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News March 21, 2011 Issue

SEC Posts FAQs on Form ADV Part 2

Earlier this month, the staff of the SECís Division of Investment Management le it be known they were working on responses to a number of frequently asked questions about the new Form ADV Part 2. The goal was to release the FAQs in advance of the March 31 filing deadline applicable to most advisers.

True to their word, the staff posted an initial series of FAQs late last week. Like the custody rule FAQs, the SEC said it intends to update the Form ADV Part 2 FAQs on a rolling basis.

Here are some highlights from the clarifications:

Brochure.

  • Thereís no "template" or fillable form available on the SECís website or on the IARD system that an adviser can use to prepare its brochure. Brochures must be drafted in response to the revised Form ADVís requirements. (Question II.1)
  • Item 2 of new Part 2, the "Summary of Material Changes," is essentially "not applicable" in the first filing of a firmís new brochure. "However, if the new narrative brochure contains material information, such as a new conflict of interest or a new disciplinary information, that is being provided to clients for the first time, an adviser may want to highlight the new information for clients." (Question II.2)
  • Item headings must appear in order, using the exact language of Form ADV, but that does not apply to any sub-parts of each item. The one exception to the item headings requirement is the cover page. There is no need to include "Item 1 Ė Cover Page" there. (Question II.3)
  • An adviser to a pooled investment vehicle may meet the Item 8 requirement to describe the material risks for each significant investment strategy or method of analysis the adviser uses by providing a brief explanation and referring [note Ė not incorporating by reference] clients to the prospectus, offering memo, or other document that the client will or has received that sets forth a more detailed discussion of the risks. (Question II.4)
  • Advisers employing multiple "significant" investment strategies must explain the risks for each one under Item 8. The adviser can use a summary explanation and refer to a more detailed disclosure document that the client has or will receive. (Question II.5)
  • If you donít have a brochure delivery obligation, you donít have to prepare or file a brochure with the SEC. (Question II.6, citing to Rule 203-1)
  • An offshore adviser to an offshore private fund has no brochure delivery obligation to those funds. Therefore, the offshore adviser has no brochure preparation or filing obligation when its only clients are such offshore funds. (Question II.6, referencing Rule 203-1 and confirming a 2006 response to the American Bar Association)
  • Advisers have no brochure delivery obligation to registered investment company and business development company clients. Where an adviser voluntarily prepares and delivers a brochure to such clients, the brochure is not required to be filed as part of the adviserís Form ADV. "Under Rule 203-1, an adviser is not required to file a brochure with the Commission if it is not required to deliver a brochure." (Question III.1)
  • The hedge fund is the adviserís "client," not the fundís investors. An adviser can meet its delivery obligation to a hedge fund client by delivering the brochure to a legal representative of the fund, such as the general partner, manager, or other person serving in a similar capacity. (Question III.2)
  • Brochures required to be delivered to hedge funds or other private funds must be filed as part of the adviserís Form ADV. (Question III.3)

Brochure supplements.

  • Advisers do not need to provide clients with a brochure supplement for a "substitute" account manager covering for a regular account services provider where the substitute serves on a temporary basis no longer than 30 days. (Question IV.1)
  • Advisers have 30 days to deliver to clients the brochure supplement of a new advisory services provider when the prior supervised person resigns or is terminated. (Question IV.2)
  • A supervised person does not "formulate" investment advice when his or her role is limited to entering client information into a computer program that cannot be altered, and no brochure supplement must be created for that supervised person. The staff believes "that the adviser does, however, have an obligation to disclose to its clients the respective roles of the computer program and supervised person." (Question IV.3)
  • A supervised person does "formulate" investment advice when assisting a client in choosing from a list of advisers and/or mutual funds, even though that list cannot be altered by the supervised person. (Question IV.4)
  • An adviser does not have to deliver a brochure supplement for a supervised person who has no direct client contact and discretion over client assets only as part of a team. If the client routinely interacts with the team or one of its members, "the adviser should consider disclosing to clients that these supervised person(s) are not permitted by the firm to formulate any advice for the client." (Question IV.5, referring to the note to Part 2B Instruction 1)
  • Whether or not it has discretion over an account, an adviser need only provide brochure supplements in circumstances where a team may have client contact for the five team members with the "most significant responsibility" for a clientís account. (Question IV.6)
  • Even where only one member of a team has primary or sole contact with a client on a non-discretionary account, the supplements of the five team members with most significant responsibility for the account must still be provided to the client. (Question IV.7)
  • Each supervised person must have their own supplement. Advisers may not bundle multiple supervised persons into a single supplement. (Question V.1)
  • If a supplement includes a professional designation, it must also include "sufficient explanation of the minimum qualifications required for each designation that allows clients to understand the value of the designation." The adviser can refer to an organizationís website for more information after that. (Question V.2)
  • When describing the supervision of a dually registered supervised person, you donít have to include supervision of the brokerage services. "However, Item 4 of Part 2B would require an adviser to disclose a supervised personís other business activities, including whether he or she is a registered representative of a broker-dealer, and describe any material conflicts of interest and how the adviser addresses such conflicts." (Question V.3)
  • No matter how many accounts a client has, only one supplement must be delivered per supervised person servicing more than one of those accounts. (Question VI.1)