Tag: Form ADV

See the Changes to Form ADV

With all the regulatory changes to Form ADV coming out, I found it tough to figure out what the changes look like on the form. The Securities and Exchange Commission published a helpful redline that highlights the changes.

The SEC is not willing to stand behind the redline, noting:

This document illustrates most of the revisions to Form ADV related to adopted rule release IA-4509. This document should not be considered a complete and comprehensive list of changes to Form ADV.

I think many will find the “separately managed account” portion to be confusing. The first being the use of this term which sounds much like the term, separate account, used in the insurance industry to invest. The borrowing and derivatives reporting will be time-intensive.

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Umbrella Registration

Continuing with my look at the changes to Form ADV, I spent some time looking at the new umbrella registration.

Umbrellas_at_Caudan_Waterfront_Mall

One investment adviser (“Filing Adviser”) will be able to file a single Form ADV on behalf of itself and other investment advisers (“Relying Advisers”). This tackles the problem fund managers had when the manager was a collection of separate fund advisers.

For a variety of tax, legal and regulatory reasons, private fund managers are often carved into separate legal entities even though they operate together. There may just be a collection of fund general partners, even it looks like a single adviser to the outside.

Form ADV is based on the legal entity and therefore skews the information since the separate legal entities would have to file separate Form ADVs (or is it Forms ADV?). The SEC had provided some guidance for umbrella registrations in 2012, but there were complications around ownership on Schedules A and B.

For a group of private fund advisers that operate as a single advisory business to qualify for Umbrella Registration, they must meet these five requirements:

  1. The Filing Adviser and each Relying Adviser advise only private funds and/or “qualified clients” in separately managed accounts that are otherwise eligible to invest in the private funds advised by the Filing Adviser or a Relying Adviser and whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to those private funds.
  2. The Filing Adviser’s principal office and place of business is in the United States, and all of the substantive provisions of the Advisers Act and rules apply to the Filing Adviser and each Relying Adviser.
  3. Each Relying Adviser, its employees, and persons acting on its behalf are subject to the Filing Adviser’s supervision and control.
  4. Each Relying Adviser’s advisory activities are subject to the Advisers Act and rules, and subject to SEC examination.
  5. The Filing Adviser and each Relying Adviser operate under a single code of ethics and written policies and procedures adopted and implemented in accordance with rule 206(4)-7 of the Advisers Act and administered by a single chief compliance officer in accordance with the rule.

There is a new Schedule R for information on the Relying Advisers.

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Umbrellas at Caudan Waterfront Mall by Martin Falbisoner CC BY SA

The SEC Wants To Know If You Have An Outsourced CCO

Continuing this week on the changes to the Form ADV is a revision to Item 1.J that lists the chief compliance officer.

Folder with the label Compliance

The new Form ADV will require a registered investment adviser to disclose whether the firm’s CCO is compensated or employed by someone other than the adviser. That is, the SEC wants to know if the CCO is outsourced.

The SEC has previously noted that it has observed a wide spectrum of quality and effectiveness with outsourced CCOs. Clearly, having an outsourced CCO will be a risk factor when deciding to examine a firm.

I think that is true in part, but depends on the outsourcing itself.

I believe the SEC is looking for trends and will be able to see which firms do a good job of acting as an outsourced CCO and which do a bad job. If the SEC sees a trend that a particular outsourcing firm is doing a bad job, it will certainly take a closer look at the advisers that used that outsourcing firm.

The disclosure will work to identify both the good outsourcing firms and the bad outsourcing firms in the eyes of the SEC.

There is one small flaw in the disclosure. That is the instance in which the outsourced CCO is not employed by a firm, but is self-employed. The new question asks for the name of the “person” (corporations are people too) and the IRS EIN that employs or compensates the outsourced CCO. The self-employed outsourced CCO would not disclose the other firms that have hired him or her. And the person would definitely not want the SSN to be used as the EIN.

