More On Legal & Compliancefrom The Advisor's Professional Library
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
- Best Practices for Working with Senior Investors Securities examiners deal harshly with RIAs that do not fulfill their fiduciary obligations toward senior investors, as the SEC and state securities regulators view older investors as particularly vulnerable and in need of protection.
By this point, all advisors with a Dec. 31 fiscal year-end should have filed their annual updating amendment to Forms ADV Part 1 and 2 with the Securities and Exchange Commission through the Investment Adviser Registration Depository. If any material changes occurred since the last annual updating amendment, advisors should have also delivered to clients at least a summary of such material changes by this point as well.
Nothing needs to be updated until this time next year, right? Not necessarily. As Confucius once said, “Only the wisest and stupidest of advisors never change.”
Okay, maybe Confucius said “men” instead of “advisors,” but you get the point: things happen, and it’s the SEC’s position that clients need to know promptly when certain of those things happen.
The bush I’m beating around is what’s known as an other-than-annual amendment to Forms ADV Part 1 and/or 2; more simply, it’s an updated version of an advisor’s ADV that is filed with the SEC at any point in between annual updating amendments. The question becomes, what triggers such an other-than-annual amendment to an advisor’s ADV?
The SEC addresses this very issue in section four of its general instructions to Form ADV (here), sections two and four of its instructions for ADV Part 2A (here), and its IARD FAQs (here). The instructions are specific and vague at the same time, as explained below.
For ADV Part 1, an amendment is triggered depending on the particular item number. Specifically, Items 1, 3, 9 (except 9.A.(2), 9.B.(2), 9.E., and 9.F.), or 11 of Part 1A or Items 1, 2.A. through 2.F., or 2.I. of Part 1B need to be updated promptly if a response to such item becomes inaccurate in any way. Notice that there is no materiality standard for this category of items — any inaccuracy triggers an amendment.
Items 4, 8, or 10 of Part 1A or Item 2.G. of Part 1B, on the other hand, need to be amended if such item becomes materially inaccurate. An advisor is not required to update its responses to Items 2, 5, 6, 7, 9.A.(2), 9.B.(2), 9.E., 9.F., or 12 of Part 1A or Items 2.H. or 2.J. of Part 1B even if the responses to those items have become inaccurate.
For ADV Part 2 (more commonly known as the brochure), an amendment is triggered any time information provided therein becomes materially inaccurate. Notice that the brochure has a blanket materiality standard for all items, unlike the item-by-item distinction in the Part 1.
It’s also important to note that an advisor need not amend its ADV solely because its assets under management or fee schedule have changed; however, if an advisor is updating other items in its ADV, it should go ahead and update AUM numbers and fee schedules as well, if they have changed.
Because the ADV Part 1 is not delivered to clients, an advisor should instead focus on what may trigger interim delivery of its brochure to clients. The SEC lists one specific instance in which an interim amendment must be delivered to clients promptly: Item 9 of ADV Part 2A (disciplinary information). If there are any new legal or disciplinary events “that are material to a client’s or prospective client’s evaluation of your advisory business or the integrity of your management,” including but not limited to all the specific instances listed in Item 9, clients need to be informed of such events.
That said, the SEC also includes a “catch-all” provision that harkens to an advisor’s fiduciary duty: “As a fiduciary, you have an ongoing obligation to inform your clients of any material information that could affect the advisory relationship. As a result, between annual updating amendments you must disclose material changes to such information to clients even if those changes do not trigger delivery of an interim amendment.”
Materiality and Promptly
Though the alphanumeric soup of triggers described earlier provides clear-cut guidance, the SEC’s references to “materially inaccurate” and “promptly” bask in the gray area of potential interpretive license. ADV amendments must be filed and delivered promptly, but the SEC has never specifically defined that time period. By reading other SEC guidance and rulemaking, one could reasonably interpret this to mean “as soon as reasonably practicable,” but this is still not a bright-line test.
The best I can offer is that an advisor should not lollygag and procrastinate when a specifically enumerated trigger occurs or when a disclosure becomes materially inaccurate. Knowingly withholding need-to-know information without a damn good excuse is not looked upon kindly by the SEC.
The definition of materiality is equally as gray, but it might help if an advisor put him or herself in the client’s shoes when contemplating the materiality of an event, occurrence, or potential disclosure item — “X,” let’s call it. Query, for example: “If I were on the fence about whether or not to continue an advisory relationship with my financial advisor, would my knowledge of “X” sway my decision one way or the other?” If the answer is yes, err on the side of caution and always remember the fundamentals of fiduciary duty.
Failure to recognize when an other-than-annual amendment to Form ADV may be required can carry significant consequences, and failure to sync up various disclosure documents (including an individual advisor’s Form U4) will only make matters worse. Then again, if you’re one of the Confucian advisors that never changes, you may be the wisest (or stupidest) of us all.