July 20, 2011
Practice Group(s):
Investment
Management
Hedge Funds and
Venture Funds
Financial Services
Reform
Private Equity
SEC Amends Form ADV Reporting
Requirements for Private Fund and Other
Advisers and Modifies Pay to Play Rule
In much anticipated companion releases implementing various provisions of the Dodd-Frank Act,1 the
U.S. Securities and Exchange Commission (the “SEC”) adopted several new rules under the
Investment Advisers Act of 1940, as amended (the “Advisers Act”).2 Among other matters, the new
rules implement the registration requirements of advisers to hedge funds and other private funds with
the SEC, enunciate new reporting requirements for such advisers, as well as reporting requirements
for “exempted advisers” (“Exempt Reporting Advisers”), reallocate regulatory responsibility and
define exemptions for advisers to venture capital funds, private fund advisers with less than $150
million under management and foreign private advisers. To view K&L Gates’ companion alerts on
these issues, please click here and here.
The SEC also took the opportunity in the Adopting Releases to adopt substantial changes to Part 1A
and Schedule D of Form ADV, requiring advisers to provide additional information on three areas of
their operations:
• the private funds they advise;
• the data that advisers provide about their advisory business; and
• advisers’ non-advisory activities and their financial industry affiliations.
In sum, the changes dramatically increase the amount of information that SEC-registered investment
advisers – and particularly advisers to private funds – must disclose on their Form ADV.3
The SEC also adopted certain amendments to the “pay to play rule,” Rule 206(4)-5.
Private Fund Reporting (Item 7.B. of Form ADV, Part 1A)
The SEC made significant changes to Item 7.B. of Part 1A of Form ADV, which now requires an
adviser to complete Section 7.B. of Schedule D for each “private fund”4 that the adviser (and not a
related person) advises. As a result, the SEC no longer will require an adviser to report on funds that
1
Investment Advisers Act Release No. 3221 (June 22, 2011) (the “IAA Release”) and Investment Advisers Act Release
No. 3222 (June 22, 2011) (the “Private Adviser Exemption Release” and, together with the IAA Release, the “Adopting
Releases”). In a separate release, the SEC also adopted a rule to define “family offices” that are excluded from the
definition of investment adviser under the Advisers Act. Investment Advisers Act Release No. 3220 (June 22, 2012). To
view K&L Gates’ alert on the “family office” rule, please click here.
2
Unless otherwise stated, any reference in this alert to a section or rule is a reference to a section or rule under the
Advisers Act.
3
The effective date of the amendments to Form ADV discussed in this alert will be 60 days from the date these
amendments are published in the Federal Register.
4
“Private funds” generally include hedge funds and other private investment vehicles that would be investment companies
but for the exemptions provided by Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. See Section
202(a)(29).
are advised by affiliates, which likely will reduce, in some cases, numerous pages of unilluminating
disclosure. Second, to avoid multiple reporting for each private fund, Item 7 permits a subadviser to
provide less information about a private fund for which an adviser already is reporting on its Schedule
D, and permits an adviser sponsoring a master-feeder arrangement to submit a single Schedule D for
the master fund and all of the feeder funds that otherwise would be submitting substantially identical
data. Finally, the SEC is modifying Item 7, as proposed, to permit an adviser with a principal office
and place of business outside the United States to omit a Schedule D for a private fund that is not
organized in the United States and that is not offered to, or owned by, United States persons.
The SEC added a new Section 7.B.(1) to Schedule D. Part A of this new section requires identifying
information of each private fund. Part A also requires an adviser to identify the state or country in
which the private fund is organized, as well as the name of its general partner, directors, trustees or
persons occupying similar positions. The item further asks for information about the organization of
the fund, including whether it is a master or a feeder fund, and information about the regulatory status
of the fund and its adviser, including the exclusion from the Investment Company Act of 1940 upon
which the fund relies, whether the adviser is subject to a foreign regulatory authority, and whether the
fund relies on an exemption from registration of its securities under the Securities Act of 1933
(“Securities Act”). The item also contains questions regarding whether the adviser is a subadviser to
the private fund and requires the adviser to identify by name and SEC file number any other advisers
to the fund. Finally, this item elicits information to help the SEC understand each private fund’s
investment activities, including the following:
• the size of the fund, including disclosure of its gross assets;
• which type of seven broadly defined investment strategies the adviser employs with regard to the
fund;
• the number and the types of investors in the fund, as well as the minimum amounts required to be
invested;
• information about the characteristics of the fund that may present the fund manager with conflicts
of interest with fund investors; and
• whether clients of the adviser are solicited to invest in the fund and what percentage of the other
clients have invested in the fund.
