[Federal Register Volume 59, Number 13 (Thursday, January 20, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-1336]
[[Page Unknown]]
[Federal Register: January 20, 1994]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release No. IA-1401; S7-2-94]
RIN 3235-AG02
Disclosure by Investment Advisers Regarding Wrap Fee Programs
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule and form amendments.
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SUMMARY: The Commission is proposing for comment rule and form
amendments that would specify the information that registered
investment advisers that are sponsors of ``wrap fee'' programs would be
required to provide to prospective clients in those programs. The
amendments are intended to provide prospective wrap fee program clients
with important information regarding the cost of the programs and the
services provided.
DATES: Comments on the proposals should be received on or before March
7, 1994.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW., Washington, DC 20549. All comment letters should refer to File No.
S7-2-94. All comments received will be available for public inspection
and copying in the Commission's Public Reference Room, 450 Fifth
Street, NW., Washington, DC 20549.
FOR FURTHER INFORMATION CONTACT: Eric C. Freed, Senior Attorney, or
Robert E. Plaze, Assistant Director, (202) 272-2107, Office of
Disclosure and Investment Adviser Regulation, Division of Investment
Management, 450 Fifth Street, NW., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission today
is proposing for comment:
(1) Amendments to Form ADV [17 CFR 279.1] under the Investment
Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.] (the ``Advisers Act'')
to require advisers that sponsor wrap fee programs (``sponsors'') to
file with the Commission as part of Form ADV a document (the ``wrap fee
brochure'') containing certain disclosure about the sponsor and its
wrap fee programs in a narrative (rather than check-the-box) format.
(2) Amendments to rule 204-3 under the Advisers Act [17 CFR
275.204-3] to require sponsors to deliver the wrap fee brochure to
current and prospective wrap fee program clients in lieu of the
disclosure document they are required to deliver to other clients and
prospective clients.
(3) Related amendments to rule 204-1 under the Advisers Act [17 CFR
275.204-1] setting forth the requirements for updating the wrap fee
brochure.
I. Background
In recent years, arrangements known as ``wrap fee'' programs have
become increasingly popular among broker-dealers, investment advisers
(``advisers''), and investors.\1\ Typically, a wrap fee program
provides an investor with a bundle of investment services, including
asset allocation, portfolio management, custody of client funds and
securities, execution of client transactions, and monitoring of
portfolio manager performance for a single ``wrap'' fee, generally a
percentage of assets under management. The wrap fee client is not
charged brokerage commissions on a transactional basis. The sponsor,
often a broker-dealer or an affiliate of a broker-dealer, selects or
assists clients in selecting an adviser or advisers (who may or may not
be affiliated with the sponsor) to manage the client's portfolio (the
``portfolio manager'') and periodically reviews the performance of the
portfolio manager or managers.
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\1\See, e.g., Brown, The `Wrap-Fee Account': Worth What It
Costs?, Phila. Inquirer, Aug. 8, 1993, at E1; What's the Wrap?, The
Economist, July 31, 1993, at 72; Shedding Light on Those Hot New
Wrap Accounts, Boston Globe, May 13, 1993, at 61; White, As Money
Rolls In, Meet the ``Kings of Wrap'', Wall St. J., Apr. 22, 1992, at
C1.
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The sponsor of a wrap fee program is generally required to register
as an adviser under the Advisers Act.2 A registered adviser is
required to file and keep current Form ADV, the form used to register
as an adviser with the Commission under section 203 of the Advisers Act
(15 U.S.C. 80b-3) and with all states that require adviser
registration.3 A registered adviser must also deliver a written
disclosure statement or ``brochure'' to prospective clients of the
adviser and annually offer to deliver the brochure to existing clients.
Part II of Form ADV (``Part II'') sets forth the information that must
be included in the brochure required by rule 204-3. An adviser has the
option to use Part II, which consists of a series of questions answered
by checking the appropriate boxes as well as some narrative
information, as the required brochure, or to prepare a separate
narrative brochure containing, at a minimum, the information required
by Part II.4
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\2\See National Regulatory Services, Inc. (pub. avail. Dec 2,
1992). The portfolio manager would also be an investment adviser
unless subject to an exception from the Advisers Act. See Section
202(a)(11)(A) of the Adviser Act [15 U.S.C. 80b-2(a)(11)(A) (banks
and bank holding companies are not investment advisers). The
requirements of current Part II of Form ADV elicit relevant
information about portfolio manager participation in wrap fee
programs, see National Regulatory Services supra, and are not being
proposed to be amended. Because of the similarity between the
services portfolio managers provide to wrap program clients and the
services they provide to other clients, there does not appear to be
a need to require generally that portfolio managers prepare a
separate disclosure document for wrap fee program clients. In
certain limited circumstances, however, the proposed amendments
would require that the portfolio manager provide a brochure to wrap
program clients that is separate from the brochure it provides to
other portfolio management clients. See Section II.C.4 infra.
\3\Uniform Form ADV was developed by the Commission and the
North American Securities Administrators Association, Inc.
(``NASAA''), the national organization of state securities
administrators, to remove unnecessary administrative burdens on
investment advisers registering with more than one governmental
entity. See Investment Advisers Act Rel. No. 991 (Oct. 15, 1985) [50
FR 42903 (Oct. 23, 1985)]. The proposed amendments were prepared in
cooperation with NASAA, which has voted to endorse the proposal of
the amendments. See NASAA Reports (CCH) 4101 (Oct. 1993).
\4\Paragraph (a) of rule 204-3 [17 CFR 275.204-3(a)].
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The proposed amendments would specify the content, format, and
delivery requirements of the brochure that a sponsor of a wrap fee
program must provide clients and prospective clients.5 The
proposed amendments are intended to facilitate the development of
clear, concise and informative wrap fee brochures.6
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\5\Part II does not currently set forth disclosure requirements
specific to wrap fee programs. The current form requires disclosure,
however, regarding the adviser's fees and services, which
encompasses wrap fee programs. Investment advisers, as fiduciaries,
also have an obligation independent of the requirements of any form
to disclose to clients all material facts about the advisory
relationship. See SEC v. Capital Gains Research Bureau, 375 U.S.
