Considerations for the Home Stretch of Form ADV Updates for 2024
On October 26, 2023, the Division of Investment Management of the US Securities and Exchange Commission (the “Division” and the “SEC” or “Commission,” respectively) updated the “Frequently Asked Questions on Form ADV and IARD” (FAQs) to provide additional guidance from Division staff regarding specific questions concerning Form ADV as well as the IARD system. Although the October FAQ updates addressed both procedural and substantive matters, this Legal Update focuses on certain of the substantive FAQ updates, in anticipation of the upcoming deadline for many investment advisers’ annual Form ADV updates at the end of March of this year.
Form ADV: Item 1.B(1) - Business Names
The Division added a new FAQ regarding whether an adviser is required to list the names under which its supervised persons primarily conduct advisory business relating to the adviser, if different from the name listed in Item 1.A.
The answer is yes. The Division stated that advisers are required to disclose all names under which they primarily conduct their advisory business, and, accordingly, this list should include the names of all businesses through which the adviser's supervised persons, investment adviser representatives, and independent contractors falling under the Form ADV glossary definition of "employee" primarily conduct advisory business on behalf of the adviser, if different from Item 1.A.
Form ADV: Item 2.A.(8) – Related Adviser Exemption
The Division added a new FAQ regarding the related adviser exemption in Advisers Act Rule 203A-2(b). For an investment adviser that meets the requirements of this exemption (i.e., the adviser controls, is controlled by, or is under common control with an investment adviser that is eligible to register, and is registered with, the SEC, and the advisers share a principal office and place of business), the query was whether the adviser needs to meet any threshold amount of regulatory assets under management to register pursuant to the related adviser exemption.
The answer from the Division is no: The related adviser exemption does not require a particular amount of regulatory assets under management.
Form ADV: Item 2.A.(9) – The 120-Day Rule
The Division added two new FAQs about the 120-day rule for investment advisers registered under Advisers Act Rule 203A-2(c).
In the first FAQ, the query was whether the rule allows for any extensions beyond the initial 120-day period. The Division answered no: There are no extensions beyond the 120 days. The Division then offered some guidance as to what to do in this circumstance:
- If an adviser remains registered after the 120-day period expires, the staff recommends correcting registration eligibility “promptly” by filing an other-than-annual amendment to Form ADV, indicating the new basis for registration, or withdrawing the registration using Form ADV-W.
- The adviser cannot correct registration eligibility by selecting Form ADV Item 2.A.(13) (no longer eligible to remain registered with the SEC).
The Division then cautioned that a failure to withdraw or correct registration as required by Rule 203A-2(c) may lead the SEC to find reasonable grounds for canceling the adviser's registration pursuant to Advisers Act Section 203(h).
In the second new FAQ on this topic, an investment adviser recently registered with the SEC under the 120-day rule, but the adviser did not establish a different basis for SEC registration within the 120-day period and accordingly filed a Form ADV-W. The query was whether there is a “waiting” period before the adviser firm can file a new Form ADV.
The Division said that an adviser may reapply for registration after filing the Form ADV-W. The Division cautioned, however, that the re-applying adviser must meet the conditions of the 120-day rule, including having a reasonable expectation of being eligible to register with the SEC within 120 days after the effective date of its registration with the SEC. Further, the adviser must not be registered or required to be registered with the SEC or a state securities authority immediately before filing the new Form ADV. The Division clarified that an adviser that re-applies for registration is submitting an initial registration request again, and, therefore, the application is subject to review by the SEC within 45 days.
The Division further warned that if the re-applying investment adviser has clients or assets under management, it may already be “required to be registered” with one or more state securities authorities, and thus would not be eligible to rely on the 120-day rule.
In addition, the Division reminded advisers that an adviser is not eligible to rely on the 120-day rule if it was registered with the SEC “immediately” prior to submitting a new registration request. Thus, an investment adviser registered under the 120-day rule that files Form ADV-W because its 120-day period has expired may not “immediately” submit a new application on the basis of the 120-day rule.
Form ADV: Item 2.A.(13) – Advisers No Longer Eligible for SEC Registration
In this new FAQ, the Division stated that marking Item 2.A.(13), which indicates that the investment adviser is no longer eligible to remain registered with the SEC, does not automatically withdraw the adviser from SEC registration. To formally withdraw from SEC registration, the adviser must file Form ADV-W. Without filing this form, the adviser will remain registered with the SEC and subject to relevant rules and regulations.
