[Federal Register Volume 59, Number 80 (Tuesday, April 26, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-9890]


[[Page Unknown]]

[Federal Register: April 26, 1994]


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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279

[Release No. IA-1411; S7-2-94]
RIN 3235-AG02

 

Disclosure by Investment Advisers Regarding Wrap Fee Programs

AGENCY: Securities and Exchange Commission.

ACTION: Final rule and form amendments.

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SUMMARY: The Commission is adopting rule and form amendments under the 
Investment Advisers Act of 1940 relating to ``wrap fee'' programs. The 
amendments specify the information that registered investment advisers 
that are sponsors of wrap fee programs must provide to prospective 
clients in these 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.

EFFECTIVE DATE: October 1, 1994.

FOR FURTHER INFORMATION CONTACT: Eric C. Freed, Senior Attorney, (202) 
942-0726, or Robert E. Plaze, Assistant Director, (202) 942-0721, 
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 
(``Commission'') today is adopting amendments to:
    (1) 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 disclosures about the sponsor and its wrap fee 
programs in a narrative (rather than check-the-box) format;
    (2) 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; and
    (3) Rule 204-1 under the Advisers Act [17 CFR 275.204-1] setting 
forth the requirements for updating the wrap fee brochure.

I. Discussion

    On January 13, 1994, the Commission issued a release proposing 
amendments to Form ADV and related rules under the Advisers Act 
(``Proposing Release'') to improve the quality of brochure disclosure 
that clients of wrap fee programs receive.\1\ A wrap fee program 
provides an investor with two types of services: investment advisory 
services and execution services for a single ``wrap'' fee, usually a 
percentage of assets under management. Among the advisory services 
typically provided are asset allocation, portfolio management, and 
monitoring of the portfolio management services.\2\ Other ancillary 
services, such as custody of client funds and securities and client 
reporting, are also provided. The Commission proposed that the sponsor 
of a wrap fee program provide the wrap fee brochure to prospective 
clients of the program in lieu of the brochure the sponsor currently is 
required to provide to other advisory clients.\3\ The Commission also 
proposed requirements for disclosure to be included in the wrap fee 
brochure. The Commission received thirty comment letters in response to 
the proposed amendments.\4\
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    \1\Investment Advisers Act Rel. No. 1401 (Jan. 13, 1994) [59 FR 
3033 (Jan. 20, 1994)].
    \2\See Proposing Release, supra note 1, at Sec. I.
    \3\An adviser has the option to deliver to prospective advisory 
clients a copy of Part II of Form ADV, which consists primarily of a 
series of questions relating to the adviser's investment advisory 
services answered by checking the appropriate boxes, or a narrative 
brochure containing, at a minimum, the information required by Part 
II, Paragraph (a) of rule 204-3 [17 CFR 275.204-3(a)].
    \4\The comment letters, as well as a comment summary prepared by 
the Commission's staff, are available for public inspection and 
copying at the Commission's Public Reference Room in File No. S7-2-
94.
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    The Commission is adopting the proposed amendments with some 
modifications to reflect comments received. The modifications generally 
relate to the scope of the obligation to deliver the wrap fee brochure 
(i.e., the definitions of ``wrap fee program'' and ``sponsor'') and the 
disclosure requirements of the brochure.5
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    \5\Form ADV is a joint federal-state form used to register as an 
adviser with the Commission and with all states that require adviser 
registration. The amendments were prepared in cooperation with the 
North American Securities Administrators Association, Inc., which 
has voted to amend its Uniform Rules under the Uniform Securities 
Act to adopt the wrap fee brochure requirements discussed in this 
Release.
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A. Applicability of Disclosure Requirements

