(g)(1). Therefore, registered advisers with a December 31, 2010 year-end must deliver the new brochure and brochure supplement to their existing clients by May 30, 2011. (Note that this is a transition rule.)
Fourth, what are the delivery requirements for the brochure?
For new clients, an adviser must deliver “your current brochure” before or at the time you and the new client execute an investment advisory contract. 17 C.F.R. § 275.204-3(b)(1).
For existing clients, see the transition rule above that requires advisers to provide the new brochure and brochure supplement within 60 days after the brochure and brochure supplement were required to be electronically filed. Thereafter, for existing clients, the annual delivery requirement is triggered ONLY “if there are material changes in the brochure since the adviser’s last annual updating amendment.” 17 C.F.R. § 275.204-3(b)(2). If these material changes exist, the adviser must deliver annually within 120 days after the end of the adviser’s fiscal year (April 30, 2011 for advisers with a December 31, 2010 year-end) the following:
• A current brochure or
• The summary of material changes to the brochure with (1) an offer to provide your current brochure, (2) the telephone number (and website address or email address, if available) by which a client may obtain the current brochure from you, and (3) the website address for obtaining information about you through the Investment Adviser Public Disclosure (IAPD) system.
17 C.F.R. § 275.204-3(b)(2)(i), (ii).
To simplify: For new clients, give a copy of your current brochure before the new client signs the advisory contract. For existing clients (where the adviser has a December 31 year –end):
• In 2011, give all existing clients a copy of your current brochure and brochure supplement by May 30, 2011.
• Thereafter, give all existing clients a copy of your current brochure by April 30, 2011.
Also an SEC-registered adviser may deliver its brochure electronically, but, as expected, electronic delivery brings its own set of regulations. (The SEC has published interpretive guidance regarding electronic delivery by investment advisers. Study this guidance or consult legal counsel before attempting electronic delivery of a brochure.)
Fifth, what are the delivery requirements for the brochure supplements?
The general rule is that an investment adviser (remember, the IA is the firm) must deliver to each client of prospective client a current brochure supplement for a supervised persons (usually the person who is giving the investment advice – that is, the investment adviser representative) before or at the time the supervised person begins to provide advisory services to the client. 17 C.F.R. § 275.204-3(b)(3). (However, keep in mind the transition rule stated above, that requires advisers to provide the brochure supplement to existing clients by May 30, 2011.)
However, the SEC has extended the compliance dates by which some advisers must deliver the brochure supplement as follows:
• Advisers registered with the SEC as of December 31, 2010, and having a fiscal year ending on December 31, 2010 through April 30, 2011, must prepare and begin delivering brochure supplements to new and prospective clients by July 31, 2011, and must deliver brochure supplements to existing clients by September 30, 2011.
• Newly-registered advisers filing applications for registration from January 1, 2011 through April 30, 2011, have until May 1, 2011 to prepare and begin delivering brochure supplements to new and prospective clients and have until July 1, 2011 to deliver brochure supplements to existing clients.
Based on the general rule, BEFORE a new individual begins to serve a particular advisory client, the investment adviser must consider whether that individual is a supervised person and, if so, whether the adviser has provided the brochure supplement of that supervised person to the client.
Please note that the brochure supplement(s) may be part of the brochure, so the client may have been provided the brochure supplement(s) when he was provided the brochure.
Sixth, how often do I have to amend my brochure?
An SEC-registered investment adviser must amend its brochure as follows:
• At least annually, within 90 days of the end of its fiscal year; AND
• More frequently, if required by the instructions to Form ADV.
17 C.F.R. § 275.204-1(a).
Seventh, according to the instructions to Form ADV, Part 2, when must I amend my brochure?
According to the instructions for Part 2A of Form ADV, an investment adviser must update its brochure as follows:
• Each year at the time the adviser files its annual updating amendment (i.e., within 90 days after year-end) AND
• Promptly whenever any information in the brochure becomes materially inaccurate. (An adviser is not required to update its brochure between annual updating amendments solely because the amount of client assets it manages has changed or because its fee schedule has changed. However, if the adviser updates its brochure for a separate reason in between annual updating amendments and the amount of client assets managed or its fees schedule has become materially inaccurate, the adviser should update these items in the interim amendment.
Eighth, can I amend my brochure other than when the instructions to Part 2 require an amendment?
Yes, an adviser can amend its brochure at any time to add or correct non-material items. I’ve already seen amendments to correct typos, to improve readability, and to insert additional explanation about an adviser’s business.
Ninth, do all amendment to my brochure – material and non-material – have to be filed through the IARD system?
All amendments to the brochure (i.e., Part 2A of Form ADV) must be filed electronically with the IARD (unless the adviser has received a hardship exemption). 17 C.F.R. § 275.204-1(b). Therefore, even if an adviser amends its brochure for minor things, such as to correct a typo, the adviser must file the amended brochure in the IARD system.
Tenth, what are the delivery requirements for amendments to the brochure or brochure supplement?
The delivery requirements for amendments to the brochure and brochure supplement are triggered ONLY if the amendment adds disclosure of a disciplinary event or materially revises information already disclosed about a disciplinary event. If this is the case, an investment adviser must deliver to each client “promptly after you create an amended brochure or brochure supplement” one of the following;
• The amended brochure or brochure supplement, as applicable, and a statement describing the material facts relating to the change in disciplinary information, or
• A statement describing the material facts relating to the change in disciplinary information.
17 C.F.R. § 275.204-3(b)(4).
The delivery requirements for interim amendments (i.e., any amendments between annual updating amendments) differ. If an adviser amends its brochure because information in the brochure became materially inaccurate (see the Seventh note above), the adviser should immediately begin to use the newly amended brochure, but it does not have to promptly provide the newly amended brochure to all existing clients. However, if an adviser amends its brochure because of disciplinary events or disciplinary disclosures described above, the adviser must promptly provide the appropriate document(s) to each client.
Eleventh, what are the primary recordkeeping requirements related to brochures?
An SEC-registered investment adviser must make and keep the following records related to brochures and brochure supplements:
• A copy of each brochure and brochure supplement and each amendment or revision thereto;
• Any summary of material changes that is not contained in the brochure; and
• A record of the dates that each brochure and brochure supplement, each amendment or revision thereto, and each summary of material changes not included in a brochure was given to any client or to any prospective client who subsequently became a client.
17 C.F.R. § 275.204-2(a)(14)(i).
These records must be maintained “in an easily accessible place for a period of not less than five years.” 17 C.F.R. § 275.204-2(e)(1).
As lawyers like to say, it depends. I have gathered some thoughts and information below that may assist you regarding your additional responsibilities. (These responsibilities come from federal law, but state securities regulators are likely to apply the same laws.)
First, what should you do with the new brochure?
