[Federal Register Volume 75, Number 155 (Thursday, August 12, 2010)]
[Rules and Regulations]
[Pages 49234-49312]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-19617]



[[Page 49233]]

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Part III





 Securities and Exchange Commission





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17 CFR Parts 275 and 279



Amendments to Form ADV; Final Rule

  Federal Register / Vol. 75 , No. 155 / Thursday, August 12, 2010 / 
Rules and Regulations  

[[Page 49234]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release No. IA-3060; File No. S7-10-00]
RIN 3235-AI17


Amendments to Form ADV

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission is adopting amendments 
to Part 2 of Form ADV, and related rules under the Investment Advisers 
Act, to require investment advisers registered with us to provide new 
and prospective clients with a brochure and brochure supplements 
written in plain English. These amendments are designed to provide new 
and prospective advisory clients with clearly written, meaningful, 
current disclosure of the business practices, conflicts of interest and 
background of the investment adviser and its advisory personnel. 
Advisers must file their brochures with us electronically and we will 
make them available to the public through our Web site. The Commission 
also is withdrawing the Advisers Act rule requiring advisers to 
disclose certain disciplinary and financial information.

DATES: Effective Date: October 12, 2010. Compliance Dates: See Section 
V of this release.

FOR FURTHER INFORMATION CONTACT: Vivien Liu, Senior Counsel, Don L. 
Evans, Senior Counsel, Daniel S. Kahl, Branch Chief, or Sarah A. 
Bessin, Assistant Director, at (202) 551-6787 or [email protected], 
Office of Investment Adviser Regulation, Division of Investment 
Management, U.S. Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'' or ``SEC'') is adopting amendments to rules 203-1, 204-
1, 204-2, and 204-3 [17 CFR 275.203-1, 275.204-1, 275.204-2, and 
275.204-3] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] 
(``Advisers Act'' or ``Act''); \1\ and amendments to Form ADV [17 CFR 
279.1] under the Advisers Act. The Commission also is withdrawing rule 
206(4)-4 [17 CFR 275.206(4)-4] under the Advisers Act.
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    \1\ Unless otherwise noted, when we refer to rule 203-1, 204-1, 
204-2, or 204-3, or any paragraph of these rules, we are referring 
to 17 CFR 275.203-1, 275.204-1, 275.204-2, or 275.204-3, 
respectively, of the Code of Federal Regulations in which these 
rules are published.
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Table of Contents

I. Introduction
II. Discussion of Form ADV, Part 2
    A. Part 2A: Brochure Format and Content
    1. Format
    2. Brochure Items
    3. Delivery and Updating of Brochures
    B. Part 2B: The Brochure Supplement
    1. Format
    2. Supplement Items
    3. Delivery and Updating
    C. Filing Requirements, Public Availability
    D. Transition to New Requirements
III. Amendments to Form ADV Instructions and Glossary
IV. Amendments to Rule 204-2
V. Effective and Compliance Dates
VI. Paperwork Reduction Act
VII. Cost-Benefit Analysis
VIII. Final Regulatory Flexibility Analysis
IX. Efficiency, Competition, and Capital Formation
X. Statutory Authority
Text of Rule and Form Amendments

