The effective date for the amended rules pertaining to the new ADV Form Part 2 is today, October 12th, 2010. Fortunately existing advisers have some lead time to comply. That being said, most must meet the requirements by March 31st, 2011[1] which will be before us in no time.

Have you taken any steps towards fulfilling your new brochure obligations?

The legal verbiage often used to disclose, disclose, and disclose (read "CYA") will no longer suffice. The SEC wants to see the new ADV Form Part 2 and accompanying supplements written in plain English. If you are planning to write this in-house, at this point, you should have at least started some initial planning and hopefully have drafted some "plain English" writing samples. If you are planning to look to the experts, at this point, you should have narrowed down your list and be close to deciding who you will engage.

So, what does "plain English" mean?

The SEC wishes to move away from the traditional "legalese" disclosure and instead provide new and prospective clients with a brochure and brochure supplements written in plain English. These new disclosure documents are designed to provide new and prospective advisory clients with clearly written, meaningful, current disclosure of the business practices, conflicts of interest and background of the investment adviser and its advisory personnel.

Among other things, Warren Buffet is known for writing plain English letters to Berkshire Hathaway's shareholders in Berkshire's annual reports. When writing these, Mr. Buffet pretends he is talking to his two sisters, Doris and Bertie. While intelligent, his siblings are not experts in accounting or finance. However, they understand plain English and like most, jargon may puzzle them. His goal is to provide information that he would wish his sisters would supply him if their positions were reversed.

Now, while I am pretty sure the SEC does not want every brochure to begin "Dear Doris and Bertie", I am sure they want registered investment advisers to provide the same degree and depth of information an adviser would want to receive in order to evaluate an investment opportunity.

Moving beyond the "plain English" requirements, some of the other more salient issues of the New Form ADV Part 2 are:

Public Document:
While publishing your brochure on the SEC's website has been an option, the vast majority of advisers, for obvious reasons, have not done so. That is about to change as the new brochure is required to be published on the SEC's website. Every lawyer and competitor will be able to read the entire contents of your brochure. Fortunately, the brochure supplement, which contains the personal information including qualifications and, if material, the more dubious and interesting disciplinary history of the five "supervised persons" who have the most day-to-day involvement in making the discretionary investment decisions, is not public.

No Established Convention:
No one really knows what ultimately will satisfy the SEC. As more and more firm brochures are published electronically and reviewed by the industry and the SEC, through various venues, a convention will be established as to how to disclose specifics. And while not necessarily a strong hook to hang your defensive hat upon, there is some solace in numbers.

Conflicts of Interest:
Disclosure of conflicts of interest in Form ADV Part 2 is not meant to resemble a laundry list. The new brochure requires only those actual or likely-to-be conflicts be disclosed along with exactly how the conflict may affect clients and what the adviser is doing to monitor or control the associated risk. It will be important for advisers to ensure that brochure disclosure of risks and conflicts of interest match up to their "inventory of risks", which is a current key focus area of the SEC.

Advisory Business:
Advisers need to describe their business including how long they have been in business , types of services provided, and whether an adviser considers itself a specialist in any particular area. Advisers also need to list their principal owners and their total assets under management (AUM). In describing its total AUM, an adviser can use a different number than in their ADV Part 1 if the adviser believes it would convey more meaningful information about the scope of the adviser's business. AUM used in ADV Part 1 is primarily used to determine whether an adviser should register federally or with the state(s).

Fees and Compensation:
Advisers are required to disclose the details around how they are compensated including fees and any other expenses clients pay in connection with advisory services. These details include timing of payments, whether clients will pay brokerage or other transactions or asset based fees including mutual fund servicing fees.

Performance Based-Fees and Side-by-Side Management:
Form ADV Part 2 now has a specific area for disclosure if an adviser charges a performance-based fee. If the adviser also manages accounts that either do not have performance fees or they have different performance-based fees, this fact must be disclosed in terms of conflicts of interest. The SEC believes certain inherent conflicts exist when a manager advises both an account where the manager earns a performance fee and a side-by-side account where the manger does not earn a performance fee. This could be an important issue for private fund advisers who may currently be or considering advising separately managed accounts.