180, 191, 201 (1963); Laird v. Integrated Resources, 897 F.2d 826,
835 (5th Cir. 1990); Investment Advisers Act Rel. No. 1092 (Oct. 8,
1987) [52 FR 38400 (Oct. 16, 1987)].
\6\Of course, compliance with the proposed amendments would not
relieve an adviser of the obligation to disclose material facts that
would not be specifically requested by the amendments. See paragraph
(e) of rule 204-3 [17 CFR 275.204-3(e)].
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II. Discussion
As the organizer of the program and the principal contact with
clients, a wrap fee sponsor is generally in a better position than the
portfolio manager to provide prospective clients with a basic
description of the program. Therefore, the proposed amendments would
require the sponsor, rather than the portfolio manager, to provide the
basic disclosure regarding the operations of and the services offered
by the program. As discussed in greater detail below, the proposed
amendments would require that the sponsor disclose this information in
a separate document provided in lieu of the brochure the sponsor
provides to its other advisory clients.7
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\7\See Section II.B infra.
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A sponsor would need to include only abbreviated disclosure about
its wrap fee programs in the narrative portions of the brochure it
delivers to clients outside the wrap fee programs. Comment is requested
on whether an instruction to this effect should be added to Form ADV.
A. Applicability of Disclosure Requirements
1. The ``Wrap Fee Program''
The wrap fee brochure would be required to be delivered only by
sponsors of wrap fee programs. A ``wrap fee program'' would be defined
to include a program under which any client is charged a specified fee
or fees not based directly upon the transactions in the client's
account for investment advisory services and execution of
transactions.8 The investment advisory services could include,
among other services, advice regarding the selection of investment
managers.9
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\8\Proposed paragraph (g)(4) of rule 204-3; Item 1 of proposed
Schedule H of Form ADV (``Schedule H''). Other services, such as
custody, may also be provided.
\9\A single ``program'' may provide clients with a choice of fee
arrangements: a wrap fee or a traditional arrangement under which
brokerage is paid for (on a transactional basis) separately from
advisory services. Under the proposed amendments, the sponsor would
provide a prospective client of such a program with only its wrap
fee brochure, which would describe both fee arrangements. A wrap fee
sponsor that offers traditional advisory services outside of the
wrap fee program would be required to deliver two brochures (its
wrap fee brochure and its general brochure) to a prospective client
being offered both the wrap fee program and traditional advisory
services. See proposed paragraph (f) of rule 204-3 (wrap fee
brochure delivered to clients and prospective clients of the wrap
fee program).
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In certain wrap fee programs, a fee is charged for advice regarding
the allocation of client assets among mutual funds affiliated with the
sponsor. Unlike typical wrap fee programs, these programs contemplate
recommendations of mutual funds (and their advisers) rather than
``portfolio managers,'' and do not provide brokerage as a
service.10 Like other wrap fee programs, however, mutual fund wrap
fee programs offer assistance in selecting and allocating assets among
managers. In light of this similarity, the definition of ``wrap fee
program'' would include a program under which a specified fee is
charged for recommendations regarding the allocation of client assets
among mutual funds (or series of a single fund) for which the sponsor
or a related person (as defined in Form ADV) serves as an investment
adviser, principal underwriter, or administrator.11 Comment is
requested on whether the definition should encompass certain programs
under which only unaffiliated funds are recommended, and, if so, how
the definition of wrap fee program should be revised to encompass these
programs without reaching all advisers that charge asset-based fees and
recommend mutual funds to their clients. Comment is requested generally
on the proposed definition of wrap fee program, and whether it
encompasses the types of programs for which the required disclosure is
material.
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\1\0An investor does not pay a ``brokerage commission,'' as the
term is commonly used, in connection with the purchase or sale of
mutual fund shares. The investor may, however, pay a ``sales load,''
which may be waived for a client of a wrap fee program, or a ``12b-1
fee.'' If a registered representative of a broker that recommends
mutual funds to clients is compensated solely through sales loads
(transaction-based fees) or 12b-1 fees (fees not charged directly to
clients), there would be no ``wrap fee program'' under the proposed
amendments because there would be no specified, non-transaction-
based fee charged to the client. Whether or not a wrap fee program
exists, a registered adviser must disclose compensation it receives
in connection with recommendations made to clients. See Items 9 and
13A of Part II.
\1\1The definition would include programs that charge a fee for
recommending asset allocation among specified mutual funds that are
affiliated with the sponsor, regardless of whether the funds are
primarily intended for investment by clients of the program.
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Under certain programs that are similar to wrap fee programs,
clients are provided with advice regarding the selection of portfolio
managers, continual monitoring of portfolio managers, and brokerage
services, but no clients are charged a ``wrap'' fee.12 Sponsors of
these ``managed account'' programs would not be required under the
proposed amendments to deliver a wrap fee brochure.13 Comment is
requested whether these managed account programs should be covered by
the proposed brochure requirements, and, if so, how the definition of
wrap fee program should be revised to encompass these programs. Comment
is specifically requested on requiring delivery of the new brochure to
clients participating in programs under which (1) advice regarding the
selection of investment advisers is provided, and (2) a single broker
provides the primary brokerage services for substantially all clients
participating in the program.
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\1\2The programs described in Wall Street Preferred Money
Managers (pub. avail. Apr. 10, 1992) and Morgan Keegan & Co. (pub.
avail. Oct. 2, 1990) are examples of this type of program.
\1\3A person that selects or assists clients in selecting
portfolio managers generally would be an investment adviser, see
Release 1092, supra note 5, and, if not subject to the proposed wrap
fee requirements, would be subject to the general brochure
requirements of paragraph (a) of Rule 204-3.
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2. The ``Sponsor''
The brochure contemplated by the proposed amendments would be
required to be delivered by a person that sponsors or organizes a wrap
fee program, or selects or provides advice to clients regarding the
selection of other investment advisers in connection with the wrap fee
program.14 This requirement is intended to include advisers that
would typically be referred to as ``sponsors,'' but not advisers that
provide only portfolio management services to wrap fee program clients.
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\1\4Proposed paragraph (f)(1) of rule 204-3; Item 1 of proposed
Schedule H.