I. Introduction

    Investment advisers provide a wide range of advisory services and 
play an important role in helping individuals and institutions make 
significant financial decisions. From individuals and families seeking 
to plan for retirement or save for college to large institutions 
managing billions of dollars, clients seek the services of investment 
advisers to help them evaluate their investment needs, plan for their 
future, develop and implement investment strategies, and cope with the 
ever-growing complexities of the financial markets. Today, the more 
than 11,000 advisers registered with us manage more than $38 trillion 
for more than 14 million clients.\2\
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    \2\ These figures are based on data derived from investment 
advisers' responses to questions on Part 1A of Form ADV reported 
through the Investment Adviser Registration Depository (``IARD'') as 
of May 3, 2010. We note that these figures will change due to the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, Public 
Law 111-203, 124 Stat. 1376 (2010).
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    Under the Advisers Act, an adviser is a fiduciary whose duty is to 
serve the best interests of its clients, which includes an obligation 
not to subrogate clients' interests to its own.\3\ An adviser must deal 
fairly with clients and prospective clients, seek to avoid conflicts 
with its clients and, at a minimum, make full disclosure of any 
material conflict or potential conflict.\4\ A client may use this 
disclosure to select his or her own adviser and evaluate the adviser's 
business practices and conflicts on an ongoing basis. As a result, the 
disclosure clients and prospective clients receive is critical to their 
ability to make an informed decision about whether to engage an adviser 
and, having engaged the adviser, to manage that relationship.
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    \3\ Proxy Voting by Investment Advisers, Investment Advisers Act 
Release No. IA-2106 (Jan. 31, 2003) [68 FR 6585 (Feb. 7, 2003)] 
(``Proxy Voting Release'').
    \4\ See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 
(1963); In the Matter of Arleen W. Hughes, Exchange Act Release No. 
4048 (Feb. 18, 1948).
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    To allow clients and prospective clients to evaluate the risks 
associated with a particular investment adviser, its business 
practices, and its investment strategies, it is essential that clients 
and prospective clients have clear disclosure that they are likely to 
read and understand. For example, such disclosure could enable a 
prospective client to screen advisers based on disciplinary history, 
financial industry affiliations or compensation methods. Such screening 
would allow clients to avoid advisers with a disciplinary history, 
should they wish to do so. Clients also would be able to choose 
advisers based on affiliations and compensation methods; in some cases, 
the client may not be comfortable with the conflicts of interest that 
those affiliations and compensation methods create, while other clients 
may value an advisory relationship that allows for broader access to 
other financial services and may seek an adviser with financial 
industry affiliates. A prospective client may seek modifications to an 
investment advisory agreement to better protect the client against an 
investment adviser's potential conflict of interest, either by better 
aligning the adviser's interest with that of the client or by 
prohibiting a particular practice in the client's account. If an 
adviser is unwilling to make such modifications, a prospective client 
may select a different adviser.
    Since 1979, the Commission has required each adviser registered 
with us to deliver a written disclosure statement to clients pursuant 
to rule 204-3 under the Advisers Act.\5\ An investment adviser may use 
this client disclosure statement to satisfy its disclosure