If you are an SEC-registered adviser, you must “deliver” a brochure and a brochure supplement(s) to each client or prospective client that contains all information required by Part 2 of Form ADV. 17 C.F.R. § 275.204-3(a).
Please note that the statute says “deliver,” not offer. For more detail on the delivery requirements, see below and/or seek legal advice.
Second, when do I start using the new brochure and brochure supplement?
An SEC-registered investment adviser must begin using the new brochure and brochure supplement by the date that the adviser was required to first electronically file its new brochure. 17 C.F.R. § 275.204-3(g)(2). Therefore, registered advisers with a December 31, 2010 year-end must start using the new brochure and brochure supplement by March 31, 2011. (Note that this is a transition rule.)
When using the new brochure and brochure supplement, an adviser must be using the “current” version. 17 C.F.R. § 275.204-3(g)(2). Therefore, advisers should control all amendments to the brochure and brochure supplement to ensure that only the current versions are being used.
Finally, an adviser must comply with the delivery requirements. See 17 C.F.R. § 275.204-3(g)(2).
Third, in this period of transitioning to the new narrative brochure, when must I provide existing clients with a copy of the new brochure and brochure supplement?
An SEC-registered investment adviser must deliver its current brochure and brochure supplement to its existing clients within 60 days after the date that the adviser was required to electronically file its new brochure. 17 C.F.R. § 275.204-3(g)(1). Therefore, registered advisers with a December 31, 2010 year-end must deliver the new brochure and brochure supplement to their existing clients by May 30, 2011. (Note that this is a transition rule.)
Fourth, what are the delivery requirements for the brochure?
For new clients, an adviser must deliver “your current brochure” before or at the time you and the new client execute an investment advisory contract. 17 C.F.R. § 275.204-3(b)(1).
For existing clients, see the transition rule above that requires advisers to provide the new brochure and brochure supplement within 60 days after the brochure and brochure supplement were required to be electronically filed. Thereafter, for existing clients, the annual delivery requirement is triggered ONLY “if there are material changes in the brochure since the adviser’s last annual updating amendment.” 17 C.F.R. § 275.204-3(b)(2). If these material changes exist, the adviser must deliver annually within 120 days after the end of the adviser’s fiscal year (April 30, 2011 for advisers with a December 31, 2010 year-end) the following:
• A current brochure or
• The summary of material changes to the brochure with (1) an offer to provide your current brochure, (2) the telephone number (and website address or email address, if available) by which a client may obtain the current brochure from you, and (3) the website address for obtaining information about you through the Investment Adviser Public Disclosure (IAPD) system.
17 C.F.R. § 275.204-3(b)(2)(i), (ii).
To simplify: For new clients, give a copy of your current brochure before the new client signs the advisory contract. For existing clients (where the adviser has a December 31 year –end):
• In 2011, give all existing clients a copy of your current brochure and brochure supplement by May 30, 2011.
• Thereafter, give all existing clients a copy of your current brochure by April 30, 2011.
Also an SEC-registered adviser may deliver its brochure electronically, but, as expected, electronic delivery brings its own set of regulations. (The SEC has published interpretive guidance regarding electronic delivery by investment advisers. Study this guidance or consult legal counsel before attempting electronic delivery of a brochure.)
Fifth, what are the delivery requirements for the brochure supplements?
The general rule is that an investment adviser (remember, the IA is the firm) must deliver to each client of prospective client a current brochure supplement for a supervised persons (usually the person who is giving the investment advice – that is, the investment adviser representative) before or at the time the supervised person begins to provide advisory services to the client. 17 C.F.R. § 275.204-3(b)(3). (However, keep in mind the transition rule stated above, that requires advisers to provide the brochure supplement to existing clients by May 30, 2011.)
However, the SEC has extended the compliance dates by which some advisers must deliver the brochure supplement as follows:
• Advisers registered with the SEC as of December 31, 2010, and having a fiscal year ending on December 31, 2010 through April 30, 2011, must prepare and begin delivering brochure supplements to new and prospective clients by July 31, 2011, and must deliver brochure supplements to existing clients by September 30, 2011.
• Newly-registered advisers filing applications for registration from January 1, 2011 through April 30, 2011, have until May 1, 2011 to prepare and begin delivering brochure supplements to new and prospective clients and have until July 1, 2011 to deliver brochure supplements to existing clients.
Based on the general rule, BEFORE a new individual begins to serve a particular advisory client, the investment adviser must consider whether that individual is a supervised person and, if so, whether the adviser has provided the brochure supplement of that supervised person to the client.
Please note that the brochure supplement(s) may be part of the brochure, so the client may have been provided the brochure supplement(s) when he was provided the brochure.
Sixth, how often do I have to amend my brochure?
An SEC-registered investment adviser must amend its brochure as follows:
• At least annually, within 90 days of the end of its fiscal year; AND
• More frequently, if required by the instructions to Form ADV.
17 C.F.R. § 275.204-1(a).
Seventh, according to the instructions to Form ADV, Part 2, when must I amend my brochure?
According to the instructions for Part 2A of Form ADV, an investment adviser must update its brochure as follows:
• Each year at the time the adviser files its annual updating amendment (i.e., within 90 days after year-end) AND
• Promptly whenever any information in the brochure becomes materially inaccurate. (An adviser is not required to update its brochure between annual updating amendments solely because the amount of client assets it manages has changed or because its fee schedule has changed. However, if the adviser updates its brochure for a separate reason in between annual updating amendments and the amount of client assets managed or its fees schedule has become materially inaccurate, the adviser should update these items in the interim amendment.
Eighth, can I amend my brochure other than when the instructions to Part 2 require an amendment?
Yes, an adviser can amend its brochure at any time to add or correct non-material items. I’ve already seen amendments to correct typos, to improve readability, and to insert additional explanation about an adviser’s business.
Ninth, do all amendment to my brochure – material and non-material – have to be filed through the IARD system?
All amendments to the brochure (i.e., Part 2A of Form ADV) must be filed electronically with the IARD (unless the adviser has received a hardship exemption). 17 C.F.R. § 275.204-1(b). Therefore, even if an adviser amends its brochure for minor things, such as to correct a typo, the adviser must file the amended brochure in the IARD system.
Tenth, what are the delivery requirements for amendments to the brochure or brochure supplement?
The delivery requirements for amendments to the brochure and brochure supplement are triggered ONLY if the amendment adds disclosure of a disciplinary event or materially revises information already disclosed about a disciplinary event. If this is the case, an investment adviser must deliver to each client “promptly after you create an amended brochure or brochure supplement” one of the following;
• The amended brochure or brochure supplement, as applicable, and a statement describing the material facts relating to the change in disciplinary information, or
• A statement describing the material facts relating to the change in disciplinary information.
