New Changes from the SEC

with co-authors Eric Wagner and Joseph Iskowitz

On August 25, 2016, the Securities and Exchange Commission (“SEC”) adopted amendments to Form ADV and to certain rules promulgated under the Investment Advisers Act of 1940, as amended (“Advisers Act”).[1] The effective date of these amendments is October 31, 2016, but the compliance date is not until October 1, 2017, and many advisers will not be required to use the amended Form ADV until March 31, 2018.

Separately Managed Accounts

Separately managed accounts (“SMAs”) are advisory accounts other than pooled investment vehicles (such as private funds). Form ADV currently collects detailed information about private funds that advisers manage, but little specific information about SMAs. Form ADV has now been amended to collect information on an aggregate level about SMAs:

• Categories of Assets.  An adviser will now be required to report the approximate percentage of its SMA regulatory assets under management (“RAUM”), and the number of its SMA clients (or fewer than five, if between one and four), that are invested in 12 broad asset categories.[2]  An adviser with at least $10 billion in RAUM attributable to SMAs will be required to report, on an annual basis, both mid-year and end-of-year percentages, while an adviser with less than $10 billion in RAUM attributable to SMAs will be required to report only end-of-year percentages.
• Borrowings and Derivatives.  An adviser to SMAs will be required to disclose information regarding the use of borrowings and derivatives in those accounts by reporting their gross notional values and their gross notional exposures.  An adviser with at least $500 million but less than $10 billion in SMA RAUM will be required to report the amount of SMA RAUM and the dollar amount of borrowings attributable to those assets that correspond to three levels of gross notional exposures ((i) less than 10 percent, (ii) 10-149 percent and (iii) 150 percent or more). An adviser with at least $10 billion in SMA RAUM will be required to report this information as well as the gross notional derivatives exposure of its SMAs corresponding to the foregoing three levels and further divided across six derivatives categories.[3]  Advisers are not required to report information about individual SMAs of less than $10 million.
• Custodians.  An adviser will be required to identify any custodians that account for at least 10 percent of its SMA RAUM, and the amount of its RAUM attributable to SMAs held at the custodian.

Umbrella Registration

The SEC has also adopted amendments to Form ADV that codify “umbrella registration” for certain advisers to private funds that, for a variety of tax, legal and regulatory reasons, are organized as a group of related advisers that are separate legal entities but effectively operate as — and appear to investors and regulators to be — a single advisory business.

In 2012, the SEC staff provided guidance and conditions under which the staff believed one adviser (the “Filing Adviser”) could file a single Form ADV on behalf of itself and other advisers that were controlled by or under common control with the Filing Adviser (each, a “Relying Adviser”), provided that they conducted a single advisory business.[4]  With these amendments to Form ADV, the SEC has now largely codified the guidance and conditions under which umbrella registration is permitted:

1. The Filing Adviser and each Relying Adviser advise only private funds and clients in SMAs that are qualified clients and are otherwise eligible to invest in the private funds and whose SMAs pursue investment objectives and strategies that are substantially similar to the private funds.
2. The principal office and place of business of the Filing Adviser is in the United States.
3. Each Relying Adviser, its employees and the persons acting on its behalf are subject to the Filing Adviser’s supervision and control.
4. The advisory activities of each Relying Adviser are subject to the Advisers Act and the rules thereunder, and each Relying Adviser is subject to examination by the SEC.
5. The Filing Adviser and each Relying Adviser operate under a single code of ethics and a single set of written policies and procedures administered by a single chief compliance officer (“CCO”).

Based on the foregoing conditions, note that the following related advisers are not eligible for umbrella registration:

1. Filing Advisers that are non-U.S. persons, regardless if their Relying Advisers are U.S.- or non-U.S. persons.
2. Exempt reporting advisers, regardless if the exempt reporting adviser is the Filing Adviser or the Relying Adviser.
3. Related advisers with similar (but not a single) code of ethics and policies administered by multiple CCOs, even if operating under a common compliance regime.[5]
4. Related advisers that do not advise private funds.
5. Related advisers that do not each have an independent basis to register with the SEC (each Filing Adviser and each Relying Adviser must separately have sufficient RAUM to register with the SEC without consolidation with its related advisers).[6]
6. Advisers with non-qualified clients in SMAs.

For eligible related advisers, umbrella registration is not mandatory — it is optional.  To satisfy the requirements of Form ADV while using umbrella registration, the Filing Adviser is required to file a single Form ADV (Parts 1 and 2) that includes all information concerning the Filing Adviser and each Relying Adviser.  The amendments to the Form ADV instructions specify the Form ADV questions that should be answered solely with respect to the Filing Adviser and those that require the Filing Adviser to answer on behalf of itself and its Relying Adviser(s).  In addition, a new schedule to Form ADV Part 1A — Schedule R — must be filed for each Relying Adviser.  Schedule R requires identifying information, basis for SEC registration and ownership information about each Relying Adviser.

Finally, a new question has been added to Form ADV that requires advisers to identify the Filing Advisers and Relying Advisers that manage or sponsor private funds reported on Form ADV.

Other Notable Amendments to Form ADV

In addition to the amendments to Form ADV discussed above, the SEC has adopted a number of other amendments to Form ADV relating to information the SEC requests from advisers about their (i) identities (e.g., their CIK Numbers, social media accounts and numbers and locations of offices); (ii) advisory businesses (e.g., types of clients, accounts and programs); and (iii) private funds that they manage (e.g., PCAOB numbers of their auditors).  Some of the more notable amendments to Form ADV in these categories include:

• Chief Compliance Officer.  An adviser is currently required to provide the name and contact information for its CCO. An adviser will now also be required to report whether its CCO is compensated or employed by any person other than the adviser (or a related person of the adviser) for providing CCO services to the adviser, and if so, to report the name and IRS Employer Identification Number (if any) of that other person (unless that other person is a registered investment company that is advised by the adviser).
• Qualified Client Reporting.  An adviser to a “3(c)(1)” private fund will now be required to report whether it limits sales of the fund to “qualified clients” within the meaning of the Advisers Act.

Amendments to Books and Records Rule

The SEC has also adopted two amendments to the Advisers Act books and records rule that will require advisers to maintain additional materials related to the calculation and distribution of performance information:

• Performance Records.  Advisers are currently required to maintain records supporting performance claims in written communications that are distributed to ten or more persons.  Advisers will now be required to maintain records supporting performance claims in written communications with even a single person.
• Performance Communications.  Advisers are currently required to maintain certain categories of written communications (generally related to (i) recommendations or advice, (ii) movement of funds or securities, and (iii) placement or execution of securities orders).  Advisers will now also be required to maintain written communications relating to performance claims.

These amendments relating to performance records and written communications will apply to written communications distributed after October 1, 2017. Advisers that distribute written communications after this date that include performance information, including information on performance that predates October 1, 2017, will be required to maintain records that demonstrate the calculation of the performance.

Effective and Compliance Dates

The effective date of the amendments is October 31, 2016, but the compliance date is not until October 1, 2017.  Any adviser filing an initial Form ADV or an amendment to an existing Form ADV on or after October 1, 2017 will be required to use the amended Form ADV.  An existing adviser that does not need to file an other-than-annual amendment after October 1, 2017 will not be required to use the amended Form ADV until it files its regular annual updating amendment as late as March 31, 2018.