    The Commission proposed to require that the wrap fee brochure be 
provided by ``sponsors'' of ``wrap fee programs.'' The Commission 
received several comments concerning the scope of these terms. The 
amendments, as adopted, contain modifications to reflect certain of 
these comments.
1. Wrap Fee Programs
    Under the proposal, a ``wrap fee program'' was defined, in part, as 
a program under which any client is charged for investment advisory and 
execution services a specified fee or fees not based directly upon the 
transactions in the client's account. Some commenters asserted that 
programs under which clients are charged a wrap fee for portfolio 
management and execution of transactions, but under which no advice 
about portfolio managers is provided, should be excluded from the 
definition of wrap fee program because of the absence of advice about 
portfolio managers.6 The wrap fee brochure is intended to address 
the special disclosure needs of clients participating in programs that 
offer investment advice and brokerage for a single fee, regardless of 
whether advice about portfolio managers is provided.7 Therefore, 
as adopted, the definition of wrap fee program includes programs under 
which no advice regarding portfolio managers is provided.8
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    \6\Under many of these programs, only a single portfolio 
manager, usually the broker itself or its affiliate, is available to 
clients.
    \7\The only disclosure requirement that necessarily will not be 
applicable to programs not contemplating the selection of a 
portfolio manager is Item 7(f) of Schedule H, regarding how the 
sponsor selects and recommends portfolio managers.
    \8\The definition includes only wrap fee arrangements that are 
part of wrap fee ``programs,'' a term intended to describe 
arrangements that have some degree of uniformity among clients and 
that are entered into more than occasionally. Thus, an adviser that 
occasionally enters into wrap fee arrangements with clients and does 
not promote or solicit clients for wrap fee arrangements is not a 
sponsor of a ``program'' under the amendments.
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    a. Managed Account Programs. In the Proposing Release, the 
Commission requested comment whether ``managed account programs,'' 
under which clients are provided with advice about portfolio managers 
but are charged advisory fees together with transaction-based 
commissions (rather than a single fee), should be included in the 
definition of wrap fee program. Commenters generally were opposed to 
the inclusion of managed account programs in the definition. Because 
managed account programs do not involve advisory and brokerage services 
provided for a single fee and thus do not raise the types of disclosure 
concerns addressed in the amendments, the Commission has not included 
these programs within the definition.9
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    \9\As noted in the Proposing Release, the definition of wrap fee 
program includes programs under which clients are offered a choice 
between a wrap fee and a fee-plus-commission arrangement. Proposing 
Release, supra note 1, at n.9. The sponsor of a program offering a 
choice of fee arrangements must provide prospective clients of the 
program with the wrap fee brochure describing each alternative.
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    b. Mutual Fund Asset Allocation Programs. The proposed amendments 
would have included as wrap fee programs arrangements under which 
advice is provided regarding the allocation of client assets among 
mutual funds affiliated with the sponsor. Many commenters argued that 
mutual fund asset allocation programs should be excluded from the 
definition because they are more similar to traditional advisory 
services than to wrap fee programs, and the disclosure concerns they 
raise are addressed under current Part II of Form ADV (``Part II''). 
The Commission believes that mutual fund asset allocation programs, 
because they do not involve the provision of advisory and brokerage 
services for a single wrap fee, generally do not raise the disclosure 
concerns addressed in the amendments, and has modified the definition 
of wrap fee program to exclude mutual fund asset allocation programs. 
The Commission may consider in connection with future revisions to Form 
ADV whether additional disclosure requirements regarding these programs 
are needed.
2. Sponsors
    The proposed amendments defined the term ``sponsor'' broadly to 
include an adviser that sponsors or organizes a wrap fee program or 
that provides advice to clients regarding the selection of portfolio 
managers in the program.\10\ The Commission recognized that such a 
broad definition might result in a single program's having more than 
one sponsor, and therefore proposed to permit the sponsors to choose 
among themselves the sponsor that would deliver the wrap fee brochure 
to clients.\11\ Some comments suggested that the definition of sponsor 
unintentionally included advisers who recommend wrap fee program 
portfolio managers to clients, but who are not involved with or 
compensated under the wrap fee program. In addition, commenters 
suggested that the definition of ``sponsor'' be made consistent with 
the North American Securities Administrators Association's proposed 
amendments to their Uniform Rules under the Uniform Securities Act.\12\
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    \10\The sponsor of a wrap fee program is generally required to 
register as an adviser under the Advisers Act. See National 
Regulatory Services, Inc. (pub. avail. Dec. 2, 1992).
    \11\As adopted, amended rule 204-3 permits the sponsors of a 
wrap fee program to allocate brochure obligations. The rule does 
not, however, relieve a sponsor from liability for violating the 
rule if another sponsor fails to deliver the brochure.
    \12\Uniform Rule 203(b)-2, NASAA Reports (CCH) 4104 (Oct. 
1993).
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    Based on these comments, the Commission is revising the definition 
of sponsor to include only those advisers that ``are compensated under 
a wrap fee program for sponsoring, organizing, or administering the 
program, or for selecting, or providing advice to clients regarding the 
selection of, other investment advisers in the program.''\13\ A 
registered adviser that has an advisory relationship or prospective 
advisory relationship with a wrap fee client, but is not compensated 
under the wrap fee program, is not a sponsor and must provide the 
client with the brochure that the adviser is otherwise required to 
provide its clients pursuant to rule 204-3 under Advisers Act (the 
``general brochure'').\14\ A sponsor of a wrap fee program that is a 
registered investment adviser must deliver the wrap fee brochure 
(unless another sponsor has assumed that obligation) to a prospective 
client of the program even if that sponsor will not have an advisory 
relationship with the prospective client (because, for example, that 
sponsor provides only administrative services under the program).\15\
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    \13\New paragraph (f)(1) of rule 204-3; Instruction 1 of 
Schedule H. A person that is paid to solicit clients for a wrap fee 
program is not a sponsor of the program merely because of the 
solicitation activities. A person that is paid to solicit clients 
for a program, but that does not provide any services under the 
program, generally will be subject to rule 206(4)-3 under the 
Advisers Act [17 CFR 275.206(4)-3].
    \14\Paragraph (a) of rule 204-3. A firm that provides services 
enumerated in the definition of sponsor, but that is not a 
registered investment adviser (e.g., a bank), is not required to 
provide any brochure. Paragraph (f)(1) of rule 204-3.
    \15\As adopted, paragraph (f) of rule 204-3 requires advisers 
that are registered or required to be registered to deliver a 
brochure to prospective clients ``of the wrap fee program.'' Compare 
paragraph (a) of rule 204-3. This provision is intended to increase 
the likelihood that at least one registered investment adviser is 
obligated to provide the wrap fee brochure to a client participating 
in a wrap fee program.
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B. The Separate Brochure