In response to several comments it received, the SEC did make several changes from its initial
proposal. First, Section 7.B.(1) does not require disclosure of both gross and net assets of a private
fund. Second, the adopted Form ADV excludes a requirement, as originally proposed, that the assets
and liabilities of a fund be disclosed and broken down by class and categorization in accordance with
GAAP. Last, the SEC agreed to exclude a proposed requirement that advisers report the approximate
percentage of each fund beneficially owned by certain types of investors.
In Part B of new Section 7.B.(1) of Schedule D, the SEC now requires advisers to report information
concerning five types of service providers – auditors, prime brokers, custodians, administrators and
marketers – that generally perform important roles as “gatekeepers” for private funds. In general, an
adviser must identify the gatekeepers, provide their location, and state whether they are related
persons.
In addition, for each such service provider, the SEC requires information to clarify the specific
services the service provider provides. For example, in the case of administrators, an adviser must
identify whether the administrator prepares and sends account statements to investors. Advisers also
must identify the percentage of the fund’s assets that are valued by an administrator or another person
2
that is not a related person of the adviser. In response to comments, the SEC elected not to adopt a
requirement that advisers disclose the identity of specific third parties who are responsible for the
valuation of fund assets.
The SEC noted that some commentators had expressed concern that the new disclosures on Section
7.B.(1) of Schedule D may call into question a private fund’s reliance on the non-public offering
exemption in the Securities Act (or the safe harbor for offshore offerings provided by Regulation S
under the Securities Act). The SEC stated, however, that public disclosure of the information now
required by Section 7.B.(1) would not, in and of itself, jeopardize a fund’s reliance on such
exemptions.
Advisory Business Information: Employees, Clients and
Advisory Activities (Item 5 of Form ADV, Part 1A)
The SEC also amended Item 5 of Part lA of Form ADV to require an adviser to provide additional
information regarding the adviser’s business, the types of services it provides, and the types of clients
to whom it provides those services, including:
• additional information about the adviser’s employees, including the number of employees that are
registered representatives of a broker-dealer, as well as the number of employees that are
registered as investment adviser representatives or insurance agents;
• a single numerical response to the questions about the number of employees instead of a range;
• an expanded list of the types of clients to include business development companies, insurance
companies, and other investment advisers, as well as to distinguish pension and profit-sharing
plans subject to ERISA from those that are not, and the approximate percentage of its regulatory
assets under management attributable to each client type;5
• the percentage of the adviser’s clients that are not United States persons;
• an expanded list of advisory activities to include portfolio management for pooled investment
vehicles, other than registered investment companies, and educational seminars or workshops;
• the SEC file number for the applicable registered investment company if the adviser checks the
box for portfolio management for an investment company; and
• a requirement that advisers indicate whether they report, in response to Item 4.B. of Part 2A of
Form ADV, that they provide investment advice only with respect to limited types of investments.
Other Business Activities and Financial Industry Affiliations
(Items 6 and 7 of Form ADV, Part 1A)
The SEC adopted amendments to Items 6 and 7 of Part lA, largely as proposed, which now require
advisers, including Exempt Reporting Advisers, to report on those financial services in which the
adviser or a related person is actively engaged from lists of financial services. The SEC adopted
several changes to provide a more complete picture of the activities of an adviser and its related
5
An adviser should not include as a client an investor in a private fund under the management of the adviser unless the
adviser has a separate advisory relationship with that investor.