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obligations as a fiduciary.\6\ Part 2 of Form ADV sets out minimum 
requirements for this disclosure statement to clients, which is 
commonly referred to as the ``brochure.'' \7\
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    \5\ Advisers use Form ADV to apply for registration with us 
(Part 1A) or with state securities authorities (Part 1B), and must 
keep it current by filing periodic amendments as long as they are 
registered. See rules 203-1 and 204-1. Form ADV has two parts. Part 
1(A and B) of Form ADV provides regulators with information to 
process registrations and to manage their regulatory and examination 
programs. Part 2A contains the requirements for the disclosure 
``brochure'' that advisers must provide to prospective clients 
initially and to existing clients annually, and Part 2B contains 
information about the advisory personnel providing clients with 
investment advice. Prior to the amendments we are adopting today, 
Part 2 was designated as ``Part II.''
    \6\ See Investment Adviser Requirements Concerning Disclosure, 
Recordkeeping, Applications for Registration and Annual Filings, 
Investment Advisers Act Release No. 664 (Jan. 30, 1979) [44 FR 7870 
(Feb. 7, 1979)] (``1979 Adopting Release'').
    \7\ Items in Part 2 of Form ADV may not address all conflicts an 
adviser may have, and may not identify all material disclosure that 
an adviser may be required to provide clients. As a result, 
delivering a brochure prepared under Form ADV's requirements may not 
fully satisfy an adviser's disclosure obligations under the Advisers 
Act. See Instruction 3 of General Instructions for Part 2 of Form 
ADV; rule 204-3(f).
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    In the past, Part 2 has required advisers to respond to a series of 
multiple-choice and fill-in-the-blank questions organized in a ``check-
the-box'' format, supplemented in some cases with brief narrative 
responses. Advisers have had the option of providing information 
required by Part 2 in an entirely narrative format, but few have done 
so.
    In 2008, we proposed a different approach to enhance the disclosure 
statement advisers provide to their clients.\8\ Instead of the check-
the-box format, each adviser registered with us would provide clients 
with a narrative plain English brochure that describes the adviser's 
business, conflicts of interest, disciplinary history, and other 
important information that would help clients make an informed decision 
about whether to hire or retain that adviser. Our proposal was designed 
to require advisers to disclose meaningful information in a clearer 
format.\9\ In addition, we proposed that advisers be required to file 
their brochures with us electronically so that we could make them 
available to the public on our Web site.\10\
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    \8\ Amendments to Form ADV, Investment Advisers Act Release No. 
2711 (Mar. 3, 2008) [73 FR 13958 (Mar. 14, 2008)] (``Proposing 
Release'').
    \9\ See Proposing Release, supra note 8 at n.6 and accompanying 
text.
    \10\ Id. at Section II.A.3.
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    We received 81 letters commenting on the Proposing Release.\11\ 
Commenters agreed with our proposal to move to a narrative 
brochure,\12\ although many suggested modifications to certain 
requirements.\13\ After careful consideration of these comment letters, 
we are adopting amendments to Part 2 of Form ADV and related rules 
under the Advisers Act. In light of our adoption of Part 2, we also are 
withdrawing rule 206(4)-4, which separately required advisers to 
disclose to clients certain financial and disciplinary information, 
because our amendments render that rule largely duplicative.
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    \11\ Comment letters submitted in File No. S7-10-00 are 
available on the Commission's Web site at: http://www.sec.gov/rules/proposed/s71000.shtml.
    \12\ See, e.g., comment letter of the American Bar Association, 
Section of Business Law, Committee on Federal Regulation of 
Securities and Committee on State Regulation of Securities (June 18, 
2008) (``ABA Committees Letter''); comment letter of the Consumer 
Federation of America (July 2, 2008) (``Consumer Federation 
Letter''); comment letter of Citigroup Global Markets Inc. (May 16, 
2008) (``CGMI Letter''); comment letter of Fried, Frank, Harris, 
Shriver & Jacobson LLP (May 2, 2008) (``Fried Frank Letter''); 
comment letter of the Investment Adviser Association (May 16, 2008) 
(``IAA Letter''); comment letter of the Investment Company Institute 
(May 16, 2008) (``ICI Letter'').
    \13\ See, e.g., comment letter of Alternative Investment 
Compliance Association (May 16, 2008) (``AICA Letter''); comment 
letter of Capital Institutional Services, Inc. (May 16, 2008) 
(``CAPIS Letter''); comment letter of Shaun Eddy (May 9, 2008) 
(``Eddy Letter''); comment letter of the Financial Planning 
Association (May 16, 2008) (``FPA Letter''); Fried Frank Letter; IAA 
Letter; ICI Letter; comment letter of Janus Capital Management LLC 
(May 16, 2008) (``Janus Letter''); comment letter of Nancy Lininger 
(May 18, 2008) (``Lininger Letter''); comment letter of the National 
Association of Personal Financial Advisers (June 4, 2008) (``NAPFA 
Letter''); comment letter of National Compliance Services, Inc. (May 
9, 2008) (``NCS Letter''); comment letter of National Regulatory 
Services (May 16, 2008) (``NRS Letter''); comment letter of L. A. 
Schnase (May 9, 2008) (``Schnase Letter''); comment letter of Sidley 
Austin LLP (May 23, 2008) (``Sidley Letter''); comment letter of 
USAA Investment Management Company/USAA Financial Planning Services 
Insurance Agency, Inc. (May 16, 2008) (``USAA Letter''); comment 
letter of Wellington Management Company, LLP (May 15, 2008) 
(``Wellington Letter'').
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II. Discussion of Form ADV, Part 2