17 C.F.R. § 275.204-3(b)(4).
The delivery requirements for interim amendments (i.e., any amendments between annual updating amendments) differ. If an adviser amends its brochure because information in the brochure became materially inaccurate (see the Seventh note above), the adviser should immediately begin to use the newly amended brochure, but it does not have to promptly provide the newly amended brochure to all existing clients. However, if an adviser amends its brochure because of disciplinary events or disciplinary disclosures described above, the adviser must promptly provide the appropriate document(s) to each client.
Eleventh, what are the primary recordkeeping requirements related to brochures?
An SEC-registered investment adviser must make and keep the following records related to brochures and brochure supplements:
• A copy of each brochure and brochure supplement and each amendment or revision thereto;
• Any summary of material changes that is not contained in the brochure; and
• A record of the dates that each brochure and brochure supplement, each amendment or revision thereto, and each summary of material changes not included in a brochure was given to any client or to any prospective client who subsequently became a client.
17 C.F.R. § 275.204-2(a)(14)(i).
These records must be maintained “in an easily accessible place for a period of not less than five years.” 17 C.F.R. § 275.204-2(e)(1).
Thursday, January 20, 2011
SEC Recommends Change to its Examination Program
The Dodd-Frank Act financial reform bill that was enacted on July 21, 2010, required the SEC to conduct a study on enhancing the examinations of SEC-registered investment advisers. Congress wanted to know what concerns the SEC has about conducting a good examination program and what legislative and regulatory steps it would recommend to meet these concerns.
The SEC recently released its study report. In the report, the SEC describes significant obstacles to the SEC conducting a good examination program. Specifically, the SEC describes what it calls “capacity” problems, funding problems, and additional requirements imposed under the Dodd-Frank Act.
Regarding its concerns, the SEC stated in the report that “the examination program requires a source of funding that is adequate to permit the Commission to meet the new challenges it faces and sufficiently stable to prevent examination resources from periodically being outstripped by growth in the number of registered investment advisers (i.e., it requires resources that are scalable to any future increase ― or, for that matter, decrease ― in the number of registered investment advisers).”
Regarding legislative and regulatory steps, the SEC gave Congress three approaches to consider when addressing these obstacles. These approaches include (1) imposing user fees on SEC-registered investment advisers that could be retained by the SEC to fund the investment adviser examination program; (2) authorizing one or more SROs to examine, subject to SEC supervision, all SEC-registered investment advisers; and (3) authorizing FINRA to examine dual registrants for compliance with the Investment Advisers Act of 1940.
It appears from the SEC’s study that additional costs may be imposed on investment advisers in the form of user fees or SRO registration fees. As the examination program and its obstacles are addressed by Congress and the SEC, advisers may also incur additional time and other resources understanding and complying with additional regulations regarding examinations.
Although the SEC’s study does not address state-registered advisers, it is clear that many states, which already have budget problems, may not be in a position to allocate existing resources to fund a good examination program. Resources will be further stretched after July 21, 2011, when advisers with AUM between $30,000,000 and $100,000,000 register with the states. State securities regulators must have an examination program that subjects these newly registered advisers to an examination. Therefore, expect states to impose additional costs on state-registered advisers. For example, South Carolina, which has one auditor to examine all of its registered advisers, has a securities law that allows the state to “assess a reasonable charge for conducting an audit or inspection” of an adviser. S.C. Code Ann. § 35-1-411(d). In the past, South Carolina has assessed a nominal charge. The South Carolina Securities Division could significantly increase this charge and thereby fund the salary, benefits, and overhead of the existing auditor and additional auditors.
The SEC recently released its study report. In the report, the SEC describes significant obstacles to the SEC conducting a good examination program. Specifically, the SEC describes what it calls “capacity” problems, funding problems, and additional requirements imposed under the Dodd-Frank Act.
Regarding its concerns, the SEC stated in the report that “the examination program requires a source of funding that is adequate to permit the Commission to meet the new challenges it faces and sufficiently stable to prevent examination resources from periodically being outstripped by growth in the number of registered investment advisers (i.e., it requires resources that are scalable to any future increase ― or, for that matter, decrease ― in the number of registered investment advisers).”
Regarding legislative and regulatory steps, the SEC gave Congress three approaches to consider when addressing these obstacles. These approaches include (1) imposing user fees on SEC-registered investment advisers that could be retained by the SEC to fund the investment adviser examination program; (2) authorizing one or more SROs to examine, subject to SEC supervision, all SEC-registered investment advisers; and (3) authorizing FINRA to examine dual registrants for compliance with the Investment Advisers Act of 1940.
It appears from the SEC’s study that additional costs may be imposed on investment advisers in the form of user fees or SRO registration fees. As the examination program and its obstacles are addressed by Congress and the SEC, advisers may also incur additional time and other resources understanding and complying with additional regulations regarding examinations.
Although the SEC’s study does not address state-registered advisers, it is clear that many states, which already have budget problems, may not be in a position to allocate existing resources to fund a good examination program. Resources will be further stretched after July 21, 2011, when advisers with AUM between $30,000,000 and $100,000,000 register with the states. State securities regulators must have an examination program that subjects these newly registered advisers to an examination. Therefore, expect states to impose additional costs on state-registered advisers. For example, South Carolina, which has one auditor to examine all of its registered advisers, has a securities law that allows the state to “assess a reasonable charge for conducting an audit or inspection” of an adviser. S.C. Code Ann. § 35-1-411(d). In the past, South Carolina has assessed a nominal charge. The South Carolina Securities Division could significantly increase this charge and thereby fund the salary, benefits, and overhead of the existing auditor and additional auditors.
Wednesday, January 19, 2011
South Carolina Guidance on the New Form ADV 2
Form ADV, Part 2, is used as an investment adviser’s disclosure document (or brochure), which must be provided to investment advisory clients. As you know, the SEC has changed the old form, which was in a check-the-box format with some narrative explanation, to a new form, which is entirely narrative. The SEC also now requires that an adviser electronically file its Form ADV, Part 2, with the SEC, making it available for viewing by the public.
However, many investment advisers do not register with the SEC. Generally, if an investment adviser has less than $25,000,000 of assets under management (or less than $100,000,000 of assets under management after July 20, 2011), then the adviser must register with one or more state securities regulators.
When registering with the South Carolina Securities Division, an adviser also must submit Form ADV, Part 2. The Securities Division has issued guidance on its requirements regarding Form ADV, Part 2. First, as of January 1, 2011, the Securities Division requires the new Form ADV, Part 2, to be submitted as part of any initial application for registration as an investment adviser in South Carolina. Second, as of January 1, 2011, all investment advisers who are already registered in South Carolina must include the new Form ADV, Part 2, as part of the adviser’s next annual updating amendment (or as part of any amendment to Form ADV). Therefore, advisers with a December 31 year-end must file the new Form ADV, Part 2, at least by March 31, 2011. Finally, the Securities Division encourages advisers to follow the distribution and delivery schedule of the new Form ADV, Part 2, as provided in the instructions to that new form.
