The Advisor's Professional Library

The New and Improved Form ADV

January 1, 2012

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Form ADV is the uniform registration document used by investment advisors to register with the appropriate securities regulator. Generally, larger firms will register with the SEC. Small and mid-sized advisors typically register with the states where they do business.

Form ADV consists of two parts. According to the SEC, “Part 1 requires information about the investment adviser’s business, ownership, clients, employees, business practices, affiliations, and any disciplinary events of the adviser or its employees. Part 1 is organized in a check-the-box, fill-in-the-blank format.” Part 1 contains registration information.

Part 2 of Form ADV requires that RIAs prepare narrative brochures written clearly and concisely. Part 2 contains information such as:

  • types of advisory services offered;
  • fees;
  • disciplinary information;
  • conflicts of interest; and
  • education and work background of management and key personnel.

Part 2 is the primary disclosure document given by RIAs to existing clients and prospective clients. While the narrative disclosure brochure requirement is relatively recent, Form ADV has been around for a long time. According to the Adopting Release (No. IA-3060) for the Amendments to Form ADV published on July 28, 2010, the SEC has required RIAs to deliver a written disclosure statement to clients since 1979. This requirement was imposed by Rule 204-3—better known as the Brochure Rule—under the Investment Advisers Act of 1940.

Part 2 of Form ADV is broken down into two parts. Part 2A provides information about the firm. Part 2B is the brochure supplement that must be prepared for certain IARs.

The primary purpose of the new Form ADV is to ensure that investors have detailed information about IARs and RIAs before entering into an advisory relationship. Existing clients will also learn if circumstances have changed that might make them reconsider whether they want to remain with the advisory firm.

As noted earlier, an RIA owes an affirmative obligation to disclose all material facts to clients to ensuring that they are making an informed decision before they enter into an advisory relationship. The RIA’s disclosure must be thorough, accurate, and timely. Disclosure must be provided before the completion of the transaction, so clients will have all of the facts at their disposal. RIAs’ disclosure should be meaningful, so clients understand what is being said. Failure to make adequate disclosure is a common deficiency found by examiners during compliance examinations.

To ensure that its Form ADV meets regulatory standards, an RIA should make certain that the firm discloses the following and much more:

  • Conflicts of interest created by business arrangements or affiliations
  • Compensation arrangements with solicitors and other service providers
  • Fees paid by clients to the RIA or affiliates
  • Services provided in exchange for those fees
  • Use of client commissions, commonly known as soft dollars, to pay for products and services

We will examine client commission practices in Client Commission Practices and Soft Dollars.

Disclosure Brochure and Brochure Supplement

The SEC, as well as most states, now require RIAs to create a narrative Form ADV Part 2 brochure in plain English. As a result of the new rule, completing Form ADV Part 2 is no longer a check-the-box exercise. Part 2A requires RIAs to create narrative brochures, which contain specified information about the advisory firm. Part 2B requires RIAs to create brochure supplements, containing information regarding certain supervised persons.

Pursuant to the new rule, RIAs are required to provide brochure supplements to clients for each supervised person who:

  • formulates investment advice for a particular client and has direct client contact; or
  • makes discretionary investment decisions for that client’s assets, even if the supervised person has no direct client contact.

If investment advice is provided by a team consisting of more than five supervised persons, an RIA only has to provide brochure supplements for the five supervised persons with the most significant responsibility for day-to-day advice given to the client.

Although SEC-registered investment advisors need not file brochure supplements with the Commission, they must be created and readily available for inspection during an examination. State-registered investment advisors are required to file their brochure supplements with the appropriate state regulator through the Investment Adviser Registration Depository (IARD). The IARD is an electronic filing system that facilitates the registration of investment advisors. In addition, the IARD is used by securities regulators to oversee RIAs, and provides information that investors use to learn more about investment advisors.

Initial Delivery of Brochures and Brochure Supplements to Clients

RIAs are not required to deliver brochures to clients receiving impersonal investment advice or paying the firm less than $500 per year. Additionally, they are not required to deliver brochures to companies registered under the Investment Company Act of 1940. RIAs, whether state or SEC-registered, must deliver narrative firm brochures before or at the time when the advisory agreement is executed. Clients should acknowledge receipt of the firm’s brochure, as well as brochure supplements. To ensure compliance, RIAs should create and retain books and records to verify that delivery took place.

If an RIA plans to deliver updated brochures and brochure supplements to clients via e-mail, the firm should ask clients to sign an Electronic Delivery Consent Form. Another way to secure this consent is by incorporating a provision in the advisory agreement. The firm should retain evidence that the intended recipient actually received the delivery, such as a return receipt or documentation that the information was accessed, downloaded, or printed.

Annual and Interim Delivery Requirements for Existing Clients

Beginning in 2012, if a current client is entitled to a brochure, RIAs have 120 days from the end of the firm’s fiscal year to deliver either:

  • a copy of the latest brochure that includes or is accompanied by a summary of material changes; or
  • a summary of material changes that includes an offer to provide a copy of the current brochure.