The Division included a warning that if the adviser is not going out of business and is withdrawing SEC registration because it is switching to state registration, the adviser must make sure that there is no "gap" in registration. Accordingly, the Division recommended that the adviser register with state authorities before SEC registration is withdrawn.
Form ADV: Item 5.C.(1) and 5.D – Clients without RAUM
In this helpful new FAQ, the Division addresses whether an adviser should report in response to these Items advisory clients for whom the adviser does not have regulatory assets under management. The answer is yes: For Items 5.C.(1) and 5.D, the adviser should include all advisory clients, even those for whom the adviser does not have regulatory assets under management.
The Division also reminded advisers that the definition of "client" for Form ADV includes clients who do not compensate the adviser. However, if the adviser offers additional services (e.g., accounting services), the Division noted that the term "client" in this context specifically refers to investment advisory clients.
Form ADV: Item 5.G – Types of Advisory Services and Automated Investment Advice
In this new FAQ, the Division states that if an adviser provides automated advice (e.g., “robo” advice or services), the adviser should not report that type of advice by selecting the “Other” category if the sole reason the adviser would select the “Other” category is because the adviser provides automated advice. The staff believes an adviser providing automated advice should not treat or disclose “robo-advice” or “robo-services” as another type of advisory service. The staff views automated advice as a means of providing an advisory service, not as a separate type of advisory service. The Division also reminded advisers about the “Robo-Advisers,” IM Guidance Update No 2017-02 (February 2017).
Form ADV: Item 5.K.(1) – Classification of Exchange-Traded Funds
In this new FAQ, the Division states that, for Schedule D, Section 5.K.(1), interests in exchange-traded funds ("ETFs") should be classified as "securities issued by registered investment companies or business development companies" rather than as "exchange-traded equity securities."
Form ADV: Item 7.B.(1) – Private Funds
The Division added two new FAQs regarding this Item and modified an existing FAQ.
In the first new FAQ, the query was when should an adviser to a newly created private fund report in question 23(a) of Schedule D, Section 7.B.(1) that the private fund is subject to an annual audit?
The Division stated that an adviser to a newly created private fund should not report that the private fund's financial statements are subject to an annual audit if an auditing firm has not been engaged to conduct an audit for the applicable fiscal year.
In the second new FAQ about this Item, the query addressed Question 27, regarding valuation. The scenario presented was that 100% of the private fund client’s assets (by value) were valued by the administrator. Specifically, the administrator carried out the valuation procedure established for all assets, and the adviser used that administrator’s valuation for purposes of investor subscriptions, redemptions, distributions, and fee calculations. The administrator is not a related person of the adviser. Further, the adviser considers itself to be ultimately responsible for valuing the private fund client's assets. In response to Schedule D, Section 7.B.(1), Question 27, should the adviser enter 0% to indicate that the adviser is ultimately responsible, or should it enter 100% to indicate that the administrator values the assets?
The Division stated that the adviser should enter 100%.
In a modified FAQ, the Division changed its answer to the question of how an adviser should answer Question 23(g) of Schedule D, Section 7.B.(1) if the private fund’s audited financial statements for the most recently completed fiscal year will be distributed to the private fund’s investors but have not yet been distributed to the private fund’s investors.
The prior answer to this question (from 2017) was that the adviser may answer “Yes” if the adviser will distribute the audited financial statements as required but has not yet done so at the time of filing the Form ADV.
The October 2023 answer is more detailed, as follows:
- If the private fund's audited financial statements for the most recently completed fiscal year will be distributed to the private fund's investors but have not yet been distributed, the adviser should, in the staff's view, answer "Yes" to Question 23(g) of Schedule D, Section 7.B.(1) if: (a) the applicable deadline for distribution has not yet passed; (b) the adviser has engaged an auditor; and (c) the audited financial statements will be distributed as required.
- However, if the deadline for distribution has already passed, and the audited financial statements were not delivered to clients for the most recently completed fiscal year, the adviser should answer "No."
Form ADV-W – Mistakes and Corrections
The Division added two new FAQs regarding mistakes on Form ADV-W.