If filing electronically through the IARD, an adviser must also file the new Form ADV, Part 2, electronically. It will then become available for viewing by the public. Since South Carolina allows filing an application for registration as an adviser by paper (i.e., not electronically, but by filing the documents directly with the Securities Division), a paper-filer presumably would file the new Form ADV, Part 2, directly to the Securities Division.
However, many investment advisers do not register with the SEC. Generally, if an investment adviser has less than $25,000,000 of assets under management (or less than $100,000,000 of assets under management after July 20, 2011), then the adviser must register with one or more state securities regulators.
When registering with the South Carolina Securities Division, an adviser also must submit Form ADV, Part 2. The Securities Division has issued guidance on its requirements regarding Form ADV, Part 2. First, as of January 1, 2011, the Securities Division requires the new Form ADV, Part 2, to be submitted as part of any initial application for registration as an investment adviser in South Carolina. Second, as of January 1, 2011, all investment advisers who are already registered in South Carolina must include the new Form ADV, Part 2, as part of the adviser’s next annual updating amendment (or as part of any amendment to Form ADV). Therefore, advisers with a December 31 year-end must file the new Form ADV, Part 2, at least by March 31, 2011. Finally, the Securities Division encourages advisers to follow the distribution and delivery schedule of the new Form ADV, Part 2, as provided in the instructions to that new form.
If filing electronically through the IARD, an adviser must also file the new Form ADV, Part 2, electronically. It will then become available for viewing by the public. Since South Carolina allows filing an application for registration as an adviser by paper (i.e., not electronically, but by filing the documents directly with the Securities Division), a paper-filer presumably would file the new Form ADV, Part 2, directly to the Securities Division.
Tuesday, November 23, 2010
Registration as an Investment Adviser or an Investment Adviser Representative under South Carolina Law
It is unlawful for a person to transact business as an investment adviser (“IA”) or an investment adviser representative (“IAR”) in South Carolina unless that person is registered as an IA or an IAR in South Carolina under the S.C. Uniform Securities Act of 2005, appropriately registered through the SEC, or exempt from registration. See S.C. Code Ann §§ 35-1-403(a), 35-1-404(a).
A person applying for registration as an IA or an IAR under South Carolina law may file an application through the CRD/IARD system or by filing the required paperwork and paying the required fees directly to the S.C. Securities Division. S.C. Reg. § 13-403B.
Regardless of the form in which a person applies for registration, to initially apply for registration as an IA under South Carolina law, an applicant must file an application and an appropriate consent to service of process and pay the applicable registration fee and any fee imposed by the CRD/IARD system. See S.C. Code Ann §§ 35-1-406(a). The application consists of “a uniform form” and “any other financial or other information or record that the Securities Commissioner determines is appropriate.” Id. Although South Carolina does not define “a uniform form,” the Securities Division requires that an applicant file Form ADV, Parts 1A and 1B and Form ADV, Part 2. The Securities Division also requires the following to be submitted: financial statements from an IA with a signed verification statement; a surety bond, if the IA does not meet its net worth and capital requirements, S.C. Reg. § 13-406; advisory contract(s) used; and a list of IARs with name, place of business in South Carolina, and CRD number.
To initially apply for registration as an IAR under South Carolina law, an applicant must file an application and an appropriate consent to service of process, pass one or more required exams (or hold one or more of several specific professional designations), and pay the applicable registration fee and any fee imposed by the CRD/IARD system. See S.C. Code Ann §§ 35-1-406(a), S.C. Reg. §§ 13-401B, C. Although South Carolina does not define “a uniform form,” the Securities Division requires that an applicant file Form U4.
Registration as an IA or an IAR under South Carolina law is on a calendar year basis. Once registered as an IA or an IAR in under South Carolina law, that registration expires on December 31 of the applicable year. S.C. Code Ann §§ 35-1-406(d).
To renew a registration as an IA or an IAR, the IA and IAR must pay the filing fee to renew, pay any fee imposed by the CRD/IARD system, pass the exam requirements (an IAR should have already satisfied this requirement at the time of initial registration as an IAR), and file any records required by rule adopted or order issued. Because no regulation currently exists imposing additional filing requirements and orders are generally specific to an individual applicant, most IAs and IARs who are renewing their registrations in South Carolina merely have to pay their South Carolina renewal fee by December 31 to renew their registration. (However, be aware that if a person is using the CRD/IARD system to apply for renewal registration, the applicable renewal fees must be in that person’s financial account at CRD/IARD weeks before December 31 – for example, for 2011 renewals, the renewal fees must be in the account by December 13, 2010).
If the South Carolina Securities Division asks a renewing IA or IAR for additional documentation at or near the time of renewal, the Securities Division is likely asking for that documentation under the applicable audit or inspection provisions of South Carolina law, see S.C. Code Ann. § 35-1-411(d), not as part of the renewal process.
The Securities Division has a web page that may provide some useful information.
A person applying for registration as an IA or an IAR under South Carolina law may file an application through the CRD/IARD system or by filing the required paperwork and paying the required fees directly to the S.C. Securities Division. S.C. Reg. § 13-403B.
Regardless of the form in which a person applies for registration, to initially apply for registration as an IA under South Carolina law, an applicant must file an application and an appropriate consent to service of process and pay the applicable registration fee and any fee imposed by the CRD/IARD system. See S.C. Code Ann §§ 35-1-406(a). The application consists of “a uniform form” and “any other financial or other information or record that the Securities Commissioner determines is appropriate.” Id. Although South Carolina does not define “a uniform form,” the Securities Division requires that an applicant file Form ADV, Parts 1A and 1B and Form ADV, Part 2. The Securities Division also requires the following to be submitted: financial statements from an IA with a signed verification statement; a surety bond, if the IA does not meet its net worth and capital requirements, S.C. Reg. § 13-406; advisory contract(s) used; and a list of IARs with name, place of business in South Carolina, and CRD number.
To initially apply for registration as an IAR under South Carolina law, an applicant must file an application and an appropriate consent to service of process, pass one or more required exams (or hold one or more of several specific professional designations), and pay the applicable registration fee and any fee imposed by the CRD/IARD system. See S.C. Code Ann §§ 35-1-406(a), S.C. Reg. §§ 13-401B, C. Although South Carolina does not define “a uniform form,” the Securities Division requires that an applicant file Form U4.
Registration as an IA or an IAR under South Carolina law is on a calendar year basis. Once registered as an IA or an IAR in under South Carolina law, that registration expires on December 31 of the applicable year. S.C. Code Ann §§ 35-1-406(d).
