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Dismantling the Form ADV Brian S. Hamburger, JD, AIFA®, CRCP Managing Director August 3, 2009 NASAA Investment Adviser Training Workshop Who is Investment Adviser? Defining an Investment Adviser (“IA”) You are an investment adviser if, for compensation, you are engaged in the business of providing advice to others or issuing reports or analyses regarding securities. Who is excluded from the definition of an IA? Banks Certain Lawyers, Accountants, Engineers, and Teachers Certain Broker-Dealers and Registered Reps Bona Fide Publishers Advisers limited to US Government Securities Government entities Identifying the Scope of the Offering 3 Financial Planner Comprehensive Modular Informal Investment Consultant Investment Manager Education Funding ~ Retirement Planning ~ Estate Planning Mutual Fund Asset Allocation Separate Account Managers Management of Individual Securities Market Timing Private Placements Wealth Manager Where to Register 4 Assets Under Management If the adviser has less than $25 million in AUM, it must register at the state level. If the adviser has between $25-$30 million in AUM, it’s the adviser’s choice whether to register at the state or SEC level. If the adviser has over $30 million in AUM, it must register with the SEC. Where to Register 5 Other basis for SEC registration: Pension consultants with respect to assets of plans having an aggregate value of at least $ 50 million Advisers controlling, controlled by, or under common control with an investment adviser registered with the Commission Newly formed advisers expecting to be eligible for SEC registration within 120 days of approval Internet-only advisers Introducing the Parts of the Form ADV 6 Part 1 Used primarily by regulators for administrative purposes Registration decisions Inquiring into complaints Managing examination process Available to the public (www.adviserinfo.sec.gov) Part II Intended primarily for client disclosure Scope of services Fees Conflicts of interest Limiting liability Furnished to each prospective client and offered to existing clients A revised Part 2 of Form ADV In March of 2008, the SEC re-proposed; however there has been no comment to date on the re-proposal and industry insiders largely agree that it is anyone's guess when the SEC will act on the re-proposal. Form Construction 7 Part 1 Part 1A: base form Part 1B: required by state securities authorities Schedule A: direct owners and executive officers Schedule B: indirect owners Schedule C: update information on Schedules A and/or B Schedule D: additional information from Part 1A Form Construction 8 Part II: Disclosure Brochure Schedule F: additional information (narrative) from Part II Schedule G: balance sheet Schedule H: wrap fee programs Part 2? Part 2A: disclosure for the firm Appendix 1: wrap fee program brochure Part 2B: disclosure brochure supplement for IA personnel Who are “You”? 9 Who are your “employees”? 10 Who are your “clients”? 11 Do your services qualify as AUM? 12 Continuous and Regular Supervisory or Management Services 13 CRITERIA You have discretionary authority over the account and: you provide ongoing supervisory or management services with respect to that account. 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. Continuous and Regular Supervisory or Management Services 14 FACTORS Terms of the advisory contract. If your advisory contract provides for 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. Form of compensation. Compensation based on the average value of the client’s assets you manage over a specified period of time suggests continuous and regular supervisory or management services for the account. Compensation in a manner similar to either of the following suggests you do not provide continuous and regular supervisory or management services for the account: Compensation based upon the time spent with a client during a client visit; or A retainer based on a percentage of assets covered by a financial plan. Continuous and Regular Supervisory or Management Services 15 FACTORS 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. Making infrequent trades (e.g., based on a “buy and hold” strategy) does not mean your services are not “continuous and regular.” Continuous and Regular Supervisory or Management Services 16 APPLICATIONS have discretionary authority to allocate client assets among various mutual provide market timing recommendations (i.e., to buy or sell), but have no ongoing do not have discretionary authority, but provide the same allocation services, provide only impersonal investment advice (e.g., market newsletters); funds; and satisfy the criteria set forth in the foregoing discussion; 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 you are a broker-dealer and treat the account as a brokerage account, but only if you have discretionary authority over the account. management responsibilities; make an initial asset allocation, without continuous and regular monitoring and reallocation; or 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)). What else are “you” doing? 17 Who are “you” related to…? 18 …and is it “material”? 19 Are they talking about me? 20 Do you have “custody”? 