1. In General
    As noted above, the Commission proposed a narrative wrap fee 
brochure that would be separate from, and would be provided to wrap fee 
clients in lieu of, the sponsor's general brochure. Commenters 
generally supported requiring a narrative disclosure document in 
connection with wrap fee programs. Commenters were divided, however, 
over whether a separate wrap fee brochure should be required. Nine 
commenters supported requiring a separate brochure, six of whom 
asserted that a separate document should be required for each 
program.\16\ Nine other commenters opposed the separate brochure 
requirement, arguing that a brochure describing all of the sponsor's 
advisory services would provide relevant information about the client's 
investment alternatives.
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    \16\The proposed amendments would give a sponsor the option of 
using a single brochure for all of its wrap fee programs or creating 
separate brochures for each program.
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    The Commission has decided to retain a separate brochure 
requirement.\17\ The Commission has observed that brochures containing 
disclosure about wrap fee programs often also describe other programs 
that are not available to most wrap fee clients because they do not 
meet the minimum account or other eligibility requirements of those 
other programs. Thus, these combined brochures may not in fact provide 
information about available investment alternatives, as argued by 
commenters opposing the separate brochure proposal. Moreover, brochures 
describing multiple programs are often lengthy and cumbersome and may 
discourage prospective clients from reading them.\18\
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    \17\New paragraph (f)(1) of rule 204-3. As noted below, more 
than one wrap fee program may be described in the same brochure. See 
Section I.B.2 infra.
    \18\For instance, the Commission staff found that one sponsor 
delivered a fifty-nine page Part II (exclusive of financial 
statements) to wrap fee program clients, while another delivered a 
fifty-two page Part II. Some commenters suggested requiring a table 
of contents in brochures as an alternative to a separate brochure. A 
table of contents requirement would not serve as an effective 
substitute for a separate brochure because all of the information 
relevant to a wrap fee client typically is not located in one 
section of the brochure.
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    Commenters opposed to a separate brochure requirement also argued 
that such a requirement would impose substantial additional costs on 
sponsors. The Commission believes, however, that the cost burden of a 
separate brochure requirement will be small in relation to its 
benefits.\19\
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    \19\See the Cost/Benefit Analysis in Section II of this Release 
infra.
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    The Commission does not expect that sponsors will need to deliver 
both their general brochure and their wrap fee brochure to significant 
numbers of prospective advisory clients. Many prospective wrap fee 
program clients will likely not be interested in or eligible for other 
programs. Furthermore, a client being offered a program with a choice 
of fee arrangements need only be offered the wrap fee brochure.\20\
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    \20\See note 9 supra.
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2. Multiple Wrap Fee Programs
    The proposed amendments would give sponsors the option to prepare 
either a single brochure describing all their wrap fee programs or 
separate brochures describing different programs. The Proposing Release 
requested comment whether separate brochures should be required for 
each of a sponsor's wrap fee programs, or whether a single brochure 
describing all programs should be required. Some commenters believed 
that separate brochures for each program should be required, while 
others believed that sponsors should have the flexibility to use either 
separate or combined brochures.
    The Commission is retaining the provision in the proposal giving 
sponsors the option to prepare either a single brochure describing all 
of their wrap fee programs or separate brochures for each program. A 
sponsor that uses separate brochures for different wrap fee programs 
must note the existence of the other programs in each brochure, and 
state how brochures for the other programs can be obtained.\21\ This 
disclosure will inform clients that alternative programs may be 
available to them.
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    \21\Item 5 of Schedule H.
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C. Contents of the Brochure

