[Federal Register Volume 63, Number 195 (Thursday, October 8, 1998)]
[Rules and Regulations]
[Pages 54308-54330]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-26863]



[[Page 54307]]

_______________________________________________________________________

Part IV





Securities and Exchange Commission





_______________________________________________________________________



17 CFR Parts 275 and 279



Investment Adviser Year 2000 Reports; Final Rule

  Federal Register / Vol. 63, No. 195 / Thursday, October 8, 1998 / 
Rules and Regulations  

[[Page 54308]]



SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release No. IA-1769; IC-23476; File No. S7-20-98]
RIN 3235-AH45


Investment Adviser Year 2000 Reports

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Commission is adopting a new rule and form under the 
Investment Advisers Act of 1940 that requires most registered 
investment advisers to file with the Commission reports regarding their 
plans for addressing the Year 2000 computer problem. The reports will 
provide the Commission and investors with information regarding 
advisers' plans to address the Year 2000 problem.

EFFECTIVE DATE: The rule and form will become effective November 13, 
1998. See section III.A for filing dates.

FOR FURTHER INFORMATION CONTACT: Carolyn-Gail Gilheany, Senior Counsel, 
or Arthur B. Laby, Special Counsel, at (202) 942-0716, Task Force on 
Investment Adviser Regulation, Division of Investment Management, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 
5-6, Washington, D.C. 20549. The Commission has placed a list of 
frequently asked questions and answers about Form ADV-Y2K on the 
Commission's Internet web site. The list is located at http://
www.sec.gov/rules/othern/advfaq.htm. The Commission staff will update 
these questions and answers from time to time. The Commission urges 
interested persons with access to the Internet to review these 
questions and answers before contacting Commission staff.

SUPPLEMENTARY INFORMATION: The Commission today is adopting rule 204-5 
(17 CFR 275.204-5) and Form ADV-Y2K (17 CFR 279.9) under the Investment 
Advisers Act of 1940 (15 U.S.C. 80b) (``Advisers Act'').

I. Executive Summary

    The Commission is conducting a review of U.S. public companies and 
the U.S. securities industry to examine how they will address the Year 
2000 computer problem.\1\ As part of this initiative, we recently 
adopted rule changes to require certain broker-dealers and transfer 
agents to file reports with the Commission on Year 2000 readiness.\2\ 
Today the Commission is adopting a new rule and form that requires most 
investment advisers registered with the Commission under the Advisers 
Act to file reports on their Year 2000 readiness. The reports will 
permit us to better evaluate the preparedness of advisers for the Year 
2000 problem, identify the advisers that pose a significant risk to 
their clients and shareholders, and evaluate the adequacy of disclosure 
made by advisers regarding the Year 2000 problem. This rule is the most 
recent in a series of actions we have taken in an effort to assure that 
the securities industry is prepared for the computer challenges 
presented by the Year 2000 problem.
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    \1\ On January 1, 2000, certain computer systems may function 
erroneously if modifications have not been made, because the systems 
may read the date 01/01/00 as being January 1, 1900, or another 
incorrect date.
    \2\ Reports to be Made by Certain Brokers and Dealers, Exchange 
Act Release No. 40162 (July 2, 1998) [63 FR 37668 (July 13, 1998)]; 
Year 2000 Readiness Reports To Be Made by Certain Transfer Agents, 
Exchange Act Release No. 40163 (July 2, 1998) [63 FR 37688 (July 13, 
1998)]. Under these rules, broker-dealers are required to file Form 
BD-Y2K; transfer agents are required to file Form TA-Y2K.
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II. Background