21 Custody for SEC Advisers 22 Definition of custody: “Adviser has custody when it holds, directly or indirectly, client funds or securities, or has any authority to obtain possession of them.” In order to ensure compliance with SEC custody rules, the following factors must be addressed: Qualified Custodian Notification Quarterly Statement SEC Examples of Custody 23 Possession of client assets unless the adviser returns them within 3 business days. Securities Funds (can forward checks payable to 3rd parties) Acts in any capacity that gives it legal ownership of, or access to, client funds or securities. General partner of a client (hedge fund, family limited partnership, etc.) Trustee of a client trust Authority to withdraw assets from a client’s account. Sign checks, withdraw assets, dispose of clients assets for any purpose other than authorized trading activity Authority to deduct advisory fees or other expenses directly from client’s account SEC Custody Compliance 24 Qualified Custodian Advisor must maintain client funds and securities at a “Qualified Custodian.” Exemptions Notification Each client must be: notified, in writing, that the custodian is holding the funds provided with information so that the client can contact the custodian Quarterly Statement The adviser must have a reasonable belief that Qualified Custodian delivers quarterly account statement directly to the client. Adviser may still maintain the responsibility for delivering statements if it remains subject to the surprise audit from an independent CPA. The Look of Custody for SEC Advisers 25 Consistent, concise definition of custody and compliance requirements. Adviser need not send statements No more surprise audits No more audited balance sheet and disclosure to clients No more need to read through numerous no-action letters Almost every investment adviser now has custody. SEC will amend the instruction Form ADV so advisers that have custody only because they deduct fees may still answer “no.” However, if you state in any of your documents, such as Part II of Form ADV, client agreements, marketing materials, etc. this must be changed. State advisers remain held to higher standards. SEC Proposed Revisions to the Custody Rule 26 Market Scandal Driven In response to recent high profile scandals, the SEC has proposed to modify the custody rule: Annual Independent Custody Audit ADV-E SAS-70 Audit The proposed rule does not appear to impact ADV disclosure Custody Compliance for State Advisers 27 What are the states’ custody rules? States that have not acted continue to rely upon repealed SEC No-Action letters. NASAA’s model rule imposes higher standards for state advisers debiting fees than corresponding the SEC rule. Some states follow the SEC’s custody rule. Others follow NASAA’s model rule. Others have adopted their own rules or have not yet acted. Must send a copy of their invoice to the client at the same time it is sent to the custodian. Disclosure on Form ADV for all state advisers Small Businesses Omit the Small Business Section 28 Ulterior Motives of Financial Planning 29 Will the real sole proprietors please stand up? 30 Is this math correct? 31 Where did everybody go? 32 The 20th Century Form ADV 33 The 20th Century Form ADV 34 The 20th Century Form ADV 35 Code of Ethics 36 Code of Ethics 37 SEC advisers must adopt and enforce a written code of ethics and include this as disclosure in Schedule F. Not all states have adopted rules requiring Code of Ethics, but some require that it appear in Schedule F. NASAA Model Rule 102(a)(4)-1 prohibits investment advisers from unethical business practices, but it never adopted a “Code of Ethics”, instead stating in a letter to the SEC that a laundry list of unethical business practices would better ensure compliance with an adviser’s fiduciary duties. Filing Part II Online 38 IARD system is designed to accept an upload of an adviser’s ADV Part II. Virtually all states require their state registered advisers to upload ADV Part II to IARD. SEC registered adviser have the option but not the obligation to upload ADV Part II. The re-proposed ADV Part 2 would be completed on the IARD system or be required to be uploaded. Form ADV Part 2 39 Part II Part 2 Check the box & written narrative Written narrative only Redundancy with Part 1 Less redundancy Lack of clarity on where to disclose certain information Clearer disclosure requirements Delivery to clients on the onset of the relationship Delivery within 120 days of the adviser’s fiscal year end, and delivery of an interim update to clients when the brochure is amended to add a disciplinary event or there is an otherwise material change Inclusion of a brochure supplement for each supervised person who (1) formulates investment advice for that client and has direct client contact or (2) makes discretionary investment decisions for the client’s assets, even if that person has no direct client contact. Required submission of Form ADV Part 2 through IARD Delivery to clients on the onset of the relationship Annual offer to deliver Certain adviser representatives or members of the Investment Committee listed in Item 6 No requirement for submission of Form ADV Part II Designation of a Chief Compliance Officer 40 Every SEC-registered investment adviser (and arguably also state-registered advisers) must appoint a Chief Compliance Officer (“CCO”). Schedule A of Form ADV now implies that a CCO be listed for all investment advisers. Many states have formally adopted similar requirements. Some states have not yet adopted rules requiring a CCO be named on Schedule A, but have cited it as a deficiency. Wrap Fee Programs 41 A wrap program is: Investment advisers that sponsor wrap fee programs must deliver a brochure meeting the requirements of Schedule H of Form ADV in lieu of their Form ADV Part II or equivalent disclosure document. “a program under which any client is charged a specified fee or fees; not based directly upon transactions in a client's account; for investment advisory services (which may include portfolio management or advice concerning