Final Rules: Updated Form ADV & Books and Records

The Securities and Exchange Commission (the “SEC”) published final rules to amend the Form ADV in order to gather additional about separately managed accounts, create an umbrella registration for affiliated private fund advisors operating a single advisory business, and to add additional identifying questions to the Form ADV. The final rules also amend the books and records rule to clarify the obligation to keep supporting information on performance and rate of return calculations. Please note that these final rules become effective in 60 days; however, compliance with these requirements does not become effective until October 1, 2017.
Click here for a link to the SEC's press release. A link to the Final Rule is included on the right.

Separately Managed Accounts

The final rules will require advisors to aggregate information about the separately managed accounts, in order to improve the SEC’s risk management initiatives and risk-based exam program. The aggregate information about separately managed accounts will include types of assets held and the use of derivatives and borrowings in the accounts. The updated form will also ask that assets in separately managed accounts be reported on Schedule D. Finally, the final rules require advisors to identify the custodians with at least ten percent of separately managed account assets under management, and the amount of the assets under management attributable to the separately managed accounts held at the custodian.

Umbrella Registration for Private Fund Advisors

The final rules also create a process for umbrella registration of private fund advisors that operate a single advisory business through multiple legal entities. Umbrella registration is not mandatory, but will simplify the registration process for these advisors. To qualify for an umbrella registration, the advisor must have a principal place of business in the United States and must advise only private funds and qualified clients in separately managed accounts. Also all of the advisors must operate under the same policies and procedures (including a single code of ethics and single CCO) and be subject to the filing advisor’s supervision and control. Finally, all the advisor must agree to be subject to examination by the SEC.

Additional Form ADV Information Required

In addition to requiring reporting for separately managed accounts and creating umbrella registrations, the final rules also require additional identifying information be provided on the Form ADV.

1. All Central Index Key numbers (“CIK Number”) for:
1. The advisor.
2. Private funds managed by the advisor (or Public Company Accounting Oversight Board, or “PCAOB”-assigned numbers).
2. The addresses for each social media account where the advisor controls the content, such as Twitter, Facebook or LinkedIn. This does not require the listing of the social media accounts of the employees of an advisor, just the accounts where the advisor control the content.
3. The total number of offices at which investment advisory business is conducted and details of the 25 largest offices in terms of number of employees.
4. Report whether the advisor’s chief compliance officer is compensated or employed by any person other than the advisor (or a related person of the advisor or a registered investment company) and if so, the name and IRS Employer Identification Number.
5. Advisors with assets of $1 billion or more report their assets within three ranges: (a) $1 billion to $10 billion; (b) $10 billion to $50 billion; (c) $50 billion or more.
6. The number of clients and amount of assets under management attributable to each category of clients.
7. The number of clients that do not have assets under management.
8. Amount of assets under management:
1. Attributable to non-United States clients.
2. Of all parallel managed accounts related to an investment company (or series thereof) or business development company.
3. Attributable to acting as a sponsor to or portfolio manager for a wrap fee program.

Books and Records Updates

Currently advisors are required to maintain records supporting performance claims in communications that are distributed or circulated to ten or more persons. However, the final rule requires that advisors maintain:

1. Records supporting performance claims in any communication that is circulated or distributed, directly or indirectly, to any person.
2. The originals of written communications received relating to the performance or rate of return of any managed accounts or securities recommendations.
3. Copies of written communications sent by the advisor relating to the performance or rate of return of any managed accounts or securities recommendations.

How should a Chief Compliance Officer respond to the Rule?

To prepare for the implementation of these rule updates at your firm for the October 1, 2017 compliance date, AdvisorAssist recommends the best practices of:

1. Review separately managed accounts to ensure that the amount of assets being held, types of assets held, and the use of derivatives and borrowings in the accounts is easily reportable.
2. Perform an annual review of custodians for separately managed accounts to ensure you can identify the accounts and assets under management with each custodian.
3. If you operate a single advisory business through multiple legal entities, review whether an umbrella registration is best for your business.
4. Start tracking and reviewing the additional identifying information that will be required on the Form ADV.
5. Prepare and maintain comprehensive records supporting performance and rate of return calculations.
6. Perform an annual review of the advisor’s books and records archive to ensure you are keeping the required documentation for the required duration.

Contributors:
Brendan Furey
Michael Conlon

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CCO Series: Top Regulatory Deficiencies for RIAs -- Advisory Agreements

What you need to know

Examiners will review agreements that the advisor uses for its client engagements during an examination as a standard request item. This will include a review of the agreement templates that you use for your prospective clients and a sample of agreements that your firm has executed with existing clients. In reviewing agreements examiners report finding two common deficiencies: 1) the fees are not fully disclosed in the agreement and 2) that firms do not have an executed copy of its client agreements in the advisor’s books and records.

