New requirements related to disclosure loom for advisers

The Securities and Exchange Commission’s adoption last week of new customer disclosure rules was overshadowed by the agency’s plan to revamp mutual fund sales charges, but will have a more immediate impact on investment advisers.

The SEC unanimously ap-proved changes in Form ADV Part 2 — known as “the brochure” — that will require advisers to disclose in a plain-English, narrative format information about their practices in 18 different business areas and to prepare supplements with biographical information on employees who work with clients. 

The current brochure is largely a check-the-box, multiple-choice document that fails to enhance investor understanding about advisers’ investment styles, fees and real or potential conflicts of interest, according to Andrew “Buddy” Donohue, director of the SEC’s Division of Investment Management.

The amended rules will be effective 60 days after they are published in the Federal Register, meaning that advisers who do business on a calendar year basis will have to distribute and publicly post the new brochure in the first quarter next year. The SEC is working with state regulators to coordinate items and instructions so that a uniform brochure can be used for both state- and federally registered advisers to enhance comparison shopping.

SEC commissioners lauded the long-anticipated ADV Part 2 revision as a major advance in helping investors select advisers and as a sharper tool in its oversight arsenal.

“Since I returned to the commission in January 2009, the need for ADV reform and a brochure update has been a constant refrain in conversations and visits with regional SEC staff across the country,” said SEC Chairman Mary Schapiro, noting that revisions were first proposed 10 years ago but were never enacted.

“So while the changes are a critical investor-oriented reform, the new ADV Part 2 also will enable our staff to do its job better,” she added.

ENHANCED DISCLOSURE

The enhanced disclosure rules should lead some advisers to modify their business practices and compensation policies, Ms. Schapiro said.

The amorphous nature of the narrative format, however, puts an onus on advisers to determine just how much to disclose, and could lead to a protect-the-flanks deluge of information to avoid lawsuits from investors down the road, some lawyers said.

“You’re really placing the burden on the adviser to know what is appropriate disclosure, and that’s a significant challenge,” said Brian Hamburger, founder and managing director at MarketCounsel, a compliance consulting firm.

“You have to think of every conceivable thing that could go wrong and disclose away those potential conflicts of interest,” he said.

Before casting her vote for the new form at last week’s meeting, SEC member Elisse Walter warned advisers and their lawyers to tell a clear story in the narrative and comply with the intent of the rules.

“If they draft to clarify and avoid confusion … rather than simply throwing in the kitchen sink to protect against legal liability, these changes will be a seminal step forward,” she said.

Weighed against the deluge of new rules and restrictions that will emanate from the Dodd-Frank financial-reform bill signed into law last week, the unrelated ADV Part 2 remodeling may prove to be a relatively minor burden, said Keith Marks, general counsel of Ascendant Compliance Management.

Advisers who have properly prepared their brochures won’t have to start from scratch, as Schedule F of the current form already provides a narrative about their services, he said.

“But it will still mean more time and energy they have to devote to this,” Mr. Marks said, conceding that the new rules should generate more business for consultants.

The new rules will require advisers to deliver the brochure to clients prior to, or at the time of, signing advisory contracts and make available to all clients an annual summary of material changes in the brochure.

Advisers will have to file their ADV Part 2 forms electronically with the SEC, which will make them available to the public on its website.

CONTENT REQUIREMENTS

The expanded content requirements for the brochure include:

• Descriptions of advisory services offered, including risks involved with particular areas of specialization, and the amount of client assets that are managed.

• Fee schedules, including whether fees are negotiable, and disclosure of brokerage fees, custody fees and other expenses that clients may pay.

• Disclosure of performance-based fees and a discussion of how conflicts of interest are managed if the adviser also oversees accounts that don’t charge such fees.

• Descriptions of unusual risks that might accompany a particular method of investment analysis, strategy or type of security in which an adviser specializes.

• Disclosure of material facts about any legal or disciplinary event that would help a client evaluate the integrity of personnel and a mandate to promptly deliver to clients updates on such events.

• Disclosure of material financial interests that an adviser or an affiliate has in securities it recommends or trades for clients, and an explanation of how conflicts are addressed.

• Disclosure of incentives from brokers such as soft-dollar services, client referrals and volume discounts on aggregated trades that could influence advisers’ execution choices.

The ADV Part 2 changes were first proposed in 2008, causing some lawyers to suggest that the SEC should have reissued them for comment given issues that since have arisen about electronic filing, data security and privacy.

But several commissioners praised Mr. Donohue’s staff for pushing ahead amid the deluge of new activities required by the Dodd-Frank bill.

Ms. Schapiro, noting that revisions had been on the agenda for a decade, added a lighter touch as she walked in late to the open meeting where the rules were adopted.

“I guess if we waited 10 years for revising the ADV, we can wait 10 minutes to start the meeting,” she said.

E-mail Jed Horowitz at [email protected].

Related Topics: Securities and Exchange Commission