SEC's ADV Changes: Much Ado?
Soft-dollar practices may remain opaque
March 17, 2008
The Securities and Exchange Commission's proposed changes to Form ADV, filed by investment advisers when they register with the agency, could improve disclosure of conflicts of interest, but observers say they may not shine as bright a light on soft-dollar commission practices.
The amendments would require more than 10,000 registered investment advisers, including those who manage hedge funds, to provide "clear, current and meaningful disclosure in narrative form to nearly 20 million clients," according to the SEC. The plain-English brochures would be available to the public on the commission's Web site.
Comments on the proposal, published in the Federal Register on March 3 after receiving unanimous approval from the commission last month, are due by May 18.
The brochures are intended to give investors more detailed information about an investment adviser's business practices, types of advisory services provided, investment risks, any soft-dollar arrangements, possible conflicts of interest and disciplinary history. They would also address a developing area of concern: the conflicts of interest arising from side-by-side management of clients who pay performance fees--such as hedge funds--and those who do not.
The SEC originally proposed changes to Part 2 of Form ADV in April 2000 as part of broader revisions to the entire document but only adopted changes to Part 1--a general description of the adviser's background--the following year.
The new rule would reinstate the requirement that investment advisers file Part 2 of Form ADV with the SEC--a practice discontinued in 2001; firms now retain Part 2 on file. The commission also wants to mandate that advisers annually present their customers with Part 2 rather than giving clients the option.
Legal experts say the SEC's decision to revisit the conflict-disclosure issue is aligned with its failed attempt in 2006 to require hedge fund advisers to register. Last year, the commission adopted Rule 206(4)-8 of the Investment Advisers Act, which does not impose fiduciary duties on private fund managers but rather antifraud responsibilities.
"The SEC has now posed an interesting question of whether unregistered investment advisers must provide their investors with the same information under the new Form ADV to comply with the SEC's ruling last year," says Jay Gould, partner and head of the investment funds group at law firm Pillsbury Winthrop Shaw Pittman in New York. According to Gould, if the agency intends the new Form ADV Part 2 to provide a safe harbor for purposes of Rule 206(4)-8, then all advisers might feel compelled to provide that information.
Currently, advisers take a "check the box" approach to disclosure on ADV Part 2, which is encouraged by its format. But that approach provides scant understanding of an adviser's business practices and policies. And the form's daunting appearance can prevent investors from wading through it.
The SEC's new approach is modeled after ADV's current Schedule H, which requires managed account sponsors to give clients a narrative description of their wrap fee programs.
"Rather than rely on the current check-the-box-format, Part 2 would specify the minimum disclosures required in a brochure and allow advisers to structure the disclosures and order the topics in a manner that accurately describes the adviser's material arrangements and services," says Jarrod James, senior consultant with Omaha-based RIA Compliance Consultants. "There will be far less confusion over whether they should disclose a conflict of interest or not."