Common Deficiency: Fees fully disclosed

The written advisory agreement must detail the relationship that the client is entering into with the advisor, including how fees are calculated and the payment methodology. The fees section of the agreement must be comprehensive to cover all fees being charged for the services, when the fees are being charged, and how they are to be paid. The information in the client agreement should also align with the general disclosure of fees made in Form ADV Part 2A Disclosure Brochure in Item 5. Any additional compensation that the firm receives in its advisory practice should also be described in Form ADV Part 2A in Item 14.

Common Deficiency: Books and records

Advisors are required to keep and maintain all written agreements (or copies thereof) entered into by the advisor with any client.¹Examiners are reporting to the North American Securities Administrators Association that advisors are not creating written agreements for all of their client relationships. They also noted that when written agreements are created, the agreements are not clearly noting, and adequately explaining, the advisory fees as described above.²

How do we avoid these deficiencies?

To avoid these deficiencies at your firm AdvisorAssist recommends the best practices of:

• Reviewing the language in your Form ADV Part 2A Disclosure Brochure to ensure that it adequately discloses for each type of fee the following:
1. How fees accrue for each service offered.
2. How fees are billed to the clients.
3. Whether the advisory fees include other fees, such as brokerage trading fees.
4. How fees are impacted by contract termination, such as a pro-rata refund if collected in advance.
5. Whether the fees represent any compensation for the sales of securities or other conflicts of interest.
• For each new client onboarded, ensure that a written agreement is executed for the services that the client will receive and the fee is consistent with Form ADV Part 2A.
• Review client agreement[s] templates and Form ADV Part 2A at least annually to ensure that the fees described are consistent and fully disclosed.

<sup>1. See 17 CFR §275.204-2(a)(10). Link. ↩
2. See North American Securities Administrators Association, “2015 Investment Adviser Coordinated Exams,”. Link. ↩</sup>

AdvisorAssist’s CCO Series: Regulatory Deficiencies for RIAs is a series of articles that will help your firm understand and avoid the most common compliance deficiencies found by regulators. Our goal is to help you increase your confidence that your firm remains “exam ready” as well as some practical steps to help Chief Compliance Officers address this topic.

Contributors:
Brendan Furey
Michael Conlon

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Analyzing the Department of Labor Fiduciary Rule

The revised Department of Labor (DOL) fiduciary rule (Rule) was published in its final form in the Federal Register and can be accessed by clicking this link. Although effective starting June 7th, 2016 the DOL has granted time for affected service providers of retirement plans to adjust to fiduciary status and partial compliance is not required until April 10, 2017 with full compliance required by January 1, 2018.

The focus here is determining if fiduciary status applies to your firm based on the advice provided to retirement plans or participants, what exemptions may apply, and what steps must be taken to maintain compliance.

Definition of Fiduciary

Under the Rule a fiduciary will now include a person providing investment advice regarding money or property within the plan for a fee or other compensation, directly or indirectly, to a plan, plan participant or beneficiary, IRA or IRA owner. Investment advice relevant to this definition include the following:

1. A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;
2. A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made; and
3. The investment advice is made, directly or indirectly (through an affiliate), by a person who:
1. Represents or acknowledges that it is acting as a fiduciary within the meaning of the ERISA or the IRS Code;
2. Renders the advice pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular needs of the advice recipient; or
3. Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The definition goes on to explain what constitutes a “recommendation” and what may be excluded from that definition, such as providing certain services or information regarding the plan or IRA, such as marketing or making available to a plan fiduciary a platform or similar mechanism where the plan fiduciary may select or monitor investment alternatives; identifying investment alternatives that meet objective criteria specified by the plan fiduciary; providing objective financial data and comparisons with independent benchmarks to the plan fiduciary.

The definition also clarifies that an advisor is not a fiduciary when providing advice to an independent person who is a fiduciary of a plan or IRA, if that fiduciary is a bank, insurance carrier, registered investment adviser, broker-dealer, or other person that holds or has assets under management of at least $50 million. This means the old definition has been expanded to focus on advice given to IRA owners and people rolling over their employer sponsored plan (e.g., 401(k) account) into an IRA. Finally, education and general marketing materials that a reasonable person would not view as investment recommendations are not included in the definition of retirement investment advice, so advisors may continue to provide general materials on retirement saving without triggering fiduciary duties.

As a fiduciary, an advisor must adhere to a “best interest” standard for a client, rather than a “suitability” standard for an investment product. Therefore, an advisor cannot receive fees that could be seen as creating conflicts of interest (i.e. commission or revenue-sharing), unless a qualified exemption applies.

Best Interest Contract Exemption (BICE) and Impartial Conduct Standards

This exemption, published at this link, provides relief for compensation, such as commissions and revenue sharing, that an advisor and the advisor’s employing firm might receive in connection with investment advice to retail retirement investors. The BICE requires financial institutions and advisors to acknowledge fiduciary status for itself and its advisors, adhere to basic standards of impartial conduct by giving prudent advice in the client’s best interest, avoid misleading statements, and receive only reasonable compensation. Additionally, financial institutions must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, disclose basic information about their conflicts of interest and the cost of their advice. Level Fee fiduciaries are subject to more streamlined conditions.