    Investment advisers (``advisers'') are responsible for managing 
approximately $15 trillion in assets, including over $5 trillion in 
mutual funds.\3\ Advisers manage these assets by using both internal 
computer systems and external systems that connect them with the 
markets, service providers and clients. The failure of advisers' 
computer systems could threaten their ability to manage client assets, 
communicate information to clients and comply with the federal 
securities laws.\4\ In the case of investment companies, a breakdown in 
their systems could interfere with the day-to-day management of fund 
portfolios, delay shareholder transactions and compromise recordkeeping 
and other compliance systems.
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    \3\See The Investment Company Institute, Current Statistical 
Releases, Trends in Mutual Fund Investing, April 1998, available at 
<http://www.ici.org/facts__figures/trends__0298html>.
    \4\See Tracey Longo, The Millennium Time Bomb, 28 Financial 
Planning 180 (Sept. 1998).
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    The Commission has taken several measures to encourage advisers and 
funds to timely address the challenges posed by the year 2000 problem. 
Since 1996, our examiners have raised year 2000 concerns during adviser 
and investment company examinations, and recently our staff has begun a 
series of examinations that focus on plans to address the year 2000 
problem. Last year, Chairman Levitt sent a letter to all registered 
advisers urging them to prepare for the year 2000 problem,\5\ and in 
July 1998, we published an interpretive release to provide guidance on 
the disclosure obligations of advisers, funds and others.\6\ Last 
month, we announced a moratorium on the implementation of new SEC rules 
that require major reprogramming of systems by, among others, 
investment advisers and funds.\7\ The moratorium is designed to 
facilitate and encourage securities industry participants to allocate 
sufficient resources to remediation of the year 2000 problem.
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    \5\ Letter from Chairman Levitt, dated November 13, 1997, 
available at <http://www.sec.gov/news/press/97-102.txt>.
    \6\ Statement of the Commission Regarding Disclosure of year 
2000 Issues and Consequences by Public Companies, Investment 
Advisers, Investment Companies, and Municipal Securities Issuers, 
Securities Act Release No. 7558 (July 29, 1998) [63 FR 41394 (Aug. 
4, 1998)] (Statement on year 2000 Disclosure).
    \7\ Commission Statement of Policy on Regulatory Moratorium to 
Facilitate the year 2000 Conversion, Investment Advisers Act Release 
No. 1949 (Aug. 27, 1998) [63 FR 47051 (Sept. 3, 1998)].
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    On June 30, 1998, the Commission issued a release proposing rule 
204-5 (``Proposing Release'') that would require most advisers 
registered with the Commission to submit a form, Form ADV-Y2K, on their 
preparedness for the year 2000 problem.\8\ In response to the proposal, 
we received 24 comment letters from professional and trade 
organizations and investment advisers. Nearly all of the commenters 
supported the proposal, which we are adopting largely as proposed.
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    \8\ Investment Adviser year 2000 Reports, Investment Advisers 
Act Release No. 1728 (June 30, 1998) [63 FR 36632 (July 7, 1998)].
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III. Discussion

A. Rule 204-5

    New rule 204-5 requires each investment adviser that is registered 
with the Commission and (i) has at least $25 million of assets under 
management,\9\ or (ii) is an adviser to an investment company 
registered under the Investment Company Act of 1940,\10\ to file Form 
ADV-Y2K with the Commission.\11\ The form must be filed

[[Page 54309]]

