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49234 Federal Register / Vol. 75, No. 155 / Thursday, August 12, 2010/ Rules and Regulations

1 Unless otherwise noted, when we refer to rule2031, 2041, 2042, or 2043, or any paragraph of these rules, we are referring to 17 CFR 275.2031,275.2041, 275.2042, or 275.2043, respectively,of the Code of Federal Regulations in which theserules are published.

2 These figures are based on data derived frominvestment advisers responses to questions on Part1A of Form ADV reported through the InvestmentAdviser Registration Depository ( IARD) as of May3, 2010. We note that these figures will change dueto the Dodd-Frank Wall Street Reform andConsumer Protection Act, Public Law 111203, 124Stat. 1376 (2010).

3 Proxy Voting by Investment Advisers,Investment Advisers Act Release No. IA2106 (Jan.31, 2003) [68 FR 6585 (Feb. 7, 2003)] ( Proxy VotingRelease ).

4 See SEC v. Capital Gains Research Bureau, Inc.,375 U.S. 180 (1963); In the Matter of Arleen W.Hughes, Exchange Act Release No. 4048 (Feb. 18,1948).

5 Advisers use Form ADV to apply for registrationwith us (Part 1A) or with state securities authorities(Part 1B), and must keep it current by filingperiodic amendments as long as they are registered.See rules 2031 and 2041. Form ADV has twoparts. Part 1(A and B) of Form ADV providesregulators with information to process registrationsand to manage their regulatory and examinationprograms. Part 2A contains the requirements for thedisclosure brochure that advisers must provide toprospective clients initially and to existing clientsannually, and Part 2B contains information aboutthe advisory personnel providing clients withinvestment advice. Prior to the amendments we areadopting today, Part 2 was designated as Part II.

SECURITIES AND EXCHANGECOMMISSION

17 CFR Parts 275 and 279

[Release No. IA3060; File No. S71000]

RIN 3235AI17

Amendments to Form ADVAGENCY : Securities and ExchangeCommission.ACTION : Final rule.

SUMMARY : The Securities and ExchangeCommission is adopting amendments toPart 2 of Form ADV, and related rulesunder the Investment Advisers Act, torequire investment advisers registeredwith us to provide new and prospectiveclients with a brochure and brochuresupplements written in plain English.These amendments are designed toprovide new and prospective advisoryclients with clearly written, meaningful,current disclosure of the businesspractices, conflicts of interest and

background of the investment adviserand its advisory personnel. Advisersmust file their brochures with uselectronically and we will make themavailable to the public through our Website. The Commission also iswithdrawing the Advisers Act rulerequiring advisers to disclose certaindisciplinary and financial information.DATES : Effective Date: October 12, 2010.Compliance Dates: See Section V of thisrelease.FOR FURTHER INFORMATION CONTACT :Vivien Liu, Senior Counsel, Don L.Evans, Senior Counsel, Daniel S. Kahl,Branch Chief, or Sarah A. Bessin,Assistant Director, at (202) 5516787 [email protected], Office of InvestmentAdviser Regulation, Division of Investment Management, U.S. Securitiesand Exchange Commission, 100 FStreet, NE., Washington, DC 205498549.SUPPLEMENTARY INFORMATION : TheSecurities and Exchange Commission(Commission or SEC) is adoptingamendments to rules 2031, 2041,2042, and 2043 [17 CFR 275.2031,275.2041, 275.2042, and 275.2043]under the Investment Advisers Act of 1940 [15 U.S.C. 80b] ( Advisers Act orAct ); 1 and amendments to Form ADV[17 CFR 279.1] under the Advisers Act.The Commission also is withdrawing

rule 206(4)4 [17 CFR 275.206(4)4]under the Advisers Act.Table of Contents

I. IntroductionII. Discussion of Form ADV, Part 2

A. Part 2A: Brochure Format and Content1. Format2. Brochure Items

3. Delivery and Updating of BrochuresB. Part 2B: The Brochure Supplement1. Format2. Supplement Items3. Delivery and UpdatingC. Filing Requirements, Public AvailabilityD. Transition to New Requirements

III. Amendments to Form ADV Instructionsand Glossary

IV. Amendments to Rule 2042V. Effective and Compliance DatesVI. Paperwork Reduction ActVII. Cost-Benefit AnalysisVIII. Final Regulatory Flexibility AnalysisIX. Efficiency, Competition, and Capital

FormationX. Statutory AuthorityText of Rule and Form Amendments

I. IntroductionInvestment advisers provide a wide

range of advisory services and play animportant role in helping individualsand institutions make significantfinancial decisions. From individualsand families seeking to plan forretirement or save for college to largeinstitutions managing billions of dollars,clients seek the services of investmentadvisers to help them evaluate theirinvestment needs, plan for their future,develop and implement investmentstrategies, and cope with the ever-

growing complexities of the financialmarkets. Today, the more than 11,000advisers registered with us manage morethan $38 trillion for more than 14million clients. 2

Under the Advisers Act, an adviser isa fiduciary whose duty is to serve the

best interests of its clients, whichincludes an obligation not to subrogateclients interests to its own. 3 An advisermust deal fairly with clients andprospective clients, seek to avoidconflicts with its clients and, at aminimum, make full disclosure of anymaterial conflict or potential conflict. 4

A client may use this disclosure toselect his or her own adviser andevaluate the advisers business practicesand conflicts on an ongoing basis. As aresult, the disclosure clients andprospective clients receive is critical totheir ability to make an informeddecision about whether to engage anadviser and, having engaged the adviser,to manage that relationship.

To allow clients and prospectiveclients to evaluate the risks associatedwith a particular investment adviser, its

business practices, and its investmentstrategies, it is essential that clients andprospective clients have clear disclosurethat they are likely to read andunderstand. For example, suchdisclosure could enable a prospectiveclient to screen advisers based ondisciplinary history, financial industryaffiliations or compensation methods.Such screening would allow clients toavoid advisers with a disciplinaryhistory, should they wish to do so.Clients also would be able to chooseadvisers based on affiliations andcompensation methods; in some cases,the client may not be comfortable withthe conflicts of interest that thoseaffiliations and compensation methodscreate, while other clients may value anadvisory relationship that allows for

broader access to other financialservices and may seek an adviser withfinancial industry affiliates. Aprospective client may seekmodifications to an investment advisoryagreement to better protect the clientagainst an investment adviserspotential conflict of interest, either by

better aligning the advisers interestwith that of the client or by prohibitinga particular practice in the clientsaccount. If an adviser is unwilling tomake such modifications, a prospectiveclient may select a different adviser.

Since 1979, the Commission hasrequired each adviser registered with usto deliver a written disclosure statementto clients pursuant to rule 2043 underthe Advisers Act. 5 An investmentadviser may use this client disclosurestatement to satisfy its disclosure

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49235Federal Register / Vol. 75, No. 155 / Thursday, August 12, 2010/ Rules and Regulations

6 See Investment Adviser RequirementsConcerning Disclosure, Recordkeeping,Applications for Registration and Annual Filings,Investment Advisers Act Release No. 664 (Jan. 30,1979) [44 FR 7870 (Feb. 7, 1979)] ( 1979 AdoptingRelease ).

7 Items in Part 2 of Form ADV may not addressall conflicts an adviser may have, and may notidentify all material disclosure that an adviser may

be required to provide clients. As a result,delivering a brochure prepared under Form ADVsrequirements may not fully satisfy an advisersdisclosure obligations under the Advisers Act. SeeInstruction 3 of General Instructions for Part 2 of Form ADV; rule 2043(f).

8 Amendments to Form ADV, InvestmentAdvisers Act Release No. 2711 (Mar. 3, 2008) [73FR 13958 (Mar. 14, 2008)] ( Proposing Release ).

9 See Proposing Release, supra note 8 at n.6 andaccompanying text.

10 Id. at Section II.A.3.11 Comment letters submitted in File No. S710

00 are available on the Commissions Web site at:http://www.sec.gov/rules/proposed/s71000.shtml.

12 See, e.g., comment letter of the American BarAssociation, Section of Business Law, Committeeon Federal Regulation of Securities and Committeeon State Regulation of Securities (June 18, 2008)(ABA Committees Letter ); comment letter of theConsumer Federation of America (July 2, 2008)(Consumer Federation Letter ); comment letter of Citigroup Global Markets Inc. (May 16, 2008)(CGMI Letter ); comment letter of Fried, Frank,Harris, Shriver & Jacobson LLP (May 2, 2008)(Fried Frank Letter ); comment letter of the

Investment Adviser Association (May 16, 2008)(IAA Letter ); comment letter of the InvestmentCompany Institute (May 16, 2008) ( ICI Letter ).

13 See, e.g., comment letter of AlternativeInvestment Compliance Association (May 16, 2008)(AICA Letter ); comment letter of CapitalInstitutional Services, Inc. (May 16, 2008) ( CAPISLetter ); comment letter of Shaun Eddy (May 9,2008) ( Eddy Letter ); comment letter of the

Financial Planning Association (May 16, 2008)(FPA Letter ); Fried Frank Letter; IAA Letter; ICILetter; comment letter of Janus Capital ManagementLLC (May 16, 2008) ( Janus Letter ); comment letterof Nancy Lininger (May 18, 2008) ( LiningerLetter ); comment letter of the National Associationof Personal Financial Advisers (June 4, 2008)(NAPFA Letter ); comment letter of NationalCompliance Services, Inc. (May 9, 2008) ( NCSLetter ); comment letter of National RegulatoryServices (May 16, 2008) ( NRS Letter ); commentletter of L. A. Schnase (May 9, 2008) ( SchnaseLetter ); comment letter of Sidley Austin LLP (May23, 2008) ( Sidley Letter ); comment letter of USAAInvestment Management Company/USAA FinancialPlanning Services Insurance Agency, Inc. (May 16,2008) ( USAA Letter ); comment letter of Wellington Management Company, LLP (May 15,2008) ( Wellington Letter ).