RIAs must promptly deliver an updated brochure, whenever it is amended to add a disciplinary event or to revise material disciplinary information previously disclosed. In lieu of the updated brochure, an RIA may deliver a document describing the material facts surrounding the disciplinary event.

Once brochure supplements are delivered to clients, there is no annual offer or delivery requirement. Firms are only required to deliver an updated brochure supplement if there is a new disciplinary event requiring disclosure or a material change to disciplinary information disclosed previously. The RIA must send an updated supplement or a sticker to clients notifying them that disciplinary information for the firm and/or the supervised person has changed. If the updated supplement is sent electronically, the RIA may disclose that the supervised person has been involved in a disciplinary event and can provide a hyperlink to the BrokerCheck or IARD systems.

If an RIA hires an IAR to help service a client’s account, a copy of the representative’s brochure supplement should be provided before or at the time that this transition occurs. An RIA should retain documentation to prove that the new IAR’s brochure supplement was delivered in a timely manner to clients who are affected.

Disclosing Methods of Analysis, Investment Strategies, and Risk of Loss

To understand the difference between the old Form ADV and the new one, it helps to look at one particular item. Form ADV Part 2A, Item 8 represents a major change, since it requires RIAs to describe their methods of analysis and investment strategies in language that will be easily understood by unsophisticated investors. RIAs are also required to provide detailed disclosure of the risks that clients face.

With the old Form ADV, RIAs in certain instances could satisfy their disclosure obligation by merely putting a checkmark next to the security analysis method they utilize. For example, an RIA relying on charting would simply put a check in that box in lieu of explaining how that type of analysis works.

The new Form ADV Part 2 requires much more detail. According to the Amendments to Form ADV Adopting Release (, Item 8 requires advisors to “explain the material risks involved for each significant investment strategy or method of analysis they use.” The General Instructions for Part 2 of Form ADV establish the following disclosure requirements.

“Methods of Analysis, Investment Strategies and Risk of Loss

  • Describe the methods of analysis and investment strategies you use in formulating investment advice or managing assets. Explain that investing in securities involves risk of loss that clients should be prepared to bear.
  • For each significant investment strategy or method of analysis you use, explain the material risks involved. If the method of analysis or strategy involves significant or unusual risks, discuss these risks in detail. If your primary strategy involves frequent trading of securities, explain how frequent trading can affect investment performance, particularly through increased brokerage and other transaction costs and taxes.
  • If you recommend primarily a particular type of security, explain the material risks involved. If the type of security involves significant or unusual risks, discuss these risks in detail.”

Items 8.B and 8.C ask for detailed discussions of “significant or unusual” risks. According to the SEC’s Adopting Release, this requirement is intended to elicit disclosure of significant risks associated with using a particular investment strategy or recommending a particular type of security that would otherwise not be apparent to the client from reading the RIA’s brochure.

Describing Methods of Analysis and Investment Strategies in Plain English

In creating new Form ADV Part 2 disclosure brochures, RIAs are required to list and explain which methods of analysis they use, as well as their investment strategies. Many RIAs rely on one or more of the following:

  • Charting Analysis
  • Fundamental Analysis
  • Technical Analysis
  • Cyclical Analysis
  • Modern Portfolio Theory
  • Long-Term Purchases
  • Short-Term Purchases
  • Short Sales
  • Margin Transactions
  • Option Writing

Unsophisticated investors are unlikely to understand how these investment strategies operate. Therefore, an RIA’s disclosure brochure should provide an explanation using investment terms that are easy to understand.

Form ADV Part 2A, Item 8

Our Methods of Analysis and Investment Strategies

We may use one or more of the following methods of analysis or investment strategies when providing investment advice to you:

Fundamental Analysis

analyzing individual companies and their industry groups, such as a company’s financial statements, details regarding the company’s product line, the experience and expertise of the company’s management, and the outlook for the company’s industry. The resulting data is used to measure the true value of the company’s stock compared to the current market value.

Technical Analysis

involves studying past price patterns and trends in the financial markets to predict the direction of both the overall market and specific stocks.

Cyclical Analysis

a type of technical analysis that involves evaluating recurring price patterns and trends.


*Used with permission from National Compliance Services, Inc.

Risk of Loss

RIAs and IARs should not gloss over the risks associated with each significant investment strategy utilized and the specific securities recommended. The disclosure brochure should clearly warn that investing in securities involves risk of loss that clients should be prepared to bear. The brochure should clearly disclose that there are no guarantees that an investment strategy will be successful or that clients will reach their goals.

If an RIA invests primarily in Exchange Traded Funds (ETFs) and index funds, the brochure should explain what they are and any significant risks that arise from investing in them. To cite an example from the Adopting Release, an RIA that specializes in leveraged ETFs should disclose any particular risks that go hand-in-hand with that particular investment.