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Separately Managed Accounts

The biggest change to the Form ADV is reporting on separately managed accounts. The Securities and Exchange Commission is looking for data and insight into advisers’ operations. I think the benefit to consumers is a side benefit.

Cash in the grass.

I have to admit that I was confused as I was browsing through the new changes to Form ADV. I mistook “separately managed accounts” for “separate accounts.” That left me particularly confused when the section started with the scope of the changes:

we consider advisory accounts other than those that are pooled investment vehicles (i.e., registered investment companies, business development companies and pooled investment vehicles that are not registered (including, but not limited to, private funds)) to be separately managed accounts.

Later on in the release, the SEC specifically chooses not to define “separately managed accounts.” That only exacerbated my initial confusion. Many advisers and fund managers are familiar with separate accounts, a species of investing vehicle used by insurance companies

Then the light came on and realized that the SEC had created a completely new term that compliance professionals for registered investment advisers will need to learn and understand. There are “separate accounts” and “separately managed accounts.”  To add to the confusion, a separate account could be a separately managed account. But maybe that was just me.

With Dodd-Frank giving the SEC more oversight over private funds, it realized that it was collected vast amounts of information about private funds, but much less about the bread and butter separately managed accounts. But rather than collect that information in the private manner for Form PF, the SEC is mandating additional disclosure in the public Form ADV filing.

Registered investment advisers will have to report the approximate percentage of their separately managed account assets invested in twelve asset categories:

  1. exchange-traded equity securities;
  2. non-exchange traded equity securities;
  3. U.S. government bonds;
  4. U.S. state and local bonds;
  5. sovereign bonds;
  6. corporate bonds – investment grade;
  7. corporate bonds – non-investment grade;
  8. derivatives;
  9. securities issued by registered investment companies and business development companies;
  10. securities issued by other pooled investment vehicles;
  11. cash and cash equivalents; and
  12. other

Don’t look for definitions of these terms in Form ADV. The SEC is leaving it up to advisers to determine how to categorize assets, so long as the methodology is consistently applied. If an adviser has more than $10 billion in RAUM, the information will have to be reported twice a year, instead of just an annual filing.

If an adviser has more than $500 million in RAUM, the adviser will have to disclose the use of borrowing attributable to those assets. If the adviser has more than $10 billion in RAUM, the adviser will also have to report on the use of derivatives in those accounts.

As with private funds, advisers will need to report information on the use of custodians. The new Item 5.K.(3) requires investment advisers to identify any custodian that accounts for at least 10 percent of total RAUM attributable to its separately management accounts, the custodian’s office location and the amount of RAUM held at the custodian.

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The SEC Wants To Know About Your Social Media

The Securities Exchange Commission published an update to Form ADV last week. I’m going to devote this week’s stories to some of the new requirements. Today, I’m looking at reporting of social media.

SOCIAL MEDIA DATABASE

Item 1.I of Part 1A of Form ADV currently requires registered investment advisers to list their websites. The SEC is casting a wider net.

Instead of just websites, the SEC is requiring the listing of accounts on social media platforms such as Twitter, Facebook and LinkedIn. We will be required to include the address of the registered adviser’s social media pages. (see page 34 of the release)

There were comments to the proposed release about the scope of this listing requirement. It’s limited to accounts on social media platforms where the adviser controls the content. You are not required to disclose information on employee social media accounts. It’s also limited to publicly available social media platforms.

Twitter, Instagram, and Facebook all fall clearly into this requirement.

LinkedIn is little fuzzy. A company can update the company page on LinkedIn. But many firms just have the default company page on LinkedIn. A firm can control the content, to some extent, but may not have exercised any control. That being said, those pages that have not been edited don’t provide much information. It would be unlikely to be of interest to the SEC. But if you are publishing information, then clearly the SEC is going to take a look at when it comes to exam time.

