The Securities and Exchange Commission has adopted final rules which substantially amend Form ADV under the Investment Advisers Act of 1940, as amended. Among other things, the Final Rules expand the information collected on Form ADV with respect to separately managed accounts (SMAs), codify under the term “umbrella registration” previous staff no-action relief permitting affiliated advisers to private funds operating a single advisory business to file a single Form ADV (Relying Adviser Relief), and make certain clarifying and technical amendments to Form ADV. The Final Rules also add to the books and records required to be kept related to performance claims.
The Final Rules, adopted in late August, will be effective October 31, 2016, and have a compliance date of October 1, 2017. Thus, investment advisers with a December 31 fiscal year end will be required to comply with the revised reporting requirements on Form ADV no later than their annual amendment filing in the first quarter of 2018.
AMENDMENTS TO FORM ADV
A. Disclosure regarding separately managed accounts
The Final Rules require investment advisers to report new information about their SMA businesses. For this purpose a “separately managed account” includes any client account other than a registered investment company, a business development company or other pooled investment vehicles (e.g., private funds).
The amount of information collected on Form ADV related to an adviser’s SMA business prior to the effectiveness of the Final Rules was limited (e.g., the percentage of clients and regulatory assets under management attributable to SMAs). The SEC indicated that one of its goals was to make the level of disclosure related to SMAs comparable to the level of data collected with respect to an adviser’s private fund business. Thus, an investment adviser that indicates that it has regulatory assets under management (RAUM) attributable to SMAs (SMA RAUM) is required to provide information about the types of assets held in SMAs, the use of derivatives and borrowing and the custodians used for such SMAs.
Reporting with respect to SMAs will increase incrementally at SMA RAUM thresholds of $500 million and $10 billion, as further described below. An investment adviser that acts as sub-adviser to an SMA should only report the required information with respect to the portion of the account for which the investment adviser acts as sub-adviser. In addition, the SEC made clear in the adopting release that an investment adviser with its principal place of business outside the US (i.e., a non-US adviser) is required to report information about all of its SMAs and, accordingly, may not exclude SMAs owned by non-US persons.
i. Types of assets held
An investment adviser that reports that it has SMA RAUM will report the approximate percentage of its SMA RAUM in 12 broad asset categories. The categories are: exchange-traded equity securities, non-exchange traded equity securities, US government bonds, US state and local bonds, sovereign bonds, investment grade corporate bonds, non-investment grade corporate bonds, derivatives, securities issued by registered investment companies and business development companies, securities issued by other pooled investment vehicles, cash and cash equivalents, and “other.”
The instructions permit investment advisers to use their own internal methodologies and the conventions of their service providers in determining how to categorize the assets held in SMAs.
An investment adviser with at least US$10 billion in SMA RAUM (a Large SMA Adviser) is required to report such information on its annual updating amendment of Form ADV as of two dates per year: the date used to calculate such adviser’s RAUM for purposes of its annual updating amendment to Form ADV (end of year) and as of the date that is six months before such adviser’s end of year (mid-year). An investment adviser with less than US$10 billion in SMA RAUM must only report such information as of end of year.
ii. Borrowings and derivatives
An investment adviser with at least US$500 million in SMA RAUM is to report information regarding the use of borrowings and derivatives in connection with its SMAs. More specifically, an investment adviser with at least US$500 million but less than US$10 billion in SMA RAUM (a Mid-Sized SMA Adviser) is required to report the amount of SMA RAUM and the dollar amount of borrowings attributable to those assets according to three levels of gross notional exposure for such accounts as of end of year.
A Large SMA Adviser is to report the same information as Mid-Sized SMA Advisers, as well as the derivative exposures in its SMAs (measured by gross notational value) in six categories of derivatives. Large SMA Advisers must report this information on their annual updating amendment of Form ADV as of two dates per year (mid-year and end-of-year).
An investment adviser may, but is not required to, report the information with respect to borrowings and derivatives with respect to SMAs with SMA RAUM of less than US$10 million.
iii. Custodians for separately managed accounts
An investment adviser must: (1) identify any custodian that holds ten percent or more of such investment adviser’s aggregate SMA RAUM, and report such custodian’s office location, and (2) disclose the amount of SMA RAUM held by each such custodian.
B. Additional information about investment advisers
More information about the investment adviser, its advisory business and its affiliations will be included in Items 1, 5 and 7 of Form ADV Part 1 under the Final Rules.
Item 1: An investment adviser is to disclose:
- the total number of offices in which the adviser conducts its advisory business, and information regarding its 25 largest offices, including the number of employees providing advisory functions and the types of other business activities conducted from such offices
- all websites and publicly-available social media platforms on which the adviser controls the content
- the name and IRS Employer Identification Number for any person other than the investment adviser or a related person (unless it is a registered investment company advised by the adviser) who compensates or employs the investment adviser’s chief compliance officer and
- if the investment adviser’s own balance sheet assets (as opposed to client assets) are at least $1 billion, the approximate amount of its assets within specified ranges: $1-10 billion; $10-50 billion; or $50 billion or more.