with the Commission no later than December 7, 1998, and an updated form 
must be filed no later than June 7, 1999. Each filing must reflect the 
adviser's preparedness for the year 2000 problem no earlier than 15 
days before the respective filing deadline.
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    \9\ The amount of assets under management for purposes of the 
rule is the amount reported on Schedule I of the adviser's most 
recently filed Form ADV (17 CFR 279.1), or the most recent amendment 
to its Form ADV.
    \10\ 15 U.S.C. 80a.
    \11\ Generally only advisers that have at least $25 million of 
assets under management or that advise a registered investment 
company can register with the Commission. See section 203A(b) of the 
Advisers Act (15 U.S.C. 80b-3a(b)). Advisers in the states that do 
not regulate investment advisers, advisers with principal places of 
business in foreign countries, and other advisers exempt by SEC rule 
from the $25 million assets under management limitation, however, 
may register with the Commission. See rule 203A-2 under the Advisers 
Act (17 CFR 275.203A-2).
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    Shortly after publication of this release, we will mail a copy of 
Form ADV-Y2K to each registered adviser. The form mailed to each 
adviser will contain certain pre-printed information, such as the 
adviser's name and registration number. The form (without the pre-
printed information) also is available on the Commission's web site, 
and advisers may down-load the form and complete it on their computers, 
print the completed form, and return it to the Commission.\12\ The 
Commission asks advisers to return the Form ADV-Y2K they receive in the 
mail containing the pre-printed information or the version down-loaded 
from the web-site.\13\ An authorized person of the adviser, who 
participates in managing or directing the adviser's affairs, must sign 
the report.\14\ Form ADV-Y2K, like all forms filed with the Commission 
by investment advisers, will be publicly available.\15\ Shortly after 
the Commission receives the forms, we will make data from the forms 
available on the Commission's web site.\16\ In addition, the Commission 
or its staff, after reviewing the forms and other pertinent 
information, may make findings or conclusions, or compile information 
from filings by individual firms, and make firm-specific, aggregate or 
derivative information available to the public, Congress or members of 
the securities industry.
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    \12\ The SEC's web site is <www.sec.gov>. The Commission also is 
making available, through its web site, the software required to 
access the form.
    \13\ The Commission had considered requiring advisers to file by 
fax, but we are not doing so because we are unsure about the ability 
of the technology we had planned to use to accept the expected 
volume of filings.
    \14\ The adviser is not required to engage an independent public 
accountant to attest to the report. The Commission had proposed not 
to require an auditor attestation for Form ADV-Y2K, and the 
commenters agreed that the auditor's attestation was not necessary.
    \15\ See section 210(a) of the Advisers Act (15 U.S.C. 80b-
10(a)). One commenter requested that the forms not be made public. 
The Commission believes it is important that investors be able to 
access information about their advisers' preparedness for the year 
2000 problem, just as they can access similar information about 
broker-dealers. See Exchange Act Rule 17a-5(e)(5)(v) (17 CFR 
240.17a-5(e)(5)(v)).
    \16\ The information will be available at <http://www.sec.gov/
rules/othern/advfaq.htm>. Several commenters expressed concern that 
their responses to certain questions may appear incomplete in the 
absence of a more detailed explanation. To address this concern, the 
Commission will place on its web site a statement explaining that 
the information on the form may be incomplete, and that it only 
reflects developments as of the date the form was submitted to the 
SEC. The statement will urge interested readers to seek more 
complete information from the adviser about its preparedness for the 
year 2000 problem.
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    Four commenters urged us to exempt from the rule advisers that also 
are SEC-registered broker-dealers or transfer agents, or affiliates of 
banks. These commenters argued that since these advisers are required 
to file similar reports with us or with the bank regulatory agencies, 
there is no reason to require duplicative reports. While the Commission 
appreciates the need to avoid imposing unnecessary paperwork on 
investment advisers, we are not adopting these commenters' suggestions. 
An adviser's response to the same or similar questions in Form BD-Y2K, 
Form TA-Y2K \17\ or similar forms filed with the banking regulatory 
agencies, may (and in some cases should) be different because of the 
different focus of those reports. To the extent there is overlap among 
the reports, the burdens imposed by completing Form ADV-Y2K should not 
be significant since previous responses can simply be restated in Form 
ADV-Y2K (if they remain accurate).\18\
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    \17\ Reports to be Made by Certain Brokers and Dealers, supra 
note 2; year 2000 Readiness Reports To Be Made by Certain Transfer 
Agents, supra note 2.
    \18\ We are also not adopting one commenter's suggestion that 
advisers organized in a holding company structure be permitted to 
file a single report on the year 2000 preparedness of the holding 
company. Such an approach would make it very difficult for us and 
members of the public reviewing the data to distinguish between 
those advisers who were not required to file Form ADV-Y2K from those 
that failed to comply with the filing requirement. Advisers that are 
members of a holding company with integrated computer systems should 
be able simply to use identical responses in each of the reports 
filed with the Commission.
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B. Form ADV-Y2K