Principal Transactions Exemption

The other main exemption from the Rule is the Principal Transactions Exemption, published at this link, which permits advisors to sell or purchase certain debt securities and other investments out of their own inventories to or from plans and IRA owners. The exemption applies even though this transaction results in payment to the advisor. However, similar to the BIC exemption, the advisor must adhere to Impartial Conduct Standards and disclose to the client any conflicts of interest in order to make use of the exemption.

How should a Chief Compliance Officer respond to the Rule?

In all cases, the advisor will want to retain documentation of compliance with this new rule, including contracts, policies, procedures, and disclosures, to support your Books & Record requirements. However, there are no additional record retention requirements for detailed data on inflows, outflows, holdings, and returns for retirement plan or IRA clients.

Chief Compliance Officers should review the information in their Form ADV Part 2A and client agreements to determine whether or not they are acting as a fiduciary based on the recommendations provided to clients regarding retirement plans, participants, beneficiaries or IRAs, and ensuring that their client agreements and ADV contains all disclosures required by the Rule regarding conflicts of interest and compensation arrangements, including a statement as to whether or not they are a fiduciary.

Although an RIA may not be compensated by a commission or revenue sharing, Form ADV requires disclosure to clients regarding potential conflicts and compensation arrangements. Hybrid advisors receiving commission compensation will want to ensure they are satisfying the BICE. Therefore as a best practice we recommend that even firms without commission or revenue sharing fees should provide notice to retirement clients that they are providing their services in the client's best interest to uphold their fiduciary duty and review and update disclosures of any potential conflict of interest. This will ensure that you are availing your firm of the BICE and creating a presumption of compliance with the Rule.

Contributors:
Brendan Furey
Michael Conlon

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CCO Series: Top 12 Regulatory Deficiencies for RIAs -- # 5: Brochure Delivery

What You Need to Know

To our surprise, failure to follow the brochure (aka Form ADV Part 2) delivery rules continues to be one of the most common deficiencies for RIA firms.

Annual distribution of Form ADV Part 2 (along with the privacy policy) is required by all RIA firms. Additionally, an updated version must be delivered to clients when any material changes occur within your business.

A common (and logical) questions we get is “What’s material?” The SEC doesn’t define material, which makes sense since materiality is very much dependent on circumstances. A rule of thumb we use with clients is this: if a knowledgeable client or prospect would expect to be alerted of a change, it’s material. Admittedly, this still leaves a lot open to interpretation (we’ve seen it first hand). Regulators will cast the final vote on this during their next examination, so it usually pays to err on the side of caution.

When material changes do occur, RIAs have the following options:

Option 1: If there have been material changes to your business, they must be described in ADV Part 2, Item 2. Under the current rules, you could provide your clients with a summary of these material changes and an offer to deliver the entire ADV Part 2. In your offer you must include instructions on how clients can obtain a copy from you.

Option 2: Advisors can also opt to deliver a full copy of the entire ADV Part 2. In this instance Item 2 - Material Changes still needs to be updated.

All brochures must be delivered to clients within 120 days of fiscal year end. Electronic delivery will suffice if you are attaching the document to an email. Uploading your ADV to your website and sending a link to clients does not constitute proper delivery. You may lose the ability to show exactly what was delivered to the client.

Why You Should Care

Your brochure informs clients of the details of your firm and any recent material changes that could potentially impact them. You should view your brochure as a publicly-visible sign for your firm, and should be written and updated with this notion of "curb appeal" in mind. Potential and current clients see this brochure as a representation of your firm, and providing them with an up-to-date, accurate brochure signals that you take external communications seriously.

Competitors are reading your firm's brochure as well. A sloppy, outdated, or inaccurate ADV sends a message to competitors that may be damaging when competing for new business.

Our Recommendations

To ensure that your firm is keeping up with regulatory requirements and industry best practices in this area:

• Review your ADV to ensure that it reflects your business, including disclosures for conflicts of interest, outside business activities, advisory services, and advisory fee practices. These are all important issues for regulators.
  
• Deliver brochure to clients within 120 days of your fiscal year end
  
• Maintain records that demonstrate delivery of Form ADV Part 2 to clients (annually or upon material changes) and prospective clients (prior to executing advisory agreement).
  
• Maintain copies of prior versions of your Form ADV Part 1 and 2
  

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AdvisorAssist’s CCO Series: Top 12 Regulatory Deficiencies for RIAs is a series of articles that will help your firm understand and avoid the most common compliance deficiencies found by regulators. Our goal is to help you increase your confidence that your firm remains “exam ready.” Click here to read more posts from our CCO Series: Top 12 Regulatory Deficiencies for RIAs. We would welcome the chance to learn more about you and your firm. Click here to request an introductory call from one of our consultants.