Item 5: New disclosures include:
- the number of clients and the amount of RAUM attributable to 14 specified categories of clients
- the number of clients for which the adviser provided investment advisory services but for whom the adviser does not have RAUM (e.g., a non-discretionary account)
- whether the adviser reports client assets in Part 2A of Form ADV different from the RAUM reported in Part 1A and
- certain additional information concerning wrap fee programs.
In the adopting release, the SEC indicated that advisers with fewer than 5 clients in a specific category (other than investment companies, business development companies and pooled investment vehicles) may indicate that fact rather than reporting the actual number of clients in such category.
Item 7: An investment adviser is to disclose certain identifying numbers (e.g., Public Company Accounting Oversight Board registration numbers) of service providers to the private funds advised by the adviser.
In addition, advisers to private funds that rely on the 100 or fewer holders exclusion from being an investment company (Section 3(c)(1) of the Investment Company Act of 1940, as amended) must indicate whether sales of interests in such private funds are limited to “qualified clients” as defined in Rule 205-3 under the Advisers Act.
The Final Rules also contain several clarifying, technical and other amendments to Form ADV.
C. Umbrella registration of affiliated investment advisers
The Final Rules effectively codify the Relying Adviser Relief by expressly permitting the “umbrella registration” of certain affiliated advisers operating a single advisory business.
For various reasons, advisers to private funds are often structured as a group of two or more affiliated advisers which are operated as a single advisory business. In theory, such a structure may require an organization to separately register affiliated entities by filing multiple Form ADVs for what is effectively the same business. The Relying Adviser Relief has allowed certain affiliated advisers to register on a single Form ADV, provided that certain conditions are met. However, because Form ADV was not originally designed to accommodate the registration of multiple entities on the same Form, the use of a single Form ADV to facilitate the registration of multiple entities under the Relying Adviser Relief had led to certain complications and confusion.
As amended, the General Instructions to Form ADV now provide standardized instructions for affiliated advisers seeking to file a single Form ADV (i.e., umbrella registration) along with the following conditions to be met in order for umbrella registration to be available:
- The filing adviser and each relying adviser advise only (i) private funds and (ii) clients in SMAs that are “qualified clients” and are otherwise eligible to invest in the private funds advised by the filing adviser or a relying adviser whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to those private funds
- The filing adviser must have its principal place of business in the US with the Advisers Act applying to the filing adviser and the relying adviser
- Each relying adviser, its employees and other persons acting on its behalf must be subject to the filing adviser’s supervision and control and are “persons associated with” the filing adviser (as defined in section 202(a)(17) of the Advisers Act)
- The activities of each relying adviser must be subject to the Advisers Act and the rules thereunder and each relying adviser must be subject to examination by the SEC and
- The filing adviser and each relying adviser must operate under a single code of ethics and a single set of policies and procedures administered by a single chief compliance officer.
The Final Rules add new Schedule R to Part 1A which requires the following information about each relying adviser: identifying information in section 1, the basis for registration in section 2 (although umbrella registration is permitted, each adviser within an affiliated group must individually meet one of the basis for SEC registration), its form of organization in section 3, and information regarding ownership and officers (i.e., control persons) in section 4. The Final Rules also amended Schedule D to require a sponsor to identify the specific adviser entity that manages or sponsors a private fund reported on Form ADV.
Umbrella registration is only available to US investment advisers, despite lobbying efforts to extend umbrella registration to non-US advisers. The SEC also declined to expressly apply umbrella registration to affiliated entities that are exempt reporting advisers, but the SEC stated in the adopting release that the Final Rules do not withdraw its previous guidance in the form of responses to “Frequently Asked Questions” that permits certain exempt reporting advisers to file a single Form ADV on behalf of multiple special purposes entities.
The Final Rules also amend Rule 204-2 under the Advisers Act, the books and records rule, to require investment advisers to maintain additional supporting materials related to the calculation and distribution of investment performance information. Specifically, the revisions require an investment adviser to maintain records supporting performance information distributed to any person, whereas the prior iteration of Rule 204-2 required the retention of such information in relation to communications that are distributed to 10 or more persons.
In addition, the revisions require an investment adviser to maintain all written communications sent or received by it relating to the performance or rate of return of all managed accounts or securities recommendations, whereas the rule previously required an investment adviser to maintain only certain categories of such written communications.
Although not as comprehensive as the Form ADV amendments adopted in 2011, the Final Rules implement significant revisions to Form ADV. Investment advisers should review the changes now in order to be ready to comply with the substantial new reporting requirements placed on many investment advisers before the compliance date of October 2017.
Investment advisers that currently rely on umbrella registration should also confirm that they will continue to be eligible to use this approach under the new rules and instructions, and should review new Schedule R and the information required to be disclosed on it with respect to relying advisers in advance of the compliance date.
Please contact any of the authors if you have any questions.