Other Financial Industry Activities and Affiliations:
Advisers are required to disclose their affiliations. The SEC believes that clients should be able to select advisers based on affiliations and compensation methods. This type of disclosure allows potential clients to determine whether, and to what degree, he or she is comfortable with the related conflicts of interest presented by certain firms. On the other hand, some clients may seek advisers who have affiliations that may be beneficial to the client.

Methods of Analysis, Investment Strategies and Risk of Loss:
The SEC wants advisers to explain the material risks involved for each significant investment strategy, method of analysis used, and for each type of security recommended. In addition, advisers are required to disclose that loss with respect to investing in securities is possible. The SEC also requires a description of "material" risk. However, the SEC has specifically noted that Form ADV Part 2 may not be the best place to "disclose risks associated with all of its methods of analysis or strategies" and that doing so "likely would lengthen the brochure unnecessarily". This indicates that the SEC wants clarity and brevity as opposed to the "laundry list" approach to disclosure of every possible risk or conflict.

Brokerage Practices
As with the prior version of Form ADV Part 2, the SEC requires disclosure of the methods advisers use to select broker-dealers and how conflicts of interest are addressed regarding soft dollar benefits and services received. What is different about the new version is that the SEC wants responses to this item to be "living and breathing" in that it requires disclosure about broker selection methods used and actual soft dollar benefits received during the last fiscal year. In addition, more information about directed brokerage arrangements are required.

Client Referrals and Other Compensation
The SEC wants clients of advisers to know if (1), their adviser is paying non-adviser personnel for client referrals and (2), if someone other than a client provided any economic benefit to the adviser or its personnel for advising the client. When these arrangements exist, the SEC wants the adviser to disclose the conflict of interest and how such conflict is being addressed by the adviser.

Closing Thoughts
The SEC is focusing more on clarity, relevance,and brevity with regard to disclosure. Further, we again note that the new brochure is written in "plain English", a type of writing which may seem elusive, but possible if we think of our own Doris and Bertie equivalents when writing. Refrain from simply trying to protect yourself as excessive and extraneous disclosure could in fact, result in exactly what you are trying to avoid - excessive SEC scrutiny. Finally, the revisions in the new brochure concerning disclosure of conflicts of interest are significant and will be carefully reviewed by the SEC. Evaluate your firm's risks and conflicts, and then cautiously consider how to communicate these items as the SEC intended.

If you have not yet started the process of preparing for your new brochure requirements, the clock is ticking. Developing a methodical process with a manageable timeframe will serve you well as you add this to your list while efficiently managing the rest of your responsibilities.

[1]For existing firms with a 12/31 year end, the new brochure format must be completed by the end of March 31st, 2011. You then have another 60 days after filing your brochure with the SEC to share it with your clients.


Get the latest compliance news and insights - delivered weekly. The SEC3 Communique covers all compliance topics. CCO3 focuses on CCO topics.
tip: check both to keep informed!


Pre-Dating & Back-Dating are Equally Risky

The SEC today suspended three accountants formerly of BDO USA LLP for improper professional conduct during its 2013 audit of AmTrust Financial Services Inc., an exchange-listed insurance company. According to the... read more »

Fiduciary Duty

On Friday, September 28, 2018 the SEC charged LendingClub Asset Management (LCA) and its former president Renaud Laplanche with fraud for improperly using fund money to benefit LendingClub Corporation (LendingClub),... read more »

Exciting Summer Project -- Dig Into Some Sand or Dig Into Your Firm's Best Ex Pr…

The Office of Compliance Inspections and Examinations (OCIE) issued a risk alert July 11 targeting investment advisers’ most common deficiencies with regard to their best execution obligations under the Investment... read more »

SEC Adopts Fund Liquidity Reporting and Disclosure Changes

The final week of June was a busy one for SEC releases following the SEC’s June 28th open meeting. Among these was a revisit of Rule 22e-4 under the Investment... read more »

More SEC Settlements - This Time Form PF Filing Deficiencies

On June 1st, the SEC announced settlements with 13 RIAs who repeatedly failed to file Form PF reports. Most of these firms never filed over the review period (2012 through... read more »

Two Recent Enforcement Actions Against Private Fund Advisers

The industry should not misinterpret the SEC’s 2018 National Exam Program Priorities as a shift away from private fund advisers. As discussed during the SEC’s recent National Compliance Outreach Seminar... read more »


Dorsey PF 2018 Symposium

When: September 26, 2018 (8:30 am - 6 pm Where: Dorsey & Whitney LLP | 51 W. 52nd Street | New York, NY 10019 Directions > SEC3’s President, Janaya Moscony will join...

