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Portfolio > Portfolio Construction > Investment Strategies

Form ADV Part 2: What Advisors Need to Know, Part 1

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July 21, 2010 will be remembered for years to come as the day that President Obama signed the Dodd-Frank Act. On the same day, however, the SEC gave its approval to an overhaul of Form ADV Part 2. While it didn’t make headlines the same way Dodd-Frank did, all investment advisory firms should be aware of the potentially far-reaching consequences of this new regulation.                 

More than a decade earlier—on April 5, 2000—Chairman Arthur Levitt and his cohorts at the SEC unanimously approved a proposal to revamp Form ADV, the basic disclosure document for investment advisory firms. The final revisions to Part 1 of the form were approved and implemented promptly. This included a requirement that all investment advisory firms submit their filings via a new electronic system, the Investment Advisor Registration Depository (IARD). Beginning in 2001, the IARD, and the public Website that displays information to anyone who knows how to use the Internet, ushered in a new and unprecedented level of transparency.

If you have never taken a look at the public disclosure Website, you should do so. With just a few clicks, you can retrieve a lot of basic information about any SEC-registered advisory firm: address, phone number, URL, types and number of clients, assets under management, ownership of the firm, key personnel, disciplinary history, and much more.  And remember that this info is required to be truthful under penalty of law.

For the past decade, the other half of Form ADV (some would say the better half) has languished.  Form ADV Part II is also called the “brochure.”  The idea of the brochure is to give both current and prospective clients appropriate disclosure about the advisory firm’s business, the qualifications of its principals, and potential conflicts of interest.  Anyone who has any real experience with old Part II would agree that it has outlived its usefulness.  It does not serve the basic purpose of giving investors something meaningful that they will actually read – and understand. 

Here is one big-picture observation about the changes to Part 2. (I’ll make another observation in a separate, second post): 

For starters, this is not just a cosmetic makeover.

Those who think the new rule is tantamount to putting lipstick on a pig are mistaken – it will require a thoughtful analysis of the firm and its activities. 

The new rule requires every advisory firm to have a narrative brochure written in plain English describing the firm’s business practices and conflicts of interest. Eighteen topics must be addressed in the brochure, including fees and compensation, disciplinary information, methods of analysis, investment strategies, risk of loss, and brokerage practices.  Advisors must address all eighteen topics specified in the order of the items in the form, using the headings provided by the form. 

In addition, each firm is required to deliver brochure supplements to new clients that provide information about the specific individuals who will provide services to the clients. The supplement will include information about the individual’s educational background, business experience, disciplinary history and name of the person’s supervisor. Investment advisory firms need to begin to work on Part 2 as soon as possible in order to meet the initial filing deadline (over 90% of advisory firms—those that use a calendar year as their fiscal year—will be required to file their revised document by the end of March 2011). 

Don’t be lulled into thinking that this is a simple project requiring little time or effort.  As with many things in life, starting early will pay benefits down the line. There are plenty of tools available to get you started and it would be best to draft working documents and have some time to refine them before your initial filing deadline (advisors will have to file amendments to the brochure at least annually and more often if there are material changes). 

I’ll write more about the new Part II in a future blog.


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