IARs who have been studying investments for decades often lose sight of the fact that investors don’t possess the same expertise. IARs will throw around terms like Modern Portfolio Theory and fundamental analysis, which sometimes leaves clients scratching their heads. With a little work, Part 2 of Form ADV can be the equivalent of Investing 101.

As an example, one IAR provided a great deal of valuable information regarding his use of fundamental analysis in his Form ADV Part 2. The IAR explained that fundamental analysis involves estimating intrinsic value and making asset allocation decisions that attempt to capture any temporary differences between market and intrinsic value. He pointed out that the primary risk of fundamental analysis is that his firm’s estimates of intrinsic value might be incorrect. To minimize that risk, the questionnaire indicated that the firm does the following:

  • Determines client risk preferences
  • Constructs portfolios that include assets with varying degrees of risk
  • Diversifies globally
  • Rebalances periodically in accordance with the client’s risk preferences
  • Minimizes taxes and transaction costs by limiting trading

Misrepresentations on Form ADV

RIAs are taking a big risk themselves if they make misrepresentations on Form ADV. On January 13, 2011, the SEC charged an RIA in Long Island, New York, with misrepresenting the firm’s investment strategy. Among other allegations, the SEC accused the firm of concealing critical information regarding how the RIA was executing its investment strategy.

According to the SEC’s complaint, the RIA created the illusion of a liquid market for clients’ holdings at inflated values. The firm claimed it was investing clients’ assets in preferred utility securities that would be held for short periods of time in order to generate capital appreciation and dividends. The RIA made these claims, even though it became apparent much earlier that the market was not sufficiently liquid to permit frequent and substantial purchases of these securities at attractive prices.

According to an Investment News article posted on November 16, 2011, the SEC has begun targeting RIAs that may have lied on their Form ADVs. Mark Schoeff Jr.’s article reported that the SEC is reviewing registration documents to find out if advisors distorted their educational background, assets under management, and other important information. The article quoted Robert Khuzami, director of the SEC’s Division of Enforcement, who said that the Commission selected firms that have not been subject to an examination for some period of time.

In his remarks before the Consumer Federation of America’s Financial Services Conference on December 1, 2011, Khuzami elaborated on his previous comments and said the following:

“First, we are reviewing registration documents for high-risk investment advisers to determine who is lying about their educational achievements, their business affiliations, and their assets under management. It’s like the crime-fighting approach championed by Rudy Giuliani in 1990s New York – if you stop people when they commit small infractions, they are less likely to graduate to bigger ones. For Rudy, it was a focus on subway turnstile-jumpers and squeegee-men. For us, it’s advisers who lie about graduating Phi Beta Kappa, conceal their association in a past failed business venture, or inflate their assets under management who might well be the same persons who outright steal your money when the markets turn against them.”

The SEC believes that if advisors lie on public documents, they pose a far greater threat to investors.

The Big Picture

Whether an RIA is describing its investment strategy in advertisements or in the new Form ADV Part 2, the firm should avoid marketing hype and any language that might be construed as a guarantee. It is important to articulate any material risks faced by advisory clients.

Although the process for creating a clearly written Form ADV Part 2 is a difficult one involving many hours of work, there is a bright side. This exercise may help IARs improve their ability to explain their methods of analysis and investment strategies in language that clients and prospective clients can easily understand. After going through this process, it will also be easier for them to communicate the risks associated with any investment or investment strategy that the firm utilizes. In an article entitled “Five Signs That Your Adviser Is Failing You,” published in the Sun-Sentinel on November 21, 2010, Christina Lourosa-Ricardo took note of the financial professional who uses jargon and talks over the client’s head. According to the article, too many financial advisors try to impress clients with industry lingo.

Advisors should make certain they are not making statements to clients that are contradicted by their disclosure brochures. Advisors sometimes brag that they are totally unbiased and have no conflicts of interest. A quick look at the firm’s disclosure brochure will frequently contradict those statements.

As firms hire new IARs, they should keep in mind that prospective clients will be reading about their background and disciplinary history in the advisor’s brochure supplement. If the IAR has disciplinary events to disclose, the brochure supplement may change the prospective client’s mind about hiring the firm.

Rule 204-3(g)(4) also requires RIAs to provide all clients in wrap fee programs with a Schedule H. A wrap fee program is one in which investment advisory and brokerage execution services are provided for one wrapped fee that is not based on the transactions in a client’s account.

Les Abromovitz

Les Abromovitz

Les Abromovitz is the author of The Investment Advisor’s Compliance Guide, published by The National Underwriter Company/ALM Media.

An attorney and member of the Pennsylvania bar, Les has handled hundreds of consulting and publishing projects for National Compliance Services,, a leading compliance and regulatory services firm. He has conducted a number of seminars and training sessions dealing with compliance subjects. Les is also the author of several white papers that analyze compliance issues impacting Registered Investment Advisors (RIAs)‎.

To contact Mr. Abromovitz, email or call 561-330-7645 Ext. 213‎.