Chief Compliance Officer Roundtable: Breakfast Briefing - June 14, 2018

When: June 14, 2018 Where: Blank Rome LLP | The Chrysler Building | 405 Lexington Avenue | New York, NY 10174 | 22nd Floor Boardroom | Phone: 212.885.5000 Schedule: 9:00-9:30am - Networking...

Webinar: 2018 SEC Exam Priorities & Recent Exam Highlights

Don’t miss the opportunity to meet with us in person to discuss the topics that matter most to you. Tobin S. Cochran, Managing Member/President of Focus 1 Associates, LLC and...

Chief Compliance Officer Roundtable: Breakfast Briefing - February 7, 2018

When: February 7, 2018 Where: Blank Rome LLP | The Chrysler Building | 405 Lexington Avenue | New York, NY 10174 | 22nd Floor Boardroom | Phone: 212.885.5000 Schedule: 9:00-9:30am - Networking...

Upcoming Events - September & October 2017

Upcoming Events Don’t miss the opportunity to meet with us in person to discuss the topics that matter most to you. SEC3 is teaming up with industry experts in NYC to discuss...

May 23, 2017 - Webcast: WannaCry Ransomware: Were You Really Protected or Just L…

When: Tuesday, May 23rd, 2017 | Schedule: 12pm - 1pm EST Who: Paul Caiazzo, CEO and Co-Founder, TruShield Security Solutions Michael Brice, Founder, BW Cyber Services John Lukan, Managing Director, SEC Compliance Consultants, Inc. We...

June 14, 2017 - Compliance Breakfast Briefing

8:30-9:00am - Networking and Continental Breakfast 9:00-10:30am - Program Location: Willkie Farr & Gallagher LLP | 600 Travis Street | Suite 2310 | Houston, TX Barry Barbash from Willkie Farr & Gallagher LLP,...

June 13, 2017 - Compliance Breakfast Briefing

8:30-9:00am - Networking and Continental Breakfast 9:00-10:30am - Program Location: Haynes and Boone, LLP | 2323 Victory Avenue | Suite 700 | Dallas, TX 75219 Validated parking is available in the garage attached...

May 31, 2017 - Chicago

9:00-9:30 a.m - Networking and Continental Breakfast 9:30-11:00 a.m - Program Location: Baker & McKenzie LLP | 300 East Randolph Drive | Suite 5000 | Chicago, IL 60601 Kristin Gonzalez and Jerome Tomas...

May 17, 2017 (NYC WIMF)

This event is by invitation only. Please email to learn more.

May 15, 2017 (NYC Chief Compliance Officer Roundtable)

9:00-9:30am - Networking and Continental Breakfast 9:30-11:00am - Program Location: Blank Rome LLP | The Chrysler Building | 405 Lexington Avenue | New York, NY 10174 | 22nd Floor Boardroom | Phone:...

Webcast: The Most Insidious Cybersecurity Threat Is Also The Least Understood

When: Tuesday, April 25th | Schedule: 12pm - 1pm EST Who: Paul Caiazzo, CEO and Co-Founder, TruShield Security Solutions Michael Brice, Founder, BW Cyber Services John Lukan, Managing Director, SEC Compliance Consultants, Inc. Ransomware, the...

CCO Liability (Part III): Managing Liability Webinar

In this webinar, panelists discuss indemnifications and insurance as potential remedies to address the direct financial risks to a CCO. Attendees will learn: What terms and conditions should Chief Compliance Officers be...

Webinar: CCO Liability (Part III): Managing Liability: Navigating Indemnities an…

When: Tuesday, February 21, 2017 Schedule: 11:00am ET / 10:00am CT / 9:00am MT / 8:00am PT / 7:00am AT Description of Webinar: The National Society of Compliance Professionals is pleased to host...

Webcast: SEC 2017 Examination Focus Area – Cybersecurity Testing

Penetration Testing & Vulnerability Assessments - Examining the SEC & FINRA Requirements When: Wednesday, January 25th | Schedule: 12pm - 1pm EST Who: Paul Caiazzo, CEO and Co-Founder, TruShield Security Solutions Michael Brice, Founder,...