To renew a registration as an IA or an IAR, the IA and IAR must pay the filing fee to renew, pay any fee imposed by the CRD/IARD system, pass the exam requirements (an IAR should have already satisfied this requirement at the time of initial registration as an IAR), and file any records required by rule adopted or order issued. Because no regulation currently exists imposing additional filing requirements and orders are generally specific to an individual applicant, most IAs and IARs who are renewing their registrations in South Carolina merely have to pay their South Carolina renewal fee by December 31 to renew their registration. (However, be aware that if a person is using the CRD/IARD system to apply for renewal registration, the applicable renewal fees must be in that person’s financial account at CRD/IARD weeks before December 31 – for example, for 2011 renewals, the renewal fees must be in the account by December 13, 2010).
If the South Carolina Securities Division asks a renewing IA or IAR for additional documentation at or near the time of renewal, the Securities Division is likely asking for that documentation under the applicable audit or inspection provisions of South Carolina law, see S.C. Code Ann. § 35-1-411(d), not as part of the renewal process.
The Securities Division has a web page that may provide some useful information.
Tuesday, October 19, 2010
SEC Recently Released its New Form ADV, Part 2
As you know by now, the SEC has adopted a new Form ADV, Part 2 – Uniform Requirements for Investment Adviser Brochure and Brochure Supplements. This new form generally must be used in 2011; however, some regulators may accept the new form in 2010. Part 2 is an important disclosure document, because it includes the information that must be provided to clients and prospective clients.
The new Part 2 and the related instructions can be found on the SEC website.
On October 17, 2010, Investment News published a good article on the new Part 2. It is titled, “New Form ADV-2 adding costs, confusion.”
The new Part 2 is not to be taken lightly. Every investment adviser should gather the resources needed to timely and completely prepare this disclosure document and should start the process of preparing its new Part 2 as early as possible.
The new Part 2 and the related instructions can be found on the SEC website.
On October 17, 2010, Investment News published a good article on the new Part 2. It is titled, “New Form ADV-2 adding costs, confusion.”
The new Part 2 is not to be taken lightly. Every investment adviser should gather the resources needed to timely and completely prepare this disclosure document and should start the process of preparing its new Part 2 as early as possible.
Friday, September 3, 2010
Municipal Advisors Must Register with the SEC
As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama on July 21, 2010, Congress amended Section 15B(a) of the Securities Exchange Act of 1934 to, among other things, make it unlawful for municipal advisors to provide certain advice or solicit municipal entities or certain other persons without registering with the U.S. Securities and Exchange Commission. Accordingly, the SEC has adopted new Rule 15Ba2-6T under the Exchange Act as an interim final temporary rule. This new rule imposes a temporary registration process for municipal advisors and becomes effective on October 1, 2010, meaning that municipal advisors must be registered on that date in order to continue their municipal advisory services.
Section 15B(a)(1) of the Exchange Act, as amended by Section 975(a)(1)(B) of the Dodd-Frank Act, makes it unlawful for a municipal advisor to provide advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, or to undertake a solicitation of a municipal entity or obligated person, unless the municipal advisor is registered with the SEC. Rule 15Ba2-6T provides a method for municipal advisors to temporarily satisfy the statutory registration requirement of Section 15B(a)(1) of the Exchange Act until the SEC has promulgated a final permanent registration program. The interim final temporary rule will expire on December 31, 2011.
A municipal advisor may temporarily satisfy the new registration requirement by submitting certain information electronically through the SEC’s public website on new Form MA-T. Because entry of information into Form MA-T will require establishing an account and securing access credentials (username and password), municipal advisors are advised to allow ample time to establish an account and obtain such credentials and complete the form before October 1, 2010.
On Form MA-T, a municipal advisor will indicate the purpose for which it is submitting the form (e.g., initial application for temporary registration), provide certain basic identifying and contact information concerning its business, indicate the nature of its municipal advisory activities, and supply information about its disciplinary history and the disciplinary history of its associated municipal advisor professionals.
Section 15B(a)(1) of the Exchange Act, as amended by Section 975(a)(1)(B) of the Dodd-Frank Act, makes it unlawful for a municipal advisor to provide advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, or to undertake a solicitation of a municipal entity or obligated person, unless the municipal advisor is registered with the SEC. Rule 15Ba2-6T provides a method for municipal advisors to temporarily satisfy the statutory registration requirement of Section 15B(a)(1) of the Exchange Act until the SEC has promulgated a final permanent registration program. The interim final temporary rule will expire on December 31, 2011.
A municipal advisor may temporarily satisfy the new registration requirement by submitting certain information electronically through the SEC’s public website on new Form MA-T. Because entry of information into Form MA-T will require establishing an account and securing access credentials (username and password), municipal advisors are advised to allow ample time to establish an account and obtain such credentials and complete the form before October 1, 2010.
On Form MA-T, a municipal advisor will indicate the purpose for which it is submitting the form (e.g., initial application for temporary registration), provide certain basic identifying and contact information concerning its business, indicate the nature of its municipal advisory activities, and supply information about its disciplinary history and the disciplinary history of its associated municipal advisor professionals.
Tuesday, August 31, 2010
SEC Requires Investment Advisers to Use a New Form ADV, Part II, in 2011
The U.S. Securities and Exchange Commission recently issued a final rule under the Investment Advisers Act of 1940 requiring investment advisers registered with the SEC to provide new and prospective clients with a brochure and brochure supplements that are written in plain English. Advisers must file their brochure electronically with the SEC, and the SEC will make these brochures available to the public through its website.
Investment advisers must prepare Part II of Form ADV and must provide it, or a brochure which contains substantially similar information, to each client or prospective client. Part II of Form ADV provides clients and prospective clients with a description of the adviser, the adviser’s services and fees, conflicts of interest, and the adviser’s business practices. Currently Part II is in a check-the-box format with a limited amount of narrative explanation.
Under the new final rule, the check-the-box format of Part II will be eliminated. The revised Part II will have to be written in plain English.
Preparing a proper brochure will require time, effort, and the making of a few decisions regarding presentation. For example, when preparing the new brochure an adviser must keep its fiduciary duty in mind so that all necessary disclosures are made and clients and prospective clients can understand such disclosures. The adviser also must properly draft the new brochure(s). For example, the SEC stated in the new final rule that advisers must “communicate clearly” by using “short sentences; definite, concrete, everyday words; and the active voice.” The brochure “should be succinct and readable.” To limit the length of the brochure, “advisers may create separate brochures for different types of advisory clients, each of which may be shorter, clearer, and contain less extraneous information than would a combined brochure.”
Components of the New Brochure
The revised Part II will be in two sub-parts: (1) 18 disclosure items about the advisory firm and (2) a supplement which includes information about advisory personnel on whom clients rely for investment advice.
The 18 disclosure items include the following:
1. On a cover page, an adviser shall include the name of the firm, its business address, contact information, website (if applicable), the date of the brochure, and a statement that the brochure has not been approved by any securities regulator. If the adviser refers to itself as a “registered investment adviser,” the cover page must also include a disclaimer that registration does not imply a certain level of skill or training.