14

Part 2 is a uniform form used by investmentadvisers registered with both the Commission andthe state securities authorities. See Instruction 5 of General Instructions for Form ADV. This Releasediscusses the Commissions adoption of Form ADVand related rules applicable to advisers registeredwith the Commission. Form ADV is also used bystate securities regulators to register investmentadvisers. It includes certain items and instructionsto Part 2 (e.g., Item 19 of Part 2A, Item 10 of Appendix 1 to Part 2A, and Item 7 of Part 2B) thatapply only to state-registered advisers. State-registered advisers are required by state, rather thanfederal, law to respond to these items. Completionof these items, therefore, is not an SEC requirement,and these items are not included in this Release asan SEC rule.

15 See Instructions 1 and 2 of General Instructionsfor Part 2 of Form ADV. In many instances wherewe refer to client in this release we are referringto both an existing and prospective client.

16 See ABA Committees Letter; comment letter of the American Institute of Certified PublicAccountants (May 20, 2008) ( AICPA Letter );CAPIS Letter; Consumer Federation Letter; CGMILetter; Fried Frank Letter; IAA Letter; ICI Letter;

Janus Letter; comment letter of Merrill Lynch,Pierce, Fenner & Smith, Incorporated (May 16,2008) ( Merrill Lynch Letter ); comment letter of theMoney Management Institute (May 16, 2008) ( MMILetter ); comment letter of Morgan Stanley & Co.Incorporated (May 16, 2008) ( Morgan StanleyLetter ); NAPFA Letter; comment letter of the NorthAmerican Securities Administrators Association,Inc. (May 16, 2008) ( NASAA Letter ); NRS Letter;comment letter of the National Society of Compliance Professionals Inc. (May 16, 2008)(NSCP Letter ); comment letter of Charles Schwab& Co. and Charles Schwab Investment Management,Inc. (May 16, 2008) ( Schwab Letter ); WellingtonLetter.

17 NAPFA Letter.18 Wellington Letter.19 Instruction 1 of General Instructions for Part 2

of Form ADV.20 See ABA Committees Letter; comment letter of

First Allied Securities, Inc. (May 16, 2008) ( FirstAllied Letter ); comment letter of Mercer Advisors(May 2, 2008) ( Mercer Letter ); NCS Letter; NRSLetter; comment letter of Reed Smith on behalf of Federated Investors, Inc. (May 16, 2008) ( FederatedLetter ).

obligations as a fiduciary. 6 Part 2 of Form ADV sets out minimumrequirements for this disclosurestatement to clients, which is commonlyreferred to as the brochure. 7

In the past, Part 2 has requiredadvisers to respond to a series of multiple-choice and fill-in-the-blankquestions organized in a check-the-

box format, supplemented in somecases with brief narrative responses.Advisers have had the option of providing information required by Part2 in an entirely narrative format, but fewhave done so.

In 2008, we proposed a differentapproach to enhance the disclosurestatement advisers provide to theirclients. 8 Instead of the check-the-boxformat, each adviser registered with uswould provide clients with a narrativeplain English brochure that describesthe advisers business, conflicts of interest, disciplinary history, and otherimportant information that would helpclients make an informed decision aboutwhether to hire or retain that adviser.Our proposal was designed to requireadvisers to disclose meaningfulinformation in a clearer format. 9 Inaddition, we proposed that advisers berequired to file their brochures with uselectronically so that we could makethem available to the public on our Website. 10

We received 81 letters commenting onthe Proposing Release. 11 Commentersagreed with our proposal to move to anarrative brochure, 12 although many

suggested modifications to certainrequirements. 13 After carefulconsideration of these comment letters,we are adopting amendments to Part 2of Form ADV and related rules underthe Advisers Act. In light of ouradoption of Part 2, we also arewithdrawing rule 206(4)4, whichseparately required advisers to discloseto clients certain financial anddisciplinary information, because ouramendments render that rule largelyduplicative.

II. Discussion of Form ADV, Part 2

The revised Part 2 requirements thatwe are adopting today include two sub-parts, Part 2A and Part 2B. 14 Part 2Acontains 18 disclosure items about theadvisory firm that must be included inan advisers brochure. We refer to Part2B as the brochure supplement, whichincludes information about certain

advisory personnel on whom clientsrely for investment advice. In thissection, we discuss our amendmentsrelating to each of these sub-parts,which are addressed separately becausethey are subject to differing content,updating and delivery requirements.

A. Part 2A: Brochure Format and Content

1. FormatWe are adopting a requirement that

investment advisers registered with usprovide prospective and existing clientswith a narrative brochure written inplain English. 15 Commenters supported

use of a narrative format.16

For example,one commenter stated that the currentcheck-the-box format does not alwaysresult in clear and meaningful clientdisclosure and it presents challenges foradvisers in identifying and presentingall of the types of information thatshould be addressed in Part 2. 17 Another commenter expressed the viewthat the flexibility of a narrative formatshould result in clearer and moremeaningful disclosures that makerelevant information readily accessibleto prospects and clients. 18 We believethese amendments will greatly improvethe ability of clients and prospectiveclients to evaluate firms offeringadvisory services and the firmspersonnel, and to understand relevantconflicts of interest that the firms andtheir personnel face and their potentialeffect on the firms services.

We have added an instruction to Part2 of Form ADV to require that anadviser provide the information in aspecified format. 19 We are persuaded bycommenters that this format for items inthe brochure will facilitate investorscomparison of multiple advisers and areadopting this requirement. 20 An adviser


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21 Instruction 1 of General Instructions for Part 2of Form ADV.

22 Id.23 Instruction 2 of General Instructions for Part 2

of Form ADV.24 Part 2A consists of a main body and an

appendix, Appendix 1. Appendix 1 contains therequirements for a specialized type of firm

brochurea wrap fee program brochureandrequires disclosure similar to current Schedule H of Part 2 of Form ADV. See rule 2043(d); Appendix1 to Part 2A; infra note 182 and accompanying text.

25 See, e.g., comment letter of the FinancialService Institute (May 16, 2008) ( FSI Letter );Schwab Letter; comment letter of the SecuritiesIndustry and Financial Markets Association (May16, 2008) ( SIFMA Letter ); comment letter of Sutherland Asbill & Brennan LLP (May 16, 2008)(Sutherland Letter ).

26 Advisers with fewer conflicts and simpler business arrangements will be able to prepareshorter brochures.

27 See rule 2043(e) (allowing advisers thatprovide substantially different advisory services todifferent clients to provide clients with different

brochures as long as each client receives allinformation about the services and fees that areapplicable to that client). Note that an adviser maynot omit any information required by Item 9 of Part2A (Disciplinary Information) in any brochureprovided to any client, and that each brochure must

be filed through IARD. See rule 2043(a); see alsoInstruction 2 for Part 2A of Form ADV. An adviserthat creates separate brochures must file each

brochure through the IARD system. See Instruction9 for Part 2A of Form ADV.

28 See Instruction 8 of Instructions for Part 2A of Form ADV. We have also added an instruction toPart 2 explaining that advisers must provide theclient with sufficiently specific facts so that theclient is able to understand the conflicts of interestthe adviser has and the business practices in which

it engages, and can give his or her informed consentto the transaction or practice that gives rise to theconflict or to reject the transaction or practice. SeeInstruction 3 of General Instructions for Part 2 of Form ADV.

29 We have observed that the emphasis on SECregistration, in some advisers marketing materials,appears to suggest that registration either carriessome official imprimatur or indicates that theadviser has attained a particular level of skill orability. Section 208(a) of the Advisers Act [15U.S.C. 80b8(a)] makes such suggestions unlawful.

30 See First Allied Letter; IAA Letter; SIFMALetter.

31

Advisers may include the summary in their brochure or in a separate document. Item 2 of Part2A. A summary prepared as a separate documentcan be used to satisfy an advisers annual clientdelivery obligations. See rule 2043(b)(2), discussedin Section II.A.3 below. Summaries provided as aseparate document must be filed with theCommission as an exhibit to Part 2. See Note toparagraphs (a) and (b) of rule 2041; Instruction 6for Part 2A of Form ADV. If an adviser includes thesummary of material changes in its brochure, andamends its brochure on an interim basis betweenannual updating amendments, the adviser shouldconsider whether it should update its summary of material changes to avoid confusing or misleadingclients reading the updated brochure. See Note toInstruction 6 for Part 2A of Form ADV.

must respond to each item in the brochure, and must present theinformation in order of the items in theform, using the headings provided bythe form. If an item is inapplicable to anadviser, the adviser must include theheading and an explanation that theinformation is inapplicable. 21 If information an adviser provides inresponse to one item is also responsiveto another item, the adviser may cross-reference the information in the otheritem. 22

Also, it is critical that adviserscommunicate clearly to their clients andprospective clients in the brochure.Thus, instructions to Part 2 provide that,in drafting the brochure, advisers,among other things, should use shortsentences; definite, concrete, everydaywords; and the active voice. In addition,the brochure should discuss onlyconflicts the adviser has or is reasonablylikely to have, and practices in which it

engages in or is reasonably likely toengage. 23 If a conflict arises or theadviser decides to engage in a practicethat it has not disclosed, supplementalinformation must be provided to theclient.2. Brochure Items

Part 2A, as adopted, contains 18separate items, each covering a differentdisclosure topic. 24 We have drawn theitems in Part 2A largely from disclosureadvisers have long been required tomake in response to the previous Part 2,and have added items to address newconcerns or developments. Much of thedisclosure required in Part 2A addressesan advisers conflicts of interest with itsclients, and is disclosure that theadviser, as a fiduciary, must make toclients in some manner regardless of theform requirements.