    New Form ADV-Y2K has two parts. The first part must be completed by 
all advisers required to file the form, while the second part must be 
completed only by advisers to investment companies registered with the 
Commission under the Investment Company Act.
1. Part I: Information Required From All Advisers
    Part I of the form contains 13 questions about an adviser's plans 
to address the year 2000 problem with respect to all of its 
clients.\19\ The questions are in multiple choice or fill-in-the-blank 
format; all advisers filing the form must respond to each question. 
Form ADV-Y2K asks for information in several areas: (1) the adviser's 
year 2000 compliance plan; (2) resources and personnel to address year 
2000 issues; (3) systems that may be affected;\20\ (4) the adviser's 
progress in addressing year 2000 issues; (5) contingency plans; (6) the 
readiness of third parties; and (7) whether, and the means by which, 
the adviser takes into consideration the year 2000 preparedness of 
issuers of securities the adviser recommends to clients.\21\
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    \19\ The questions in Part I of Form ADV-Y2K are generally the 
same as the questions in Part I of Form BD-Y2K and Form TA-Y2K.
    \20\ There are no universal definitions for mission-critical 
systems; it is up to each adviser to determine which of its systems 
are mission-critical.
    \21\ See Question 11 to Part I of Form ADV-Y2K. The Commission 
has added this question in light of the important role advisers can 
play in identifying issuers and securities that may be adversely 
affected by year 2000 problems, and protecting their clients from 
losses as a result. The Commission recognizes, however, that some 
advisers have investment styles that make consideration of year 2000 
preparedness of issuers irrelevant. For example, some advisers' 
advice is limited to the advisability of investing in broad asset 
classes (e.g., market timers); some manage accounts that track 
indexes; and others use ``technical analysis'' and base their advice 
on market trends, but not on the fundamentals of particular issuers. 
These advisers would respond to this item by checking the ``Not 
Applicable'' response. An adviser should only check the ``Not 
Applicable'' box if it is an appropriate response with respect to 
all of its accounts.
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    Several questions elicit information on specific aspects of the 
adviser's plans to address the year 2000 problem and when those plans 
will be complete.\22\ This information is important so that the 
Commission can learn not only about the steps an adviser is taking to 
prepare, but also when it expects to complete those steps. Several 
commenters expressed concern that some of these questions, as proposed, 
appeared to prescribe specific steps that all advisers must take in 
order to prepare for the year 2000 problem.\23\ We have revised the 
wording of these questions to clarify that the Advisers Act requires no 
particular steps to be taken by an adviser to prepare for the year 2000 
problem.\24\ The Commission highly recommends, however, that all 
advisers consider the six steps of preparation the Commission has

[[Page 54310]]