2. An adviser shall identify and discuss material changes since the prior year’s brochure.
3. An adviser shall include a table of contents that is detailed enough to permit clients and prospective clients to locate information easily.
4. An adviser shall provide a description of its business that includes the types of advisory services offered, whether the adviser holds itself out as specializing in a particular type of advisory service, and the amount of client assets that it manages.
5. Regarding fees and compensation, an adviser shall describe how it is compensated for its advisory services; provide a fee schedule; and disclose whether fees are negotiable, its billing practices, and information about other costs to the client.
6. An adviser shall disclose whether the adviser charges performance-based fees or whether a supervised person manages an account that pays such a fee and, if so, the adviser shall discuss the conflicts of interest.
7. An adviser shall describe the types of advisory clients the firm generally has and the requirements (e.g., minimum account size) for opening or maintaining an account.
8. An adviser shall describe the methods of analysis and investment strategies used and the fact that investing in securities involves risk of loss. An adviser shall also disclose risks due to frequent trading and risks for each investment strategy or method of analysis and particular type of security it recommends.
9. An adviser shall disclose material facts about any legal or disciplinary event that is material to a client’s or prospective client’s evaluation of the adviser’s or its management’s integrity.
10. An adviser shall disclose material relationships or arrangements that the adviser has with related financial industry participants, related material conflicts of interest and how such conflicts are addressed, and information about selecting or recommending other advisers.
11. An adviser shall disclose its code of ethics and any participation or interest in client transactions and the conflicts of interest presented by such participation or interest.
12. An adviser shall disclose its brokerage practices.
13. An adviser shall disclose whether, and how often, it reviews clients’ accounts or financial plans, and identify who conducts the review.
14. An adviser shall disclose any arrangement under which it compensates another for a client referral and shall describe such compensation. An adviser shall also disclose any economic benefit (e.g., sales prizes) received from a person, who is not a client, for providing advisory services to clients.
15. An adviser with custody shall disclose that clients will receive account statements directly from a qualified custodian and that clients should carefully review these account statements. If the adviser also sends account statements, the adviser shall further disclose that clients should compare the account statements provided by the qualified custodian to the account statements provided by the adviser.
16. An adviser with discretionary authority over client accounts shall disclose its discretionary authority and any limitations clients may place on this authority.
17. An adviser shall disclose its proxy voting practices.
18. An adviser shall disclose certain material financial information about the adviser.
Advisers that sponsor a wrap fee program continue to be required to prepare a separate, specialized brochure for clients of the wrap fee program in lieu of the sponsor’s standard brochure.
The supplement to Part II shall include, among other things, information about the education, experience, and disciplinary history of the supervised person(s) who provides advisory services to the client.
Effective Date
Each adviser applying for initial registration with the SEC after January 1, 2011 must file a brochure pursuant to the new final rule.
Advisers who are already registered with the SEC must comply with the requirements of the new final rule when they file their first annual updating amendment to Form ADV for the fiscal year ending on or after December 31, 2010. Therefore, for advisers whose fiscal year ends on December 31, 2010, they must file a new brochure pursuant to the new final rule by March 31, 2011, and immediately begin to distribute the new brochure to new and prospective clients. Within 60 days of filing the new brochure, existing SEC-registrants must deliver the new brochure to existing clients.
Applicability to Advisers Registered with the South Carolina Securities Division
I am not aware of any statement by the Securities Division about whether it will require advisers to file Part II pursuant to the requirements of the SEC’s new final rule. In fact, South Carolina law is vague on what form an adviser must file at all. S.C. Code Ann. § 35-1-406(a)(1) merely states that an applicant shall file “the information or record required for the filing of a uniform application,” but it does not define “uniform application.” The Securities Division historically has required the form required by the SEC. I expect that the Securities Division will want state-registered advisers to file Part II pursuant to the requirements of the SEC’s new final rule.
Investment advisers must prepare Part II of Form ADV and must provide it, or a brochure which contains substantially similar information, to each client or prospective client. Part II of Form ADV provides clients and prospective clients with a description of the adviser, the adviser’s services and fees, conflicts of interest, and the adviser’s business practices. Currently Part II is in a check-the-box format with a limited amount of narrative explanation.
Under the new final rule, the check-the-box format of Part II will be eliminated. The revised Part II will have to be written in plain English.
Preparing a proper brochure will require time, effort, and the making of a few decisions regarding presentation. For example, when preparing the new brochure an adviser must keep its fiduciary duty in mind so that all necessary disclosures are made and clients and prospective clients can understand such disclosures. The adviser also must properly draft the new brochure(s). For example, the SEC stated in the new final rule that advisers must “communicate clearly” by using “short sentences; definite, concrete, everyday words; and the active voice.” The brochure “should be succinct and readable.” To limit the length of the brochure, “advisers may create separate brochures for different types of advisory clients, each of which may be shorter, clearer, and contain less extraneous information than would a combined brochure.”
Components of the New Brochure
The revised Part II will be in two sub-parts: (1) 18 disclosure items about the advisory firm and (2) a supplement which includes information about advisory personnel on whom clients rely for investment advice.
The 18 disclosure items include the following:
1. On a cover page, an adviser shall include the name of the firm, its business address, contact information, website (if applicable), the date of the brochure, and a statement that the brochure has not been approved by any securities regulator. If the adviser refers to itself as a “registered investment adviser,” the cover page must also include a disclaimer that registration does not imply a certain level of skill or training.
2. An adviser shall identify and discuss material changes since the prior year’s brochure.
3. An adviser shall include a table of contents that is detailed enough to permit clients and prospective clients to locate information easily.
4. An adviser shall provide a description of its business that includes the types of advisory services offered, whether the adviser holds itself out as specializing in a particular type of advisory service, and the amount of client assets that it manages.
5. Regarding fees and compensation, an adviser shall describe how it is compensated for its advisory services; provide a fee schedule; and disclose whether fees are negotiable, its billing practices, and information about other costs to the client.
6. An adviser shall disclose whether the adviser charges performance-based fees or whether a supervised person manages an account that pays such a fee and, if so, the adviser shall discuss the conflicts of interest.
7. An adviser shall describe the types of advisory clients the firm generally has and the requirements (e.g., minimum account size) for opening or maintaining an account.
8. An adviser shall describe the methods of analysis and investment strategies used and the fact that investing in securities involves risk of loss. An adviser shall also disclose risks due to frequent trading and risks for each investment strategy or method of analysis and particular type of security it recommends.
9. An adviser shall disclose material facts about any legal or disciplinary event that is material to a client’s or prospective client’s evaluation of the adviser’s or its management’s integrity.
10. An adviser shall disclose material relationships or arrangements that the adviser has with related financial industry participants, related material conflicts of interest and how such conflicts are addressed, and information about selecting or recommending other advisers.