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CCO Series: Top 12 Regulatory Deficiencies for RIAs -- #2: Registration

What You Need to Know

The second most common compliance deficiency for RIA firms is omissions or inaccuracies in the firm’s Form ADV. Some of these result from inconsistent upkeep of the ADV as the firm evolves. But in most cases we see, the deficiencies occur when firms use cookie cutter ADVs or borrow some/all of the content from another firm’s ADV.

On at least a yearly basis, RIAs are required to review and update their Form ADV so that it accurately describes the nature of their business to clients and prospects. (This occurs within 90 days of the firm’s fiscal year end.)

Advisors are also expected to immediately update their Form ADV to reflect any material changes that occur throughout the year. These updates include, but are not limited to:

• An accurate description of their fee structure
• Full and accurate description of their business and services
• Disclosure of any conflicts of interest or affiliations
• Significant changes in their business (e.g. meaningful changes in AUM)
• Changes in how clients may contact the firm (e.g. Address, Phone Number)

Why You Should Care

While it may seem like a hassle to maintain an accurate Form ADV, these documents will not only make a difference from a regulator’s perspective, but also from the point of view of clients and prospects. While not always apparent, your Form ADV creates an initial (sometimes lasting) impression on prospects, clients and competitors. Ensuring the accuracy of your Form ADV can lead to to more productive and efficient relationships by removing (or at least not creating) any potential ambiguity in the early stages of your relationships.

It is not only important that the information contained in Form ADV is comprehensive and accurate, but you must also be able to evidence its timely delivery to all clients and prospects, keeping in mind that regulators must take a stance that if it’s not documented, it didn’t happen.

Our Recommendations

To ensure that your firm is keeping up with regulatory requirements and industry best practices in this area:

• Avoid using a “one size fits all” approach to creating your Form ADV so that you can be sure that it accurately reflects your firm’s business practices, conflicts of interest, fee schedule, etc.
• Update both Parts 1 and 2 of the Form ADV at least annually, keeping in mind that it must be updated more frequently if there have been material changes in your RIA.
• Deliver Form ADV to clients in a timely fashion (within 120 days following your fiscal year end or upon any material update of the document).
• Deliver Form ADV to all prospects prior to them signing your investment advisory agreement.
• Maintain records of these distributions to ensure proper documentation for regulators.

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AdvisorAssist’s CCO Series: Top 12 Regulatory Deficiencies for RIAs is a series of articles that will help your firm understand and avoid the most common compliance deficiencies found by regulators. Our goal is to help you increase your confidence that your firm remains “exam ready.” Click here to read more posts from our CCO Series: Top 12 Regulatory Deficiencies for RIAs. We would welcome the chance to learn more about you and your firm. Click here to request an introductory call from one of our consultants.

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How to Properly Count Advisory Clients for your RIA Firm's Form ADV

Most advisors view their client base in terms of households (i.e distinct relationships), which often makes it challenging to translate into the “clients” and “accounts” data that regulators expect to see accurately reported in Form ADV 1.

Regulators care about two things: clients and accounts. They do not recognize or ask for any data related to households [Note: In some instances a household may equal a client.] During examinations, regulators will check the accuracy of these numbers in your Form ADV 1, so it is important to understand the logic that goes into calculating them.

In another post, we discuss some tips on how to determine your firm's total accounts.

Who is a Client?

A "client" is any natural person, along with their children (minors) and relatives or spouse with same principal residence. This includes any accounts or trusts where a natural person(s) are the only primary beneficiaries or any entity (corporation, general partnership, limited partnership, limited liability company, trust) where you provide investment advice based on the entity’s investment objectives.

Sometimes it helps to think about this way: to whom do I owe a fiduciary duty? If multiple accounts all roll up to one individual, then typically they count as just one client because your are maintaining one fiduciary relationship between you and that one individual.

Confused yet? Me too. So let’s go through a few scenarios.

If Mr. Smith has an IRA, a taxable account and a corporate account where he’s the sole owner, that’s ONE client because Mr. Smith is the only person engaged in this fiduciary relationship.

If you manage accounts for Mr. and Mrs. Smith and consider both of their interests in making investment decisions, they are generally considered ONE client. (In this case, you should have both spouses as a party to your client agreement.)

If Mr. and Mrs. Smith has two individual accounts and one UGMA, this is ONE client.

If Mr. and Mrs. Smith have one joint tenant account and a trust where they are the sole beneficiaries, this is ONE client. Now if the trust had one additional beneficiary outside of their family, then the trust becomes a separate client (that’s TWO clients).

If Mr. and Mrs. Smith have one joint tenant account and a corporate account that is wholly-owned by both, then that is ONE client. But...if that corporate account had external shareholders (outside their family), then it is TWO clients--the couple and the corporation are each a separate client.

If Mr. and Mrs. Smith have one joint tenant account and an adult child with an IRA, that would generally be TWO clients. But if it were a minor child with a 529 plan, it would be ONE client.

If Mr. and Mrs. Smith have one joint tenant account as well as a trust account for the sole benefit of Mrs. Smith, you can still consider this ONE client. But if trust is for an adult child, it would be counted as TWO clients.