identified that advisers and funds can take to prepare for the year 
2000 computer problem.\25\
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    \22\ See Questions 5, 7-10 to Part I of Form ADV-Y2K.
    \23\ Also, two commenters raised questions about the requirement 
in the instructions to Part I that advisers include information 
about their affiliates that are not required to file the form. The 
Commission has clarified that advisers should include information 
about SEC registered affiliates that are not required to complete 
the form, i.e., those that have less than $25 million of assets 
under management, but are permitted to register under an exemption.
    \24\ See Questions 7-8 to Part I of Form ADV-Y2K. Under the 
Advisers Act, an adviser that is unable, or uncertain about its 
ability, to address year 2000 issues, would be required to disclose 
this information, if material, to its clients. See Statement on year 
2000 Disclosure, supra note 6.
    \25\ These steps are: (i) identification of potential year 2000 
problems; (ii) assessment of steps to avoid year 2000 problems; 
(iii) implementation of steps to avoid year 2000 problems; (iv) 
internal testing of software designed to avoid year 2000 problems; 
(v) point-to-point testing of software designed to avoid year 2000 
problems (i.e., testing with service providers such as broker-
dealers, custodians, transfer agents and distributors); and (vi) 
implementation of tested software that will avoid year 2000 
problems.
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    An adviser that has computer systems for which it has made 
different amounts of progress in preparing for the year 2000 must 
respond to questions regarding its year 2000 preparedness based on a 
``qualitative average'' of its systems.\26\ This qualitative average 
requires an adviser to give greater weight to mission-critical systems 
than to other of its systems. Commenters generally preferred this 
approach to an alternative under which the adviser's progress with 
respect to each system would be separately reported.
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    \26\ See Instruction 4 to Part I of Form ADV-Y2K.
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    Responses to several questions in Form ADV-Y2K depend on obtaining 
information about third party systems that communicate with the 
adviser's systems. Several commenters asserted that advisers should be 
required to report only on their own readiness for the year 2000 
problem, not on the readiness of third parties, especially since the 
adviser is required to execute the form. Because many advisers rely 
extensively on the computer systems of third parties in their day-to-
day business, eliminating these questions would reduce substantially 
the utility of these reports and yield an incomplete picture of 
readiness for the year 2000. The Commission, therefore, has not 
eliminated these questions from the form.\27\
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    \27\ In our Statement on year 2000 Disclosure, supra note 6, we 
stated that an issuer should assess ``whether third parties with 
whom a company has material relationships are year 2000 compliant.'' 
We also stated that an issuer should take ``reasonable steps to 
verify the year 2000 readiness of any third party that could cause a 
material impact on the company'' and that we understood ``that this 
is often done by analyzing the response to questionnaires sent to 
these third parties.'' We believe that investment advisers should 
take similar steps. Therefore, the Commission has added an 
instruction to the form that requires advisers to make reasonable 
inquiries of third parties to obtain information necessary to 
respond to the form. See General Instructions to Form ADV-Y2K. If an 
adviser has no reason to believe that a third party's responses to 
an inquiry were not truthful, the Commission would not expect the 
adviser to inquire further.
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2. Part II: Information Required From Advisers to Investment Companies
    Part II of Form ADV-Y2K must be completed by advisers to a 
registered investment company or group of investment companies. Part II 
is designed to elicit information about the year 2000 readiness of the 
investment companies (``funds''). Only advisers that are sponsors or 
administrators of a fund complex must complete Part II.\28\ If no 
sponsor or administrator of the complex is a registered adviser, at 
least one adviser to a fund (or series) in the complex must submit a 
report for the fund complex, if the adviser is registered with the 
Commission.\29\
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    \28\ If there are multiple administrators or sponsors, the 
adviser must complete the form only with respect to funds for which 
another adviser has not reported.
    \29\ See Instruction 1 to Part II of Form ADV-Y2K.
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    The Commission proposed to require each adviser to a fund complex 
to report for the entire complex unless another adviser is reporting on 
behalf of the fund, and explained that this approach would permit 
multiple advisers to a single fund complex to decide among themselves 
which adviser would file the report.\30\ We received numerous 
objections to this proposal from advisers to funds. Many argued that 
advisers or sub-advisers that do not sponsor funds are not in a 
position to report on a fund's preparation for the year 2000 problem. 
In response, we have added a note clarifying that the adviser that is 
the sponsor or administrator of a fund complex should file the 
report.\31\ In some cases, however, the sponsor or administrator of a 
fund complex is not a registered investment adviser, and no adviser 
otherwise might be required to file Part II for that fund complex. 
Therefore, in such cases (which the Commission believes to be few) at 
least one of the advisers to the fund complex must file Part II of Form 
ADV-Y2K on behalf of the complex.\32\
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    \30\ See Proposing Release, supra note 8.
    \31\ See Instruction 1 to Part II of Form ADV-Y2K.
    \32\ As noted in the Proposing Release, the Commission does not 
have authority under Section 204 of the Advisers Act (15 U.S.C. 80b-
4) to require a fund sponsor or administrator that is not registered 
under Section 203 of the Advisers Act (15 U.S.C. 80b-3) to file Form 
ADV-Y2K.
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    Commenters on the Proposed Form expressed concern that some of the 
questions in Part II contained assumptions that funds rather than third 
party service providers (such as advisers or administrators) were 
engaged in year 2000 planning and remediation activities. We have 
revised several questions and deleted others to make clear that the 
form is not based on these assumptions. We also have added an 
instruction at the suggestion of one commenter to clarify that 
advisers, in responding to questions in Form ADV-Y2K, should treat as 
third parties any other advisers or sub-advisers for the fund or funds 
for which the adviser is completing the Form.\33\ Finally, in response 
to two comments, we have added an instruction clarifying how advisers 
to insurance company separate accounts,\34\ and the funds underlying 
the separate accounts, should respond to items in Form ADV-Y2K.\35\
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    \33\ See Instruction 3 to Part II of Form ADV-Y2K.
    \34\ These separate accounts are typically registered with the 
Commission as unit investment trusts.
    \35\ See Instruction 4 to Part II of Form ADV-Y2K. This 
instruction is designed to exclude from Form ADV-Y2K information 
about the year 2000 preparedness of the insurance company's general 
computer systems, the primary function of which is to support fixed 
rate insurance products that are generally excluded from regulation 
as securities.
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IV. Paperwork Reduction Act