I do have a question about dormant accounts. I know many firms signed up for an account to control a particular account name, without intending to actually publish information. I remember back in the early days of Twitter, Lexis Nexis ignored the platform. Some yahoos grabbed the handle and started publishing strange stuff on the @LexisNexis twitter account. Lexis would eventually get it back because it was its trade name. I think you would need to list these unused accounts.

A hitch will be updating this social media information. If you add a new account or create an account on a new platform you will need to file an update to Form ADV, just as you would if you created a new website.

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SEC Loses Case Over the Word “May”

Few things make a compliance officer’s eyes roll more than the case the SEC was fighting against an adviser who used the word “may” in its Form ADV when the SEC thought it should say “will.” One of the SEC’s own administrative judges slapped down the SEC and dismissed the case.

Cash in the grass with room for your type.

According to the SEC charging order, an unnamed broker agreed to pay The Robare Group a fee for client funds invested in funds sold by that broker. Of course, there is nothing inherently wrong with that arrangement as long as it is disclosed to clients. Obviously, the concern is that the adviser would direct clients to invest in those funds because it is good for the adviser, not necessarily because it is good for the client.

The SEC is focused solely on a violation for failure to disclose. The SEC claimed the disclosures were not adequate because they said the Robare Group “may” receive compensation from the broker for selling the mutual funds, when it was definitely receiving payments. That’s a very thin distinction to make. Especially when the SEC stated in the complaint that it did not identify any harm to Robare Group’s clients or even that the clients were invested in those funds in a disproportionate amount.

The Robare Group used Fidelity mutual funds and much later found out that Fidelity offered a “revenue sharing arrangement” in which it would pay the firm between two and twelve basis points based on the assets under management. According to the final decision, Robare confirmed that the arrangement would not result in additional costs to its clients and would not alter the construction of its clients’ portfolios.

In the order, the judge highlights the testimony of Melissa Harke, a branch chief in the Commission’s Division of Investment Management, who testified that advisers are expected to disclose material conflicts in the Form ADV and should conversely not throw in everything just to “cover” themselves “for legal purposes.”

The judge also highlighted that the firm used an outside compliance consultant, Renaissance Regulatory Services to help with drafting the Form ADV.

No doubt, Mr. Robare and Mr. Jones paid Renaissance in hopes of avoiding the very proceeding of which they are now the subject.

There is no doubt that the revenue sharing arrangement gave rise to a potential conflict of interest. If the conflict is “material” it has to be disclosed in the Form ADV. The judge found that the conflict was material. The judge went on to find that the SEC failed to prove that Robare acted with any intent to deceive, manipulate or defraud its clients.

The SEC tried to argue that even if Robare did not have the intent to deceive, it was reckless in its failure to “fully and accurately disclose.” The judge found that

“with respect to Form ADV disclosures, advisers operate in a difficult environment that presents challenges for even experienced compliance professionals….I find that the relevant standard of care entails employing a compliance professional and following his or her advice.”

That similarly doomed the SEC’s argument that Robare was negligent. The firm and its principals did not have the expertise to properly disclose the information on Form ADV.

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Bad Actors on Form ADV and Under Rule 506(d)

venn diagram and compliance

The Securities and Exchange Commission has layered two tests for bad actors on to private fund managers. On Form ADV, the fund manager will need to disclose bad actor events. Then the second test comes under the new Rule 506(d) that also requires disclosure for bad actors in private placements and a bar for recent bad actors. From a compliance perspective, the question comes down to how do you deal with certifications.

Unfortunately, the employees for Form ADV disclosure are potentially different than the employees than the 506(d) disclosure and bans. For 506(d) its limited to “officers participating in the offering.”

Participation in an offering would have to be more than transitory or incidental involvement, and could include activities such as participation or involvement in due diligence activities, involvement in the preparation of disclosure documents, and communication with the issuer, prospective investors or other offering participants.

I’m not sure that helps much for fund managers. It does mean that you can exclude administrative assistants.