    The requirements for the contents of the wrap fee brochure are set 
forth in a new schedule to Form ADV, Schedule H.\22\ The requirements 
of Schedule H are substantially similar to the requirements set forth 
in the proposed amendments.
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    \22\Wrap fee brochures must be filed with the Commission 
attached to a completed Schedule H.
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    The Commission urges sponsors to draft wrap fee brochures in a 
direct and understandable manner. Consideration should be given, for 
example, to the level of sophistication of clients and prospective 
clients of the program. In addition, technical language should be 
avoided, unless it is clearly explained or substantially all of the 
program's clients and prospective clients possess the sophistication to 
understand the disclosure without explanation.
1. Cover Page and Table of Contents
    Schedule H requires that the cover page of the wrap fee brochure 
include the sponsor's name, address, telephone number, and a legend 
regarding the purpose of the brochure.\23\ These requirements are the 
same as those of the proposed amendments. In addition, the amendments 
require that the wrap fee brochure include a table of contents 
reflecting the subject headings in the brochure. The table of contents 
need not be on the cover page.\24\
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    \23\Item 7(a) of Schedule H.
    \24\Item 7(b) of Schedule H. The amendments do not require that 
the information in the brochure be ordered or organized in any 
particular manner, except with regard to the information required to 
be on the cover page.
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2. Fee and Compensation Disclosure
    The Commission is adopting as proposed those provisions of Schedule 
H that require the wrap fee brochure to set forth the wrap fee, the 
services provided for that fee, and whether the fee is negotiable.\25\ 
Schedule H also requires that the brochure describe the nature of any 
fees the client may pay in addition to the wrap fee, state that the 
program may cost the client more or less than the same services 
purchased separately, and disclose the factors that bear upon the cost 
of the program in relation to the cost of the same services purchased 
separately.\26\ If fees vary according to a schedule (e.g., on the 
basis of the amount of assets the client has in the program), the fee 
schedule must be presented in a table.
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    \25\Item 7(c) of Schedule H.
    \26\The brochure is required only to explain the factors that 
affect whether a wrap fee arrangement or a traditional fee-plus-
commission arrangement will be less costly to a client, and need not 
provide actual or estimated costs for particular services outside 
the wrap fee program.
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    As adopted, Schedule H also retains the requirement of the proposal 
that the portion of the wrap fee paid to portfolio managers (or the 
range of those amounts) be disclosed in the wrap fee brochure.\27\ The 
Proposing Release requested comment whether similar information should 
be required regarding the compensation paid to registered 
representatives of the sponsor in connection with wrap fee accounts, 
and whether disclosure that registered representatives have a financial 
incentive to recommend the wrap fee program over other services of the 
sponsor should be required. Industry commenters were opposed to 
requiring amounts of compensation to be disclosed, in part because the 
amounts often vary substantially among representatives, but many 
acknowledged the need for disclosure that representatives are 
compensated.
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    \27\Item 7(c) of Schedule H. Because of the inclusion of this 
information in the sponsor's wrap fee brochure, the Division of 
Investment Management would not object if the portfolio manager's 
brochure omitted the portion of the wrap fee received by the manager 
in response to Item 1 of Part II. See National Regulatory Services, 
supra note 10.
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    The method and amount of compensation of an adviser or its 
representative may create a conflict of interest between the adviser 
and its client and the representative and his client if incentives are 
created for recommending a wrap fee program rather than, for example, 
mutual funds or other advisory programs (including traditional fee-
plus-commission arrangements) that meet the needs of clients and that 
may be less expensive. To alert investors to this conflict of interest, 
Schedule H requires that, if persons recommending a wrap fee program 
receive compensation as a result of client participation in the 
program, the wrap fee brochure must disclose (1) that persons 
recommending the program will be compensated, (2) that the amount of 