Some commenters urged us to requirefewer items and require advisers toprovide less detailed information. 25 Wehave reviewed carefully thesesuggestions and have modified some of our items in response. In some cases,

however, commenters urged us toeliminate particular proposeddisclosures, such as the fee schedule,that have long been required in Part 2and provide investors essentialinformation. Elimination of suchproposed disclosures would result inclients not receiving importantinformation they currently receive fromtheir advisers and on which they mayrely. In many other cases, further cutswould not have reduced the amount of disclosure an adviser would have tomake to clients, but rather would havepermitted the disclosure to be made ina different document or manner. Thus,elimination of disclosure requirementsin Part 2A suggested by somecommenters would be unlikely toreduce burdens or eliminate the amountof information required to be providedto clients to satisfy an advisersfiduciary obligations. 26

We agree that disclosure to clients

should be succinct and readable. Wenote that advisers, because of how theychoose to present their programs orservices to clients or the complexity of their disclosures, have the ability to takesteps that would limit the length of their

brochures. For example, advisers maycreate separate brochures for differenttypes of advisory clients, each of whichmay be shorter, clearer, and contain lessextraneous information than would acombined brochure. 27 Advisers thatchoose to disclose more than is required

by the form (and their fiduciaryobligations) will create lengthier

brochures than those that take a morefocused approach. Advisers with a morecomplicated offering of advisoryservices (or business arrangements)might consider including a summary inthe beginning of their brochure,followed by a more detailed discussionof each item in the brochure. We haveamended the instructions to clarify thatincluding a summary is permissible. 28

Below, we discuss each of the itemsin the form and the modifications wehave made from our proposal.

Item 1. Cover Page. Item 1 requiresthat an adviser disclose on the coverpage of its brochure the name of thefirm, its business address, contactinformation, Web site (if it has one), andthe date of the brochure. The cover pagealso must include a statement that the

brochure has not been approved by theCommission or any state securitiesauthority. If an adviser refers to itself asa registered investment adviser, it alsomust include a disclaimer thatregistration does not imply a certainlevel of skill or training. 29

The item reflects one change from ourproposal. Item 1 requires an adviser todisclose on the cover page of the

brochure only a general telephonenumber and/or e-mail address thatclients can use to contact the adviser if they have questions about the brochure.

Commenters asserted that some largeradvisers would find it cumbersome tocomply with our proposal, which wouldhave required the name and phonenumber of a specific individual orservice center. 30

Item 2. Material Changes. Item 2requires that an adviser amending its

brochure identify and discuss thematerial changes since the last annualupdate on the cover page or thefollowing page or as a separatedocument accompanying the

brochure. 31 This item is designed tomake clients aware of information that

has changed since the prior years brochure and that may be important tothem.


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32 See ASG Letter; comment letter of the CFAInstitute Centre for Financial Market Integrity (May22, 2008) ( CFA Institute Letter ); ConsumerFederation Letter; FPA Letter; IAA Letter; JanusLetter; NASAA Letter.

33 See AICA Letter; FSI Letter; ICI Letter;comment letter of Jackson, Grant InvestmentAdvisers, Inc. (May 26, 2008) ( Jackson Letter );comment letter of Katten Muchin Rosenman LLP(May 16, 2008) ( Katten Letter ); Mercer Letter;Morgan Stanley Letter; NSCP Letter; comment letterof the Financial Service Roundtable (May 16, 2008)(Roundtable Letter ); SIFMA Letter; SutherlandLetter.

34 We have revised Item 2 to require advisers notonly to identify, but also to discuss materialchanges to clarify our intent.

35 A few commenters also sought clarification of the term material changes. See comment letter of the American Council of Life Insurance (May 16,2008) ( ACLI Letter ); Fried Frank Letter; FSI Letter;IAA Letter; Roundtable Letter; comment letter of T.Rowe Price Associates, Inc. (May 16, 2008) ( T.

Rowe Letter). The standard of materiality under theAdvisers Act is whether there is a substantial

likelihood that a reasonable investor (here, client)would have considered the information important.See S.E.C. v. Steadman, 967 F.2d 636, 643 (D.C. Cir.1992). Cf. Basic Inc. v. Levinson , 485 U.S. 224, 231232 (1988); TSC Industries v. Northway, Inc., 426U.S. 438, 445, 449 (1976). This is a facts andcircumstances test, requiring an assessment of thetotal mix of information, in the characterization of the Supreme Court. TSC Industries, 426 U.S. at 449.Given that materiality depends on the factualsituation, which may vary with each situation, wedo not believe that it is appropriate to specificallydefine or provide any bright line tests for what i sand is not material.

36 See supra note 20.

37 See Fried Frank Letter; Janus Letter; Lininger

Letter.38 Instruction 1 of General Instructions for Part 2of Form ADV.

39 For an explanation of Part 1As requirementsfor computing assets under management, seeInstruction 5.B for Part 1A of Form ADV.

40 See rule 2042(a)(14)(ii) and Note to Item 4.Eof Part 2A.

41 See NAPFA letter.42 See Sutherland Letter.43 See Proposing Release at Section II.A.2.44 The CFA Institute Letter, IAA Letter, Janus

Letter, Mercer Letter, and NRS Letter argued thatthe calculation requirements should be the same.Others supported our proposal that would permitadvisers to use a different calculation of assets

under management than the one required for Part1A, with most of these commenters arguing that thisflexibility would allow advisers to more accuratelyportray the business of the firm and total assetsmanaged. See comment letter of AshlandCompliance Group LLC (May 16, 2008) ( AshlandLetter ); Lininger Letter; MMI Letter; MorganStanley Letter.

45 For example, in calculating assets undermanagement, for purposes of Part 1A, an advisermay include the entire value of a managedportfolio, but only if at least 50% of the portfoliostotal value consists of securities. See current FormADV: Instructions for Part 1A of Form ADV. Thus,for Part 1A purposes, an adviser will not includeother assets (including securities) that it manages ina non-securities portfolio. The Part 1A formula forcalculating assets under management was designed

based on considerations related to the NationalSecurities Markets Improvement Act of 1996division of responsibility for regulation of advisers

between the Commission and state securitiesregulatory authorities. Public Law 104290, 110Stat. 3416 (1996).

46 See Morgan Stanley Letter; MMI Letter.47 See Note to Instruction 4 of General

Instructions for Form ADV.48 Note to Instruction 2 of Instructions for Part 2A

of Form ADV. Disclosure updating the advisersassets under management could be provided toclients by means other than the brochure. We have

brought enforcement actions charging advisers withengaging in fraud by misrepresenting their assetsunder management to advisory clients and

Continued

Several commenters supported thisrequirement, agreeing that advisers canachieve meaningful disclosure with anannual disclosure highlighting changesto the brochure. 32 Others expressedconcern that advisers would writelengthy summaries to avoid liability. 33 We emphasize that we intend thisdocument to be a summary thatidentifies and broadly discusses thematerial changes, 34 and that it shouldnot be a lengthy discussion thatreplicates the brochure itself. 35 Instead,the summary need contain no more thannecessary to inform clients of thesubstance of the changes to the adviserspolicies, practices or conflicts of interests so that they can determinewhether to review the brochure in itsentirety or to contact the adviser withquestions about the changes.

Item 3. Table of Contents. Item 3requires each adviser to include in its

brochure a table of contents detailedenough to permit clients andprospective clients to locate topicseasily. Some commenters supported theuse of a table of contents but urged theCommission to mandate a uniformformat so that investors can compare

brochures of multiple advisers moreeasily. 36 Others opposed a uniformformat, arguing that flexibility wouldenable an adviser to best convey

information about its firm to clients. 37 As discussed above, we are persuaded

by commenters that a uniform format foritems in the brochure will facilitateinvestors comparison of multipleadvisers and are adopting thisrequirement. We therefore added aninstruction to Part 2 of Form ADV torequire advisers to present theinformation in the order of the items inthe form, using the headings provided

by the form. 38 Item 4. Advisory Business. Item 4

requires each adviser to describe itsadvisory business, including the typesof advisory services offered, whether itholds itself out as specializing in aparticular type of advisory service, andthe amount of client assets that itmanages. In computing the amount of client assets that it manages, an advisermay use a method that differs from themethod used in Part 1A of Form ADVto report assets under management. 39

An adviser opting to use a differentmethod must keep documentationdescribing the method used. 40

Two commenters urged theCommission not to require that advisersmake additional disclosure if they holdthemselves out as specializing in aparticular type of advisory service. Onewas concerned that advisers would haveinterpretive problems in definingspecialized advisory services and thatdisclosure describing specializedservices would not provide meaningfulinformation to clients. 41 The otherargued that Item 8 (Strategies and Risks)covers similar information. 42 As weexplained in the Proposing Release, werequire that advisers identify aspecialized advisory service because we

believe that clients likely will want tounderstand this before engaging thatadviser. 43 Accordingly, we are adoptingthis item as proposed.

