The amended Form ADV, which goes into effect October 1, 2017, will require investment advisers to expand the information they report on Form ADV about separately managed accounts and other important aspects of their advisory business. The SEC also adopted a number of other amendments to the Form ADV and certain rules under the Investment Advisers Act of 1940 that include permitting consolidated investment adviser registrations for certain private fund advisers that operate a single advisory business through multiple entities, amending the Advisers Act books and records rule to require investment advisers to maintain additional information supporting performance claims, and making certain other clarifying and technical amendments to the Form ADV and Advisers Act rules.
On August 25, 2016, the US Securities and Exchange Commission (SEC) announced the adoption of amendments to Form ADV and certain Investment Advisers Act of 1940 (“Advisers Act”) rules (collectively, the “amendments”). The amendments substantially expand the information required by Form ADV Part 1A to include more detailed information regarding an investment adviser’s separately managed accounts (SMAs) and other aspects of an adviser’s business activities. The amendments also implement a number of other amendments to Part 1A, including (i) a new mechanism for certain private fund adviser entities (relying advisers) to make consolidated or “umbrella” registration filings, (ii) provisions requiring additional information about an adviser’s business activities and affiliations, and (iii) certain clarifying and technical amendments to existing items and instructions. The SEC indicated in its Adopting Release that the amendments to Form ADV are designed to improve the depth and quality of information that the staff collects on investment advisers, facilitate risk-monitoring initiatives, and assist in the SEC staff’s risk-based examination program. In addition to implementing changes to Form ADV, the amendments also modify the recordkeeping rules under the Advisers Act to require the maintenance of additional records supporting the calculation of performance claims and make certain clarifying and technical amendments to Advisers Act rules.
The amendments will greatly impact the disclosure requirements of investment advisers. As adopted, the amendments to Form ADV contain a number of modifications to those that were originally proposed on May 20, 2015 (the “Proposed Rules”) in order to address concerns raised by commenters during the comment period. Below, we discuss key aspects of the Adopting Release and its significant implications for investment advisers.
The amendments modify existing Item 5 of Form ADV Part 1A, and Section 5 of Schedule D, to require advisers to report information on an aggregate level regarding the SMAs that they manage. For purposes of Form ADV reporting, the Securities and Exchange Commission (SEC) considers a “separately managed account” to be any investment advisory account other than pooled investment vehicles (i.e., registered investment companies, business development companies, and pooled investment vehicles that are not registered with the SEC, such as private funds). The stated rationale for the amendments to Form ADV is to collect detailed information for SMAs similar to that which the SEC already collects for pooled investment vehicles, in order to “better understand” how such assets are invested across the industry and enhance the SEC’s risk-monitoring and risk-based examination activities. The types of information that advisers will be required to report regarding SMAs include
Similar to the existing reporting regime under Form PF relating to private funds, the amount of detail that an adviser will be required to report on amended Form ADV will be determined by the level of the adviser’s RAUM attributable to SMAs. The more SMA assets that the adviser manages, the more data and information it will be required to report regarding the holdings and exposure of such accounts:
The Adopting Release contains important guidance from the SEC on how the information regarding SMAs should be reported. With respect to reporting of derivatives and borrowing information for SMAs, an adviser that acts as a subadviser to an SMA should only include the portion of the account that it subadvises. Additionally, advisers may, but are not required to, only include those SMAs with $10 million or more under management when reporting information in new Section 5.K.(2) of Form ADV regarding the use of derivatives and borrowing. Note that all SMA accounts, including those under $10 million, must be included in the asset class percentage reporting of new Section 5.K.(1).
Additionally, for purposes of calculating the asset class percentage holdings of an adviser’s SMAs in Section 5.K.(1), the SEC indicated that advisers should not double count assets, and are not required to look through an SMA’s holdings in mutual funds or ETFs to the underlying asset classes. Acknowledging a number of commenters’ concerns regarding the methodology for attributing assets to the new asset class categories, and consistent with the approach taken for the Form PF, the SEC indicated that advisers may use their own methodologies, as well as the conventions of their service providers, in determining how to categorize SMA assets. The SEC stated that such methodologies or conventions must be “consistently applied” as well as “consistent with information the advisers report internally and to current and prospective clients.”