this compensation may be more than the amount the person would receive 
if the client participated in other programs of the sponsor or paid 
separately for investment advice, brokerage and other services, and (3) 
that the person may therefore have a financial incentive to recommend 
the program over other programs or services.\28\
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    \28\Item 7(e) of Schedule H. Because the amount a registered 
representative will receive may not be readily determinable at the 
time a client selects a program or service, Schedule H does not 
require that the brochure state that the representative will receive 
greater compensation in connection with the wrap fee program than 
with alternative programs.
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3. Portfolio Manager Performance Information
    The Commission proposed that the wrap fee brochure be required to 
disclose if performance information provided to clients regarding 
portfolio managers is not calculated on a uniform or consistent basis, 
and to refer to any standards under which the information is 
calculated.\29\ The Commission also proposed that the brochure disclose 
whether performance information is reviewed by the sponsor or a third 
party, and, if so, the identity of the reviewer.\30\ These requirements 
are being adopted substantially as proposed.
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    \29\Item 7(h) of Schedule H.
    \30\Id.
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    The Proposing Release requested comment whether sponsors should be 
required to explain the extent of any review of portfolio manager 
performance information. Most commenters addressing the issue favored 
such disclosure, and the amendments require the wrap fee brochure to 
describe briefly the nature of the review.\31\ This description should 
include, among other matters, whether the review is designed to 
determine whether the performance information reflects the actual 
experience of accounts under management, the appropriateness of the 
methodology used to calculate performance, compliance with any 
standards the sponsor or portfolio manager has stated it will follow, 
and/or whether the reviewer has merely reviewed the mathematical 
accuracy of the calculations.\32\ If the scope of the review of the 
performance information is limited to the mathematical accuracy of the 
calculations, the brochure should describe that the reviewer has not 
reviewed the information to determine the appropriateness of the 
methodology used or whether the information reflects the actual 
experience of accounts under management.
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    \31\Id.
    \32\The Proposing Release requested comment whether the 
Commission should propose the use of standardized formulas for the 
calculation of performance information of portfolio managers in wrap 
fee programs, or of advisers generally. The Commission plans to 
continue to study this issue.
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4. Other Disclosure Requirements
    The other disclosure requirements of the proposed amendments are 
being adopted largely as proposed. These requirements include how 
portfolio managers in the program are selected,33 the information 
about the client that is communicated to its portfolio manager,34 
and restrictions placed on client contact with portfolio 
managers.35 The general disclosure about the sponsor that is 
required to be included in the wrap fee brochure by reference to 
certain questions of Part II is also being adopted without modification 
to the proposal.36
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    \3\3Item 7(g) of Schedule H.
    \3\4Item 7(i) of Schedule H.
    \3\5Item 7(j) of Schedule H. One commenter requested that the 
Commission clarify that the requirement to disclose restrictions on 
client contact with portfolio managers does not indicate a change in 
the Division of Investment Management's position that an adviser 
managing accounts in a collective manner may be operating an 
unregistered investment company. It does not.
    \3\6Item 7(k) of Schedule H. Item 7(m) of Schedule H requires 
that the wrap fee brochure discuss the nature of the portfolio 
management services provided under the program by the sponsor's 
employees or divisions covered under the same investment adviser 
registration as the sponsor. Although the Schedule would not require 
disclosure regarding the educational and business background of, and 
the particular investment strategy used by, every registered 
representative that serves as a portfolio manager in a wrap fee 
program sponsored by the representative's employer, such information 
may be material and may have to be provided to clients in some form. 
See Proposing Release, supra note 1, at n.33.
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D. Delivery and Updating