Commenters were divided on whetherwe should require investment advisersto calculate the amount of their assets ina manner consistent with theinstructions for Part 1A in order toavoid confusion. 44 The methodology for

calculating assets required under Part1A is designed for a particular purpose(i.e., for making a determination as towhether an adviser should register withthe Commission or with the states),rather than to convey meaningfulinformation about the scope of theadvisers business. Thus, we arepermitting advisers to use a differentmethodology for Part 2A disclosure. 45 Finally, several commenters urgedthat we permit an adviser to update theamount of assets under managementonly in its annual updating amendmentrather than (as we proposed) at the timean adviser makes an interim update toits brochure if the amount had becomematerially inaccurate. 46 We believe thatour proposal appropriately balanced the

burdens that would be imposed onadvisers by having to amend their

brochures repeatedly with the need toprovide clients with reasonably currentinformation. Therefore, we are adopting

this instruction as proposed.47

Advisersmust update the amount of their assetsunder management annually (as part of their annual updating amendment) andmake interim amendments only formaterial changes in assets undermanagement when they are filing another than annual amendment for aseparate reason. As we have noted, as afiduciary, an adviser has an ongoingobligation to inform its clients of anymaterial information that could affectthe advisory relationship, which couldinclude a material change to assetsunder management. 48


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prospective clients, including in advisory brochures. See, e.g., SEC v. Locke Capital

Management, Inc. and Leila C. Jenkins, LitigationRelease No. 20936 (Mar. 9, 2009) (settled order).49 See Item 5.A of Part 2A.50 See Item 5.B of Part 2A.51 See Item 5.C of Part 2A.52 See Item 5.D of Part 2A. Item 18 of Part 2A also

requires the disclosure of certain financialinformation about an adviser that requiresprepayment of fees.

53 See Item 5.E of Part 2A. Because of this conflictof interest, advisers are required by the antifraudprovisions of the Advisers Act to disclose theirreceipt of transaction-based compensation toclients. We have brought enforcement actionscharging advisers with failures to make suchdisclosures. See, e.g., In the Matter of FinancialDesign Associates, Inc. and Albert L. Coles, Jr.,Investment Advisers Act Release No. 2654 (Sept.25, 2007) (settled order); In the Matter of IMS, CPAs

& Associates, Vernon T. Hall, Stanley E. Hargrave,and Jerome B. Vernazza, Investment Advisers ActRelease No. 1994 (Nov. 5, 2001) (settled order)(petitioners appeal denied in Vernazza v. SEC, 327F.3d 851 (9th Cir. 2003)).

54 See Item 5.E.2 of Part 2A. In addition to therequirement in Item 5.E.2 of Part 2A, an adviser thatreceives more than half of its revenue fromcommissions and other sales-based compensationmust explain that commissions are the firmsprimary (or, if applicable, exclusive) form of compensation. See Item 5.E.3 of Part 2A. An adviserthat charges advisory fees in addition tocommissions or markups to an individual clientmust disclose whether it reduces its fees to offsetthe commissions or markups. See Item 5.E.4 of Part2A.

55 See comment letter of the Certified FinancialPlanner Board of Standards, Inc. (May 29, 2008)(CFP Board Letter ). The ASG Letter, the CFAInstitute Letter, the Lininger Letter, and the NRSLetter also expressed strong support for most of these requirements.

56 See comment letter of Eric A. Brill (Apr. 26,2008) ( Brill Letter ); IAA Letter. The IAA Letterstated that larger firms may have to prepareextremely long fee schedules. They urged theCommission to provide flexibility regarding feeschedule disclosure as long as the fee is fullydisclosed in the advisory contract. One commentersuggested that we amend General Instruction 4,which permits advisers to update any change to itsfee schedules only annually, reasoning thatpotential clients would need this updatedinformation in selecting advisers. See NASAALetter. The exception contained in the instructionis designed to prevent an adviser from having tomake multiple interim amendments as a result of small changes in a fee schedule each of which may

be material only to certain affected clients orprospective clients who would learn of them whenconsidering whether to enter into an advisoryagreement that would reflect a revised fee. On

balance, we believe that an annual update may besufficient.

57 This information may be particularly useful toclients searching for an adviser by comparinginformation on brochures that will be available onthe Internet.

58 See IAA letter; Wellington Letter.59 Qualified purchasers, as defined under

section 2(a)(51)(A) of the Company Act [15 USC80a2(a)(51)(A)], include, among others, naturalpersons who own $5 million or more ininvestments and persons who manage $25 mill ionor more in investments for their account or otheraccounts of other qualified purchasers.

60 See NAPFA Letter; NRS Letter; NSCP Letter.

61 See FSI Letter; Sutherland Letter.62 Moreover, the item is not, in substance,

different from the previous Item 9 of Part 2, which,in recognition of this conflict, required an adviserto disclose whether the adviser effects securitiestransactions for clients. See also supra note 53;Applicability of the Investment Advisers Act toFinancial Planners, Pension Consultants, and OtherPersons Who Provide Investment Advisory Servicesas a Component of Other Financial Services,Investment Advisers Act Release No. 1092 (Oct. 16,1987) [52 FR 38400 (Oct. 16, 1987)] ( Release1092 ).

63 We note that nothing in the Advisers Act

precludes an adviser from accepting transaction- based compensation. However, an adviser thatreceives compensation in connection with thepurchase or sale of securities should carefullyconsider the applicability of the broker-dealerregistration requirements of the Securities ExchangeAct of 1934.

64 As fiduciaries, advisers must disclose allmaterial information regarding any proposedperformance fee arrangements as well as anymaterial conflicts posed by the arrangements. SeeExemption To Allow Investment Advisers ToCharge Fees Based Upon a Share of Capital GainsUpon or Capital Appreciation of a Clients Account,Investment Advisers Act Release No. 1731, atnn.1314 and accompanying text (July 15, 1998) [63FR 39022 (July 21, 1998)].

Item 5. Fees and Compensation. Item5 requires that an adviser describe in its

brochure how it is compensated for itsadvisory services, provide a feeschedule, and disclose whether fees arenegotiable. 49 An adviser must disclosewhether it bills clients or deducts feesdirectly from clients accounts, and howoften it assesses fees (or bills clients). 50 The item also requires each adviser todescribe the types of other costs, suchas brokerage, custody fees and fundexpenses that clients may pay inconnection with the advisory servicesprovided to them by the adviser. 51 Anadviser charging fees in advance mustexplain how it calculates and refundsprepaid fees when a client contractterminates. 52

Item 5 also requires an adviser thatreceives compensation attributable tothe sale of a security or other investmentproduct (e.g., brokerage commissions),or whose personnel receive such

compensation, to disclose this practiceand the conflict of interest it creates,and to describe how the adviseraddresses this conflict. 53 Such anadviser also must disclose that the clientmay purchase the same security orinvestment product from a broker that isnot affiliated with the adviser. 54

Some commenters expressed strongsupport for these disclosurerequirements, with one commenterstating that such disclosure is essentialto a healthy adviser-client

relationship. 55 Others argued generallythat most of the information is notrelevant for many clients, andspecifically that providing a completeset of fee schedules would impose anundue burden on advisers. 56 Wedisagree with commenters who favoreda broad elimination of fee informationfrom the brochure. Information aboutfees is important to clients and can beused to compare fees of differentadvisers. 57 More persuasive, however,were arguments that brochure feeinformation is likely not useful toinstitutional and large, sophisticatedclients who are often in a position tonegotiate fee arrangements with theiradviser and for whom, therefore, a feetable would have little utility. 58 Thesearguments have persuaded us to providean exception which permits an adviserto omit disclosure of its fee scheduleand the other information in Item 5.A inany brochure provided only to clients

who arequalified purchasers.

59

A few commenters urged us to notrequire description of other types of feesor expenses because, among otherthings, such fees may vary significantlyamong clients and disclosure regardingthem may confuse clients. 60 However,this simple and brief disclosure (whichis not required to include the amount orrange of the fees) may be helpful to

investors unacquainted with thepractices of an adviser or the ancillarycosts of actively managed investing.Therefore, we are adopting thisdisclosure requirement, as proposed.

As noted above, Item 5 also requiresan adviser that receives transaction-

based compensation, or whose

personnel receive such compensation,to disclose this practice and the conflictof interest it creates and to describe howthe adviser addresses this conflict. Somecommenters argued that this iteminappropriately implies endorsement of a fee-based compensation structureover a commission-based structure. 61 That is not our intent. The item simplyrecognizes that an adviser that acceptscompensation from the sale to a clientof securities has an incentive to baseinvestment recommendations on theamount of compensation it will receive,rather than on the clients best interests,and thus involves a significant conflictof interest. 62 As a result, we areadopting the requirement as proposed. 63

Item 6. Performance-Based Fees and Side-By-Side Management. Item 6requires an adviser that chargesperformance-based fees or that has asupervised person who manages anaccount that pays such fees to disclosethis fact. If such an adviser also managesaccounts that are not charged aperformance fee, the item also requiresthe adviser to discuss the conflicts of interest that arise from its (or itssupervised persons) simultaneousmanagement of these accounts, and todescribe generally how the adviseraddresses those conflicts. 64


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65 See CFA Institute Letter; Lininger Letter.66 See IAA Letter; Schnase Letter.67 See Proposing Release, at nn.5153 and

accompanying text. An adviser chargingperformance fees to some accounts faces a varietyof conflicts because the adviser can potentiallyreceive greater fees from its accounts having aperformance-based compensation structure thanfrom those accounts it charges a fee unrelated toperformance (e.g., an asset-based fee). As a result,the adviser may have an incentive to direct the bestinvestment ideas to, or to allocate or sequencetrades in favor of, the account that pays aperformance fee. We have brought enforcementactions charging advisers with undisclosed conflicts

in regard to accounts that pay performance fees.See, e.g., In the Matter of Nevis CapitalManagement, LLC, et al., Investment Advisers ActRelease No. 2214 (Feb. 9, 2004) (settled order). Seealso In the Matter of Alliance Capital Management,L.P., Investment Advisers Act Release No. 2205(Dec. 18, 2003) (settled order).