The amendments also contain a number of key modifications from the Proposed Rules with respect to reporting on the use of derivatives and borrowing in SMAs. Importantly, the Adopting Release raised the minimum threshold at which an adviser is required to report the use of derivatives and borrowing in its SMA accounts from $150 million to $500 million in RAUM attributable to SMAs. The SEC noted that its rationale for this change was a number of comment letters indicating that such a change would permit the SEC to collect 95% of the data it would collect using the $150 million threshold, as proposed, while relieving a reporting burden for 3,000 advisers. Additionally, the amendments added the requirement that advisers with RAUM of $10 billion or more report derivatives and borrowings information on their SMAs at both midyear and end of year as part of their annual amendments. The amendments also modify the basis on which derivatives and borrowing figures are reported. Under the Proposed Rules, advisers would have been required to base the reporting of derivatives and borrowing in SMAs that they manage on net asset value. The amendments, however, require advisers to base such reporting on RAUM and borrowings that correspond to ranges of gross notional exposure. Additionally, the amendments eliminate the proposed requirement that advisers report the actual number of SMA accounts that they manage.
In addition to the reporting requirements above, the amendments also create new Item 5.K.(4) of Part 1A and Section 5.K.(3) of Schedule D to Form ADV. Advisers will be required to identify any custodians that custody at least 10% of RAUM that is attributable to the advisers’ SMAs under management, and will also need to disclose the amount of the advisers’ RAUM attributable to SMAs held at such custodians. The SEC stated that this new information mirrors the existing disclosure regime for private funds and registered investment companies, and will allow the SEC’s examination staff to identify advisers whose clients use the same custodian in the event that concerns are raised about a particular custodian.
In addition to the SMA reporting discussed above, the amended Form ADV will require additional disclosure in Part 1A about an adviser’s business activities, affiliations, and clients. Below we discuss some of the most notable changes to Part 1A adopted by the SEC:
The SEC has also amended Form ADV to codify “umbrella registration” through which private fund advisers that operate a single advisory business through multiple legal entities may register with the SEC by filing a single Form ADV. The SEC staff first provided guidance permitting private fund advisers to take advantage of consolidated registrations in a 2012 no-action letter issued to the American Bar Association. While the SEC noted in the Adopting Release that most advisers that can rely on umbrella registration consistent with the SEC staff’s guidance in the 2012 ABA Letter are doing so, the SEC acknowledged that the current structure of Form ADV does not lend itself to a consolidated filing. Consequently, the amendments modify the Form ADV instructions to establish conditions under which umbrella registration is available, and add a new Schedule R to Form ADV that must be filed for each adviser other than the filing adviser that is relying on umbrella registration. The conditions for umbrella registration (which will be added to the Form ADV instructions) are consistent with those in the 2012 ABA Letter and, as proposed, and require the following:
The SEC stated that these conditions are designed to limit eligibility for umbrella registration to private fund advisers that operate as a single advisory business, and that the following are indicia of a single advisory business: commonality of advisory services and clients; consistent application of the Advisers Act and the rules thereunder to all advisers in the business; and a unified compliance program. The single Form ADV filed by the filing adviser in an umbrella registration meeting these conditions must include all information relating to both the filing adviser and each relying adviser, and must include this same information in any other reports or filings it is required to make under the Advisers Act or the rules thereunder. In addition to new Schedule R, the SEC is also amending the private fund reporting requirements of Schedule D to require advisers to identify the filing advisers and relying advisers that manage or sponsor private funds.
Notably, the SEC acknowledged in the Adopting Release that several commenters urged the Commission to expand the eligibility of umbrella registration to additional types of advisers, including non-US advisers and exempt reporting advisers. The SEC chose to adopt the amendments as proposed, without modification, despite some acknowledgment as to the legitimacy of the requests. The SEC noted that it did not extend umbrella registration to non-US filing advisers, based on its concern that a group of related advisers based within and outside the United States could cause a non-US adviser to file as “filing adviser” and assert, based on the theory of operating a single advisory business, that the Advisers Act’s substantive provisions largely would not apply to the non-US clients of the US-based relying advisers. Additionally, the SEC chose not to extend umbrella registration to exempt reporting advisers “at this time” but acknowledged a set of Frequently Asked Questions (FAQs) that permit certain exempt reporting advisers to file a single Form ADV on behalf of multiple special purpose entities. Notably, the SEC stated that the views expressed in such FAQs are not being withdrawn as a result of the amendments.
In addition to the amendments to Form ADV, the SEC also adopted amendments to Advisers Act Rule 204-2, the books and records rule, that will require advisers to maintain additional materials related to the calculation and distribution of performance information. The rule amendment reflects the SEC’s stated belief that requiring the retention of additional records will “better protect investors from fraudulent performance claims.”