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In some wrap fee programs, the services typically performed by a
single sponsor are divided among two or more registered advisers. For
instance, certain programs are organized by a person whose primary role
is to monitor, evaluate and provide recommendations on portfolio
managers. Clients for these programs are generally obtained through
various brokers, registered representatives or financial planners who
do not have their own wrap fee program. The brokers, representatives or
planners assist their clients in developing investment objectives and
assessing the type of portfolio manager that is appropriate. Both the
program organizer and the persons that obtain clients for the program
may be providing advisory services to clients and may be included
within the general definition of ``sponsor'' discussed above. The
Commission believes that unnecessary duplication might result, however,
if both advisers were required to provide clients with the wrap fee
brochure containing the comprehensive description of the program.
Therefore, the proposed amendments would require that only one of the
advisers need file and deliver the separate wrap fee brochure.\15\ The
advisers may allocate this responsibility as they choose.\16\
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\15\Proposed paragraph (f)(3) of rule 204-3; Item 4 of proposed
Schedule H. The wrap fee brochure would be required to discuss all
services provided under the program, whether or not the adviser
delivering the brochure provides all the services.
\16\While proposed amended rule 204-3 would permit the sponsors
of a wrap fee program to allocate brochure obligations, it would not
relieve a sponsor from liability for violating the rule if another
sponsor failed to deliver the brochure.
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A sponsor in a multiple-sponsor program that is not responsible for
delivering the wrap fee brochure would, as an adviser to clients
participating in the program, be required to provide its regular
brochure to those clients. These clients must also receive the brochure
of the portfolio manager they choose under the program. The Commission
is concerned that this multiplicity of disclosure documents will reduce
client understanding of core information about the program, and
requests comment on methods to alleviate this problem, including
requiring that the wrap fee brochure, or a supplement, provide relevant
information about all sponsors.
B. Format of Wrap Fee Program Brochure
The proposed wrap fee brochure would differ in two significant
respects from the disclosure document generally provided under current
requirements. First, the disclosure contemplated by the amendments
would be presented in narrative text, rather than in a check-the-box
format, as is currently permitted.\17\ Second, the wrap fee brochure
would include only information that pertains to the sponsor's wrap fee
programs. A single document describing both the adviser's services
under the wrap fee program and its other advisory services would not be
permitted.
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\17\According to data derived from Form ADVs filed with the
Commission, approximately 75% of advisers use Part II to fulfill
their brochure obligations.
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The departure from the check-the-box format is designed to
facilitate a more complete and accurate explanation of the wrap fee
programs offered by the sponsor, and thereby provide clients and
prospective clients with a better understanding of the programs. Given
the many variations of wrap fee programs and the dissimilarity of the
services provided under wrap fee programs to more traditional
investment advisory services, a check-the-box format may not
accommodate a full explanation of the services provided under a wrap
fee program or how a wrap fee arrangement compares to a fee-plus-
commission arrangement.\18\
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\18\A number of questions in Part II require that narrative
explanations of check-the-box answers be provided in Schedule F.
See, e.g., Items 1.D and 5 of Part II. While narrative disclosure
about wrap fee programs could be provided in this manner, the
proposed amendments would likely result in clearer and more readable
disclosure than would the use of Schedule F.
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The Commission is proposing that wrap fee sponsors provide clients
with a separate brochure to address disclosure problems that can arise
when wrap fee sponsors engage in other advisory activities. Under
current rules, these sponsors may combine in a single brochure
information relevant to their wrap fee clients with information
concerning other advisory services offered by the sponsor. Because the
services provided by the sponsor for its wrap fee clients, such as
manager selection and monitoring, differ substantially from the
services the sponsor may provide to other advisory clients, such as
money management, inclusion of wrap fee program disclosure in a
brochure also intended for delivery to the sponsor's non-wrap fee
clients may obscure the disclosure provided to both types of clients.
This problem is compounded when a sponsor's brochure describes at
length a variety of different advisory programs in addition to the wrap
fee program. Therefore, the Commission is proposing to require that a
separate brochure containing only information relevant to prospective
wrap fee program clients be delivered to prospective clients of the
wrap fee program in lieu of the brochure delivered to the sponsor's
other clients.\19\
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\19\Proposed paragraph (f)(1) of rule 204-3; Item 2 of proposed
Schedule H of Form ADV (``Schedule H'').
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A sponsor would not be required to prepare a separate brochure for
each wrap fee program it sponsors. As proposed to be amended, Rule 204-
3 would specify that a sponsor of more than one wrap fee program has
the option to prepare separate brochures for one or more programs or to
prepare a single brochure covering all its programs.\20\ The Commission
is concerned, however, that a prospective client who receives a
brochure relating only to a single program may not be made aware of all
options offered by the sponsor, and requests comment on whether
sponsors should be required to deliver a single brochure describing all
their wrap fee programs. The Commission acknowledges that a brochure
describing all the sponsor's wrap fee programs may be lengthy and
difficult to read and requests comment whether sponsors should be
required to prepare separate brochures for each wrap fee program.
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\20\Proposed paragraph (f)(2) of rule 204-3. As noted below, a
sponsor using more than one wrap fee brochure would be required to
file each brochure as part of its Schedule H. The option to use
either a single brochure or multiple brochures to provide the
required wrap fee disclosure would be similar to the option,
currently available to advisers that deliver narrative brochures to
clients, to use either a single brochure or multiple brochures to
describe different types of advisory services. See paragraph (d) of
rule 204-3 [17 CFR 275.204-3(d)].
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C. Content of Wrap Fee Brochure
The wrap fee brochure would cover the following basic disclosure
areas.
1. Cover Page
The cover page of the brochure would be required to include the
sponsor's name, address and telephone number. In addition, the cover
page would include a legend in bold type (or made prominent in some
other fashion) stating that the brochure is intended to provide
information about the sponsor and its wrap fee program or programs and
that the contents of the brochure have not been approved or verified by
any governmental authority.\21\
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\21\Item 8(a) of proposed Schedule H.