68 According to data derived from investmentadvisers responses to Item 5.E of Part 1A of FormADV reported through IARD as of May 3, 2010,approximately 28% of SEC-registered investmentadvisers reported charging performance-based feesto some accounts but not others.

69 See Sutherland Letter.70 We note that disclosure of this information is

already required in the previous Item 2 of Part 2 of Form ADV.

71 We have brought enforcement actions chargingadvisers with omissions and misrepresentationsregarding investment strategies. See, e.g., In theMatter of George F. Fahey, Investment Advisers ActRelease No. 2196 (Nov. 24, 2003) (settled order); Inthe Matter of Gary L. Hamby and Gary B. Ross,Investment Advisers Act Release No. 1668 (Sept.22, 1997) (settled order).

72 See CFA Institute Letter; Lininger Letter;NAPFA Letter; NRS Letter.

73 See NAPFA Letter.74 For these purposes, we would view a method

of analysis or strategy as significant if more than asmall portion of the advisers clients assets areadvised using the method or strategy.

75 See Proposing Release at Section II.A.2.

76 See comment letter of Gary D. Case (May 12,2008) ( Case Letter ); FSI Letter; IAA Letter;comment letter of ProEquities, Inc. (May 21, 2008)(ProEquities Letter ); comment letter of the TrustAdvisory Group (May 12, 2008) ( TAG Letter ); T.Rowe Price Letter.

77 See ASG Letter; IAA Letter; T. Rowe Letter.78 An adviser that is also registered as a broker-

dealer may also have disclosure obligations relatingto its cash balance practices arising underCommission and self-regulatory organizationrequirements. See NYSE information Memo No. 0511 (Customer Account Sweeps to Banks) (Feb.2005).

79 See Schnase Letter.80 See Items 8.B and 8.C of Part 2A (requiring

disclosure of material risks ).

Two commenters explicitly supportedthis requirement. 65 Two othercommenters urged us to eliminate it,arguing that the required disclosurealready should be in Item 5 (Fees andCompensation) or is required by otheritems. 66 As discussed in the ProposingRelease, an adviser chargingperformance fees to some accounts butnot others faces a variety of conflicts of interest. 67 The number of advisers withthese arrangements has grown, and we

believe that it is important that clientsand prospective clients receivedisclosure regarding these conflicts andhow the adviser addresses them. 68 While Item 5 requires disclosure of anadvisers fee arrangements, it does notspecifically require disclosure of theconflicts any particular fee arrangementmay create other than with respect totransaction-based compensation.

Item 7. Types of Clients. Item 7requires that the brochure describe the

types of advisory clients the firmgenerally has, as well as the firmsrequirements for opening or maintainingan account, such as minimum accountsize. One commenter recommended thatwe eliminate this proposed disclosurerequirement, arguing that theinformation is not material to thedecision of whether to hire or retain aninvestment adviser. 69 We disagree. We

believe that many prospective clientswould consider the type of clients to bean important factor in determiningwhether an advisers business model isa good fit for them. 70 As a result, we areadopting Item 7 as proposed.

Item 8. Methods of Analysis,Investment Strategies and Risk of Loss.

Item 8 requires that advisers describetheir methods of analysis andinvestment strategies and disclose thatinvesting in securities involves risk of loss which clients should be prepared to

bear. 71 Item 8 also requires specificdisclosure of how strategies involvingfrequent trading can affect investmentperformance. Finally, this item requiresthat advisers explain the material risksinvolved for each significant investmentstrategy or method of analysis they useand particular type of security theyrecommend, with more detail if thoserisks are unusual.

Several commenters supported thisproposed disclosure requirement ascentral to the advisers fiduciaryrelationship with its client. 72 Oneobjected, stating that the item creates adifferent disclosure obligation for multi-strategy firms because, as proposed, itonly required advisers primarily using aparticular strategy to discuss the risksinvolved in their strategy. 73 We agreethat advisers should disclose materialrisks associated with their strategies thatwill be relevant to most clients,regardless of whether they use onestrategy or many strategies. We have,therefore, modified the item to requirethat advisers explain the material risksinvolved for each significant investmentstrategy or method of analysis they use,rather than those they primarily use, aswe believe this threshold for disclosure

better captures those methods of analysis or strategies that will berelevant to most clients. 74 However, aswe noted in the proposal, the brochuremay not always be the best place for amulti-strategy adviser to disclose risksassociated with all of its methods of analysis or strategies. 75 Disclosure of that information likely would lengthenthe brochure unnecessarily given thatdifferent clients will be pursuingdifferent strategies, each of which posesspecific and different risks.

Some commenters urged us to definethe term frequent trading of securities, which is used in Item 8.B, but did notsuggest a definition in response to our

request. 76 As commenters implicitlyacknowledged, the phrase frequenttrading is hard to define. We wouldexpect advisers to respond to this itemonly if their intended investmentstrategies involve frequent trading of securities that a reasonable client wouldotherwise not expect in light of theother disclosures contained in the

brochure.Several commenters urged us to notrequire disclosure in the brochure of cash balance practices, arguing thatsuch practices vary widely dependingon the client, are typically addressed inthe clients investment advisoryagreement, and typically do not involveconflicts of interest. 77 We acknowledgethat in many instances such practices donot involve conflicts of interest andhave omitted the requirement from Part2A. We note, however, that an advisermay have an obligation (independent of Part 2A) to disclose material

information about its policies regardingthe management of cash balances wherethe omission of such information wouldconstitute a breach of the advisersfiduciary duty (e.g., where the cash isnot managed in the best interest of theclient). 78

One commenter noted that, asproposed, Items 8.B and 8.C wouldrequire disclosure of all risks associatedwith using a particular investmentstrategy or primarily recommending aparticular type of security, and not justmaterial risks. 79 We intended theseitems to require disclosure only of material risks, and have amended theseitems accordingly. 80 This commenter also noted that Items8.B and 8.C call for detailed discussionsof significant or unusual risks,inquired whether this differed frommaterial risks, and asked forclarification of this terminology. Thisrequirement is intended to elicit fromthe adviser disclosure of significantrisks associated with using a particularinvestment strategy or recommending aparticular type of security thatotherwise would not be apparent to theclient from reading the advisers


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81 Note to Item 9 of Part 2A (explaining fourfactors an adviser should consider when assessingwhether the presumption can be rebutted).

82 Rule 2042(a)(14)(iii).83 See AICPA Letter; Sutherland Letter; Jackson

Letter.84 See supra note 35 for a discussion of

materiality under the Advisers Act. See also the

note at the end of Item 9 of Part 2A and Financialand Disciplinary Information that Investment

Advisers Must Disclose to Clients, InvestmentAdvisers Act Release No. 1035 (Sept. 19, 1986) [51FR 34229 (Sept. 26, 1986)] ( Rule 206(4)4Proposing Release ), at nn.1213 and accompanyingtext. One commenter noted the use of the termcurrently material in Item 9 and asked if thisphrase differed in meaning from material. SeeABA Committees Letter. We did not intend thisphrase to have a different meaning than material and, therefore, we have deleted the wordcurrently in the Item 9 as adopted.

85 See Rule 206(4)4 Proposing Release, at nn. 1213 and accompanying text. The Commission haslong viewed information about a prior disciplinaryproceeding involving an adviser as important toclients and that failure to disclose such aproceeding may violate the antifraud provisions of sections 206(1) and 206(2) of the Advisers Act. Seee.g., In the Matter of Jesse Rosenblum, InvestmentAdvisers Act Release No. 913 (May 17, 1984).

86 See Morgan Stanley Letter; Sutherland Letter.87 See IAA Letter.88 See NASAA Letter; NCS Letter.89 We note that failure to disclose material

information to clients constitutes a violation of section 206 of the Advisers Act. We have broughtenforcement actions charging advisers with failuresto make such disclosures. See, e.g., Colley AssetManagement, Inc., and John E. Colley, InvestmentAdvisers Act Release No. 2363 (Feb. 25, 2005)(settled order).

90 We also note that an adviser is required in Part1A of Form ADV to disclose disciplinary eventsregardless of whether they are material. Part 1A isfiled electronically with the Commission and ispublicly available on our website.

91 See Proposing Release at Section II.A.2. Wealso requested comment in the Proposing Releaseon whether we should require that advisers subjectto a Commission administrative order provideclients with a copy of that order. Commenters didnot support such a requirement and stated that,when appropriate, we should require delivery of orders in individual proceedings. See FederatedLetter; Fried Frank Letter; Morgan Stanley Letter;Sutherland Letter. We agree with commenters andPart 2A does not require that such orders beprovided to advisory clients.