11. An adviser shall disclose its code of ethics and any participation or interest in client transactions and the conflicts of interest presented by such participation or interest.
12. An adviser shall disclose its brokerage practices.
13. An adviser shall disclose whether, and how often, it reviews clients’ accounts or financial plans, and identify who conducts the review.
14. An adviser shall disclose any arrangement under which it compensates another for a client referral and shall describe such compensation. An adviser shall also disclose any economic benefit (e.g., sales prizes) received from a person, who is not a client, for providing advisory services to clients.
15. An adviser with custody shall disclose that clients will receive account statements directly from a qualified custodian and that clients should carefully review these account statements. If the adviser also sends account statements, the adviser shall further disclose that clients should compare the account statements provided by the qualified custodian to the account statements provided by the adviser.
16. An adviser with discretionary authority over client accounts shall disclose its discretionary authority and any limitations clients may place on this authority.
17. An adviser shall disclose its proxy voting practices.
18. An adviser shall disclose certain material financial information about the adviser.
Advisers that sponsor a wrap fee program continue to be required to prepare a separate, specialized brochure for clients of the wrap fee program in lieu of the sponsor’s standard brochure.
The supplement to Part II shall include, among other things, information about the education, experience, and disciplinary history of the supervised person(s) who provides advisory services to the client.
Effective Date
Each adviser applying for initial registration with the SEC after January 1, 2011 must file a brochure pursuant to the new final rule.
Advisers who are already registered with the SEC must comply with the requirements of the new final rule when they file their first annual updating amendment to Form ADV for the fiscal year ending on or after December 31, 2010. Therefore, for advisers whose fiscal year ends on December 31, 2010, they must file a new brochure pursuant to the new final rule by March 31, 2011, and immediately begin to distribute the new brochure to new and prospective clients. Within 60 days of filing the new brochure, existing SEC-registrants must deliver the new brochure to existing clients.
Applicability to Advisers Registered with the South Carolina Securities Division
I am not aware of any statement by the Securities Division about whether it will require advisers to file Part II pursuant to the requirements of the SEC’s new final rule. In fact, South Carolina law is vague on what form an adviser must file at all. S.C. Code Ann. § 35-1-406(a)(1) merely states that an applicant shall file “the information or record required for the filing of a uniform application,” but it does not define “uniform application.” The Securities Division historically has required the form required by the SEC. I expect that the Securities Division will want state-registered advisers to file Part II pursuant to the requirements of the SEC’s new final rule.
Wednesday, August 18, 2010
SEC Seeks Public Input on the Standard of Care for Brokers, Dealers, and Investment Advisers
The Dodd-Frank Wall Street Reform and Consumer Protection Act requires the U.S. Securities and Exchange Commission to conduct a study regarding the standard of care of brokers, dealers, and investment advisers. That process has already begun. The SEC has issued a request for comment in which it is seeking public input, comments, and data regarding the standard of care imposed or to be imposed upon these financial industry professionals. Comments are due by August 30, 2010.
Current law imposes a higher standard of care on investment advisers (i.e., a fiduciary duty) while imposing a lesser standard of care on brokers (i.e., a suitability standard). Regulators have long been concerned that retail customers do not understand the differences in these standards of care.
In announcing the SEC’s request for comments, Chairman Shapiro stated, “At the completion of this study, we will have the authority to write rules that would create a uniform standard of conduct for professionals who provide personalized investment advice to retail customers. And, the new law requires that this standard be ‘no less stringent’ than the standard applicable to investment advisers.” Therefore, this study is important because it likely will result in the SEC issuing new rules that will impose a greater standard of care on brokers and dealers.
In the study, the SEC will evaluate the effectiveness of the existing legal or regulatory standards of care for brokers, dealers, investment advisers, and persons associated with them for providing personalized investment advice and recommendations about securities to retail customers. The SEC will also evaluate whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers.
Specifically, the SEC requests comment on fourteen issues, including the following:
1. The effectiveness of the existing legal or regulatory standards of care for brokers, dealers, investment advisers, and associated persons.
2. Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for brokers, dealers, investment advisers, and associated persons.
3. Whether retail customers understand that there are different standards of care applicable to brokers and investment advisers.
4. The regulatory, examination, and enforcement resources devoted to enforcement of the standards of care.
5. The potential impact on retail customers of imposing a higher standard of care on brokers, dealers, and their associated persons.
6. The varying level of services provided by brokers and investment advisers.
7. Potential additional costs and expenses to retail customers and to brokers, dealers, and investment advisers.
Current law imposes a higher standard of care on investment advisers (i.e., a fiduciary duty) while imposing a lesser standard of care on brokers (i.e., a suitability standard). Regulators have long been concerned that retail customers do not understand the differences in these standards of care.
In announcing the SEC’s request for comments, Chairman Shapiro stated, “At the completion of this study, we will have the authority to write rules that would create a uniform standard of conduct for professionals who provide personalized investment advice to retail customers. And, the new law requires that this standard be ‘no less stringent’ than the standard applicable to investment advisers.” Therefore, this study is important because it likely will result in the SEC issuing new rules that will impose a greater standard of care on brokers and dealers.
In the study, the SEC will evaluate the effectiveness of the existing legal or regulatory standards of care for brokers, dealers, investment advisers, and persons associated with them for providing personalized investment advice and recommendations about securities to retail customers. The SEC will also evaluate whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers.
Specifically, the SEC requests comment on fourteen issues, including the following:
1. The effectiveness of the existing legal or regulatory standards of care for brokers, dealers, investment advisers, and associated persons.
2. Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for brokers, dealers, investment advisers, and associated persons.
3. Whether retail customers understand that there are different standards of care applicable to brokers and investment advisers.
4. The regulatory, examination, and enforcement resources devoted to enforcement of the standards of care.
5. The potential impact on retail customers of imposing a higher standard of care on brokers, dealers, and their associated persons.
6. The varying level of services provided by brokers and investment advisers.
7. Potential additional costs and expenses to retail customers and to brokers, dealers, and investment advisers.
Tuesday, August 10, 2010
Some Changes Related to Accredited Investors under Dodd-Frank Are Already Applicable
Regulation D of the Securities Act of 1933 includes rules governing the limited offerings and sales of securities that are not registered under the 1933 Act. “Accredited investor” is an important term that is defined and used throughout Regulation D.
Since unregistered, Regulation D offerings and sales of securities are often used to raise funds, any change to the definition of an accredited investor is critical. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted on July 21, 2010, changed the definition of accredited investor and allows for subsequent changes to that definition.
First, Dodd-Frank immediately changed the definition of accredited investor. Effective on the date of enactment of Dodd-Frank, the net worth standard for a natural person remains at $1,000,000; however, the value of the investor’s primary residence now must be excluded from that person’s net worth. This change is effective from July 21, 2010, through July 21, 2014.