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2. Fees and Other Program Costs
The amendments would require the wrap fee brochure to disclose the
amount of the wrap fee and the services provided for that fee.\22\ The
wrap fee brochure would also be required to disclose whether the fee is
negotiable.\23\ Comment is requested on whether the wrap fee brochure
should be required to disclose the range within which the wrap fee may
be negotiated. Comment is also requested whether the wrap fee should be
required to be disclosed more prominently than the other disclosure in
the brochure, for example, by requiring the fee to be on the cover page
of the brochure or in bold type.
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\22\Item 8(b) of proposed Schedule H.
\23\Id.
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The portion of the total wrap fee that is paid to portfolio
managers (or the range of amounts paid to portfolio managers) would
also be required to be disclosed. The amount received by a portfolio
manager may be relevant in assessing the value of services provided by
the respective parties and may facilitate negotiation of the wrap
fee.\24\ Comment is requested regarding the value to clients of this
information about portfolio manager compensation. The proposed
amendments would not require that the portion of the wrap fee paid to
registered representatives of the sponsor be disclosed (unless the
registered representatives are also the program's portfolio managers).
Comment is requested whether disclosure of the portion of the wrap fee
(or other amounts related to wrap fee accounts) paid to registered
representatives (or other persons) should be required. Such information
may be material because, depending upon the amount of the payments, the
registered representative may have a substantial incentive to advise
clients to participate in wrap fee programs. In this regard, comment is
requested whether, if applicable, a statement that the registered
representative has a financial incentive to recommend the wrap fee
program over other services also should be required.
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\24\The portfolio manager is required to disclose in its
brochure the schedule of the fees it receives under the wrap fee
program. See National Regulatory Services, supra note 2.
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The wrap fee brochure would be required to explain that the wrap
fee may be more or less than the cost of purchasing the same services
separately, and to set out generally the factors bearing upon whether
the total cost of the wrap fee program will be more or less than the
cost of the same services purchased separately.\25\ These factors would
generally include the amount of the wrap fee, the level of trading
activity that takes place in the client's account, and the brokerage
commissions that the client would pay as a result of the trading
activity in the absence of the wrap fee. Disclosure of the nature of
any fees that a wrap fee client may pay in addition to the wrap fee,
such as mutual fund expenses and mark-ups or mark-downs on principal
transactions, would also be required.\26\
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\25\Item 8(c) of proposed Schedule H.
\26\Item 8(d) of proposed Schedule H.
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3. Portfolio Manager Selection, Review and Contact
A wrap fee program sponsor would be required to disclose how the
program's portfolio managers are selected and reviewed and the basis
upon which portfolio managers are recommended or chosen for particular
clients. This disclosure would include how the qualifications of the
portfolio manager are assessed and how the needs of the particular
client are matched with the philosophy, style or expertise of the
portfolio manager.\27\ Disclosure of the factors that may lead the
sponsor to replace or recommend the replacement of a portfolio manager
would also be required.
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\27\Item 8(e) of proposed Schedule H. A similar requirement
would apply to programs that allocate client assets among mutual
funds. Sponsors would be required to disclose the basis upon which
recommendations regarding the allocation of client assets are
developed. However, the advisory services in mutual fund wrap fee
programs are performed by the sponsor and the mutual fund advisers,
not by ``portfolio managers.'' Therefore, the proposed disclosure
requirements that relate to ``portfolio managers'' would generally
be inapplicable to mutual fund wrap fee programs. Item 7 of proposed
Schedule H.
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Sponsors often provide existing and prospective wrap fee program
clients with performance data for the portfolio managers or mutual
funds used in the program. In some instances, the performance data is
not calculated uniformly or verified as to its accuracy. The Commission
believes that clients may incorrectly assume that all performance
information they receive is calculated uniformly among portfolio
managers and that the accuracy of information provided by a manager or
a fund has been verified. Therefore, the Commission is proposing that,
if the performance information is not calculated on a uniform or
consistent basis, or is not verified by the sponsor or a third party,
the brochure would be required to so state.\28\ If the performance
information is verified, the sponsor would be required to disclose by
whom it is verified, and, if the information is calculated uniformly,
the sponsor would be required to state the standards (i.e., industry
standards or standards used solely by the sponsor) under which it may
be calculated, although a detailed description of the standards would
not be required.\29\ Comment is requested whether the wrap fee brochure
should be required to describe the extent of the sponsor's (or third
party's) review of the portfolio managers' performance information
(i.e., whether only the managers' calculations are reviewed, or whether
the actual data used in those calculations have also been reviewed).
Comment is requested whether the Commission should consider proposing
the use of standardized formulas for the calculation of performance
information for portfolio managers in wrap fee programs, or for
investment advisers generally, and, if so, what those standardized
formulas should be.
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\28\Item 8(f) of proposed Schedule H.
\29\Item 8(g) of proposed Schedule H.
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The sponsor of a wrap fee program would be required to disclose, in
addition to the information described above, the nature of the
information it conveys to the portfolio manager about the client's
investment objectives and financial circumstances, as well as how often
or under what circumstances the sponsor provides the portfolio manager
with updated information about the client.\30\ The sponsor would also
be required to disclose any restrictions imposed upon client contact
with portfolio managers.\31\
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\30\Item 8(h) of proposed Schedule H.
\31\Item 8(i) of proposed Schedule H.
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4. Portfolio Management Services
Under the Commission's proposal, the services of particular
portfolio managers in a wrap fee program would typically be discussed
in the brochure of each portfolio manager and would not be required to
be discussed in the program sponsor's brochure.\32\ In some programs,
the sponsor or its divisions or employees covered under the same
investment adviser registration act as portfolio managers for the
program. Confusion and duplicative disclosure may result if clients who
participate in these programs are provided with both the sponsor's wrap
fee brochure and the brochure the sponsor delivers to non-wrap fee
clients. Therefore, if the sponsor or its divisions or employees act as
portfolio managers for the program, the wrap fee brochure would be
required to discuss the nature of the portfolio management services
provided by those persons.\33\
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\32\In describing the services provided under the program, a
sponsor would be required to outline the types of portfolio
management provided under the program (e.g., equity, balanced, or
fixed income). See Item 8(b) of Schedule H. Except in the
circumstances explained in the text, however, it would not be
necessary to describe the management styles of particular managers.