92 See Consumer Federation Letter; CFA InstituteLetter; CFP Board Letter; NASAA Letter.

93 See comment letter from Michael Berlin (Apr.28, 2008) ( Berlin Letter ); Federated Letter; FirstAllied Letter; Fried Frank Letter; IAA Letter; ICILetter; Janus Letter; Mercer Letter; Morgan StanleyLetter; NRS Letter; SIFMA Letter; comment letter of R.C. Verbeck (May 12, 2008) ( Verbeck Letter ).

94 We note that failure to disclose materialinformation to clients constitutes a violation of section 206 of the Advisers Act.

95 See the Glossary to Form ADV.96 See Federated Letter; IAA Letter; Morgan

Stanley Letter.

brochure. An adviser that describes awide range of investment advisoryactivities in its brochure but, in fact,specializes, for example, in investing inleveraged exchange-traded funds shoulddisclose such information in response tothis item.

Item 9. Disciplinary Information. Item9 requires that an adviser disclose in its

brochure material facts about any legalor disciplinary event that is material toa clients (or prospective clients)evaluation of the integrity of the adviseror its management personnel. Theserequirements incorporate into the

brochure the client disclosure regardingdisciplinary information required byrule 206(4)-4 under the Advisers Act.

Items 9.A, B, and C provide a list of disciplinary events that arepresumptively material if they occurredin the previous 10 years. Item 9 cautionsadvisers, however, that the events listedin that item are those that are presumedto be material and do not constitute anexhaustive list of material disciplinaryevents. The list includes anyconvictions for theft, fraud, bribery,perjury, forgery, counterfeiting,extortion and violations of securitieslaws by the adviser or one of itsexecutives. Events such as these reflecton the integrity of the adviser and itsmanagement personnel and, therefore,are presumptively material to clients.The adviser may rebut thispresumption, in which case nodisclosure to clients is required. 81 Anadviser rebutting this presumption mustdocument its determination in amemorandum and retain that record toenable our staff to monitor compliancewith this important disclosurerequirement. 82

As required by rule 206(4)4, Item 9requires that disciplinary events morethan 10 years old be disclosed if theevent is so serious that it remainsmaterial to a clients or prospectiveclients evaluation of the adviser and theintegrity of its management. Threecommenters requested that theCommission further define and clarifywhat disciplinary information ismaterial in these circumstances. 83 We

have determined not to do so, however,as advisers should evaluate theirobligations to disclose information toclients under existing materialitystandards adopted by the courts and theCommission. 84 We note that a prior

disciplinary event involving an adviserwould be important to clients for manyreasons, including how it may reflectupon the advisers integrity, the effect itmay have on the degree of trust andconfidence a client would place in theadviser, or if it imposed limitations onan advisers activities. 85

Two other commenters addressed therebuttable presumption of materialityunder Item 9. 86 One commentersupported the flexibility of allowingadvisers to rebut the presumption of materiality. 87 Other commenterssuggested, however, that an advisershould not be permitted to rebut thispresumption, stating that this wouldgive advisers little incentive to disclosedisciplinary information that may beconsidered material. 88 We note that anadviser, as a fiduciary, has an obligationto disclose material information toclients. 89 We believe that the legalconsequences that flow from its failure

to meet this obligation provide anincentive for an adviser to disclosematerial disciplinary information.Moreover, advisers that seek to excludeinformation from their brochures

because they believe that they can rebutthe presumption of materiality mustmemorialize the basis for thatdetermination, which is subject toreview by our staff. 90

In the Proposing Release, werequested comment on whether weshould require disclosure about

arbitration awards and claims. 91 A fewcommenters supported arbitrationdisclosure, arguing that investorsdeserve the most complete informationavailable to build a picture of anadvisers integrity. 92 Others objected,with some reasoning that arbitrationclaims are easy to make and thatarbitration settlements and awards maynot necessarily include findings of wrongdoing (i.e., parties may settlearbitration proceedings and/orarbitration awards may be granted evenin the absence of legal violations). 93 Forthis reason, we have determined not torequire disclosure of arbitration awardsin the client brochure. Advisers should,however, carefully consider whetherparticular arbitration awards orsettlements do, in fact, involve orimplicate wrongdoing and/or reflect onthe integrity of the adviser, and should

be disclosed to clients in the brochureor through other means. 94 Because

many disputes involving securitiesfirms (including investment advisers)are resolved through arbitration or othermethods of alternative disputeresolution, we will continue to assesswhether we should require that theseevents be reported by firms registeredwith us.

Item 9 requires that an adviser mustdisclose if it (or any of its managementpersons) has been involved in one of theevents listed in that item. Involved isdefined as [e]ngaging in any act oromission, aiding, abetting, counseling,commanding, inducing, conspiring withor failing reasonably to superviseanother in doing an act. 95 Threecommenters requested that we narrowthe definition of involved, arguing thatthe proposed definition is bothoverbroad and vague. 96 Othercommenters supported using the term


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97 See CFA Institute Letter; NASAA Letter.98 See NASAA Letter.99 See Amendments to Form ADV, Investment

Advisers Act Release No. 1897 (Sept. 12, 2000) [65FR 57438 (Sept. 22, 2000)]; Form BD Amendments,Securities Exchange Act Release No. 37431 (July 12,1996) [61 FR 37357 (July 18, 1996)].

100 See comment letter of the AlternativeInvestment Management Association (May 16,2008) ( AIMA Letter ); ASG Letter; Janus Letter;Morgan Stanley Letter; NRS Letter; SIFMA Letter;Sutherland Letter.

101 Consumer Federation Letter.102 See Form ADV: Glossary. Firm employees that

perform only clerical, administrative, support, orsimilar functions are excluded from the definition.

103 In addition to requiring disclosure of certaindisciplinary information, rule 206(4)4 requires anadviser to disclose certain financial information toclients. As with the disciplinary disclosure, wehave incorporated this requirement into the new

brochure. Similar to rule 206(4)4(a)(1), Item 18.Bof Part 2A requires certain advisers to disclose anyfinancial condition that is reasonably likely toimpair their ability to meet contractualcommitments to clients. See infra note 177 andaccompanying text.

104 See infra Section V.105 Our requirements regarding to which clients

an adviser must deliver a brochure are discussed inSection II.A.3 below. One commenter suggested thatwe retain rule 206(4)4 to require only the deliveryof disciplinary information to clients for whom the

brochure delivery requirement does not apply. SeeABA Committees Letter.

106

See Financial and Disciplinary Informationthat Investment Advisers Must Disclose to Clients,Investment Advisers Act Release No. 1035 (Sept.19, 1986) ( Rule 206(4)4 Adopting Release )(explaining that rule 206(4)4 was designed tocodify an investment advisers fiduciary obligationto disclose material financial and disciplinaryinformation to clients. ). We have broughtenforcement actions charging advisers with failuresto make such disclosures. See, e.g., In the Matter of Veritas Financial Advisors LLC, Veritas Advisors,Inc., Patrick J. Cox and Rita A. White, InvestmentAdvisers Act Release No. 2577 (Dec. 29, 2006)(settled order); In the Matter of Harry MichaelSchwartz, Investment Advisers Act Release No.1833 (Sept. 27, 1999) (settled order); In the Matterof Renaissance Capital Advisors, Inc., and Richard

N. Fine, Investment Advisers Act Release No. 1688(Dec. 22, 1997) (settled order). In addition, undersection 9(a) of the Company Act [15 USC 80a9(a)]an investment adviser to a registered investmentcompany may be prohibited from serving in certaincapacities with the fund as a result of a disciplinaryevent.

107 This item is similar to Item 8 of the previousPart 2. Two commenters requested that we clarifyor provide guidance regarding materiality indescribing relations and arrangements with relatedpersons, and conflicts of interest arising from theserelations or arrangements. See IAA Letter; NRSLetter. We address this comment earlier in thisRelease. See supra note 35 for a further discussionof materiality under the Advisers Act.

108 We have brought enforcement actions chargingadvisers with failures to make such disclosures.See, e.g., In the Matter of Morgan Stanley & Co.,Incorporated, Investment Advisers Act Release No.2904 (July 20, 2009) (settled order); In the Matterof Yanni Partners, Inc. and Theresa A. Scotti,Investment Advisers Act Release No. 2642 (Sept. 5,2007) (settled order).