When determining your RIA firm’s total number of clients:

• You may (but are not required to) include clients where you do not receive no compensation for your services.
• Include clients who are not U.S. residents (and also report these separately on Form ADV 1).
• For pooled vehicles (hedge funds and mutual funds), the underlying investors are generally not counted as clients (but this may vary by state). So the fund is considered one client.
• If you have your principal office and place of business outside the United States, you are not required to count clients that are not United States residents. But if your principal office and place of business is in the United States, you must count all clients.

Please also click here see the definition of a Client in the Adviser's Act.

Brian Lauzon

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Are you a late ADV filer? You still have time.

Annual ADV Filing - Due April 1st!

If you have yet to file your annual update to your ADV 1 and 2, you still have time.

An RIA is required to file its annual amendment to Form ADV1 and ADV2 (the "Disclosure Brochure") and ensure all related documents and disclosures are up to date. Each year the advisors are required to complete these updates through the IARD filing system within 90 days following fiscal year end. For those December 31 year end firms, the deadline would be March 31st. As March 31st falls on a Sunday and a Holiday, with the loss of Friday and Saturday as filing days, the SEC issued a notice (see below) that extends the ADV filing deadline to Monday, April 1, 2013.

The SEC notice is below:

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Notice to Form ADV Filers

Filers should be aware of the following:

Rule 204-1 under the Advisers Act requires advisers to file an "Annual Updating Amendment" to Form ADV with the Commission within 90 days after their firm's fiscal year end. Many advisers have a December 31 fiscal year end, which means that they would have to file their annual amendment by March 31, 2013. This year, March 31 falls on a Sunday. In addition, Friday, March 29, 2013 is a holiday for FINRA (the entity that runs the IARD system). The IARD system therefore is closed both March 29 and March 31, 2013.

Rule 0-4 under the Advisers Act provides that fillings required to be made through the IARD on a day that the IARD is closed will be considered timely filed with the Commission if filed through the IARD no later than the following business day. (See Title 17: Commodity and Securities Exchanges Part 275 - Rules and Regulations, Investment Advisers Act of 1940) Therefore, advisers with a December 31 fiscal year end may file their Annual Updating Amendments no later than Monday, April 1, 2013.

If you have any questions about the Form ADV deadlines, please contact:

The Office of Chief Counsel / Public Inquiry

Phone: (202) 551-6865
E-mail: IMOCC@sec.gov

http://www.sec.gov/divisions/investment/imannouncements/formn-mfp-im.htm

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SEC Issues Notice of Intent to Cancel Registrations of 293 Investment Advisers

SEC Issues Notice of Intent to Cancel Registrations of 293 Investment Advisers

Summary of SEC Release No. IA-3490; October 19, 2012

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was signed into law requiring mid-sized advisers (those between $25 million and $90 million) to move from SEC to state registration by June 28, 2012. As of the date of this report, more than 2,300 mid-sized advisers – those managing less than $100 million of assets – have made the transition to state regulation, but there are 293 that have yet to transition.

On October 19, 2012, the SEC issued Release No. IA-3490 identifying 293 advisers who may no longer be eligible for registration with the SEC because they manage less than $90 million or have failed to comply with other requirements.

Advisers identified in the notice have until December 17, 2012 to withdraw their SEC registration by filing a partial Form ADV-W, or inform the Commission staff that they have should remain eligible for registration with the SEC. After that date, the Commission may issue an order cancelling the registration of advisers who have not filed an amendment, withdrawn from registration, or requested a hearing.

Advisors receiving such a letter should work with their compliance consultants and their state regulators to promptly resolve any open registrations. If you have a registration in process with the state(s), we do suggest contacting the SEC in writing to demonstrate that the Advisor is making a good faith effort to comply.

If you have any questions regarding this compliance alert, please contact us at Support@AdvisorAssist.com or call 617-800-0388.

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Regulators are Looking at the Accuracy of Advisors' AUM

Have you been diligent about calculating and reporting regulatory AUM for your RIA?

Dan Jameison of InvestmentNews.com put out a great article about an RIA firm that allegedly has mis-calculated assets under management.

The firm was setting AUM at $25 million over the past several years (the former SEC minimum threshold). The assets were not accurate and the state believed that they included assets under their broker-dealer affiliation, which are not assets of the RIA.
The Massachusetts Securities Division has denied registration to this RIA firm and they no longer qualify for SEC registration. Effectively, they are out of business.

Read the full story at InvestmentNews.com

Here is a recap of the current rules related to calculating your RIA's "Regulatory Assets Under Management".
Advisors must quantify the amount of assets they manage. Advisors must calculate "Regulatory Assets Under Management", which is slightly different from the asset calculations you are used to. Here are the key components to the calculation:

Securities Portfolio

Include the securities portfolios for which you provide continuous and regular supervisory or management services as of the filing date. An account is a securities portfolio if at least 50% of the total value of the account consists of securities. For purposes of this 50% test, you may treat cash and cash equivalents (i.e., bank deposits, certificates of deposit, bankers acceptances, and similar bank instruments) as securities.

