Comparing notes: Form ADV

One of the joys of becoming a registered investment adviser with the US Securities and Exchange Commission (SEC) is filing a Form ADV – which provides regulators a basic sense of a firm’s size and operations.

To enhance transparency the SEC added “Part 2 of Form ADV” in 2010, which is meant to compel investment advisers to communicate with their clients in a plain-English, narrative format about the fund’s key characteristics, strategy and personnel.

SEC: Keeper of the ADV

Breaking the form down further still, Form ADV Part 2B (otherwise known as the “brochure supplement”) provides investors with information on fund managers or investment advisers directly associated with the fund in question, an advisor’s education and work history, disciplinary records, other business activities and compensation.

The brochure supplement is notably the one section of Form ADV not publicly disclosed on the SEC’s website – a privacy GPs no doubt enjoy, but which can make it difficult for firms to compare best practices on some of the supplement’s more ambiguous reporting sections. Speaking with industry legal and compliance experts, PE Manager offers some guidelines: 

On who to include: The SEC wants Part 2B to name the five people who have the “most significant responsibility for the day-to-day discretionary advice” provided to the fund. Unfortunately that’s not always clear-cut. The logical starting point would be the fund’s investment committee, says Debevoise & Plimpton funds partner Ken Berman.  “And if the committee happens to have more than five members, many managers will list them all,” he advises.

Funds without investment committees can be trickier. For instance funds operating in multiple sectors, and which have a host of advisers all with their own areas of expertise, may instead list the firm’s five senior partners as a solution. Since key men and other senior figureheads are generally responsible for setting the fund’s overall vision, it would make sense to prioritize their names ahead of the 20 or so dealmakers involved in the investment decision making process.   

On educational background: For each listed adviser, the brochure should include the person’s formal education after high school (or disclose the fact if there is none). A fairly straightforward disclosure, but sources say some advisers have been testing the SEC’s will by listing what years they attended a post-graduate school, without explicitly disclosing they had not ultimately graduated, leaving the reader to assume a degree had been awarded. 

On disciplinary history: Arguably the section of Part 2B with the most room for interpretation, advisers must disclose any legal or disciplinary events that an investor would reasonably care to know about. But knowing what disciplinary events are material to LPs can sometimes be subjective. For instance is a misdemeanor drug charge during a GP’s college years material? What if the possession charge – or a DUI – was as recent as a year ago?

Willkie Farr & Gallagher private funds partner James Silk says the form provides certain events that are presumed material, and criteria to use when overcoming that presumption, including: the proximity of the person to the actual investment activities; the nature of the infraction (with, for instance, investment-related crimes like embezzlement presumed to be, and far more likely to be, material relative to a pot charge); and the time lapse (how long ago did the infraction occur?). All together, Silk suggests “putting yourself in the shoes of the investor and ask yourself what you would want to know” is a good guideline to go by.

On other business activities:  Another gray area, GPs must disclose if their supervised persons are engaged in any other investment-related or significant business or occupation. Whether a person’s activities are “investment-related” or represent a “business or occupation” or are “significant” may not always be clear. Silk noted, for example, that there may be a distinction between simply sitting on the investment committee of a hypothetical charity versus serving as the chairman of the committee. “It could be argued a couple ways,” he says, adding it is generally better to err on the side of caution when it comes to disclosure.

Likewise, if person rents out his summer cabin from time to time to collect a profit, that may not need to be disclosed, but raise the number of rented cabins to three and it becomes gray – is the person now locked in a second “occupation” as a landlord? Silk noted that “the SEC gives a rough guide to what is significant by saying that if a business activity consumes less than 10 percent of a person’s time and income, it’s safe to leave out of the supplement”.

Filling out the brochure supplement need not be a strenuous exercise, sources say. And due to a quirk in the law, GPs don’t necessarily need to notify their LPs when Part 2b is updated. However, as a matter of best practice, most firms will annually provide their investor base a copy of Form ADV in full, says one US-based compliance consultant. And because investors are more frequently reading Form ADV as part of their due diligence process, that leaves little room for error on the form during fundraising.