    The revised Part 2 requirements that we are adopting today include 
two sub-parts, Part 2A and Part 2B.\14\ Part 2A contains 18 disclosure 
items about the advisory firm that must be included in an adviser's 
brochure. We refer to Part 2B as the ``brochure supplement,'' which 
includes information about certain advisory personnel on whom clients 
rely for investment advice. In this section, we discuss our amendments 
relating to each of these sub-parts, which are addressed separately 
because they are subject to differing content, updating and delivery 
requirements.
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    \14\ Part 2 is a uniform form used by investment advisers 
registered with both the Commission and the state securities 
authorities. See Instruction 5 of General Instructions for Form ADV. 
This Release discusses the Commission's adoption of Form ADV and 
related rules applicable to advisers registered with the Commission. 
Form ADV is also used by state securities regulators to register 
investment advisers. It includes certain items and instructions to 
Part 2 (e.g., Item 19 of Part 2A, Item 10 of Appendix 1 to Part 2A, 
and Item 7 of Part 2B) that apply only to state-registered advisers. 
State-registered advisers are required by state, rather than 
federal, law to respond to these items. Completion of these items, 
therefore, is not an SEC requirement, and these items are not 
included in this Release as an SEC rule.
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A. Part 2A: Brochure Format and Content

1. Format
    We are adopting a requirement that investment advisers registered 
with us provide prospective and existing clients with a narrative 
brochure written in plain English.\15\ Commenters supported use of a 
narrative format.\16\ For example, one commenter stated that ``the 
current check-the-box format does not always result in clear and 
meaningful client disclosure and it presents challenges for advisers in 
identifying and presenting all of the types of information that should 
be addressed in Part 2.'' \17\ Another commenter expressed the view 
that ``the flexibility of a narrative format should result in clearer 
and more meaningful disclosures that make relevant information readily 
accessible to prospects and clients.'' \18\ We believe these amendments 
will greatly improve the ability of clients and prospective clients to 
evaluate firms offering advisory services and the firms' personnel, and 
to understand relevant conflicts of interest that the firms and their 
personnel face and their potential effect on the firms' services.
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    \15\ See Instructions 1 and 2 of General Instructions for Part 2 
of Form ADV. In many instances where we refer to ``client'' in this 
release we are referring to both an existing and prospective client.
    \16\ See ABA Committees Letter; comment letter of the American 
Institute of Certified Public Accountants (May 20, 2008) (``AICPA 
Letter''); CAPIS Letter; Consumer Federation Letter; CGMI Letter; 
Fried Frank Letter; IAA Letter; ICI Letter; Janus Letter; comment 
letter of Merrill Lynch, Pierce, Fenner & Smith, Incorporated (May 
16, 2008) (``Merrill Lynch Letter''); comment letter of the Money 
Management Institute (May 16, 2008) (``MMI Letter''); comment letter 
of Morgan Stanley & Co. Incorporated (May 16, 2008) (``Morgan 
Stanley Letter''); NAPFA Letter; comment letter of the North 
American Securities Administrators Association, Inc. (May 16, 2008) 
(``NASAA Letter''); NRS Letter; comment letter of the National 
Society of Compliance Professionals Inc. (May 16, 2008) (``NSCP 
Letter''); comment letter of Charles Schwab & Co. and Charles Schwab 
Investment Management, Inc. (May 16, 2008) (``Schwab Letter''); 
Wellington Letter.
    \17\ NAPFA Letter.
    \18\ Wellington Letter.
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    We have added an instruction to Part 2 of Form ADV to require that 
an adviser provide the information in a specified format.\19\ We are 
persuaded by commenters that this format for items in the brochure will 
facilitate investors' comparison of multiple advisers and are adopting 
this requirement.\20\ An adviser