You must include securities portfolios that are:

1. Your family or proprietary accounts;
2. Accounts for which you receive no compensation for your services; and
3. Accounts of clients who are not United States persons.

For purposes of this definition, treat all of the assets of a private fund as a securities portfolio. For accounts of private funds, include in the securities portfolio any uncalled commitment pursuant to which a person is obligated to acquire an interest in, or make a capital contribution to, the private fund.

Value of Portfolio

Include the entire value of each securities portfolio for which you provide continuous and regular supervisory or management services.

If you provide continuous and regular supervisory or management services for only a portion of a securities portfolio, include as regulatory assets under management only that portion of the securities portfolio for which you provide such services.

• Under management by another person; or
• That consists of real estate or businesses whose operations you “manage” on behalf of a client but not as an investment.

Now that we’ve discussed the two key components, (i) Identifying the Assets; and (ii) Quantifying the Assets - Here’s the How!!
(i) Determine which assets constitute "Continuous and Regular Supervisory or Management Services". You provide continuous and regular supervisory or management services with respect to an account if:

• You have discretionary authority over and provide ongoing supervisory or management services with respect to the account; or
• You do not have discretionary authority over the account, but you have ongoing responsibility to select or make recommendations, based upon the needs of the client, as to specific securities or other investments the account may purchase or sell and, if such recommendations are accepted by the client, you are responsible for arranging or effecting the purchase or sale.

You should consider the following factors in evaluating whether you provide continuous and regular supervisory or management services to an account.

1. The Advisory Contract. If you agree in an advisory contract to provide ongoing management services, this suggests that you provide these services for the account. Other provisions in the contract, or your actual management practices, however, may suggest otherwise.
2. Compensation. If you are compensated based on the average value of the client’s assets you manage over a specified period of time that suggests that you provide continuous and regular supervisory or management services for the account. If you receive compensation in a manner similar to either of the following, that suggests you do not provide continuous and regular supervisory or management services for the account.

• You are compensated based upon the time spent with a client during a client visit; or
 
• You are paid a retainer based on a percentage of assets covered by a financial plan.
• Management practices. The extent to which you actively manage assets or provide advice bears on whether the services you provide are continuous and regular supervisory or management services. The fact that you make infrequent trades (e.g., based on a “buy and hold” strategy) does not mean your services are not “continuous and regular.”

You should consider the following examples in evaluating whether you provide continuous and regular supervisory or management services to an account.Examples of providing continuous and regular supervision:

1. Have discretionary authority to allocate client assets among various mutual funds;
2. Do not have discretionary authority, but provide the same allocation services, and satisfy the criteria set forth in Instruction 5.b.(3);
3. Allocate assets among other managers (a “manager of managers”), but only if you have discretionary authority to hire and fire managers and reallocate assets among them; or
4. You are a broker-dealer and treat the account as a brokerage account, but only if you have discretionary authority over the account.

Examples of NOT providing continuous and regular supervision:

1. Provide market timing recommendations (i.e., to buy or sell), but have no ongoing management responsibilities;
2. Provide only impersonal investment advice (e.g., market newsletters);
3. Make an initial asset allocation, without continuous and regular monitoring and reallocation; or
4. Provide advice on an intermittent or periodic basis (such as upon client request, in response to a market event, or on a specific date (e.g., the account is reviewed and adjusted quarterly).

(ii) Determine the value of those assets identified above:
Determine your regulatory assets under management based on the current market value of the assets as determined within 90 days prior to the date of filing this Form ADV. Determine market value using the same method you used to report account values to clients or to calculate fees for investment advisory services. In the case of a private fund, determine the current market value (or fair value) of the private fund’s assets and the contractual amount of any uncalled commitment pursuant to which a person is obligated to acquire an interest in, or make a capital contribution to, the private fund.
Examples:
You should consider the following examples in calculating your value of Regulatory Assets Under Management.
The client's portfolio consists of the following:

Stocks and Bonds	$6,000,000
Cash and Cash Equivalents	$1,000,000
Non-securities (collectibles, commodities, real estate, etc.)	$3,000,000
Total Assets	$10,000,000

Let’s run through some Key Questions:

1. First, is the account a securities portfolio? The account is a securities portfolio because securities as well as cash and cash equivalents (which you have chosen to include as securities) ($6,000,000 + $1,000,000 = $7,000,000) comprise at least 50% of the value of the account.
2. Second, does the account receive continuous and regular supervisory or management services? The entire account is managed on a discretionary basis and is provided ongoing supervisory and management services, and therefore receives continuous and regular supervisory or management services.
3. Third, what is the entire value of the account? The entire value of the account ($10,000,000) is included in the calculation of the adviser's total regulatory assets under management.

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ADV Amendment Filed – What’s Next?

Here are some next steps now that you’ve filed your annual amendment. Below are questions our consultants at AdvisorAssist are frequently asked:

What am I required to provide to Clients?

