The proposed rules would require expanded reporting about separately managed accounts and other aspects of an adviser’s business, allow consolidated registrations for certain private fund advisers that operate a single advisory business through multiple entities, and amend the record-keeping rules affecting investment advisers.
On May 20, 2015 the US Securities and Exchange Commission (SEC) proposed to expand substantially Form ADV Part 1A to capture more detailed information about separately managed accounts, as well as other aspects of an adviser’s business, and to provide a mechanism for certain advisers to make consolidated or “umbrella” registration filings (Proposing Release). The proposal represents the most significant changes to Form ADV since 2011, when the SEC added Item 7.B. to collect detailed information about private funds managed by registered advisers. The proposed amendments are designed to provide information about separately managed accounts (SMAs) similar to that which is already required for private funds. The SEC indicated in the Proposing Release that the proposals are motivated, at least in part, by the desire to collect more detailed quantitative information that the examination staff can use to run risk analytics and design examination initiatives. The request for information about SMAs is also presumably a response to the Financial Stability Oversight Council (FSOC), which recently noted that because information about SMA portfolio positions is not collected on a systematic, industrywide basis, information about the assets held in these accounts, their counterparty and other exposures, and amounts of leverage are not routinely available to regulators for assessment and monitoring purposes.
In addition to facilitating data collection about SMAs, the proposed changes would also
The SEC simultaneously issued a companion release proposing to enhance the reporting requirements applicable to registered investment companies. The SEC unanimously approved both proposals, which it noted were intended to further “modernize and enhance” its monitoring and regulation of the asset management industry. In addition to providing more accurate and up-to-date information for investors, the SEC indicated that the proposed forms, rules, and other actions would facilitate its risk monitoring objectives.
The following is a summary of the Proposing Release, including some key points to note and significant implications for investment advisers. We encourage investment advisers to carefully consider how these proposals could affect their business and whether they want to provide their perspectives to the SEC through the comment process.
Under the proposal. Part 1A of Form ADV would require advisers to provide detailed information about the types of assets, derivatives positions, and borrowings associated with SMAs. Similar to the reporting regime under Form PF relating to private funds, the amount of detail required to be reported would be driven by the level of an adviser’s regulatory assets under management (RAUM) attributable to SMAs. The more SMA assets an adviser has, the more data it would need to provide under the proposal.
It is important to note that—in all cases—the SMA information would only need to be filed once a year as part of an adviser’s annual amendment.
All advisers to SMAs would also be required to identify each custodian that holds 10% or more of an adviser’s RAUM attributable to SMAs, as well as the amount of SMA assets held by each such custodian. These proposed changes align with the more detailed disclosure currently required by private fund advisers in Item 7.B. of the current Form ADV Part 1A and the corresponding sections of Schedule D.
In addition to the SMA data, the proposal would also amend Part 1A to collect additional information about an adviser and its clients. Below are some of the more notable proposed changes.
The SEC also seeks to amend Form ADV to better facilitate consolidated or “umbrella registrations” through which private fund advisers that operate a single advisory business through multiple entities could register by filing a single Form ADV. The SEC staff first permitted private fund advisers to take advantage of consolidated registrations in certain contexts in a 2012 No-Action Letter issued to the American Bar Association (ABA). Although that guidance provided a practical method for streamlining the registration process for certain private fund advisers, Form ADV’s structure did not provide the flexibility necessary to support such a consolidated filing. In the Proposing Release, the SEC acknowledges the difficulties associated with relying on the 2012 ABA Letter in light of the current version of Form ADV and the resulting inconsistencies in Form ADV disclosure among advisers seeking to rely on that no-action position. The amendments would allow one adviser (the “filing adviser”) to file a single Form ADV (an “umbrella registration”) on behalf of itself and other advisers that are controlled by, or under common control with, the filing adviser (each, a “relying adviser”), provided that they operate a single advisory business and satisfy the following conditions:
Advisers filing an umbrella registration would need to complete new Schedule R, which would provide a mechanism for the filing adviser to report the requisite information for each relying adviser. Schedule R would not necessarily require any additional information but would provide more uniformity in the disclosure of information regarding relying advisers than under the current Form ADV.