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must respond to each item in the brochure, and must present the 
information in order of the items in the form, using the headings 
provided by the form. If an item is inapplicable to an adviser, the 
adviser must include the heading and an explanation that the 
information is inapplicable.\21\ If information an adviser provides in 
response to one item is also responsive to another item, the adviser 
may cross-reference the information in the other item.\22\
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    \19\ Instruction 1 of General Instructions for Part 2 of Form 
ADV.
    \20\ See ABA Committees Letter; comment letter of First Allied 
Securities, Inc. (May 16, 2008) (``First Allied Letter''); comment 
letter of Mercer Advisors (May 2, 2008) (``Mercer Letter''); NCS 
Letter; NRS Letter; comment letter of Reed Smith on behalf of 
Federated Investors, Inc. (May 16, 2008) (``Federated Letter'').
    \21\ Instruction 1 of General Instructions for Part 2 of Form 
ADV.
    \22\ Id.
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    Also, it is critical that advisers communicate clearly to their 
clients and prospective clients in the brochure. Thus, instructions to 
Part 2 provide that, in drafting the brochure, advisers, among other 
things, should use short sentences; definite, concrete, everyday words; 
and the active voice. In addition, the brochure should discuss only 
conflicts the adviser has or is reasonably likely to have, and 
practices in which it engages in or is reasonably likely to engage.\23\ 
If a conflict arises or the adviser decides to engage in a practice 
that it has not disclosed, supplemental information must be provided to 
the client.
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    \23\ Instruction 2 of General Instructions for Part 2 of Form 
ADV.
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2. Brochure Items
    Part 2A, as adopted, contains 18 separate items, each covering a 
different disclosure topic.\24\ We have drawn the items in Part 2A 
largely from disclosure advisers have long been required to make in 
response to the previous Part 2, and have added items to address new 
concerns or developments. Much of the disclosure required in Part 2A 
addresses an adviser's conflicts of interest with its clients, and is 
disclosure that the adviser, as a fiduciary, must make to clients in 
some manner regardless of the form requirements.
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    \24\ Part 2A consists of a main body and an appendix, Appendix 
1. Appendix 1 contains the requirements for a specialized type of 
firm brochure--a wrap fee program brochure--and requires disclosure 
similar to current Schedule H of Part 2 of Form ADV. See rule 204-
3(d); Appendix 1 to Part 2A; infra note 182 and accompanying text.
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    Some commenters urged us to require fewer items and require 
advisers to provide less detailed information.\25\ We have reviewed 
carefully these suggestions and have modified some of our items in 
response. In some cases, however, commenters urged us to eliminate 
particular proposed disclosures, such as the fee schedule, that have 
long been required in Part 2 and provide investors essential 
information. Elimination of such proposed disclosures would result in 
clients not receiving important information they currently receive from 
their advisers and on which they may rely. In many other cases, further 
cuts would not have reduced the amount of disclosure an adviser would 
have to make to clients, but rather would have permitted the disclosure 
to be made in a different document or manner. Thus, elimination of 
disclosure requirements in Part 2A suggested by some commenters would 
be unlikely to reduce burdens or eliminate the amount of information 
required to be provided to clients to satisfy an adviser's fiduciary 
obligations.\26\
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    \25\ See, e.g., comment letter of the Financial Service 
Institute (May 16, 2008) (``FSI Letter''); Schwab Letter; comment 
letter of the Securities Industry and Financial Markets Association 
(May 16, 2008) (``SIFMA Letter''); comment letter of Sutherland 
Asbill & Brennan LLP (May 16, 2008) (``Sutherland Letter'').
    \26\ Advisers with fewer conflicts and simpler business 
arrangements will be able to prepare shorter brochures.
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    We agree that disclosure to clients should be succinct and 
readable. We note that advisers, because of how they choose to present 
their programs or services to clients or the complexity of their 
disclosures, have the ability to take steps that would limit the length 
of their brochures. For example, advisers may create separate brochures 
for different types of advisory clients, each of which may be shorter, 