    As discussed in the Proposing Release, certain provisions of rule 
204-5 (17 CFR 275.204-5) contain collection of information requirements 
within the meaning of the Paperwork Reduction Act of 1995 \36\ because 
registered advisers would have to file new Form ADV-Y2K (17 CFR 279.9) 
with the Commission. The form is necessary for the Commission to assess 
the steps advisers are taking to manage and avoid year 2000 problems. 
The Commission did not receive public comments in response to its 
request for comments in the Proposing Release on the Paperwork 
Reduction Act analysis.\37\
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    \36\ 44 U.S.C. 3501.
    \37\ Although two commenters discussed the amount of time that 
would be required to complete Form ADV-Y2K, none specifically 
addressed the Paperwork Reduction Act analysis in the Proposing 
Release. One commenter believed that the time estimate for 
completing Form ADV-Y2K was reasonable; the other commenter believed 
the Commission's estimate was too low, but did not specify the 
amount of time it would take to complete the form.
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    Under Office of Management and Budget rules, an agency may not 
conduct or sponsor, and a person is not required to respond to, a 
collection of information unless the agency displays a valid OMB 
control number.\38\ The Commission, therefore, has sent the collection 
of information requirements contained in rule 204-5 and Form ADV-Y2K to 
the Office of Management and Budget for review in accordance with 44 
U.S.C. 3507(d) and 5 CFR 1320.11. The title for the collection of 
information is ``Proposed Rule 204-5'' and ``Form ADV-Y2K.'' OMB has 
approved the PRA request and assigned control number 3235-0513 to Form 
ADV-Y2K with an expiration date of December 31, 1999.
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    \38\ 44 U.S.C. 3506(c)(1)(B)(v).
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    The Commission is adopting rule 204-5 and Form ADV-Y2K and 
requiring most registered investment advisers to file the form with the 
Commission regarding advisers' plans to

[[Page 54311]]

address the year 2000 computer problem. The rule imposing this 
collection of information can be found at 17 CFR 275.204-5 and 17 CFR 
279.9. The collection of information required by Form ADV-Y2K is 
mandatory and responses are not kept confidential.
    Rule 204-5 describes the requirement to file Form ADV-Y2K. The 
Commission estimates that there are approximately 7,500 investment 
advisers registered with the Commission, approximately 6,500 of which 
would be required to file Form ADV-Y2K. Although the amount of time 
needed to comply with the rule could vary, the Commission estimates 
that, on average, an adviser would devote approximately two employee 
hours of preparation time to completing Part I of the form, and an 
additional two employee hours to completing Part II of the form, if the 
adviser is required to complete Part II. This estimate was based on 
field-testing of Form ADV-Y2K by the Commission's Office of Compliance 
Inspections and Examinations. The total annual burden will be 14,782 
hours ((6,500 advisers  x  2 hours) + (891 advisers  x  2 hours)). This 
burden would be incurred twice, once in 1998 and once in 1999. The rule 
would not impose an ongoing reporting requirement, and the rule and 
form, as adopted, do not impose a greater paperwork burden on advisers 
than was estimated and described in the Proposing Release.

