Significant Amendments to Form ADV Go into Effect on October 1, 2017

September 25, 2017

Investment advisers that file Form ADV with the Securities and Exchange Commission ("SEC") either as registered investment advisers ("RIAs") or as exempt reporting advisers ("ERAs")[1] are reminded that significant amendments to Part 1A of Form ADV ("Part 1A") go into effect on October 1, 2017.  For most investment advisers having a fiscal year end of December 31st, the amendments will first impact their annual updating filings that will be due on April 2, 2018.

The following Client Alert provides a brief summary of the changes that have been made to Part 1A.  Investment advisers would be well-advised to begin considering how these changes will impact their Form ADV filing requirements for 2018 and how they will capture the additional data they will need to complete amended Part 1A.[2]

1.   Enhanced Reporting Regarding Separately Managed Accounts.

One of the most significant changes to Part 1A is the addition of new reporting requirements for RIAs[3] with respect to their separately managed accounts ("SMAs").[4]  Specifically, new Item 5.K has been added to Part 1A that will require an RIA to identify (i) whether it has any regulatory assets under management ("RAUM") attributable to SMAs ("SMA Assets"), (ii) whether it engages in borrowing transactions on behalf of SMAs, (iii) whether it engages in derivatives transactions on behalf of SMAs, and (iv) whether any single custodian holds more than 10% of the RIA’s SMA Assets.  A "yes" answer to any of these questions will trigger a requirement to complete the applicable parts of new Section 5.K of Schedule D to Form ADV.

New Section 5.K of Schedule D requires an RIA to report certain data on an aggregated basis with respect to its SMA Assets.[5]  In particular:

1. Section 5.K(1) will require an RIA to report the percentage of SMA Assets it manages in each of twelve separate asset categories.[6]  An RIA with $10 billion or more in SMA Assets must report this data as of the end of its second fiscal quarter and as of the end of its fiscal year.  An RIA will less than $10 billion in SMA Assets is only required to report this data as of the end of its fiscal year.
2. Section 5.K(2) will require an RIA with $10 billion or more in SMA Assets that engages in borrowing or derivatives transactions on behalf of its SMAs to report the amount of SMA Assets it manages in three ranges of "gross notional exposure:" (i) less than 10%, (ii) between 10% and 149%, and (iii) 150% or more.  For each range, the RIA is further required to report the aggregate dollar amount of all borrowings on behalf of the SMAs in such range, and the gross notional value of all derivatives held in such accounts, broken down into six categories of derivative instruments.[7]  This information must be presented on a semi-annual basis as of the end of the RIA’s second fiscal quarter and as of the end of its fiscal year.  For purposes of calculating this data, an RIA may (but is not required to) exclude SMAs with less than $10 million in RAUM. 
   1. An RIA with between $500 million and $10 billion in SMA Assets will be required to report the amount of SMA Assets it manages in each of the three ranges of gross notional exposure as of the end of its fiscal year only. Such RIAs will also be required to report the aggregate dollar amount of borrowings on behalf of its SMAs within each range of gross notional exposure, but will not be required to provide a breakdown of the derivative instruments held in such accounts. 
   2. An RIA with less than $500 million in SMA Assets will not be subject to this reporting requirement.
3. Finally, Section 5.K(3) will require an RIA to identify each custodian that holds more than 10% of the RIA’s SMA Assets.

2.   Enhanced Reporting of Certain Information Regarding the Investment Adviser and its Business.

A number of amendments have been made to Part 1A that will increase the level of detail an investment adviser is required to provide relating to itself and the nature of its business.  In particular:

1. Item 1 of Part 1A has been amended to require an investment adviser to identify any publicly available social media sites whose content is controlled by the adviser.  In addition, the adviser will be required to report the total number of branch offices it has and identify each of its 25 largest branch offices by number of employees, including (i) the number of employees in such branch office engaged in performing investment advisory functions, (ii) any other business activities conducted by the investment adviser at the branch office, and (iii) a brief description of the investment-related activities conducted from the branch office.[8]  Further, an adviser who outsources its chief compliance officer ("CCO") function to a third party will be required to provide the name and IRS employer identification number of the CCO’s employer.  Finally, a large investment adviser with $1 billion or more in assets on its own balance sheet will be required to identify whether such assets fall within one of three ranges.[9]
2. Item 5 of Part 1A has been amended to significantly change the manner in which RIAs report information relating to their client base.[10]  Specifically, an RIA will be required to complete a new table identifying the number of clients it has in each of thirteen enumerated classes of clients[11] and the amount of the RIA’s RAUM attributable to each class of clients.  RIA’s will also be required to identify approximately how many clients it has that do not have RAUM attributable to them (i.e., client accounts for which the RIA does not provide "continuous and regular supervisory or management services"),[12] the approximate percentage of its clients that are non-U.S. persons and the amount of its RAUM that is attributable to such non-U.S. person clients.  An RIA that manages registered investment companies or who participates in wrap fee programs will also be subject to additional reporting requirements with respect to those activities.
3. Finally, Section 7.B(1) of Schedule D to Part 1A, under which an investment adviser is required to provide detailed information with respect to the private funds it manages, has been revised to require an investment adviser to provide the PCAOB number, if any, of the auditor of each of its private funds, and to report whether the investors in any 3(c)(1) funds it manages are required to be "qualified clients."

3.   Relying Advisers.

The amendments to Part 1A also codify certain no-action relief granted by the SEC in 2012[13] permitting certain registered private fund advisers ("Filing Advisers") to register multiple entities ("Relying Advisers") under the Advisers Act using a single Form ADV filing ("Umbrella Registration").  For the most part, these amendments to Part 1A follow the already existing no-action letter precedent and do not impose significant additional reporting or other compliance burdens on a Filing Adviser that is already using Umbrella Registration.  However, as discussed below, in adopting the amendments the SEC has clarified certain interpretations of its requirements pertaining to Umbrella Registration that may result in some unexpected results for private fund advisers. 

1. The conditions for qualifying to register Relying Advisers pursuant to an Umbrella Registration under amended Part 1A have not changed in substance.  A Filing Adviser and its Relying Advisers must operate as a single private fund investment advisory business where: (i) the firm’s only clients are private funds or SMAs for qualified clients that invest in parallel with such private funds, (ii) the principal place of business for the firm is located in the U.S., (iii) all personnel are subject to the Filing Adviser’s supervision and control, (iv) the investment activities of each Relying Adviser are subject to the Advisers Act and SEC examination, and (v) the Filing Adviser and all Relying Advisers are subject to a single compliance program and code of ethics administered by a single CCO.
2. A Filing Adviser relying on Umbrella Registration will now be required to complete a new Schedule R to Form ADV for each Relying Adviser covered by the Umbrella Registration.  For the most part, the information that is required to be reported in Schedule R is as one would expect.  It should be noted, however, that new Schedule R will require a Filing Adviser to separately identify the basis upon which each Relying Adviser independently qualifies to register under the Advisers Act.[14]  In addition, a Filing Adviser will be required to separately report the complete ownership structure for each Relying Adviser in such Relying Adviser’s Schedule R to the same degree of detail as is required for the Filing Adviser in Schedules A and B of Form ADV. 

Despite numerous requests in comment letters to do so, the SEC declined to expand the availability of Umbrella Registration beyond U.S. based RIAs whose business is limited exclusively to managing private funds.  In particular, Umbrella Registration is still not available to non-U.S. based advisers or to ERAs.  The SEC did state in the Adopting Release, however, that certain no-action relief permitting ERAs to rely on a somewhat different form of Umbrella Registration will still be available.[15]

4.   Other Changes.

In addition to the changes summarized above, the SEC adopted two amendments to Rule 204-2 under the Advisers Act (the "Books and Records Rule") that expand an RIA’s record-keeping obligations with respect to written communications containing performance data.[16]  In particular:

1. First, the SEC amended Rule 204-2(a)(16) such that RIAs will be required to maintain records to support performance claims in communications sent to any person.  Under the current rule, RIAs are only required to maintain such records for performance claims in communications sent to ten or more persons.
2. In addition, the SEC added a new requirement to Rule 204-2(a)(7) that will require RIAs to maintain records of all written communications sent or received by the RIA relating to the performance or rate of return of any or all managed accounts or securities recommendations.

Both of these amendments go into effect on October 1, 2017.

Clients are urged to speak to their Gibson Dunn contacts if they have any questions or concerns regarding these or any other regulatory requirements.