the selection of other investment advisers); and execution of client transactions.” Schedule H acts as the table of contents for a written narrative brochure that reads like a mix of Schedule F of Form ADV and a mutual fund prospectus. Clients that have two relationships (one in which transaction fees are included in the adviser’s fees and one in which transaction fees are separate) may have to get both Form ADV Part II and the wrap brochure. This also must be disclosed on Form ADV Part 1. Brian S. Hamburger, JD, CRCP, AIFA® 42 Brian Hamburger is the Founder and Managing Member of the Hamburger Law Firm. Brian is also the Founder and Managing Director of MarketCounsel, affiliated business, regulatory, and compliance consulting firm for entrepreneurial investment advisory firms nationwide. MarketCounsel and the Hamburger Law Firm are the result of an incessant entrepreneurial spirit and genuine desire to provide an unexpected level of value and service. Together, the consulting and law firms represent an unparalleled combination of preeminent counsel and uncompromising service to the retail securities industry. an Previously, Mr. Hamburger was an attorney with the securities practice group of a large New Jersey law firm. While there, he practiced in the area of securities law, concentrating in investment adviser and broker-dealer registration and compliance matters as well as broker transition and practice management issues. Prior to that post, Brian served as a law clerk in the Enforcement Division of the U.S. Securities & Exchange Commission. He was also a judicial intern at the U.S. District Court for the Southern District of Florida and then, the State of Florida Third District Court of Appeal. Earlier, Brian was the chief compliance officer of an SEC-registered investment adviser. In addition to his father's lifelong influence, Brian’s involvement in the securities industry started before he could even drive a car. Since then, he has been involved in a myriad of areas within the industry, posting a rich diversity of experiences with investment adviser and financial planning firms. Mr. Hamburger is admitted to the bars of New Jersey, New York, Pennsylvania, Massachusetts, the District of Columbia, as well as the U.S. Supreme Court. He is a member of the American Bar Association (Business Law Section) and other bar associations; the Securities Industry and Financial Markets Association, Compliance & Legal Division; National Society of Compliance Professionals; Financial Planning Association; and Society of Financial Service Professionals. Brian has been appointed to the American Bar Association’s Committees on Federal Regulation of Securities; State Regulation of Securities; and Professional Conduct; and is a Platinum and Gold Key Member of the New York Chapter of the Investment Management Consultants Association and New Jersey Financial Planning Association, respectively. He has also heeded the call of the Certified Financial Planner Board of Standards to sit on various task forces to shape industry-wide initiatives. Brian is a frequent lecturer to regional and national groups in the securities industry including members of the wealth management, investment management, financial planning, accounting, and insurance professions. His forums have ranged from delivering the keynote address to the country's state securities regulators to addressing school-age children on career and entrepreneurial issues. For the past several years, he has been engaged by the North American Securities Administrators Association (NASAA) to train state securities examiners on the intricacies of Form ADV and investment adviser client contracts. Mr. Hamburger proudly sits on several boards of directors and advisory boards. He maintains his FINRA securities licenses (Series 7, 63 and 65), is a member of the FINRA Dispute Resolution Board of Arbitrators and served as an arbitrator for the New York Stock Exchange. A graduate of Quinnipiac College, Mr. Hamburger received his B.S. with the school's first dual major in Economics and Financial Management. He went on to earn his Juris Doctor from the University of Miami School of Law where he was the recipient of a Dean’s Service Scholarship and the President's Pinnacle Award for his role as Editor-in-Chief of the Res Ipsa Loquitur, the Bi-Weekly Journal of the University of Miami School of Law. Brian was among the first to earn the designation of Certified Regulatory and Compliance Professional (CRCP) by the Wharton School and the FINRA Institute after completing his residency at the Wharton School of the University of Pennsylvania. He was recently awarded the Accredited Investment Fiduciary Analyst™ (AIFA®) designation by the Center for Fiduciary Studies. AIFA designees have the knowledge necessary to understand and implement a prudent investment process for investment advisers, investment managers, and investment stewards and can perform a fiduciary assessment to verify or certify an entity's conformity to a "global fiduciary standard of excellence.“Brian is an active member of the US Coast Guard Auxiliary. He lives with his wife, Kari, their daughter, Ella, and sons, Jacob and Sidney, in New Jersey. © 2009 MarketCounsel, LLC. All rights reserved. No portion of this presentation may be reproduced without the express written consent of the author. MarketCounsel is a consulting firm, is not affiliated with any government entity, and does not render legal or investment advice. MarketCounsel is affiliated with the Hamburger Law Firm, LLC. 201.705.1200 www.marketcounsel.com Speaker Contributors Brian S. Hamburger, JD, AIFA ®, CRCP Robert J. Seco, JD