There are two different routes advisors can take when it comes to delivering their ADV Part 2. First and foremost, regardless of the path you chose for your ADV Part 2, you must deliver a copy of your privacy policy annually. For the ADV Part 2:

• Option 1: If there have been material changes to your business the material changes must be described in ADV Part 2, Item 2. Under the current rules, you could provide your clients with a summary of these material changes and an offer to deliver the entire ADV Part 2. In your offer you must include instructions on how clients can obtain a copy from you.
• Option 2: Advisors can also opt to deliver a full copy of the entire ADV Part 2. In this instance Item 2 - Material Changes still needs to be updated.

Generally, AdvisorAssist recommends that advisors include a cover letter explaining what is being provided to clients and why. For an example letter, please contact us.

May I email this information to Clients?

You may attach the information described above as pdf files in an email to clients. Sending an email with a link to the documents does not constitute delivery. You should only email this information to clients if you generally use email as a means of communication with that client.

When must I deliver the information?

The information described above must be delivered within 120 days of your fiscal year end. Generally the 120 day mark is May 1st, however, since 2012 is a Leap Year, the 120th day is actually April 30th.

What constitutes a material change?

The best way to determine if a change is material is to consult an independent resource who can assist you in making an objective determination. Material changes to your Form ADV Part 2A may include changes to your services, fees, advisory personnel, financial industry affiliations, disciplinary events and financial challenges of the firm or principals, such as a bankruptcy.

Besides my annual amendment, what other times must I update my ADV Part 2?

Investment advisors are required to update their Form ADV Part 2A promptly when the information in the brochure is materially inaccurate. Remember to file your updated Form ADV Part 2A on the IARD system.

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SEC to State Transition

Attention: Mid Size Advisors!

As 2011 comes to a close, many of you are busy planning for the new year. Don’t forget to add SEC to State transition planning to your list.

In July 2010, President Obama signed the Financial Reform Bill into law as the Dodd-Frank Act, which set forth rules to require “mid-size” SEC advisors that are under $100 million in assets under management to transition their registration with the Securities and Exchange Commission (“SEC”) to the one or more state regulators based on the applicable state laws. The SEC postponed the dates for compliance from the July 2011 timeframe to 2012, which is nearly upon us. This regulatory change is estimated to affect approximately 3,200 advisors, which is more that 25% of those currently registered with the SEC. 

The final amended rules provide for a bit more flexibility than the initial July 2010 plan as it  was originally signed into law. While the threshold for which investment advisers must register with the SEC will still move to $100 million, the SEC pushed back the compliance dates into 2012 and created a “buffer” in an attempt to avoid unnecessary back and forth filings. They also hoped to reduce the confusion around this transition with the additional time and communication on the matter. While the additional time and the buffer will certainly be helpful to advisors, the final rules certainly do not alleviate the confusion!

The “Buffer”

The amended rule now includes a provision for a buffer of $10 million above or below the $100 million threshold to avoid unnecessary frequent SEC and State switches based on market swings. An advisor must register with the SEC if it exceeds $110 million in assets under management. The buffer also provide for existing SEC advisors whose assets may temporarily drop to remain SEC registered if their assets do not drop below $90 million. So where’s the confusion?

And the critical dates for compliance...

• July 21, 2011 to January 1, 2012 -- An existing mid-size investment advisor registered with the SEC will be required to remain registered with the SEC (Note that some states are recommending an early switch to manage workflow.  However, the SEC expects you to remain registered until 2012).
• July 21, 2011 to January 1, 2012 -- Any existing state investment advisor with assets between $25 million and $100 million will not be permitted to register with the SEC and must remain registered with the state(s).
• July 21, 2011 to January 1, 2012 -- Any new investment advisor with assets between $25 million and $100 million will not be permitted to register with the SEC and must remain registered with the state(s).
• Fall 2011 -- Some state regulators are encouraging mid-size advisors that do not expect to remain eligible for SEC registration in 2012 to begin their transition. Now is the time to fully understand your registration status and options.
• January 1, 2012 -- If you are currently registered or have a registration pending with the SEC on or after January 1, 2012 you must file an amendment to your ADV no later than March 30, 2012 to indicate eligibility to remain SEC registered.
• January 1, 2012 -- Also effective January 1, 2012, mid-size advisors registered with the SEC that are no longer eligible for SEC registration can begin filing amendments to their ADV indicating their ineligibility.
• January 1, 2012 to March 30, 2012 -- An existing SEC advisor may select the date for calculation of the “regulatory assets” provided the date is within 90 days of the filing. The SEC has also added the flexibility in determining what constitutes regulatory assets to include proprietary accounts and the accounts of family where no fees are charged.
• March 30, 2012 -- Deadline to file the above mentioned amendment to Form ADV.
• June 28, 2012 -- 90 days following the March deadline, all advisors must be properly registered with the applicable state regulators and withdraw their SEC registration. Note: If you don’t withdraw on June 28, 2012, the SEC cautions it will do if for you. Make sure you are not put out of business!