For Form ADV, the disclosure pertains to

Your advisory affiliates are: (1) all of your current employees (other than employees performing only clerical, administrative, support or similar functions); (2) all of your officers, partners, or directors (or any person performing similar functions); and (3) all persons directly or indirectly controlling you or controlled by you.

The Form ADV disclosure is potentially for a broader group of employees. Your organization may have employees who are not clerical, but are also not officers participating in the offering.

I think it’s probably just easier to require every employee to fill out the questionnaires. Then you can get into the weeds of the analysis if there is a disclosure event.

That leads to the next item which is the questionnaires. The main concept between the two are the same. If your employees have been involved in financial crimes, you need to disclose that information. However, the time frames, laws covered, and conviction status vary between each regulatory requirement.

I tried to sit down and create a unified questionnaire that would address disclosures for both Form ADV and Rule 506(d). In ended up being a huge pain in the neck and I gave up. I have two separate questionnaires that I require all employees to deliver.  Let me know if you have come up with a unified questionnaire.

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One Week Left to File Your Form ADV Update

march 2013

Most advisory firms and fund managers end their fiscal year on December 31. Under the SEC Advisers Act Rule 0-4, you have 90 days to file your Form ADV update after the end of your fiscal year.

Last year that put the filing deadline on March 30 because it was a leap year. The next leap year does not come until in 2016.

This year that 90th day falls on March 31st. But that’s a Sunday. So we have one extra day this year. The filing deadline is April 1.

“Filings required to be made through the IARD on a day that the IARD is closed shall be considered timely filed with the Commission if filed with the IARD no later than the following business day.”

The Danger of Overstating Assets Under Management

Form ADV requires a registered investment adviser to state the firm’s assets under management. The new form changed the calculation and the term to “regulated assets under management”. At the same time, the threshold between state and federal registration has been increased from $25 million to $100 million.

I thought it would be useful to look back to 1997 when the regulation of investment advisers was first split at the $25 million level. Warwick Capital Management wanted to stay registered with the SEC and was accused of inflating its assets under management to maintain SEC registration. The main charge was a violation of Section 203A of the Investment Advisers Act. But the firm was also found to have violated section 207 by making an untrue statement of material fact in an SEC filing. Fraudulent intent is not required under Section 207. Even more, violations of Sections 206(1) and 206(2), by falsely representing Warwick’s assets under management and 2003 total performance returns to database services that published the misrepresentations to subscribers in the securities industry. Section 206 prohibits actions would operate as a fraud or deceit on a client.

In 1996 Warwick’s Form ADV listed $5 million of assets under management on a discretionary basis. In 1997 when the registration threshold increased, Warwick inflated assets under management to $26.55 million. That kept the firm under SEC registration and examination, instead of state-level.

Warwick also used inflated numbers in database services that acted as referral sources for Warwick. The amounts differed from those used in Form ADV and even differed from service to service.

Of course, you probably realize the importance of keeping the records that prove performance. Warwick did also. But they were destroyed in a fire, or a smoking chimney, or a flood. When asked by the SEC to make the records available, the firm used those series of excuses. The Administrative judge took the position that records never existed.

It probably comes as no surprise that in addition to inflating assets under management, Warwick inflated performance returns.

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Inflating the Balloon by Terry Feuerborn

Middle Names and Form ADV

When filling out Form ADV, Schedule A and Schedule B require you to disclose control persons, owners, and significant indirect owners of the investment adviser. The instructions call for the full legal name: Last name, first name, and middle name.

And the SEC means it. They require full legal names (last, first, and middle name). If there is no middle name or only a middle initial, the information provided next to the name should reflect as such; (NMN) or (MI ONLY).

Unfortunately, FINRA’s system does not place one of those red stars next to the middle name field indicating that it’s a required field. Similarly, the online IARD filing system’s completeness check does not pick up a missing entry for a middle name.