3
persons, as follows:
• expanding the lists in both Items 6 and 7 to include business as a trust company, registered
municipal advisor, registered security-based swap dealer, and major security-based swap
participant, the latter three of which are new SEC registrants under the Dodd-Frank Act;
• adding accountants (or accounting firms) and lawyers (or law firms) to the list in Item 6, but, with
respect to natural persons, only such persons that have a separate business in that field, rather than
persons the adviser may employ as accountants or lawyers;
• moving from Item 7.B. to Item 7.A. the question that asks whether a related person is a sponsor or
the general partner or managing member of a pooled investment vehicle;
• requiring additional reporting in the corresponding sections of Schedule D for Items 6 and 7;
• adding new Section 6.A. of Schedule D, which requires an adviser that checks the box that it is
engaged in another business under a different name to list those other business names and the other
lines of business in which the adviser engages using that name;
• similarly modifying Item 6.B. to require advisers primarily engaged in another business under a
different name to also provide that name in Section 6.B. of Schedule D;
• requiring advisers to provide this same information with respect to any type of related person listed
in Item 7.A.;
• expanding the information regarding related persons to include more details about the relationship
between the adviser and the related person, whether the related person is registered with a foreign
financial regulatory authority, and how they share personnel and physical space with the adviser;6
and
• relocating to Section 7.A. of Schedule D a question currently under Item 9 that requires reporting
of whether a related person foreign financial institution is a qualified custodian for client assets
under the adviser custody rule, and to ask, if the adviser is reporting a related person investment
adviser, whether the related person is exempt from registration.
Participation in Client Transactions (Item 8 of Form ADV, Part
1A) and Client Referrals (Item 9 of Form ADV, Part 1A)
Item 8 requires an adviser to report information about its transactions, with clients, if any, including
whether the adviser or a related person engages in transactions with clients as a principal, sells
securities to clients, or has discretionary authority over client assets. This item previously had
required an adviser to indicate if it had discretionary authority to determine the brokers or dealers for
client transactions and if it recommended brokers or dealers to clients. The SEC adopted amendments
to Item 8, as proposed, which now requires that advisers supplement this information by asking
whether any of the brokers or dealers are related persons of the adviser. In addition, if an adviser
indicates that it receives “soft dollar benefits,” it also will need to report whether all of those benefits
qualify for the safe harbor under Section 28(e) of the Securities Exchange Act of 1934 (“Exchange
Act”) for eligible research or brokerage services. Item 9 also has a new question requiring an adviser
6
An adviser need not complete Section 7.A. of Schedule D for any related person if: (1) the adviser has no business
dealings with the related person in connection with advisory services it provides clients; (2) the adviser does not share
operations with the related person; (3) there are no client referrals between the adviser and the related person; (4) the
adviser and related person do not share supervised persons or premises; and (5) the adviser has no reason to believe its
relationship with the related person creates any conflict of interest with its clients.
4
to indicate whether it or its related person receives direct or indirect compensation for client referrals
to complement the existing question concerning whether the adviser compensates any person for client
referrals.
Reporting $1 Billion in Assets (Item 1 of Form ADV, Part 1A)
Section 956 of the Dodd-Frank Act requires the SEC, jointly with certain other federal regulators, to
adopt rules or guidelines addressing certain excessive incentive-based compensation arrangements,
including those of investment advisers with $1 billion or more in assets. To enable the SEC to
identify those advisers that would be subject to Section 956, Form ADV now requires, as proposed,
that each adviser indicate in Item 1 whether or not the adviser had $1 billion or more in assets as of the
last day of the adviser’s most recent fiscal year. For purposes of this reporting requirement, the
amount of assets is the adviser’s total assets determined in the same manner as the amount of “total
assets” is determined on the adviser’s balance sheet for its most recent fiscal year end.
Other Amendments to Form ADV
The SEC also adopted a number of other amendments to Part 1 of Form ADV which were not directly
related to the Dodd-Frank Act but are intended to improve the SEC’s ability to assess compliance
risks, including:
• adding changes to improve certain identifying information the SEC obtains from other items of
Part lA of Form ADV, including requiring an adviser to provide contact information for its chief
compliance officer to give the SEC direct access to the person designated to be in charge of its
compliance program. Advisers will have the option, in Item 1.K., to provide an additional
regulatory contact for Form ADV, neither of which will be viewable by the public on the SEC’s
website;
• amending Item 1 to require an adviser to indicate whether it or any of its control persons is a public
reporting company under the Exchange Act;
• adding new Item 1.P., which requires an adviser to provide a “legal entity identifier” if it has one;
• adding “limited partnership” as another choice advisers may select to indicate how their
organization is legally formed;
• adopting three technical changes with regard to the reporting of disciplinary events; and
• modifying Item 9, relating to custody of client assets, to:
o add an additional question to require advisers to indicate the total number of persons that act as
qualified custodians for the adviser’s clients in connection with advisory services the adviser
provides to its clients;
o clarify that Item 9 custody questions exclude the custody of assets of clients who are registered
investment companies; and
o enable an adviser to indicate that it has not yet received a report from the independent
accountant that audited a pooled investment vehicle or examined its internal controls.7
7
If an adviser indicates that it has not yet received a report from an independent accountant, then the adviser must
promptly update its Form ADV once the report is available. Since private fund audited financial statements are often not
completed until after an adviser has filed its annual update to Form ADV, this new requirement means that advisers to
5
Amendments to “Pay to Play” Rule
Adopted last July, Rule 206(4)-5 (the “Pay to Play Rule”) generally prohibits registered and certain
unregistered advisers from engaging directly or indirectly in certain pay to play practices. The SEC
amended the Pay to Play Rule in several respects.