  [1]   RIAs and ERAs are referred to collectively herein as investment advisers.

  [2]   Complete copies of the revised instructions to Form ADV and amended Part 1A can be found on the SEC’s website using the following links:

General Instructions:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-a.pdf

Instructions for Part 1A:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-b.pdf

Glossary of Terms:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-c.pdf

Part 1A:  https://www.sec.gov/rules/final/2016/ia-4509-appendix-d.pdf

In addition, a copy of amended Part 1A, marked to show changes against the current version, can also be found on the SEC’s website at https://www.sec.gov/rules/final/2016/ia-4509-form-adv-summary-of-changes.pdf.

  [3]   ERAs will not be subject to these new reporting requirements.

  [4]   An SMA is defined for this purpose as any client account other than a registered investment company, business development company or other pooled investment vehicle (including private funds). 

  [5]   The reporting requirements are somewhat akin to reporting obligations under Form PF that apply to an RIA with respect to any private funds it manages.  Unlike the data provided under Form PF, however, the data provided in response to Schedule D, Section 5.K, will be publicly available on the SEC’s website.

  [6]   The asset categories are (i) exchange-traded equity securities, (ii) non exchange-traded equity securities, (iii) U.S. government/agency bonds, (iv) U.S. state and local government bonds, (v) sovereign bonds, (vi) investment grade corporate bonds, (vii) non-investment grade corporate bonds, (viii) derivatives, (ix) securities issued by registered investment companies or business development companies, (x) securities issued by other pooled investment vehicles, (xi) cash and cash equivalents, and (xii) other.

  [7]   The six categories of derivative instruments are (i) interest rate derivatives, (ii) foreign derivatives, (iii) credit derivatives, (iv) equity derivatives, (v) commodities derivatives and (vi) other derivatives.

  [8]   Unlike most of the information provided in Item 1 (which must be promptly updated on an other-than-annual basis if the information provided becomes inaccurate in any respect), the information with respect to an investment adviser’s branch offices will only need to be updated once a year as part of the investment adviser’s annual updating amendment to its Form ADV.

  [9]   The ranges are (i) from $1 billion to $10 billion, (ii) from $10 billion to $50 billion, and (iii) more than $50 billion.

[10]   ERAs, which are not required to complete Item 5 of Part 1A, will not be subject to these requirements.

[11]   The enumerated classes of clients are (i) individuals (other than high net worth individuals), (ii) high net worth individuals, (iii) banking or thrift institutions, (iv) business development companies, (v) registered investment companies, (vi) other pooled investment vehicles, (vii) pension and profit sharing plans (other than government pension plans), (viii) state and municipal government entities (including government pension plans), (ix) other investment advisers, (x) insurance companies, (xi) sovereign wealth funds and foreign government institutions, (xii) corporations and other businesses, and (xiii) other clients. 

[12]   In the Adopting Release, the SEC cites nondiscretionary accounts or one-time financial plans as examples of situations where, depending on the facts and circumstances, an adviser may provide investment advice but does not have RAUM.  See SEC Adopting Release, Form ADV and Investment Advisers Act Rule, Release No. IA-4509, File No. S7-09-15 (Aug. 25. 2016), https://www.sec.gov/rules/final/2016/ia-4509.pdf, at footnote 144. 

[13]   See SEC No-Action Letter, Investment Advisers Act of 1940 – Sections 203(a) and 208(d) American Bar Association, Business Law Section (Pub. avail. Jan. 18, 2012), https://www.sec.gov/divisions/investment/noaction/2012/aba011812.htm.

[14]   This will not be a problem for any Relying Adviser that has the same principal place of business with the Filing Adviser.  However, Relying Advisers whose principal place of business is not the same as the Filing Adviser will need to identify a separate grounds for claiming SEC jurisdiction under the Advisers Act, such as by having $100 million or more in RAUM or by having its principal place of business located outside of the U.S.

[15]   See SEC Staff Interpretive Guidance, Frequently Asked Questions on Form ADV and IARD (June 12, 2017), https://www.sec.gov/divisions/investment/iard/iardfaq.shtml at "Reporting to the SEC as anExempt Reporting Adviser."

[16]   ERAs are not subject to these record-keeping requirements.