The first new FAQ addresses what an adviser should do if it mistakenly filed a full Form ADV-W and terminated SEC registration while intending to file a partial withdrawal to deregister from a state. The Division stated that in this situation if the adviser contacts EXAMSRegistrationsInquiries@sec.gov within 3 business days of accidentally filing a full Form ADV-W, the staff might be able to restore the adviser’s “Approved” registration status with the SEC. However, the staff is unable to change the registration status of a state-registered adviser, and, thus, requests to alter state registration status (or any impacted investment adviser representative registrations or adviser notice filings) must be directed to applicable state regulators.
The second new FAQ addresses what an adviser should do if it discovers after filing the Form ADV-W that a response to an Item was incorrect. The Division stated that after an adviser submits a Form ADV-W, the IARD system will not permit the adviser to update any incorrect response or to amend that filing. The Division recommends that in this situation the adviser can email EXAMSRegistrationsInquiries@sec.gov to discuss whether and how any corrections can be memorialized.
Final Filings for Exempt Reporting Advisers – Corrections
Similar to the new FAQ on Form ADV-W corrections, the Division added a new FAQ regarding what an adviser should do if it discovers that a response to an Item in its final report was incorrect. The Division stated that after an adviser submits a final report as an exempt reporting adviser, the IARD system will not permit the adviser to update any incorrect response or to amend the filing. The Division suggests that in this situation the adviser may email EXAMSRegistrationsInquiries@sec.gov to discuss whether and how any corrections can be memorialized. As with any outreach to SEC staff, advisers should carefully consider their approach to this in discussion with their counsel.
Form ADV: Part 2 – Item 2, Material Changes
The Division added a new FAQ regarding Item 2 of Form ADV Part 2A, material change disclosures. The Division stated that simply providing a list of material changes is not considered sufficient. An adviser must both identify and discuss material changes.
Form ADV: Part 3 (Form CRS; Relationship Summary)
In this new FAQ, the Division states that Form CRS (Customer Relationship Summary) is required to be filed with an initial registration request for a Commission-registered investment adviser if the adviser intends to have clients who are retail investors.
Form ADV: Schedule C – Form Instructions vs. IARD
In this new FAQ, the Division addresses the fact that although the instructions to Form ADV direct registered advisers to make changes to Schedules A and B by using Schedule C, when entering IARD, advisers do not see Schedule C.
The Division’s response is that if an adviser is already registered and needs to make updates to the information in Schedule A or Schedule B in the IARD system, the adviser should use Schedule A/C to update information in Schedule A and use Schedule B/C to update information in Schedule B.
Form ADV: Schedule R – Switching Filing and Relying Advisers
The Division added a new FAQ addressing how to switch which adviser is designated as the filing adviser (Adviser A) and which is designated as the relying adviser (Adviser B). The Division suggests the following process to avoid a period during which neither adviser is registered with the Commission:
- Adviser B should file an initial application for SEC registration and include on that initial application a Schedule R listing Adviser A as a "relying adviser."
- Once Adviser B’s registration request is approved, Adviser A should file Form ADV-W to withdraw its registration.
Form ADV: Schedule R – Deleting a Relying Adviser
The Division modified a 2017 FAQ regarding how to delete a relying adviser from Form ADV. The question itself was not modified, i.e., can a relying adviser be deleted from a Form ADV simply by selecting Item (9) in Section 2? The answer remains no, and the adviser is still instructed to select one of the two options under “Delete a Schedule R” at the top of Schedule R. However, the Division added that the adviser must also remove the relying adviser’s name from all applicable entries in Section 7.B.(1) of Schedule D.
Most investment advisers (i.e., those with December 31 fiscal year-ends) will be required to file their annual Form ADV amendments by March 30 (don’t forget it’s a leap year!). In preparing these amendments, legal and compliance personnel of these advisers should review the FAQs, particularly those that were most recently added or modified in October 2023. In addition, advisers should, as they do every year, consider other modifications to their Form ADV Part 2A, bearing in mind that these disclosures often provide the “first line of defense.” Advisers may also consider updates to Part 2A risk disclosures related to interest rates, inflation, sunsetting of “LIBOR risk” issues, geopolitical instability, and the steady drumbeat of increasing regulatory and compliance obligations, among other matters.