First, the SEC amended the scope of the Pay to Play Rule, as proposed, to make it apply to Exempt
Reporting Advisers and foreign private advisers.
Second, the SEC added a new category – “municipal advisor” – to the definition of what constitutes a
“regulated person” for purposes of the prohibition on advisers paying persons (e.g., “solicitors” or
“placement agents”) to solicit government entities unless such persons are “regulated persons” (i.e.,
registered investment advisers or broker-dealers subject to rules of a registered national securities
association, such as the FINRA, that restricts its members from engaging in pay to play activities). To
qualify as a “municipal advisor,” a solicitor must be registered under Section 15B of the Exchange Act
and subject to pay to play rules adopted by the MSRB, which rules must impose substantially
equivalent or more stringent restrictions on municipal advisors as the Advisers Act imposes on
investment advisers and must be consistent with the objectives of the Pay to Play Rule.8
Finally, the SEC extended the compliance date for the third-party solicitation ban from September 13,
2011 to June 13, 2012, to provide time for the MSRB and FINRA to adopt pay to play rules if they
choose to do so and give third-party solicitors additional time to come into compliance with such
rules.
The SEC elected not to adopt a proposed amendment to the definition of a “covered associate” of an
investment adviser that would have provided that a legal entity, not just a natural person, that is a
general partner or managing member of an investment adviser would meet the definition. The SEC
noted that this amendment could have unintended consequences, such as triggering the Pay to Play
Rule’s two year time-out because of contributions made by a political action committee controlled by
an adviser’s parent company.
Technical and Conforming Amendments
a. Rules 203(b)(3)-1 and 203(b)(3)-2
Rules 203(b)(3)-1 and 203(b)(3)-2 specify how advisers “count clients” for purposes of determining
whether the adviser is eligible for the “private adviser exemption” of Section 203(b)(3). Since the
private adviser exemption was repealed by the Dodd-Frank Act, the SEC rescinded these two rules.
b. Amendments to Rule 204-2
Finally, the SEC amended Rule 204-2, the “books and records” rule, to update the rule’s
“grandfathering provision” for investment advisers that currently are exempt from registration under
the “private adviser exemption,” but will be required to register when the Dodd-Frank Act’s repeal of
the “private adviser exemption” becomes effective on July 21, 2011. These advisers will become
subject to the recordkeeping requirements of the Advisers Act at the time they become registered,
including the requirement to keep certain records relating to performance.
newly formed funds may be required to update Part 1A of their Form ADV mid-year once the accountant’s report is
available.
8
The SEC decided not to adopt a more radical change that would have limited the exception to the ban on third-party
solicitation solely to “registered municipal advisors.”
6
The transition period exempts advisers from the obligation to keep certain performance-related
records so long as they did not actually register when they were eligible for the “private adviser
exemption”; however, to the extent that these advisers preserved these performance-related records
without being required to do so, the adopted grandfathering provision requires them to continue to
preserve such records. In addition, the SEC amended Rule 204-2(e)(3)(ii) to cross-reference the new
definition of “private fund,” and rescinded Rule 204-2(l) (which states that the books and records of a
private fund are, under certain circumstances, the books and records of its adviser), because (a) it was
vacated by a federal appeals court in Goldstein9 and (b) because the approach of the rule has been
codified in new Section 204(b)(2).
Authors:
Marc Mehrespand
marc.mehrespand@klgates.com
+1.202.778.9191
Joshua M. O’Melia
joshua.omelia@klgates.com
+1.212.536.4078
9
Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006).
7