clearer, and contain less extraneous information than would a combined 
brochure.\27\ Advisers that choose to disclose more than is required by 
the form (and their fiduciary obligations) will create lengthier 
brochures than those that take a more focused approach. Advisers with a 
more complicated offering of advisory services (or business 
arrangements) might consider including a summary in the beginning of 
their brochure, followed by a more detailed discussion of each item in 
the brochure. We have amended the instructions to clarify that 
including a summary is permissible.\28\
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    \27\ See rule 204-3(e) (allowing advisers that provide 
substantially different advisory services to different clients to 
provide clients with different brochures as long as each client 
receives all information about the services and fees that are 
applicable to that client). Note that an adviser may not omit any 
information required by Item 9 of Part 2A (Disciplinary Information) 
in any brochure provided to any client, and that each brochure must 
be filed through IARD. See rule 204-3(a); see also Instruction 2 for 
Part 2A of Form ADV. An adviser that creates separate brochures must 
file each brochure through the IARD system. See Instruction 9 for 
Part 2A of Form ADV.
    \28\ See Instruction 8 of Instructions for Part 2A of Form ADV. 
We have also added an instruction to Part 2 explaining that advisers 
must provide the client with sufficiently specific facts so that the 
client is able to understand the conflicts of interest the adviser 
has and the business practices in which it engages, and can give his 
or her informed consent to the transaction or practice that gives 
rise to the conflict or to reject the transaction or practice. See 
Instruction 3 of General Instructions for Part 2 of Form ADV.
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    Below, we discuss each of the items in the form and the 
modifications we have made from our proposal.
    Item 1. Cover Page. Item 1 requires that an adviser disclose on the 
cover page of its brochure the name of the firm, its business address, 
contact information, Web site (if it has one), and the date of the 
brochure. The cover page also must include a statement that the 
brochure has not been approved by the Commission or any state 
securities authority. If an adviser refers to itself as a ``registered 
investment adviser,'' it also must include a disclaimer that 
registration does not imply a certain level of skill or training.\29\
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    \29\ We have observed that the emphasis on SEC registration, in 
some advisers' marketing materials, appears to suggest that 
registration either carries some official imprimatur or indicates 
that the adviser has attained a particular level of skill or 
ability. Section 208(a) of the Advisers Act [15 U.S.C. 80b-8(a)] 
makes such suggestions unlawful.
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    The item reflects one change from our proposal. Item 1 requires an 
adviser to disclose on the cover page of the brochure only a general 
telephone number and/or e-mail address that clients can use to contact 
the adviser if they have questions about the brochure. Commenters 
asserted that some larger advisers would find it cumbersome to comply 
with our proposal, which would have required the name and phone number 
of a specific individual or service center.\30\
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    \30\ See First Allied Letter; IAA Letter; SIFMA Letter.
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    Item 2. Material Changes. Item 2 requires that an adviser amending 
its brochure identify and discuss the material changes since the last 
annual update on the cover page or the following page or as a separate 
document accompanying the brochure.\31\ This item is designed to make 
clients aware of information that has changed since the prior year's 
brochure and that may be important to them.
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    \31\ Advisers may include the summary in their brochure or in a 
separate document. Item 2 of Part 2A. A summary prepared as a 
separate document can be used to satisfy an adviser's annual client 
delivery obligations. See rule 204-3(b)(2), discussed in Section 
II.A.3 below. Summaries provided as a separate document must be 
filed with the Commission as an exhibit to Part 2. See Note to 
paragraphs (a) and (b) of rule 204-1; Instruction 6 for Part 2A of 
Form ADV. If an adviser includes the summary of material changes in 
its brochure, and amends its brochure on an interim basis between 
annual updating amendments, the adviser should consider whether it 
should update its summary of material changes to avoid confusing or 
misleading clients reading the updated brochure. See Note to 
Instruction 6 for Part 2A of Form ADV.