    The amendments require that the wrap fee brochure be delivered to 
prospective wrap fee clients and annually offered to an adviser's 
existing wrap fee clients.37 The Commission is also requiring that 
the wrap fee brochure be delivered to all clients (including clients 
who have received the sponsor's general brochure) on a one-time basis 
when the brochure is first filed with the Commission, so that existing 
clients of wrap fee programs receive the basic disclosure about the 
program that will in the future be provided to prospective 
clients.38
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    \3\7These delivery requirements are the same as the requirements 
in the proposed amendments and for the general brochure. Paragraphs 
(b) and (c) of rule 204-3 [17 CFR 275.204-3 (b) and (c)]. The 
delivery to prospective clients must occur not less than forty-eight 
hours before the client enters 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. Paragraph (b)(1) of rule 204-3 [17 CFR 275.204-3(b)(1)].
    \3\8New paragraph (f)(4) of rule 204-3. See the effectiveness 
provisions in Section I.E of this Release infra.
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    The wrap fee brochure is required to be updated promptly to reflect 
material changes to the information it contains, or within ninety days 
after the end of the sponsor's fiscal year to reflect other 
changes.39 The wrap fee brochure may be updated by the use of a 
sticker (i.e., a supplement affixed to the brochure that indicates what 
information is being added or updated and states the new or revised 
information). The proposed amendments would have limited sponsors to 
two consecutive stickers before all changes would have had to be 
incorporated into the brochure itself. As some commenters suggested, 
the Commission is not adopting a numerical limit on stickers; instead, 
updating by sticker will be permitted so long as the resulting brochure 
remains readable.40
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    \3\9Paragraph (b) of rule 204-1, as amended.
    \4\0Item 6 of Schedule H. The Commission would consider a 
brochure subject to multiple stickers or a single sticker amending 
multiple provisions to be unreadable if the brochure has become 
particularly unwieldy or difficult to follow as a result of the 
stickers or sticker.
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E. Date of Effectiveness