Note that that advisers qualifying for umbrella registration would be permitted, but not required, to file umbrella registrations. In addition, the SEC explicitly stated that umbrella registration is not available for exempt reporting advisers (ERAs). The SEC’s rationale for excluding ERAs from the proposed umbrella registration is that ERAs would not meet the condition of a single advisory business given that such advisers are not required to adopt policies and procedures and a code of ethics in accordance with Rule 206(4)-7 and Rule 204A-1. Depending on the outcome of the final rules, any advisers currently filing consolidated ERA filings may need to reconsider their filings.
In addition, as noted above, the proposed approach would effectively preclude advisers with a variety of business lines and advisers that provide advice outside of the private fund context from relying on an umbrella registration. The SEC, however, requested comment as to whether the umbrella registration provisions should be expanded to permit registrants with broader business lines to benefit from a consolidated registration.
The SEC is proposing to amend the books and records rule on the retention of records relating to advertisements and other written communications. Both proposed changes reflect the examination staff’s continued focus on reviewing and evaluating adviser performance claims.
Advisers Act Rule 204-2(a)(16) currently requires advisers to retain all documents or records that are necessary to form the basis for, or demonstrate the calculation of, the performance or rate of return of any or all managed accounts or securities recommendations in any communication that an adviser distributes, directly or indirectly, to 10 or more persons. The proposal would remove the “10 or more persons” condition and instead require that advisers retain the requisite performance records for communications that are distributed to any person. Although we generally believe that, as a best practice, most advisers retain the relevant records for communications provided to any number of clients and prospective clients (including one-on-one presentations), if adopted, this proposal would make any failure to maintain such records a regulatory infraction.
The SEC also proposes to amend rule 204-2(a)(7) to require advisers to maintain originals of all written communications received and copies of written communications sent relating to the performance or rate of return of any or all managed accounts or securities recommendations. This proposed change was precipitated by, among other things, a recent enforcement action wherein the evidentiary record prevented the action from moving forward.
Finally, the SEC also proposes numerous minor amendments to Form ADV to clarify areas where it received numerous requests to remove expired provisions and provide further instruction. In addition, the SEC proposes to amend certain Advisers Act rules to remove transition provisions that are no longer applicable.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the authors, Jennifer L. Klass (+1.212.309.7105), Christine M. Lombardo (+1.212.309.6629), and Jasmin M. Ali (+1.617.951.8477), or any of the following Morgan Lewis lawyers:
. Notice Seeking Comment on Asset Management Products and Activities, 79 FR 77488 (Dec. 24, 2014) at p.15.
. Those categories are exchange-traded equity securities, US government/agency bonds, US state and local bonds, sovereign bonds, corporate bonds - investment grade (sufficiently liquid that it can be sold at or near its carrying value within a reasonably short period of time and is subject to no greater than moderate credit risk), corporate bonds - noninvestment grade, derivatives, securities issued by registered investment companies or business development companies, securities issued by pooled investment vehicles (other than registered investment companies), and other. “Other” must be generally described.
. Gross notional exposure would be defined as the percentage obtained by dividing (i) the sum of (a) the dollar amount of any borrowings and (b) the gross notional value of all derivatives by (ii) the net asset value of the account.
. The derivative types are interest rate derivatives, foreign exchange derivatives, credit derivatives, equity derivatives, commodity derivatives, and other derivatives. Each type of derivative has a definition in the new proposed glossary.
. Such disclosure requirements mandate that an adviser identify the custodian(s) for each private fund it manages.
 “Qualified Client” is defined by reference to Rule 205-3 under the Advisers Act.
. See Proposing Release at footnote 56.
. Rule 204-2(a)(7) currently requires advisers to make and keep “Originals of all written communications received and copies of all written communications sent by such investment adviser relating to (i) any recommendation made or proposed to be made and any advice given or proposed to be given, (ii) any receipt, disbursement or delivery of funds or securities, or (iii) the placing or execution of any order to purchase or sell any security.”
. In the Matter of Michael R. Pelosi, Investment Advisers Act Release No. 3141 (Jan. 14, 2011); Initial Decision Release No. 448 (Jan. 5, 2012); Investment Advisers Act Release No. 3805 (Mar. 27, 2014) (Commission opinion dismissing proceeding against associated person of registered investment adviser charged with providing false and misleading performance information because the record lacked an evidentiary basis from which to determine that the performance information was materially false or misleading).