\33\Item 8(l) of proposed Schedule H. If a wrap fee program uses
registered representatives of the sponsor to manage client accounts,
Item 8(l) of proposed Schedule H would require the brochure to
disclose the general nature of the management services provided or
the nature of any investment discipline that registered
representatives are required to follow. Item 6 of Part II, which the
wrap fee brochure incorporates, requires disclosure of the
educational and business backgrounds of only certain types of
employees. Therefore, the wrap fee brochure would not be required to
disclose the backgrounds for all registered representatives who
provide portfolio management services. Nor would the brochure be
required to disclose the investment strategies used by individual
registered representatives. Nonetheless, information regarding the
backgrounds and investment strategies of registered representatives
may be material and may have to be provided to clients in some form.
See note 5 supra. Information regarding a registered representative
would ordinarily be material, among other circumstances, if the
representative makes investment decisions for clients independently
of any investment discipline imposed by the sponsor.
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5. General Disclosure About Sponsor
The wrap fee brochure would be required to include narrative
responses to a number of existing Part II questions about the sponsor
generally, and about its practices and personnel as they are relevant
to wrap fee clients.\34\ For example, the brochure would be required to
disclose the minimum account size for participation in the wrap fee
program and the nature and frequency of the review of wrap fee client
accounts.\35\ Disclosure of arrangements for the payment of fees by and
to the sponsor for referrals of wrap fee clients would also be
required.\36\ The balance sheet required by Item 14 of Part II would
only be required to be provided to wrap fee program clients if the
sponsor has custody of wrap fee program accounts or requires
substantial prepayments from wrap fee clients.
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\34\See Item 8(j) of proposed Schedule H. Responses to Items 7
and 8 (Other Business Activities and Other Financial Industry
Activities or Affiliations, respectively) of Part II would be
required in the wrap fee brochure. Responses to Items 2 (Types of
Clients), 5 (Education and Business Standards), 6 (Education and
Business Background), 9A (relating to principal transactions) and 9C
(relating to agency-cross transactions), 10 (Conditions for Managing
Accounts), 11 (Review of Accounts), 13 (Additional Compensation) and
14 (Balance Sheet) of Part II would also be required, but only as
such answers relate to wrap fee clients.
\35\Item 8(j) of proposed Schedule H and Items 10 and 11 of Part
II.
\36\Item 8(j) of proposed Schedule H and Item 13 of Part II.
Rule 206(4)-3 [17 CFR 275.206(4)-3], the cash solicitation rule
under the Advisers Act, may apply to payments from portfolio
managers to sponsors for recommending the manager to wrap fee
program clients, or to payments by the sponsor to third parties for
referrals of wrap fee clients. The allocation of a wrap fee between
the sponsor and the portfolio manager for services provided under
the program generally would not, however, constitute the payment of
a referral fee to the sponsor for recommending the manager.
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A number of the Part II requirements incorporated into the wrap fee
brochure concern advisory practices and business relationships that
give rise to conflicts of interest between the adviser and its clients.
To assist clients in understanding how these conflicts could be
important to them, the wrap fee brochure would be required to disclose
not merely the practices and the relationships, but also the nature of
the conflicts of interest presented by those practices and
relationships.\37\
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\37\Item 8(k) of proposed Schedule H. For example, Item 8C of
Part II requires disclosure of, among other matters, whether the
adviser has arrangements material to its advisory business with a
related person who is also an investment adviser. If related persons
of the sponsor are portfolio managers in the sponsor's wrap fee
program, the wrap fee brochure would be required by Item 8(j) of
proposed Schedule H to identify the related managers and describe
the relationships and the arrangements. In addition, Item 8(k) of
Schedule H would require the sponsor to explain in its wrap fee
brochure that these relationships create a conflict between the
interests of the sponsor and those of its clients because the
sponsor has an incentive to recommend the related managers over
other managers.
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Comment is requested whether other matters should also be required
to be disclosed in the brochure by advisers sponsoring wrap fee
programs.
D. Filing, Delivery, and Updating
1. Filing and Delivery
The requirements for the wrap fee brochure would be set forth in a
new Schedule to Form ADV, Schedule H. The wrap fee brochure would be
prepared as a separate document (rather than on the Schedule itself),
and would be filed with the Commission (and the states) by attaching it
to the Schedule.\38\ If the sponsor prepared separate wrap fee
brochures for different wrap fee programs, each brochure used would be
attached to a separate Schedule H.\39\
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\38\Sponsors would be required to include on Schedule H cross-
references to the pages of the wrap fee brochure on which the
various disclosure requirements of Schedule H appear. Item 9 of
Schedule H. In addition, any wrap fee brochure filed with the
Commission would be required to include the adviser's registration
number (801- ) in the upper right hand corner of the cover page.
Item 2 of proposed Schedule H.
\39\Item 5 of proposed Schedule H.
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Sponsors would be required to deliver the wrap fee brochure to
clients and prospective clients under the existing brochure delivery
requirements. Under rule 204-3, an adviser must deliver a brochure to
prospective clients not less than forty-eight hours before entering
into an advisory contract or, if the contract may be terminated by the
client without penalty within five business days of its execution, at
the time of entering into the contract.\40\ In addition, an adviser
must at least annually deliver a brochure, or offer in writing to
deliver a brochure, to its advisory clients.\41\
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\40\Rule 204-3(b)(1) [17 CFR 275.204-3(b)(1)].
\41\Rule 204-3(c)(1) [17 CFR 275.204-3(c)(1)].
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2. Updating
Rule 204-1, as proposed to be amended, would require that the wrap
fee brochure be updated promptly to reflect material changes to the
information it contains, or within 90 days after the end of the
sponsor's fiscal year to reflect other changes. These updating
requirements would be the same as the updating requirements applicable
to most of the information required by Part II.\42\ The updated
brochure would be filed with the Commission and the states by attaching
it to Schedule H and, as with any amendment to Form ADV, accompanying
it with an executed signature page (page 1 of Part I). Comment is
requested whether updates to the wrap fee brochure that reflect
material changes in the program should be required to be delivered,
rather than offered, to existing clients.\43\
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\42\See rule 204-1(b) [17 CFR 275.204-1(b)].