109 See CFA Institute Letter; Lininger Letter.110 See Sutherland Letter.111 This requirement is almost identical to the

previous disclosure requirement in Item 9 of theprevious Part 2.

involved, as defined. 97 One of thesecommenters noted that this term also isused in Form BD and in Form U4 and,as such, changing the meaning of theterm (or eliminating it from Part 2A)would undermine uniformity and createdisparate reporting between broker-dealers and advisers. 98 We believe that,for purposes of consistency, it isappropriate to continue to define theterm involved as currently defined inForm ADV. This term and definition has

been used in Form ADV for over 9 yearsand on Form BD for over 14 years, andwe believe its meaning should be wellunderstood. 99

Some commenters recommended thatadvisers be permitted to satisfy theobligation to disclose and updatedisciplinary events by referring clientsto the Investment Adviser PublicDisclosure system (IAPD) to obtain thefirms disclosures from Part 1A of FormADV and providing a copy of the

disciplinary disclosures to clients whodo not have Internet access. 100 Onecommenter strongly opposed thisrecommendation, however, stating that[a]rming investors with thisinformation is one of the best tools wehave to put investors on their guard sothat they can protect their owninterests. 101

The disciplinary informationprovided in Part 1A is provided to theCommission primarily for registrationpurposes and not with an eye towardsclient disclosure. Part 1A, therefore,requires disclosure not just about theadvisory firm and its managementpersonnel, but also about all of itsadvisory affiliates. A firms advisoryaffiliates include all of the firmsemployees, officers, partners, ordirectors and all persons directly orindirectly controlling or controlled bythe firm. 102 Having disciplinaryinformation about this broad group isimportant to the Commission forregulatory purposes. However, many of the largest investment advisers mayhave a large number of advisoryaffiliates and voluminous disciplinarydisclosure, much of which may be

regarding advisory affiliates with norelationship to particular clients.Accordingly, we believe that requiringclients to sift through an advisory firmsPart 1A disciplinary disclosure is notthe most effective client disclosure.Therefore, we are adopting the proposedrequirement that the brochureaffirmatively disclose disciplinaryinformation about the adviser and itsmanagement personnel.

Because Part 2A, as amended,incorporates disciplinary disclosuresformerly required by rule 206(4)4directly in the advisory brochurerequirements, we are rescinding rule206(4)4. 103 The rescission of rule206(4)4 will be effective, with respectto any particular investment adviser, onthe date by which that adviser mustdeliver its narrative brochure to existingclients and begin delivering its brochureto prospective clients under the rule andform amendments we are adopting

today.104

Some advisers, however, mayhave clients to whom they are notrequired to deliver a brochure, such ascertain clients receiving onlyimpersonal investment advice or thosethat are registered investmentcompanies and business developmentcompanies. 105 For these advisers, theirfiduciary duty of full and fair disclosurerequires them to continue to disclose toall their clients material disciplinaryand legal events and their inability tomeet contractual commitments to theirclients. 106

Item 10. Other Financial Industry Activities and Affiliations. Item 10requires each adviser to describe in its

brochure material relationships orarrangements the adviser (or any of itsmanagement persons) has with relatedfinancial industry participants, anymaterial conflicts of interest that theserelationships or arrangements create,and how the adviser addresses theconflicts. 107 In addition, if an adviserselects or recommends other advisersfor clients, Item 10 requires that itdisclose any compensationarrangements or other businessrelationships between the advisoryfirms, along with the conflicts created,and explain how it addresses theseconflicts. 108 The disclosure that Item 10requires highlights for clients theiradvisers other financial industryactivities and affiliations that can createconflicts of interest and may impair theobjectivity of the advisers investment

advice.Two commenters explicitly stated thatthey supported the disclosure required

by this item. 109 At the suggestion of onecommenter, 110 we have modified Item10.D to require advisers that recommendother advisers to disclose, in particular,payments or business relationships thatcreate material conflicts of interest withclients, so as not to capture allrelationships.

Item 11. Code of Ethics, Participationor Interest in Client Transactions and Personal Trading.

Code of Ethics. Item 11 requires eachadviser to describe briefly its code of ethics and state that a copy is availableupon request. 111 Two commentersstrongly supported the proposed item,

believing the required disclosure is


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112 See CFA Institute Letter; CFP Board Letter.113 See Morgan Stanley Letter.114 This summary should not be a reiteration of

the entire code of ethics, but rather should provideenough information for the client to determine if itwould like to read the full code of ethics and tounderstand generally the advisers ethical cultureand standards, how the adviser controls sensitiveinformation, and what steps it has taken to preventemployees from misusing their inside positions atclients expense. See Investment Adviser Code of Ethics, Investment Advisers Act Release No. 2256(July 2, 2004), at text accompanying notes nn.6667 [69 FR 41696 (July 9, 2004)].

115 An advisers related persons are: (1) Theadvisers officers, partners, or directors (or anyperson performing similar functions); (2) all personsdirectly or indirectly controlling, controlled by, orunder common control with the adviser; (3) all of the advisers current employees; and (4) any personproviding investment advice on the advisers

behalf. See Form ADV: Glossary. Items 11.B, 11.C,and 11.D are similar to Item 9 of the previous Part2.

116 We have brought enforcement actions chargingadvisers with failures to make such disclosures.See, e.g., In the Matter of Thomson McKinnon AssetManagement, L.P., Investment Advisers Act ReleaseNo. 1243 (July 26, 1990) (settled order).

117 We have brought enforcement actions chargingadvisers with failures to make such disclosures.See, e.g., In the Matter of Chancellor CapitalManagement, Inc., et al., Investment Advisers ActRelease No. 1447 (Oct. 18, 1994) (settled order).

118 See CFA Institute Letter; CFP Board Letter.

119 See IAA Letter; ICI Letter; T. Rowe Letter.120 We have brought enforcement actions charging

advisers with fraudulent personal trading. See Inthe Matter of Roger W. Honour, InvestmentAdvisers Act Release No. 1527 (Sept. 29, 1995)(settled order).

121 We have brought enforcement actions chargingadvisers with inaccurate disclosure in this context.See, e.g., In the Matter of Hutchens InvestmentManagement and William Hutchens, InvestmentAdvisers Act Release No. 2514 (May 9, 2006)(settled order).

122 See comment letter of Thaddeus Borek, Jr.(May 16, 2008).

123 See Code of Ethics Adopting Release, supranote 114 at n.42 and accompanying text.

124 See Proposing Release, supra note 2, at n.85.125

Item 12 is similar to It em 12.B in the previousPart 2.126 Section 28(e) of the Exchange Act provides a

limited safe harbor for advisers with discretionaryauthority in connection with their receipt of softdollar benefits. Under section 28(e), a person whoexercises investment discretion over a clientaccount has not acted unlawfully or breached afiduciary duty solely by causing the account to paymore than the lowest commission rate available, solong as that person determines in good faith that thecommission amount is reasonable in relation to thevalue of the brokerage and research servicesprovided. Advisers must disclose their receipt of soft dollar benefits to clients, regardless of whetherthe benefits fall inside or outside of the safe harbor.See Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act of 1934and Related Matters, Exchange Act Release No.23170 (Apr. 23, 1986) [51 FR 16004 (Apr. 30,1986)], at n.33 and accompanying text.

127 According to IARD data as of May 3, 2010,approximately 61% of advisers registered with theCommission report on Form ADV, Part 1A, Item 8.Ethat they or related persons receive soft dollar

benefits in connection with client transactions.128 Commission Guidance Regarding Client

Commission Practices Under Section 28(e) of theSecurities Exchange Act of 1934, Exchange ActRelease No. 54165 (July 18, 2006) [71 FR 41978(July 24, 2006)] ( 2006 Soft Dollar Release ) ([u]seof client commissions to pay for research and

brokerage services presents money managers withsignificant conflicts of interest, and may giveincentives for managers to disregard their bestexecution obligations when directing orders to

indicative of an advisers commitmentto its fiduciary duties. 112 Onerecommended that we instead simplyrequire an adviser to note in the

brochure that a copy of its code of ethicsis available upon request. 113 We believethat a brief, concise summary of thecode of ethics (as the item requires) will

be helpful to prospective clients whomay not wish or feel the need to requestthe entire code of ethics and will assistthose clients in determining whetherthey would like to read the entire codeof ethics. 114

Participation or Interest in ClientTransactions. If the adviser or a relatedperson recommends to clients, or buysor sells for client accounts, securities inwhich the adviser or a related personhas a material financial interest, Item11.B requires the brochure to discussthis practice and the conflicts of interestpresented. 115 Conflicts could arise, forexample, when an adviser recommends

that clients invest in a pooledinvestment vehicle that the firm advisesor for which it serves as the generalpartner, 116 or when an adviser with amaterial financial interest in a companyrecommends that a client buy shares of that company. 117 The item requiresadvisers to disclose any practices givingrise to these conflicts, the nature of theconflicts presented, and how the adviseraddresses the conflicts. Twocommenters expressed support for thisrequirement. 118 We are adopting Item11.B. substantially as proposed, exceptthat at the suggestion of three

commenters, we have omitted theportion of the proposed item thatrequired advisers to discloseprocedures for making the disclosuresto clients. 119 We agree with thesecommenters that the requirement wasinconsistent with the Commissionsgeneral approach throughout the

brochure of requiring disclosure aboutconflicts and how they are addressed,

but not about procedures. Personal Trading. Items 11.C and 11.D

require disclosure of personal trading bythe adviser and its personnel. 120 Item11.C requires an adviser to disclosewhether it or a related person (e.g.,advisory personnel) invests (or ispermitted to invest) in the samesecurities that it recommends to clients,or in related securities (such as optionsor other derivatives). If so, the brochuremust discuss the conflicts presented anddescribe how the firm addresses theconflicts. Item 11.D requires a similardiscussion, but focuses on the specificconflicts an adviser has when it or arelated person trades in the samesecurities at or about the same time asa client. 121 In response to this item, anadviser should explain how its internalcontrols, including its code of ethics,prevent the firm and its staff from

buying or selling securitiescontemporaneously with clienttransactions.

One commenter suggested that wespecify a minimum amount of assetsthat must be managed by an adviser inorder for that adviser to be required todisclose personal securitiestransactions, arguing that small firmssecurities transactions are not largeenough to generate a market impact andthus should not require disclosure. 122 We disagree. A small firm could stillplace a trade large enough to have amarket impact, especially in a thinlytraded security. In addition, given thatan advisers ability to place its owntrades before or after client trades in thesame security may affect the objectivityof the advisers recommendations, we

believe disclosure of this practice iswarranted. As a result, we are adopting

Items 11.C and 11.D as proposed.