When to transition?

If your firm is a mid-size advisor, you need to take a realistic self-assessment now. What is your current situation? What do you expect your assets under management to be in Q1 2012? 

With so many firm’s transitioning, major backlogs are a certainty. For instance, California expects in excess of 900 transitions alone. Of the 3,000 advisors, many will be required to register in several state jurisdictions. Facing this enormous task, the understaffed securities division is asking advisors to start their transitions this fall and remain dually registered for a short period of time.

To help guide you in the planning, we created a table of actionable dates based on various scenarios:

Who does not transition?

• Investment advisors are to remain SEC registered if exempt or excluded in a state where their principal office is located.
• Mid-size investment advisors with their primary place of business in New York and Wyoming are excluded from the transition as they are not subject to examination by state regulators.

Investment advisors required to register in 15 or more states can register with the SEC. Be careful here. This means that you would required to register, not voluntarily deciding to register in 15 states!

Resources?

NASAA Switch Schedule
NASAA IA Switch FAQ
Final Rule - IA -3221 (amendment for switch)
IARD System Schedule

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Changes to Form ADV Part 1

A new version of Form ADV Part 1 was released by FINRA on November 7, 2011.

The next time your firm logs onto the IARD system to file an amendment to your Form ADV Part 1, you will be prompted to answer several new questions and also confirm (re-answer) certain existing questions

Below we have listed the Items that have been updated and summarized many of the changes that were implemented (We focus on the significant changes here. To be certain that your RIA addresses all of the updates thoroughly, it would be best to review with your compliance consultant or attorney.).

Item 1
Item 1 specifically asks advisors to identify contact information for the firm’s Chief Compliance Officer and also provides an option to include one additional regulatory contact person.

Advisors are also now asked the following questions:

• Are you a public reporting company under Sections 12 or 15(d) of the Securities Exchange Act of 1934? If "yes," provide your CIK number.
• Did you have $1 billion or more in assets on the last day of your most recent fiscal year?
• Provide your Legal Entity Identifier if you have one?

Item 5
ADV Part 1 Item 5 now asks that advisors specifically identify the exact number (as opposed to ranges) of employees that fall into each functional category. We believe that this was partially motivated by an interest in adding clarity to staffing levels among the increasingly large number of smaller RIAs.

This section also now asks advisors about the “percentage of clients that fall into various categories”. The previous version of ADV Part 1 asked only for the approximate percentage that each type of client comprised of the total number of clients. The new version requests the same breakdown but also asks for the approximate amount of regulatory assets under management (reported in Item 5.F. of ADV Part 1) attributable to each type of client.

Advisors should note that the list of client types was expanded and now includes “business development companies,” “other investment advisers”, and “insurance companies.” This higher level of granularity will likely reduce reliance on the "other" category, and improving transparency to investors.

Item 5 also asks advisors to disclose what percentage of their clients are non-United States persons.

Item 6 and Item 7
Working with our clients in the past, we have noticed frequent confusion around the differences between Item 6 and Item 7 of ADV Part 1, specifically regarding when a “business activity” impacts Item 6 versus Item 7.

The list of “business activities” in each of these sections has doubled. While this expansion will likely alleviate some confusion, advisors should carefully review this updated list (particularly the responses related to “broker-dealer” and “registered representatives”.

Item 8
While we’re on the topic, Item 8 now asks for some additional information about your broker-dealer relationships. Specifically, if you have client discretion for broker-dealer selection, Item 8.E. now asks if this broker-dealer a “related person.” This addition further helps identify and disclose potential conflicts of interest.

The new version of the ADV drills down deeper into the benefits that advisors receive from broker-dealers, asking specifically about "soft-dollar benefits." If the advisor does receive "soft-dollar benefits," they are asked to affirm that the service(s) received are eligible under 28(e) of the Exchange Act. This change seems to bifurcate benefits received by participating on an institutional wealth platform and benefits received via soft-dollars.

In addition to asking advisors if they compensate individuals for referrals, the new Item 8 also asks if the advisors themselves are compensated for referrals.

Item 9
For advisors that do have custody of some assets, the new Item 9 drills down into those assets and asks: “If you or your related persons have custody, how many persons, including, but not limited to, you and your related persons, act as qualified custodians for your clients in connection with advisory services?

Item 11
Item 11 relates to disciplinary events. The new version first asks advisors if any of the events described in the disciplinary questions involve you or any of your supervised persons specifically. This broadens the scope of the questions to anyone you supervise.

Item 11 generally requires advisors to describe disciplinary events that involve advisory affiliates, which include:

(1) all current employees (excluding employees performing only clerical, administrative, support or similar functions);

(2) officers, partners, or directors (or any person performing similar functions); and

(3) all persons directly or indirectly controlling you or controlled by you.

If you have any questions about how these changes impact you firm, please do not hesitate to reach out to AdvisorAssist.

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