\43\While Part II is not currently required to be delivered
annually to existing clients, an adviser's fiduciary responsibility,
as well as Section 205 of the Advisers Act [15 U.S.C. 80b-5] and
state contract law, may require clients to be notified regarding
material changes in the advisory relationship.
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Currently, advisers update Form ADV by replacing pages that require
amendment. Because the wrap fee brochure would be a separate narrative
document, updating it in this manner may not be practical. Reprinting
the entire brochure for each amendment, however, may be unnecessarily
expensive for sponsors. Therefore, the Commission is proposing to
permit sponsors to update wrap fee brochures by using a brochure
supplement or ``sticker,'' unless the last two preceding updates were
also made by sticker, in which case the amendments would have to be
incorporated in a revised brochure.44 The Commission is concerned
that a succession of amendments, if not incorporated into the brochure,
could make the document difficult for clients to understand.45
Comment is requested on alternative approaches to assure that
successive amendments would not affect the coherence of the brochure.
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\4\4The sticker would be filed with the Commission by attaching
it to Schedule H and including the required signature page.
\4\5A single amendment may change a wrap fee brochure to an
extent that would render the brochure unreadable if the amendment
were made by sticker. Therefore, updating by sticker may be
inappropriate in certain circumstances even if no prior amendments
had been made by sticker.
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III. Transition Period
If proposed Schedule H is adopted, sponsors of wrap fee programs
would be required to file amendments to their existing Form ADV to
include the brochure that would be required by Schedule H. The
Commission would provide an appropriate transition period for advisers
to file any necessary amendments and to convert to the delivery of the
wrap fee brochure. Comment is requested on requiring the transition to
take place within 120 days of the adoption of the amendments.
IV. General Request for Comments
Any interested persons wishing to submit written comments on the
rule and form changes that are the subject of this release, to suggest
additional changes, or to submit comments on other matters that might
have an effect on the proposals described in this release, are
requested to do so.
V. Cost/Benefit Analysis
The rule and form changes proposed today are intended to improve
disclosure by investment advisers and thereby improve the protection of
investors. The Commission believes that the disclosure that would be
required by new Schedule H of Form ADV would greatly increase the
ability of clients and potential clients of wrap fee programs to
understand and evaluate the services provided under the program and the
nature of the relationships between the client and the sponsor and
between the client and the portfolio manager.
By requiring a separate narrative brochure for wrap fee clients,
the amendments would increase the costs to sponsors in complying with
their disclosure and registration obligations. The Commission believes
that this increase would be small in comparison with the benefits. Most
of the increase in costs would be related to the initial preparation of
the wrap fee brochure; any ongoing increase in costs would be minimal.
Updating a narrative document would not be significantly more costly
than updating a check-the-box document; nor would the duplication and
distribution of the narrative brochure be more costly. Any increase in
costs in the actual preparation of the brochure need not be
substantial, since the brochure would not need to be professionally
printed or bound. All the information required should be within the
knowledge or easy access of the adviser, and much of the information is
already required to be disclosed under existing Part II and the
adviser's fiduciary obligations to clients.
VI. Summary of Initial Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis in accordance with 5 U.S.C. 603 regarding the proposed
amendments. The analysis notes the Commission's belief that few wrap
fee sponsors are small entities. The analysis also notes that the rule
and form proposals contained in the release are intended to improve
disclosure provided to wrap fee program clients. Other aggregate cost-
benefit information reflected in the ``Cost/Benefit Analysis'' section
of this release also is reflected in the analysis. The analysis notes
that alternatives to the proposed amendments, such as amending Part II
to require wrap fee disclosure in existing Schedule F, were considered,
but concludes that these alternatives would result in less-
comprehensive and less-understandable disclosure. A copy of the Initial
Regulatory Flexibility Analysis may be obtained by contacting Eric C.
Freed, Office of Disclosure and Adviser Regulation, Division of
Investment Management, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, DC 20549.
VII. Text of Proposed Rule and Form Amendments
List of Subjects in 17 CFR Parts 275 and 279
Investment advisers, Reporting and recordkeeping requirements.
For the reasons set out in the preamble, title 17, chapter II of
the Code of Federal Regulations is proposed to be amended as follows.
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
1. The general authority citation for part 275 is revised to read
as follows:
Authority: 15 U.S.C. 80b-3, 80b-4, 80b-6A, 80b-11, unless
otherwise noted.
* * * * *
2. By revising paragraph (b)(1) of Sec. 275.204-1 to read as
follows:
Sec. 275.204-1 Amendments to application for registration.
* * * * *
(b)(1) If the information contained in the response to Items 1, 2,
3, 4, 5, 8, 11, 13A, 13B, 14A and 14B of Part I of any application for
registration as an investment adviser, or in any amendment thereto,
becomes inaccurate for any reason or if the information contained in
response to any question in Items 9 and 10 of Part I, all of Part II
(except Item 14), and all of Schedule H of any application for
registration as an investment adviser, or in any amendment thereto,
becomes inaccurate in a material manner, the investment adviser shall
promptly file an amendment on Form ADV (Sec. 279.1 of this chapter)
correcting such information.
* * * * *
3. By amending Sec. 275.204-3 by redesignating paragraph (f) as
paragraph (g), and by adding paragraphs (f) and (g)(4) to read as
follows:
Sec. 275.204-3 Written disclosure statements.
* * * * *
(f) Sponsors of Wrap Fee Programs. (1) An investment adviser,
registered or required to be registered pursuant to Section 203 of the
Act, that sponsors or organizes a wrap fee program, or that selects or
provides advice to clients regarding the selection of other investment
advisers in connection with a wrap fee program, shall, in lieu of the
written disclosure statement required by paragraph (a) of this section
and in accordance with the other provisions of this section, furnish
each client and prospective client of the wrap fee program with a
written disclosure statement containing at least the information
required by Schedule H of Form ADV (Sec. 279.1 of this chapter). Any
information included in such disclosure statement that is not
specifically required by Schedule H should be limited to information
concerning wrap fee programs for which the investment adviser is
required to furnish disclosure statements under this paragraph (f).