This amendment to the net worth standard for an accredited investor requires immediate attention. It impacts how an issuer or manager conducts its business. For example, a fund’s subscription agreement may need to be changed, and an adviser’s policies and procedures may need to be amended.
Second, within four years of July 21, 2010, the U.S. Securities and Exchange Commission may review and modify by regulation the definition of accredited investor as the term applies to a natural person. Any modification shall not affect the exclusion of the primary residence from the net worth of the individual. Also, every four years thereafter, the SEC shall review the definition of accredited investor and may make changes by regulation.
Third, by July 21, 2013, the Comptroller General of the United States shall study, and submit its report to Congress, the following: the appropriate financial thresholds or other criteria needed to qualify as an accredited investor and eligibility to invest in private funds. Congress could then enact additional legislation affecting Regulation D offerings and accredited investors.
Since unregistered, Regulation D offerings and sales of securities are often used to raise funds, any change to the definition of an accredited investor is critical. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted on July 21, 2010, changed the definition of accredited investor and allows for subsequent changes to that definition.
First, Dodd-Frank immediately changed the definition of accredited investor. Effective on the date of enactment of Dodd-Frank, the net worth standard for a natural person remains at $1,000,000; however, the value of the investor’s primary residence now must be excluded from that person’s net worth. This change is effective from July 21, 2010, through July 21, 2014.
This amendment to the net worth standard for an accredited investor requires immediate attention. It impacts how an issuer or manager conducts its business. For example, a fund’s subscription agreement may need to be changed, and an adviser’s policies and procedures may need to be amended.
Second, within four years of July 21, 2010, the U.S. Securities and Exchange Commission may review and modify by regulation the definition of accredited investor as the term applies to a natural person. Any modification shall not affect the exclusion of the primary residence from the net worth of the individual. Also, every four years thereafter, the SEC shall review the definition of accredited investor and may make changes by regulation.
Third, by July 21, 2013, the Comptroller General of the United States shall study, and submit its report to Congress, the following: the appropriate financial thresholds or other criteria needed to qualify as an accredited investor and eligibility to invest in private funds. Congress could then enact additional legislation affecting Regulation D offerings and accredited investors.
Thursday, July 29, 2010
Dodd-Frank Securities Reform Bill Affects Investment Advisers, Brokers, and Hedge Funds
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act. The public policy reasons for this bill were to control or reduce the systemic risk that exists in our financial system and to protect consumers. Although this bill significantly affects large banks and insurance companies, it also will affect many smaller, but important, players in the financial services industry here in South Carolina and around the country. Specifically, the Dodd-Frank bill directly affects investment advisers, broker-dealers, and hedge funds.
Regarding investment advisers, under the new legislation, more investment advisers will have to resister with State securities regulators instead of registering with the U.S. Securities and Exchange Commission. Previously, investment advisers with assets under management of less than $25,000,000 had to register with the applicable State securities regulator. The new legislation requires that by July 21, 2011, investment advisers with AUM of less than $100,000,000 register with the applicable State securities regulator. (Some exceptions apply.) Additionally, the new legislation eliminated the private fund exemption from registration and imposed a requirement on many advisers to private funds (e.g., hedge funds) to register as investment advisers with the SEC. The new legislation requires investment advisers who act solely as an adviser to private funds and who have AUM of $150,000,000 or more to register as investment advisers with the SEC. Under the Dodd-Frank bill, these hedge fund managers, whether registered or not, will have to keep records, make them available to the SEC or other regulators, and/or be subject to examination. The new legislation will also impose additional costs on investment advisers. These changes generally are effective on July 21, 2011.
The Dodd-Frank bill gives the SEC the ability to impose a fiduciary standard on broker-dealers. The fiduciary standard, which is currently applicable to investment advisers, means that investment advisers must always make decisions and recommendations that are in the best interests of their clients. This is a high standard of care. Broker-dealers have generally been held to a lesser standard of care when making recommendations to clients. If the SEC imposes this higher standard of care on broker-dealers, the potential liability of broker-dealers will increase.
The new consumer protection agency created in the Dodd-Frank bill will not directly oversee investment advisers and broker-dealers. Their existing regulators will retain this oversight jurisdiction.
The new legislation also affects private offerings of securities under Regulation D of federal securities laws. The Dodd-Frank bill changed the definition of “accredited investor” and “qualified client.” For example, for determining net worth, accredited investors under the new legislation should no longer include the fair market value of their primary residence. The new legislation also requires the Comptroller General of the United States to study whether private funds should be overseen by a newly formed self-regulatory organization.
Many of the burdens, restrictions, and costs imposed on the financial services industry by the Dodd-Frank bill are unknown. The SEC and other regulatory bodies will have to write and approve many pages of regulations that will define the true extent of the new legislation.
Regarding investment advisers, under the new legislation, more investment advisers will have to resister with State securities regulators instead of registering with the U.S. Securities and Exchange Commission. Previously, investment advisers with assets under management of less than $25,000,000 had to register with the applicable State securities regulator. The new legislation requires that by July 21, 2011, investment advisers with AUM of less than $100,000,000 register with the applicable State securities regulator. (Some exceptions apply.) Additionally, the new legislation eliminated the private fund exemption from registration and imposed a requirement on many advisers to private funds (e.g., hedge funds) to register as investment advisers with the SEC. The new legislation requires investment advisers who act solely as an adviser to private funds and who have AUM of $150,000,000 or more to register as investment advisers with the SEC. Under the Dodd-Frank bill, these hedge fund managers, whether registered or not, will have to keep records, make them available to the SEC or other regulators, and/or be subject to examination. The new legislation will also impose additional costs on investment advisers. These changes generally are effective on July 21, 2011.
The Dodd-Frank bill gives the SEC the ability to impose a fiduciary standard on broker-dealers. The fiduciary standard, which is currently applicable to investment advisers, means that investment advisers must always make decisions and recommendations that are in the best interests of their clients. This is a high standard of care. Broker-dealers have generally been held to a lesser standard of care when making recommendations to clients. If the SEC imposes this higher standard of care on broker-dealers, the potential liability of broker-dealers will increase.
The new consumer protection agency created in the Dodd-Frank bill will not directly oversee investment advisers and broker-dealers. Their existing regulators will retain this oversight jurisdiction.
The new legislation also affects private offerings of securities under Regulation D of federal securities laws. The Dodd-Frank bill changed the definition of “accredited investor” and “qualified client.” For example, for determining net worth, accredited investors under the new legislation should no longer include the fair market value of their primary residence. The new legislation also requires the Comptroller General of the United States to study whether private funds should be overseen by a newly formed self-regulatory organization.
Many of the burdens, restrictions, and costs imposed on the financial services industry by the Dodd-Frank bill are unknown. The SEC and other regulatory bodies will have to write and approve many pages of regulations that will define the true extent of the new legislation.
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