V. Cost/Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules, and understands that completing Form ADV-Y2K may impose 
costs on advisers and funds. As discussed below, we believe that the 
costs imposed by requiring advisers to complete Form ADV-Y2K are 
necessary and justified in light of the need to make information on the 
year 2000 problem available to investors, Congress and the Commission.
    The Commission believes that requiring advisers to report on their 
readiness for the year 2000 problem will yield important benefits, both 
direct and indirect. The year 2000 reports required by the rule will 
yield direct benefits because they will assist the Commission in 
evaluating the preparedness of advisers and funds for the year 2000 
computer problem. The reports also will help us identify advisers and 
funds that may not be preparing for the year 2000 problem and may pose 
a risk to their clients and shareholders. The reports also will 
identify disclosure by advisers and funds regarding risks associated 
with the year 2000 problem that may be inadequate. Finally, the reports 
will permit the Commission to make information available to the public 
and to fulfill requests by members of Congress for information 
regarding the securities industry's readiness for the year 2000 
problem.
    The year 2000 reports will yield important indirect benefits. By 
requiring the year 2000 reports at this time, some advisers and funds, 
whose year 2000 preparedness efforts to date have been inadequate, may 
be persuaded to accelerate their efforts, which could save them 
significant costs in the future if they fail to make the necessary 
modifications to their computer systems.\39\ This indirect benefit is 
difficult to quantify. It is difficult to estimate the costs that could 
be incurred if computer systems of advisers and funds fail to function 
properly after December 31, 1999.\40\ Moreover, if the systems of 
advisers and funds fail after December 31, 1999, it could have negative 
effects not only for the advisers and funds themselves, but also for 
investors and third parties, such as underwriters, brokers, transfer 
agents, custodians, sub-advisers and other service providers.
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    \39\ It has been estimated that without corrective measures, 
ninety percent of all computer applications worldwide may fail, or 
fail to function properly, because of the inability properly to 
recognize the date change. Maggie Parent, Morgan Stanley, year 2000 
Issue Paper (May 1997), available at <http://www.ms.com/main/
link12.html.
    \40\ The Securities Industry Association has stated that the 
transition to the year 2000 is the largest business and technology 
effort that the world has ever experienced. See SIA, year 2000, 
available at < http://www.sia.com/year__2000/index.html.
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    Avoiding the harm to third parties may be one of most important 
benefits to proper preparation for the year 2000 problem. Most firms' 
computer systems today depend on the systems of many other firms and 
individuals. If even one of these systems were to fail, this could have 
negative repercussions on the systems of other firms with which its 
computers communicate. The failure to address this interdependence may 
be one of the greatest harms stemming from the year 2000 problem.\41\ 
The benefit of avoiding this harm from occurring, although difficult to 
quantify, may be extremely significant to investors, firms and the 
economy in general.
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    \41\ C. Lawrence Meador and Leland G. Freeman, year 2000: The 
Domino Effect, Datamation (Jan. 1997), available at <http://
www.datamation.com/PlugIn/issues/1997/jan/01depend.html.
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    The proposed rule may impose some additional costs on advisers and 
funds. Advisers may need to spend resources obtaining answers to 
questions in the form, completing the form and submitting it to the 
Commission. These costs likely will vary from adviser to adviser. Small 
advisers, for example, may spend comparatively little time completing 
the form because small advisers are likely to have few systems, and one 
person may be responsible for all of the systems. This person may have 
all of the information necessary to complete the form and can do so in 
a few minutes. Larger advisers may require more time because they are 
more likely to have many systems and it is possible that such advisers 
would have to draw on the knowledge of several individuals to complete 
the form.
    The Commission estimates that there are approximately 7,500 
investment advisers registered with the Commission, approximately 6,500 
of which would be required to file Form ADV-Y2K. Although the time 
needed to comply with the rule likely will vary from adviser to 
adviser, the Commission estimates that an adviser will devote 
approximately two employee hours of time to complete Part I of the 
form. In addition, approximately 891 registered investment advisers 
have registered investment companies as clients. In our view, those 891 
advisers are likely to need an additional two hours completing Part II 
of the form on behalf of a fund or fund complex.
    These estimates are based on field-testing of the form by the 
Commission's Office of Compliance Inspections and Examinations. Two 
commenters discussed the amount of time it would take to complete the 
form. One agreed with the Commission's estimate while the other stated 
that the Commission's estimate was low, but did not specify the amount 
of time that would be required. Thus, the Commission is not revising 
its annual burden estimate, which is 14,782 hours ((6,500 advisers x 2 
hours) + (891 advisers x 2 hours)). The form likely will be completed 
by information technology professionals. The Commission estimates the 
hourly wage rate for these professionals to be $100 per hour. The 
Commission, therefore, estimates that the total annual cost of 
completing the forms is $1,478,200.\42\ The Commission believes that 
the proposed rule would not impose significant additional costs on 
investment advisers.
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    \42\ This burden would be incurred twice, once in 1998 and once 
in 1999.
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    The Commission requested comment on its cost/benefit analysis, and 
commenters were requested to provide views and empirical data relating 
to any costs and benefits associated with the rule. No comments about 
the cost/benefit analysis, other than those discussed above, were 
provided, and no

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data were presented. The Commission believes that the costs imposed by 
the rule are insignificant compared to the benefits. If advisers and 
funds are not prepared for the Year 2000 problem, however, the effect 
on advisers and funds, and their clients and third party service 
providers, could be very substantial. For that reason, in the 
Commission's view, the chance of ameliorating the Year 2000 problem 
with respect to advisers and funds justifies the costs involved.