(2) If an investment adviser is required under this paragraph (f)
to furnish disclosure statements to clients or prospective clients of
more than one wrap fee program, the investment adviser may omit from
the disclosure statement furnished to clients and prospective clients
of a wrap fee program or programs any information required by Schedule
H that is not applicable to clients or prospective clients of that wrap
fee program or programs.
(3) An investment adviser need not furnish the written disclosure
statement required by paragraph (f)(1) of this section to clients and
prospective clients of a wrap fee program if another investment adviser
is required to furnish and does furnish the written disclosure
statement to all clients and prospective clients of the wrap fee
program.
(g) Definitions. * * *
(4) Wrap fee program means a program under which any client is
charged a specified fee or fees not based directly upon transactions in
a client's account for:
(i) Investment advisory services (which may include advice
regarding the purchase or sale of specific securities or advice
concerning the selection of other investment advisers) and execution of
client transactions, or
(ii) Advice regarding the allocation of client assets among
investment companies or among series of a single investment company, if
the adviser or a related person (as defined in Form ADV) serves as
investment adviser, principal underwriter, or administrator for any
such investment company.
PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF
1940
4. The authority citation for part 279 continues to read as
follows:
Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1,
et seq.
Note: The text of Form ADV does not and the amendments will not
appear in the Code of Federal Regulations.
5. By revising Instructions 2, 6 and 7 of Form ADV (Sec. 279.1),
and by adding Instruction 9 to read as follows:
Form ADV Instructions
* * * * *
2. Organization
The Form contains two parts. Parts I and II are filed with the SEC
and the jurisdictions; Part II can generally be given to clients to
satisfy the brochure rule. The Form also contains the following
schedules:
Schedule A--for corporations;
Schedule B--for partnerships;
Schedule C--for entities that are not sole proprietorships,
partnerships or corporations;
Schedule D--for reporting information about individuals
under Part I Item 12;
Schedule E--for continuing responses to Part I items;
Schedule F--for continuing responses to Part II items;
Schedule G--for the balance sheet required by Item 14 of
Part II; and
Schedule H--for satisfaction of the brochure rule by
sponsors of wrap fee programs.
* * * * *
6. Continuation Sheets--Schedules E and F provide additional
space for continuing Form ADV items (Schedule E for Part I; Schedule
F for Part II) but not for continuing Schedules A, B, C, D, G or H.
To continue Schedules A, B, C, D and G, use copies of the schedule
being continued. The response to Schedule H should be included as a
separate document attached to the Schedule.
7. SEC Filings.
Submit filings in triplicate to the Securities and
Exchange Commission, Washington, D.C. 20549. To register, submit a
check or money order for $150 payable to the Securities and Exchange
Commission. This fee is non-refundable. There is no fee for
amendments.
Non-Residents--Rule 0-2 under the Investment Advisers
Act of 1940 [17 CFR 275.0-2] covers those non-resident persons named
anywhere in Form ADV that must file a consent to service of process
and a power of attorney. Rule 204-2(j) under the Investment Advisers
Act of 1940 [17 CFR 275.204-2] covers the notice of undertaking on
books and records non-residents must file with Form ADV.
Updating. Federal law requires filing amendments:
--promptly for any changes in:
Part I--Items 1, 2, 3, 4, 5, 8, 11, 13A, 13B, 14A, and 14B;
--promptly for material changes in:
Part I--Items 9 and 10, all Items of Part II except Item 14, and
all Items of Schedule H;
--Within 90 days of the end of the fiscal year for any other
changes.
Federal Information Law and Requirements--Investment
Advisers Act of 1940 Sections 203(c), 204, 206, and 211(a) authorize
the SEC to collect the information on this Form from applicants for
investment adviser registration. The information is used for
regulatory purposes, including deciding whether to grant
registration. The SEC maintains files of the information on this
form and makes it publicly available. Only the Social Security
Number, which aids identifying the applicant, is voluntary. The SEC
may return as unacceptable Forms that do not include all other
information. By accepting this Form, however, the SEC does not make
a finding that it has been filled out or submitted correctly.
Intentional misstatements or omissions constitute Federal criminal
violations under 18 USC 1001 and 15 USC 80b-17.
* * * * *
9. Sponsors of Wrap Fee Programs--Sponsors of wrap fee programs
must provide clients and prospective clients of wrap fee programs
with a document containing the information required by Schedule H.
This document is to be provided to clients of the wrap fee program
in lieu of Part II (or the document containing the information
required by Part II), which the sponsor is required to provide to
other advisory clients.
* * * * *
6. By revising Item 16 of Part I of Form ADV (Sec. 279.1) to read
as follows:
Form ADV
Part I
* * * * *
16. With a few exceptions, the ``brochure rule'' (Advisers Act
Rule 204-3) requires that clients must be given information about
the investment adviser. Will applicant be giving clients (other than
wrap fee clients to be given Schedule H):
------------------------------------------------------------------------
Yes No
------------------------------------------------------------------------
A. Part II of this Form ADV?.......................... ____ ____
B. Another document that includes at least the
information contained in Form ADV Part II?........... ____ ____
------------------------------------------------------------------------
* * * * *
7. By adding Schedule H to Form ADV (Sec. 279.1) to read as
follows:
Note: The proposed new Schedule H to Form ADV is attached as
Appendix 1 to this document and the Schedule will not appear in the
Code of Federal Regulations.
By the Commission.
January 13, 1994.
Margaret H. McFarland,
Deputy Secretary.
Appendix 1
Applicant:
SEC File No.:
801-
DATE
MM/DD/YY
(for sponsors of wrap fee programs)
Name of wrap fee program or programs described in attached brochure:
1. Applicability of Schedule. This Schedule must be completed by
applicants that sponsor or organize any program, or that select, or
provide advice to clients regarding the selection of, other
investment advisers in connection with any program, that charges a
specified fee or fees not based directly upon transactions in a
client's account for (i) investment advisory services (which may
include portfolio management or advice concerning the selection of
other investment advisers) and execution of client transactions, or
(ii) advice regarding the allocation of client assets among
investment companies or series of a single company, if the applicant
or a related person serves as investment adviser, principal
underwriter, or administrator for any such investment company
(``sponsors'' of ``wrap fee programs'').