    A sponsor is required to file an amendment to Form ADV to include 
the necessary wrap fee brochure or brochures, to deliver the wrap fee 
brochure to existing wrap fee clients,41 and to begin to deliver 
the wrap fee brochure to prospective wrap fee clients, by October 1, 
1994, approximately five months after the adoption of the 
amendments.42
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    \4\1See Section I.D supra.
    \4\2The Proposing Release requested comment whether a 120-day 
transition period would be appropriate. A few commenters stated that 
a 180-day transition period would be more appropriate.
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II. Cost/Benefit Analysis

    Several commenters raised concerns that the form and rule 
amendments as proposed, particularly the requirement for a separate 
wrap fee brochure, could result in additional costs for sponsors that 
may be passed on to investors. The Commission has modified the 
amendments in part because of these concerns, but continues to believe 
that the cost of a separate wrap fee brochure is outweighed by the 
benefit to investors of improved disclosure about wrap fee programs.
    The Commission has narrowed the scope of the terms ``wrap fee 
program'' and ``sponsor.'' As a result, certain advisers that would 
have incurred the costs of the wrap fee brochure under the proposed 
amendments will not incur any costs as a result of the amendments, and 
other advisers will incur reduced costs because fewer of their programs 
are subject to the amendments. The Commission has also liberalized the 
use of stickers, which should reduce the cost of updating the brochure.
    The Commission does not believe that the cost of a separate wrap 
fee brochure need be substantial. The brochure need not be 
professionally printed, and professionally printed brochures generally 
can be updated by sticker, rendering frequent reprinting 
unnecessary.43
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    \4\3One commenter suggested that sponsors would find 
professional printing necessary for marketing purposes. Many 
sponsors, however, currently deliver Part II, rather than a printed 
document, to clients as their brochure. Many sponsors that use Part 
II presumably would deliver a typewritten wrap fee brochure to wrap 
fee clients.
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III. Regulatory Flexibility Act Analysis

    A summary of the Initial Regulatory Flexibility Analysis, which was 
prepared in accordance with 5 U.S.C. 603, was published in Investment 
Advisers Act Rel. No. 1401. No comments were received on this analysis. 
The Commission has prepared a Final Regulatory Flexibility Analysis, a 
copy of which may be obtained by contacting Eric C. Freed, Office of 
Disclosure and Investment Adviser Regulation, Division of Investment 
Management, 450 Fifth Street, NW., Washington, DC 20549.

IV. Text of 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, the Commission is amending 
chapter II, title 17 of the Code of Federal Regulations 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 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 is compensated under a wrap fee program for sponsoring, 
organizing, or administering the program, or for selecting, or 
providing advice to clients regarding the selection of, other 
investment advisers in the 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 additional 
information included in such disclosure statement should be limited to 
information concerning wrap fee programs sponsored by the investment 
adviser.
    (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.
    (4) An investment adviser that is required under this paragraph (f) 
to furnish a disclosure statement to clients of a wrap fee program 
shall furnish the disclosure statement to each client of the wrap fee 
program (including clients that have previously been furnished the 
brochure required under paragraph (a) of this section) no later than 
October 1, 1994.
    (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 investment advisory services (which may include 
portfolio management or advice concerning the selection of other 
investment advisers) and execution of client transactions.

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 (referenced in 
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 Part II Item 
14; 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, DC 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 U.S.C. 1001 and 15 U.S.C. 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.
     Wrap Fee Programs--A wrap fee program is any program under 
which any client is charged a specified fee or fees not based directly 
upon transactions in a client's account for investment advisory 
services (which may include portfolio management or advice concerning 
the selection of other investment advisers) and execution of client 
transactions.
     Sponsors--A sponsor of a wrap fee program is any applicant 
that is compensated under a wrap fee program for sponsoring, 
organizing, or administering the program, or for selecting, or 
providing advice to clients regarding the selection of, other 
investment advisers in the program.
    The document prepared in response to Schedule H must 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. Part II and Schedule F 
need only contain an abbreviated narrative discussion of a sponsor's 
wrap fee programs, although responses to check-the-box questions in 
Part I and Part II should reflect the applicant's wrap fee programs.
* * * * *
    6. By revising Item 16 of Part I of Form ADV (referenced in 
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 (referenced in Sec. 279.1) to 
read as follows:

    Note: 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.

    April 19, 1994.
Margaret H. McFarland,
Deputy Secretary.

