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News March 14, 2011 Issue

Still Struggling With Those Item 8 Disclosures? Tips For Finalizing Your Brochure

For a majority of registered advisers, their new brochure is due at the end of the month. Item 8 of the new Form ADV Part 2A, "Methods of Analysis, Investment Strategies and Risk of Loss," has been widely acknowledged as one of the most difficult sections to draft.

Pickard & Djinis partner Mari-Anne Pisarri said that Item 8 is "probably the most annoying, aggravating, head-scratching and anxiety-producing" part of the brochure. She asked rhetorically - How do you explain your risks in a way that is informative and enlightening? Youíve got OCIE over here, and the plaintiffís bar over there. What are you supposed to do?

Pisarri made her remarks as a panelist at the recent Investment Adviser Association (IAA) 2011 Compliance Conference. On the panel with her was SEC branch chief Dan Kahl. This item has generated most of the questions submitted to the staff about the brochure, he acknowledged. The SEC is endeavoring to provide guidance, and is hoping to get that guidance out by the end of the month, he said. The staff understands that advisers have concerns in this area. "We donít want or think the Commission intended for this to become a prospectus," said Kahl. "We donít want to see duplication of the risk section from a mutual fund prospectus. We donít think this is the place." The goal is to keep the brochure readable and really give clients a sense of whatís going on, he said.

The panel, rounded out by Affiliated Managers Group senior counsel Lewis Collins, and IAA general counsel Karen Barr, offered many other timely tips regarding the brochure.

In General.

Remember, advisers cannot incorporate material by reference that is legally required to be in the brochure, but they can cross-reference among the brochure items to avoid duplication of information, said Barr. In fact, cross-referencing is encouraged where appropriate, said Collins. Kahl added that referring to other helpful disclosures outside the adviserís specific brochure disclosure obligations is permitted. If that material is incorporated by reference however, it becomes a legal part of the brochure.

Advisers using multiple brochures must file each version, said Pisarri. The IARD system allows multiple uploads for this purpose.

Use narratives from other materials, such as responses provided during SEC examinations or responses to deficiency letters as starting points for some disclosures, said Collins.

Barr noted that Form ADV requires all items to be listed, in order, with the same headings. If an item is not applicable, the adviser must say that. Put a footnote to the brochure up front, suggested Pisarri. Give it a heading such as, "A note about the format of this brochure." In the footnote, the adviser can explain the new format, the requirement to include all headings, and anything else that will help clients and investors have a better understanding of the brochureís contents, she said.

Remember, Item 19 of the brochure and Item 7 of the brochure supplement are technically not part of the Form ADV requirements, said Kahl. Advisers are not required to list those headings or to respond "not applicable" to them.

Item-specific tips.

For the description of the adviserís business in Item 4, "think of it as your elevator speech, if you will," said Collins. The obligation is to describe services the adviser "offers," said Kahl. Services provided as an accommodation on a one-off basis and that are not offered to other clients are not required to be described. An adviser may want to include language such as "solely at our discretion, we may offer lther types of servicesÖ" suggested Pisarri. She also noted that advisers should ensure that the client receiving the accommodation services understands the scope and limitations of those services.

Kahl noted that the Item 5 fee and compensation disclosure requirement was not subject to a qualifying term, such as "that the adviser offers." All fee structures an adviser uses must be disclosed.

Conflicts disclosures appear in several parts of the brochure, said Kahl. Donít just identify conflicts of interest, explain what they are and tell clients how you deal with them. For example, it is important to describe the process, conflicts and controls around your brokerage practices, he said. Soft dollar practices can also represent "huge" conflicts for advisers. Describe the firmís practices and soft dollar benefits in a way that clients can understand, said Kahl. Thereís no need to "name names," said Collins, just "give examples of what you get." Donít attach your policies and procedures, either, he noted.

Also important to the Item 12 "Brokerage Practices" disclosure is an understanding that the adviser can paraphrase, said Pisarri. The instructions may say "disclose that ___," but you do not need to use that exact language, she said. Paraphrasing goes to tailoring the disclosure to what your business does, said Collins.