Comparing notes: Form ADV

Registration with the Securities and Exchange Commission (SEC) last year has introduced many private equity firms to a reporting requirement where agency guidance is sparse and the pool of previously filed reports to glean insights from is inconsistent. That report, Part 2 of Form ADV, is commonly referred to as the “brochure.”  

Recently revised rules require the brochure be written in a narrative plain English format that describes the adviser’s business, conflicts of interest, disciplinary history, and other pertinent information that will help investors make informed decisions. With so many new and existing registrants filing brochure supplements and amendments to original disclosures over the past two years, one may expect patterns to emerge. However, this is proving difficult.   

SEC: err on the side of disclosure

Bettina Eckerle, head of compliance services provider BE Compliance, explains the subjective preference of registrants: “Generally, it’s largely a matter of personal taste as to how firms present their disclosures. Many firms use the brochure as a marketing document, though, so firms should do what feels right to them.”

No matter where it is discussed, Eckerle emphasizes firms “should really focus on conflicts of interest. It’s one of the SEC’s most favorite topics and always at the top of the list for enforcement actions.”

PICKING YOUR SPOT

When comparing multiple brochure filings, it becomes apparent that GPs have taken different strategies in which sections of the form they discuss potential conflicts of interest. 

For example while every brochure acknowledges that carried interest and other performance-based distributions may create conflicts of interests, this is where the similarities end.   

TPG, in one sentence, states that the firm has adopted policies that ensure in good faith that investment opportunities are allocated fairly across its clients. The Carlyle Group, on the other hand, discusses in great detail investment objectives, risk tolerance and return targets among other disclosures. In comparison Kohlberg Kravis Roberts directs clients to their policies which are designed to ensure fair allocations of securities to client accounts, but goes further in discussing the ways in which their side-by-side vehicles do not give rise to conflict of interests. Apollo Capital Management, the outlier, devoted pages to their discussion, far more than other firms.   

Perhaps the most amorphous of disclosure requirements, Item 8, requires filers to describe their investment and risk strategies. Apollo breaks the item down into discussions on the research Apollo credit managers perform, investment objectives and approach, as well as a much longer discussion on risk factors and risk of loss. 

KKR also provides a lengthy discussion on material risks and research methods, naming several categories of source material. The firm makes mention of “supplemental insights” that KKR Capstone, the firm’s in-house team dedicated to improving the operations of portfolio companies, and senior advisors provide from a management consulting and C-level executive perspective. 

TPG and Bain Capital followed the same formula of first discussing research methodology and objectives, before laying the groundwork for risk of loss disclosures. 

It is important to note that each brochure addressed regulatory scrutiny and government intervention in their discussion of material risks. TPG Capital, however, is the only brochure that points investors to the respective offering documents for more detailed information on additional risks in each investment vehicle.  

WHY THE VARIANCE?

The most glaring reason for such fluctuation lies in the fact that there is a scant track record from which firms can base their responses, according to legal sources.

Jonathan Shapiro, head of west coast litigation at law firm Mintz Levin Cohn Ferris Glovsky and Popeo PC, says that disclosures can change depending on a reporting period. “In just one period a fund may fall in and out of hedge fund or private equity status, and in order to avoid inconsistencies, particularly between Form ADV disclosures and those in Form PF, some firms tend to be more aggressive in their disclosures than others.”   

Inconsistent messaging from third party resources also poses a barrier to disclosure uniformity. Firms are receiving different advice from law firms and consulting agencies who are assisting them in complying with Form ADV requirements, gripe industry sources. 

Another reason for the differences in reporting is the question of how much to disclose. Often the same disclosure can be reasonably included in multiple sections of the brochure, but some compliance experts warn of an “information overload” in repeating yourself too often. 

BEST PRACTICES EMERGING 

Despite inconsistencies among brochures, industry insiders note that best practices are emerging.    

For example, instead of summarizing the firm’s policies and internal protocols, the brochure should direct clients to the precise portions of their policies where further clarification may serve useful. Vista360, a compliance advisory firm, warns registrants against the temptation to pull language directly from in-house documents when completing the brochure. The firm writes in their drafting guidelines: “Do not copy and paste extensive sections of your prospectus or private fund offering memorandums into your brochure. Instead the firm recommends GPs “include concepts from these documents into the Part 2 brochure as appropriate and liberally refer investors/shareholders to these documents”.  

Shapiro adds that private equity firms should remain cognizant of changes and enforcement actions the SEC takes against other firms and to act accordingly – which may in the end create greater consistency across brochures. “Firms should be particularly mindful of exam process proceedings and deficiency letters,” he adds.

Jason Scharfman of Corgentum Consulting adds that site visits from the SEC should not be something firms shy away from. “Even light touch inspections raise an opportunity for firms to engage one-on-one with the agency and ask questions.”  

And GPs are likely to have plenty of questions to ask. Shapiro says that because the revised Form ADV is so new, filers have never been through the exam process. “It’s scary in a sense that it’s new, but not so scary in that there are opportunities to engage with the SEC and the agency has an appreciation for how difficult this process really is.” 

As time goes on, there is no question that these disclosures will become more consistent, predict industry compliance experts. Eckerle assures firms that completing the brochure will only get easier over time. “Many of the gray areas will be cleared up by additional SEC guidance”, as well as evolving market practice, she elaborates. Among other considerations, one of the most important things is to put forth your best, good faith effort in engaging in a transparent dialogue with the SEC. Patterns will come later. 

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CLEAR COMMUNICATIONS

The SEC provides a list of the most common problems they’ve encountered when reading disclosure documents:

• Long sentences 
• Passive voice 
• Weak verbs 
• Superfluous words 
• Legal and financial jargon 
• Numerous defined terms 
• Abstract words 
• Unnecessary details 
• Unreadable design and layout