Appendix 1

Schedule H of Form ADV

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 are compensated under a wrap fee program for 
sponsoring, organizing, or administering the program, or for 
selecting, or providing advice to clients regarding the selection 
of, other investment advisers in the program (``sponsors''). A wrap 
fee program is any program under which a specified fee or fees not 
based directly upon transactions in a client's account is charged 
for investment advisory services (which may include portfolio 
management or advice concerning the selection of other investment 
advisers) and execution of client transactions.
    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   sposor'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 7 
below, should not be repeated in the brochure. Rather, this Schedule 
describes minimum disclosures that must be made in the brochure to 
satisfy the sponsor's duty to disclose all material facts about the 
sponsor and its wrap fee programs. Nothing in this Schedule relieves 
the sponsor 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 sponsor's wrap fee programs. If the sponsor is required to 
complete this Schedule with respect to more than one wrap fee 
program, the sponsor 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 a sponsor of more than one wrap fee program 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. Each such brochure 
must state that the sponsor sponsors other wrap fee programs and 
state how brochures for those programs may be obtained.
    6. Updating. Sponsors 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 supplement affixed to the brochure that 
indicates what information is being added or updated and states the 
new or revised information, as long as the resulting brochure is 
readable. Stickers should be dated and should be incorporated into 
the text of the brochure when the brochure itself is revised.
    7. 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) a table of contents reflecting the subject headings in the 
sponsor's brochure;
    (c) the amount of the wrap fee charged for each program or, if 
fees vary according to a schedule established by the sponsor, a 
table setting forth the fee schedule, 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 of sale of specific securities under the program 
(``portfolio managers''), and the services provided under each 
program (including the types of portfolio management services);
    (d) 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);
    (e) if applicable, a statement that the person recommending the 
program to the client receives compensation as a result of the 
client's participation in the program, that the amount of this 
compensation may be more than what the person would receive if the 
client participated in other programs of the sponsor or paid 
separately for investment advice, brokerage, and other services, and 
that the person may therefore have a financial incentive to 
recommend the wrap fee program over other programs or services;
    7. (f) 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, mark-downs or spreads paid to market makers 
from whom securities were obtained by the wrap fee broker);
    (g) 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 
sponsor will replace or recommend the replacement of the portfolio 
manager;
    (h) (1) if applicable, a statement to the effect that portfolio 
manager performance information is not reviewed by the sponsor or a 
third party and/or that performance information is not calculated on 
a uniform and consistent basis,
    (2) if performance information is reviewed to determine its 
accuracy, the name of the party who reviews the information and a 
brief description of the nature of the review,
    (3) a reference to any standards (i.e., industry standards or 
standards used solely by the sponsor) under which performance 
information may be calculated;
    (i) a description of the information about the client that is 
communicated by the sponsor to the client's portfolio manager, and 
how often or under what circumstances the sponsor provides updated 
information about the client to the portfolio managers;
    (j) any restrictions on the ability of clients to contact and 
consult with portfolio managers;
    (k) 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;
    (l) if any practice or relationship disclosed in response to 
Items 7, 8, 9A, 9C and 13 of Part II presents a conflict between the 
interests of the sponsor and those of its clients, explain the 
nature of any such conflict of interest; and
    (m) 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.
    8. Organization and Cross References. Except for the cover page 
requirements in Item 7(a) above, information contained in the 
brochure need not follow the order of the items listed in Item 7. 
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 7 are provided.

------------------------------------------------------------------------
                          Item No.                              Page(s) 
------------------------------------------------------------------------
7(a)........................................................  Cover     
7(b)........................................................  ..........
7(c)........................................................  ..........
7(d)........................................................  ..........
7(e)........................................................  ..........
7(f)........................................................  ..........
7(g)........................................................  ..........
7(h)........................................................  ..........
7(i)........................................................  ..........
7(j)........................................................  ..........
7(k)........................................................  ..........
7(l)........................................................  ..........
7(m)........................................................  ..........
------------------------------------------------------------------------


[FR Doc. 94-9890 Filed 4-25-94; 8:45 am]
BILLING CODE 8010-01-M