2. Use of Schedule. This Schedule sets forth the information the
sponsor must include in the wrap fee brochure it is required to
deliver or offer to deliver to clients and prospective clients of
its wrap fee programs under Rule 204-3 under the federal Advisers
Act and similar rules of the jurisdictions. The wrap fee brochure
prepared in response to this Schedule must be filed with the
Commission and the jurisdictions as part of Form ADV by completing
the identifying information on this Schedule and attaching the
brochure. Brochures should be prepared separately, not on copies of
this Schedule. Any wrap fee brochure filed with the Commission as
part of an amendment to Form ADV shall contain in the upper right
hand corner of the cover page the applicant's registration number
(801- ).
3. General Contents of Brochure. Unlike Parts I and II of this
form, this Schedule is not organized in ``check-the-box'' format.
These Instructions, including the requests for information in Item 8
below, should not be repeated in the brochure. Rather, this Schedule
describes minimum disclosures that must be made in the brochure to
satisfy the applicant's duty to disclose all material facts about
the applicant and its wrap fee programs. Nothing in this Schedule
relieves the applicant from any obligation under any provision of
the federal Advisers Act or rules thereunder, or other federal or
state law to disclose information to its advisory clients or
prospective advisory clients not specifically required by this
Schedule.
4. Multiple Sponsors. If two or more persons fall within the
definition of ``sponsor'' in Item 1 above for a single wrap fee
program, only one such sponsor need complete the Schedule. The
sponsors may choose among themselves the sponsor that will complete
the Schedule.
5. Omission of Inapplicable Information. Any information not
specifically required by this Schedule that is included in the
brochure should be applicable to clients and prospective clients of
the applicant's wrap fee programs. If the applicant is required to
complete this Schedule with respect to more than one wrap fee
program, applicant may omit from the brochure furnished to clients
and prospective clients of any wrap fee program or programs
information required by this Schedule that is not applicable to
clients or prospective clients of that wrap fee program or programs.
If the applicant prepares separate wrap fee brochures for clients of
different programs, each brochure prepared must be filed with the
Commission and the jurisdictions attached to a separate copy of this
Schedule.
6. Updating. Applicants are required to file an amendment to the
brochure promptly after any information in the brochure becomes
materially inaccurate. Amendments may be made by use of a
``sticker,'' i.e., a piece of paper affixed to the brochure that
indicates what information is being added or updated and states the
new or revised information, unless the two most recent amendments to
the brochure were made by sticker. Stickers should be dated and
should be incorporated into the text of the brochure when the
brochure itself is revised.
7. Mutual Fund Wrap Fee Programs. The sponsor of a wrap fee
program under which clients are provided with advice regarding the
allocation of assets among mutual funds should provide disclosure
regarding only those items that are applicable. In general, items
that request information on ``portfolio managers'' will not be
applicable to mutual fund wrap fee programs.
8. Contents of Brochure. Include in the brochure prepared in
response to this Schedule:
(a) on the cover page, the sponsor's name, address, telephone
number, and the following legend in bold type or some other
prominent fashion:
This brochure provides clients with information about [name of
sponsor] and the [name of program or programs] that should be
considered before becoming a client of the [name of program or
programs]. This information has not been approved or verified by any
governmental authority.
(b) the amount of the wrap fee charged for each program, whether
such fees are negotiable, the portion of the total fee (or the range
of such amounts) paid to persons providing advice to clients
regarding the purchase or sale of specific securities under the
program (``portfolio managers''), and the services provided under
each program (including the types of portfolio management services),
(c) a statement that the program may cost the client more or
less than purchasing such services separately and a statement of the
factors that bear upon the relative cost of the program (e.g., the
cost of the services if provided separately and the trading activity
in the client's account),
8. (d) a description of the nature of any fees that the client
may pay in addition to the wrap fee and the circumstances under
which these fees may be paid (including, if applicable, mutual fund
expenses and mark-ups and mark-downs paid to market makers from whom
securities were obtained by the wrap fee broker),
(e) how the program's portfolio managers are selected and
reviewed, the basis upon which portfolio managers are recommended or
chosen for particular clients, and the circumstances under which the
applicant will replace or recommend the replacement of the portfolio
manager, or, in the case of a mutual fund wrap fee program, how the
applicant develops recommendations regarding the allocation of
client assets among mutual funds,
(f) if applicable, a statement to the effect that portfolio
manager or mutual fund performance information is not verified by
the sponsor or a third party and/or that performance information is
not calculated on a uniform and consistent basis,
(g) the name of any party who verifies performance information
if such information is verified, and a reference to any standards
(i.e., industry standards or standards used solely by the sponsor)
under which performance information may be calculated,
(h) a description of the information about the client that is
communicated by the applicant to the client's portfolio manager, and
how often or under what circumstances the applicant provides updated
information about the client to the portfolio manager,
(i) any restrictions on the ability of clients to contact and
consult with portfolio managers,
(j) in narrative text, the information required by Items 7 and 8
of Part II of this form and, as applicable to clients of the wrap
fee program, the information required by Items 2, 5, 6, 9A and C,
10, 11, 13 and 14 of Part II,
(k) if any practice or relationship disclosed in response to
Item 7, 8, 9A, 9C and 13 of Part II presents a conflict between the
interests of the applicant and those of its clients, explain the
nature of any such conflict of interest, and
(l) if the sponsor or its divisions or employees covered under
the same investment adviser registration as the sponsor act as
portfolio managers for a wrap fee program described in the brochure,
a brief, general description of the investments and investment
strategies utilized by those portfolio managers.
9. Organization and Cross References. Except for the cover page
requirements in Item 8(a) above, information contained in the
brochure need not follow the order of the items listed in Item 8.
However, the brochure should not be organized in such a manner that
important information called for by the form is obscured.
Set forth below the page(s) of the brochure on which the various
disclosures required by Item 8 are provided.
------------------------------------------------------------------------
Page(s)
Item cover
------------------------------------------------------------------------
#8(a)
#8(b)
#8(c)
#8(d)
#8(e)
#8(f)
#8(g)
#8(h)
#8(i)
#8(j)
#8(k)
#8(l)
------------------------------------------------------------------------
[FR Doc. 94-1336 Filed 1-19-94; 8:45 am]
BILLING CODE 8010-01-M