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[[Page 49237]]

    Several commenters supported this requirement, agreeing that 
advisers can achieve meaningful disclosure with an annual disclosure 
highlighting changes to the brochure.\32\ Others expressed concern that 
advisers would write lengthy summaries to avoid liability.\33\ We 
emphasize that we intend this document to be a summary that identifies 
and broadly discusses the material changes,\34\ and that it should not 
be a lengthy discussion that replicates the brochure itself.\35\ 
Instead, the summary need contain no more than necessary to inform 
clients of the substance of the changes to the adviser's policies, 
practices or conflicts of interests so that they can determine whether 
to review the brochure in its entirety or to contact the adviser with 
questions about the changes.
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    \32\ See ASG Letter; comment letter of the CFA Institute Centre 
for Financial Market Integrity (May 22, 2008) (``CFA Institute 
Letter''); Consumer Federation Letter; FPA Letter; IAA Letter; Janus 
Letter; NASAA Letter.
    \33\ See AICA Letter; FSI Letter; ICI Letter; comment letter of 
Jackson, Grant Investment Advisers, Inc. (May 26, 2008) (``Jackson 
Letter''); comment letter of Katten Muchin Rosenman LLP (May 16, 
2008) (``Katten Letter''); Mercer Letter; Morgan Stanley Letter; 
NSCP Letter; comment letter of the Financial Service Roundtable (May 
16, 2008) (``Roundtable Letter''); SIFMA Letter; Sutherland Letter.
    \34\ We have revised Item 2 to require advisers not only to 
identify, but also to ``discuss'' material changes to clarify our 
intent.
    \35\ A few commenters also sought clarification of the term 
``material changes.'' See comment letter of the American Council of 
Life Insurance (May 16, 2008) (``ACLI Letter''); Fried Frank Letter; 
FSI Letter; IAA Letter; Roundtable Letter; comment letter of T. Rowe 
Price Associates, Inc. (May 16, 2008) (``T. Rowe Letter''). The 
standard of materiality under the Advisers Act is whether there is a 
substantial likelihood that a reasonable investor (here, client) 
would have considered the information important. See S.E.C. v. 
Steadman, 967 F.2d 636, 643 (D.C. Cir. 1992). Cf. Basic Inc. v. 
Levinson, 485 U.S. 224, 231-232 (1988); TSC Industries v. Northway, 
Inc., 426 U.S. 438, 445, 449 (1976). This is a facts and 
circumstances test, requiring an assessment of the ``total mix of 
information,'' in the characterization of the Supreme Court. TSC 
Industries, 426 U.S. at 449. Given that materiality depends on the 
factual situation, which may vary with each situation, we do not 
believe that it is appropriate to specifically define or provide any 
bright line tests for what is and is not material.
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    Item 3. Table of Contents. Item 3 requires each adviser to include 
in its brochure a table of contents detailed enough to permit clients 
and prospective clients to locate topics easily. Some commenters 
supported the use of a table of contents but urged the Commission to 
mandate a uniform format so that investors can compare brochures of 
multiple advisers more easily.\36\ Others opposed a uniform format, 
arguing that flexibility would enable an adviser to best convey 
information about its firm to clients.\37\ As discussed above, we are 
persuaded by commenters that a uniform format for items in the brochure 
will facilitate investors' comparison of multiple advisers and are 
adopting this requirement. We therefore added an instruction to Part 2 
of Form ADV to require advisers to present the information in the order 
of the items in the form, using the headings provided by the form.\38\
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    \36\ See supra note 20.
    \37\ See Fried Frank Letter; Janus Letter; Lininger Letter.
    \38\ Instruction 1 of General Instructions for Part 2 of Form 
ADV.
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    Item 4. Advisory Business. Item 4 requires each adviser to describe 
its advisory business, including the types of advisory services 
offered, whether it holds itself out as specializing in a particular 
type of advisory service, and the amount of client assets that it 
manages. In computing the amount of client assets that it manages, an 
adviser may use a method that differs from the method used in Part 1A 
of Form ADV to report ``assets under management.'' \39\ An adviser 
opting to use a different method must keep documentation describing the 
method used.\40\
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    \39\ For an explanation of Part 1A's requirements for computing 
``assets under management,'' see Instruction 5.B for Part 1A of Form 
ADV.
    \40\ See rule 204-2(a)(14)(ii) and Note to Item 4.E of Part 2A.
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    Two commenters urged the Commission not to require that advisers 
make additional disclosure if they hold themselves out as specializing 
in a particular type of advisory service. One was concerned that 
advisers would have interpretive problems in defining specialized 
advisory services and that disclosure describing specialized services 
would not provide meaningful information to clients.\41\ The other 
argued that Item 8 (Strategies and Risks) covers similar 
information.\42\ As we explained in the Proposing Release, we require 
that advisers identify a specialized advisory service because we 
believe that clients likely will want to understand this before 
engaging that adviser.\43\ Accordingly, we are adopting this item as 
proposed.
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    \41\ See NAPFA letter.
    \42\ See Sutherland Letter.
    \43\ See Proposing Release at Section II.A.2.
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    Commenters were divided on whether we should require investment 
advisers to calculate the amount of their assets in a manner consistent 
with the instructions for Part 1A in order to avoid confusion.\44\ The 
methodology for calculating assets required under Part 1A is designed 
for a particular purpose (i.e., for making a determination as to 
whether an adviser should register with the Commission or with the 
states), rather than to convey meaningful information about the scope 
of the adviser's business. Thus, we are permitting advisers to use a 
different methodology for Part 2A disclosure.\45\
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    \44\ The CFA Institute Letter, IAA Letter, Janus Letter, Mercer 
Letter, and NRS Letter argued that the calculation requirements 
should be the same. Others supported our proposal that would permit 
advisers to use a different calculation of assets under management 
than the one required for Part 1A, with most of these commenters 
arguing that this flexibility would allow advisers to more 
accurately portray the business of the firm and total assets 
managed. See comment letter of Ashland Compliance Group LLC (May 16, 
2008) (``Ashland Letter''); Lininger Letter; MMI Letter; Morgan 
Stanley Letter.
    \45\ For example, in calculating ``assets under management,'' 
for purposes of Part 1A, an adviser may include the entire value of 
a managed portfolio, but only if at least 50% of the portfolio's 
total value consists of securities. See current Form ADV: 
Instructions for Part 1A of Form ADV. Thus, for Part 1A purposes, an 
adviser will not include other assets (including securities) that it 
manages in a ``non-securities'' portfolio. The Part 1A formula for 
calculating assets under management was designed based on 
considerations related to the National Securities Markets 
Improvement Act of 1996 division of responsibility for regulation of 
advisers between the Commission and state securities regulatory 
authorities. Public Law 104-290, 110 Stat. 3416 (1996).
---------------------------------------------------------------------------