Advisers Act Rule 204-2(a)(16) currently requires advisers to maintain 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 or circulates to 10 or more persons. Consistent with the proposed rules, the SEC is amending Rule 204-2(a)(16) to remove the “10 or more persons” condition and will instead require that advisers maintain records to support performance claims in communications that are distributed to any person.
Additionally, the SEC has amended Rule 204-2(a)(7) to require advisers to maintain originals of all written communications received and copies of written communications sent by an adviser relating to the performance or rate of return of any or all managed accounts or securities recommendations. Rule 204-2(a)(7) currently requires advisers to keep originals of written communications relating to securities recommendations, advice, and transactions. As noted in the Proposing Release, the amendment was motivated by, among other things, a recent enforcement action where the lack of evidentiary record prevented the action from moving forward. The SEC further stated that it believed these records will be useful for the SEC examination staff in reviewing and evaluating adviser performance claims.
Finally, the SEC also adopted a number of minor amendments to Form ADV to clarify areas where it has received requests to remove expired provisions or provide further instruction. In addition, the SEC amended certain Advisers Act rules to remove transition provisions that are no longer applicable.
The SEC stated in the Adopting Release that it is currently working with the Financial Industry Regulatory Authority (FINRA) to reprogram the IARD system to implement these amendments to Form ADV, and that the IARD system is expected to be able to accept filings of revised Form ADV by October 1, 2017. Any investment adviser filing an initial Form ADV or an amendment to an existing Form ADV on or after October 1, 2017 will be required to provide responses to the amended Form ADV, Part 1A. The SEC acknowledged that in most cases, advisers will not be filing on the amended Form ADV, Part 1A until their annual updating amendments, which (for most) will occur in March 2018. The SEC further stated that the amendments to Advisers Act Rule 204-2, the books and records rule, will apply to communications circulated or distributed after October 1, 2017.
As adopted, the amendments to Form ADV present a wide range of new disclosure requirements that investment adviser firms should review and begin to prepare for well in advance of October 2017. In particular, the new SMA reporting requirements will require firms to evaluate their methodologies, and the conventions of their service providers, with respect to how they categorize client holdings into different asset classes and how they calculate derivatives and borrowing exposure. Additionally, any private fund adviser currently filing a single Form ADV for itself and its affiliated relying advisers should review the new Form ADV, Part 1A in preparation for the new form. Moreover, any affiliated exempt reporting adviser filing on a single Form ADV and any adviser filing on behalf of itself and its non-US affiliates should consider the availability of umbrella registration going forward. Finally, the amendments to the books and records rule relating to the calculation and distribution of performance information represent the SEC staff’s continued focus on reviewing and evaluating advisers’ performance claims. Advisers who currently advertise performance should ensure that they are maintaining documentation that supports all advertised performance claims or figures, including underlying assumptions and calculation methodologies.
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 Eric L. Perelman (+1.212.309.6735), or any of the following Morgan Lewis lawyers:
Christine M. Lombardo
Monica L. Parry
Steven W. Stone
Steven W. Hansen
Timothy W. Levin
John J. O’Brien
 Form ADV and Investment Advisers Act Rules, SEC Release No. IA-4509 (Aug. 25, 2016) (hereinafter, the “Adopting Release”).
 Amendments to Form ADV and Investment Advisers Act Rules, SEC Release No. IA-4091 (May 20, 2015) (hereinafter, the “Proposing Release”).
 As amended, the three categories of gross notional exposure that certain advisers will be required to report RAUM, borrowings, and derivatives exposure for are (i) less than 10%, (ii) 10-149%, and (iii) 150% or more. This is a modification from the Proposing Release, which had four categories with the highest threshold set at 200%.
 The SEC staff recently issued an IM Information Update clarifying that advisers that do not have enough data to provide a complete response to a new or amended question in Item 5, or the corresponding sections of Schedule D, could insert a “0” as a placeholder in order to submit their Form ADV, along with a corresponding note in the Miscellaneous section of Schedule D. This guidance applies only to interim filings submitted between October 1, 2017 and the adviser’s next annual amendment.
 These categories include interest rate derivatives, equity derivatives, foreign exchange derivatives, credit derivatives, commodity derivatives, and others.
 See American Bar Association, Business Law Section, SEC Staff Letter (Jan. 18, 2012) (hereinafter, the “2012 ABA Letter”).
 See Frequently Asked Questions on Form ADV and IARD, Reporting to the SEC as an Exempt Reporting Adviser (Mar. 2012).
 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).