Finally, we note that we havemodified the note to Item 11 to clarifythat Items 11.B, 11.C, and 11.D wouldnot require disclosure with respect tosecurities that are not reportablesecurities under Advisers Act rule204A1(e)(10), such as shares inunaffiliated mutual funds. 123 As weindicated in the Proposing Release, suchsecurities are not reportable underAdvisers Act Rule 204A1 because theyappear to present little opportunity forfront-running. 124

Item 12. Brokerage Practices. Item 12requires that advisers describe how theyselect brokers for client transactions anddetermine the reasonableness of brokerscompensation. This item also requiresadvisers to disclose how they addressconflicts of interest arising from theirreceipt of soft dollar benefits (i.e.,research or other products or servicesthey receive in connection with client

brokerage). 125 Soft Dollar Practices. Many advisers

receive brokerage and research servicesin reliance on section 28(e) of theSecurities Exchange Act of 1934(Exchange Act ),126 as well as other softdollar products and services provided

by brokers in connection with clienttransactions. 127 Use of client securitiestransactions to obtain research and other

benefits creates incentives that result inconflicts of interest between advisersand their clients. 128 Because of these


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obtain client commission services as well as totrade client securities inappropriately in order toearn credits for client commission services ).

129 See Item 12 of the previous Part 2.130 See Item 12.A.1 of Part 2A.131 See note to Item 12.A.1.e of Part 2A.132 See Item 12.A.1. An adviser accepting soft

dollar benefits must explain that (a) the adviser benefits because it does not have to produce or payfor the research or other products or servicesacquired with soft dollars, and (b) the advisertherefore has an incentive to select or recommend

brokers based on the advisers interest in receivingthese benefits, rather than on the clients interest ingetting the most favorable execution. See Item12.A.1.a and b of Part 2A.

133 Paying up refers to an adviser causing aclient account to pay more than the lowest availablecommission rate in exchange for soft dollarproducts or services.

134 See comment letter of the Council of Institutional Investors (May 16, 2008) ( CII Letter );CFA Institute Letter; NRS Letter; comment letter of Carolina Capital Markets, Inc. (Aug. 8, 2008).

135 See, e.g., comment letter of the Alliance inSupport of Independent Research (May 16, 2008)(Alliance Letter ); CAPIS Letter; IAA Letter; ICILetter; comment letter of Pickard and Djinis LLP(May 14, 2008) ( Pickard Letter ); SIFMA Letter; T.Rowe Letter.

136 See Alliance Letter; CAPIS Letter; IAA Letter;ICI Letter; Pickard Letter.

137 See Alliance Letter; CAPIS Letter; IAA Letter;ICI Letter.

138 See Alliance Letter; IAA Letter; ICI Letter;SIFMA Letter.

139 See 2006 Soft Dollar Release, supra note 128,at nn.46 and accompanying text.

140 We have brought enforcement actions chargingadvisers with not adequately disclosing soft dollararrangements and related conflicts. See, e.g., In theMatter of Schultze Asset Management LLC and

George J. Schultze, Investment Advisers Act ReleaseNo. 2633 (Aug. 15, 2007) (settled order); In theMatter of Rudney Associates, Inc. et al., InvestmentAdvisers Act Release No. 2300 (Sept. 21, 2004)(settled order).

141 Item 12.B. of the previous Part 2 required, forexample, that the adviser describe the factorsconsidered in selecting brokers and determining thereasonableness of their commissions. In addition, if the value of products, research and services givento the adviser is a factor in selecting brokers, theadviser was required to, among other things,describe whether clients may pay commissionshigher than those obtainable from other brokers inreturn for those products and services.

142 Item 12.A.2 of Part 2A.143 See Item 13.B. of the previous Part 2.

144 We have brought enforcement actions chargingadvisers with failing to disclose to clients that theydirected their brokerage commissions in return forclient referrals. See, e.g., In the Matter of FleetInvestment Advisors, Inc., Investment Advisers ActRelease No. 1821 (Sept. 9, 1999) (settled order).

145 See Item 12.A.3.b of Part 2A. As we discussedin the Proposing Release, clients sometimes instructtheir adviser to send transactions to a specific

broker-dealer for execution. Clients may initiate thistype of arrangement for a variety of reasons, suchas favoring a family member or friend orcompensating the broker-dealer indirectly forservices it provides to the client. But thearrangement also may be initiated by the adviser,

who may benefit, for example, when brokerage isdirected to its affiliated broker-dealer. In eithercase, clients directing (or agreeing to direct)

brokerage need to understand the consequences of directing brokerage, including the possibility thattheir accounts will pay higher commissions andreceive less favorable execution.

146 See Item 12.A.3.a of Part 2A. We have broughtenforcement actions charging advisers with failuresto make such disclosures. See also In the Matter of Callan Associates, Investment Advisers Act ReleaseNo. 2650 (Sept. 19, 2007) (settled order); In theMatter of Jamison, Eaton & Wood, Inc., InvestmentAdvisers Act Release No. 2129 (May 15, 2003)(settled order).

147 See note to Item 12.A.2 of Part 2A.148 See CII Letter.

conflicts, we have long requiredadvisers to disclose their policies andpractices with respect to their receipt of soft dollar benefits in connection withclient securities transactions. 129

Item 12 requires an adviser thatreceives soft dollar benefits inconnection with client securitiestransactions to disclose its practices. 130 The description must be specific enoughfor clients and prospective clients tounderstand the types of products orservices the adviser is acquiring andpermit them to evaluate associatedconflicts of interest. Disclosure must bemore detailed for products or servicesthat do not qualify for the safe harbor insection 28(e) of the Exchange Act, suchas services that do not aid in theadvisers investment decision-makingprocess. 131

Item 12 also requires that an adviserdiscuss in its brochure the types of conflicts it has when it accepts softdollar benefits and explain how itaddresses those conflicts. 132 The itemrequires the adviser to explain whetherit uses soft dollars to benefit all clientaccounts or only those accounts whose

brokerage pays for the benefits, andwhether the adviser seeks to allocate the

benefits to client accountsproportionately to the soft dollar creditsthose accounts generate. The item alsorequires the adviser to explain whetherit pays up for soft dollar benefits. 133

Some commenters, including oneassociation representing more than 130pension funds, expressed their strongsupport for the soft dollar disclosurerequirement. 134 Other commentersobjected to various portions of thisitem. 135 Some of these commenters

recommended elimination of theproposed requirements to disclosewhether an adviser allocates soft dollar

benefits to client accountsproportionately to the brokerage creditsthose accounts generate, 136 and todisclose the procedures it uses todirect client transactions to a particular

broker-dealer. 137 Some of thesecommenters also questioned theconflicts we identified and expressedconcern that the item will tend to createa misleading impression that the use of soft dollar arrangements is harmful. 138

There are significant conflictsassociated with soft dollararrangements. Section 28(e) wasenacted, in part, to address them. 139 Weare not taking a view on the proprietyof soft dollar arrangements, but ratherare requiring full disclosure of arrangements that involve significantconflicts of interest. 140 Moreover,disclosure required by Item 12 is similar

to disclosure requirements previouslyrequired in Part 2 of Form ADV. 141 Weare adopting this requirement asproposed.

Client Referrals. If an adviser usesclient brokerage to compensate orotherwise reward brokers for clientreferrals, it also must disclose thispractice, the conflicts of interest itcreates, and any procedures the adviserused to direct client brokerage toreferring brokers during the last fiscalyear (i.e., the system of controls used bythe adviser when allocating

brokerage). 142 Part 2 previously requiredthat advisers disclose thesearrangements, but did not specificallyrequire that the description discuss theconflicts of interest created. 143 We didnot receive any comments relating to

this item and are adopting therequirement as it was proposed so thatclients are aware that their adviser mayhave a bias toward referring brokers, asignificant conflict of interest. 144

Directed Brokerage. Item 12 requiresan adviser that permits clients to direct

brokerage to describe its practices inthis area. Item 12 also requires that suchan adviser explain that it may be unableto obtain the most favorable executionof client transactions if the client directs

brokerage and that directing brokeragemay be more costly for clients. 145 If,however, an adviser routinelyrecommends, requests or requiresclients to direct brokerage, Item 12 alsorequires the adviser to describe thispractice in its brochure, to disclose thatnot all advisers require directed

brokerage, and to describe anyrelationship with a broker-dealer towhich the brokerage may be directedthat creates a material conflict of

interest.146

An adviser may omitdisclosure regarding its inability toobtain best execution if directed

brokerage arrangements are onlyconducted subject to the advisersability to obtain best execution. 147

Two commenters addressed thisrequirement. One, representing pensionfunds, endorsed our proposal assupporting transparency in brokeragearrangements. 148 The other urged thatwe broaden the proposed exception inthe item to all directed brokerage subjectto best execution, whetherrecommended by the adviser or directed

by the client. The commenter pointedout that such client-imposed limitationson direction of brokerage should


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149 See Alliance Letter.150 See NRS Letter.151 See IAA Letter.152 See Fried Frank Letter.153 See Schnase Letter.154 Item 13 is similar to I tem 11 in the previous

Part 2.155 See CFA Institute Letter

Final Rule Notice

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