VI. Summary of Regulatory Flexibility Analysis

    The Commission has prepared a Final Regulatory Flexibility Analysis 
(``FRFA'') in accordance with the provisions of the Regulatory 
Flexibility Act (``Reg. Flex. Act'') (5 U.S.C. 604) in connection with 
the adoption of the rule described in this Release. An Initial 
Regulatory Flexibility Analysis (``IRFA'') was prepared in accordance 
with 5 U.S.C. 603 in conjunction with the Proposing Release and was 
made available to the public. A summary of the IRFA was published in 
the Proposing Release. No comments were received on the IRFA.\43\
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    \43\ Although two commenters discussed the amount of time 
required to complete Form ADV-Y2K, none specifically addressed the 
IRFA.
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    The FRFA discusses both the need for, and objectives of, the rule 
and form adopted by the Commission. As set forth in greater detail in 
the FRFA, the rule requires most registered investment advisers to file 
with the Commission a report on Form ADV-Y2K regarding plans to address 
the Year 2000 computer problem.
    The FRFA provides a description and an estimate of the number of 
small entities to which the rule will apply. For purposes of the 
Advisers Act and the Reg. Flex. Act, an investment adviser generally is 
a small entity if (i) it manages assets of $25 million or less reported 
on its last amended Form ADV (17 CFR 279.1) or its most recent Schedule 
I to Form ADV (17 CFR 279.1), (ii) it does not have total assets of $5 
million or more on the last day of its most recent fiscal year, and 
(iii) it is not in a control relationship with another investment 
adviser that is not a small entity.\44\ The Commission estimates that 
approximately 1,000 investment advisers registered with the Commission 
are small entities.
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    \44\ The Commission recently adopted revised definitions of 
``small entity.'' See Definitions of ``Small Business'' or ``Small 
Organization'' Under the Investment Company Act of 1940, the 
Investment Advisers Act of 1940, the Securities Exchange Act of 
1934, and the Securities Act of 1933, Investment Adviser Act Release 
No. 1727 (June 24, 1998) [63 FR 35508 (June 30, 1998)].
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    Few or none of the approximately 1,000 small entities would be 
subject to the rule. Only Commission registered advisers that either 
have $25 million or more under management or act as advisers to 
registered investment companies must file Form ADV-Y2K. Since the 
definition of small entity establishes a threshold of $25 million under 
management, most or all small entities are exempt from the rule by its 
terms. In addition, the Commission believes that few or no investment 
advisers that have less than $25 million under management have more 
than $5 million in assets or are in a control relationship with an 
entity that is not considered a small entity. The only other potential 
small entities that would be subject to the rule are those advisers 
that advise a registered investment company. The Commission is not 
aware of any small entity that advises a registered investment company. 
Therefore, the Commission believes that there are few or no small 
entities affected by the rule.
    Finally, the FRFA states that, in adopting the amendments, the 
Commission considered (a) the establishment of differing compliance 
requirements that take into account the resources available to small 
entities; (b) simplification of the rule's requirements for small 
entities; (c) the use of performance rather than design standards; and 
(d) an exemption from the rules for small entities. The FRFA states 
that the Commission concluded that different standards for small 
entities are not necessary or appropriate.
    The FRFA is available for public inspection in File No. S7-20-98, 
and a copy may be obtained by contacting Carolyn-Gail Gilheany, Senior 
Counsel, Task Force on Investment Adviser Regulation, Division of 
Investment Management, Securities and Exchange Commission, 450 Fifth 
Street, N.W., Mail Stop 5-6, Washington, D.C. 20549.

VII. Statutory Authority

    The Commission is adopting rule 204-5 and Form ADV-Y2K under the 
authority in sections 204 and 211(a) of the Investment Advisers Act of 
1940 (15 U.S.C. 80b-4 and 80b-11(a)).

List of Subjects in 17 CFR Parts 275 and 279

    Reporting and recordkeeping requirements, Securities.

Text of Rule and Form

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is amended as follows:

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    1. The authority citation for Part 275 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80b-2(a)(17), 80b-3, 80b-4, 80b-6(4), 80b-
6a, 80b-11, unless otherwise noted.
* * * * *
    2. Section 275.204-4 is added and reserved and section 275.204-5 is 
added to read as follows:


Sec. 275.204-4  [Reserved]


Sec. 275.204-5  Year 2000 reports.

    Every investment adviser registered with the Commission that has 
assets under management of not less than $25 million or is an 
investment adviser to an investment company registered under the 
Investment Company Act of 1940 (15 U.S.C. 80a-1) must file with the 
Commission:
    (a) A completed Form ADV-Y2K (17 CFR 279.9) no later than December 
7, 1998; and
    (b) An additional completed Form ADV-Y2K no later than June 7, 
1999.

PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 
1940

    3. 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.

    4. Section 279.9 and Form ADV-Y2K are added to read as follows:


Sec. 279.9  Form ADV-Y2K.

    This form must be filed pursuant to Sec. 275.204-5 of this chapter 
by certain investment advisers.

    By the Commission.
    Dated: October 1, 1998.

Margaret H. MacFarland,
Deputy Secretary.
    Note: The text of Form ADV-Y2K will not appear in the Code of 
Federal Regulations. Form ADV-Y2K is attached as Exhibit A.

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[FR Doc. 98-26863 Filed 10-7-98; 8:45 am]
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