    Finally, several commenters urged that we permit an adviser to 
update the amount of assets under management only in its annual 
updating amendment rather than (as we proposed) at the time an adviser 
makes an interim update to its brochure if the amount had become 
materially inaccurate.\46\ We believe that our proposal appropriately 
balanced the burdens that would be imposed on advisers by having to 
amend their brochures repeatedly with the need to provide clients with 
reasonably current information. Therefore, we are adopting this 
instruction as proposed.\47\ Advisers must update the amount of their 
assets under management annually (as part of their annual updating 
amendment) and make interim amendments only for material changes in 
assets under management when they are filing an ``other than annual 
amendment'' for a separate reason. As we have noted, as a fiduciary, an 
adviser has an ongoing obligation to inform its clients of any material 
information that could affect the advisory relationship, which could 
include a material change to assets under management.\48\
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    \46\ See Morgan Stanley Letter; MMI Letter.
    \47\ See Note to Instruction 4 of General Instructions for Form 
ADV.
    \48\ Note to Instruction 2 of Instructions for Part 2A of Form 
ADV. Disclosure updating the adviser's assets under management could 
be provided to clients by means other than the brochure. We have 
brought enforcement actions charging advisers with engaging in fraud 
by misrepresenting their assets under management to advisory clients 
and prospective clients, including in advisory brochures. See, e.g., 
SEC v. Locke Capital Management, Inc. and Leila C. Jenkins, 
Litigation Release No. 20936 (Mar. 9, 2009) (settled order).

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[[Page 49238]]

    Item 5. Fees and Compensation. Item 5 requires that an adviser 
describe in its brochure how it is compensated for its advisory 
services, provide a fee schedule, and disclose whether fees are 
negotiable.\49\ An adviser must disclose whether it bills clients or 
deducts fees directly from clients' accounts, and how often it assesses 
fees (or bills clients).\50\ The item also requires each adviser to 
describe the types of other costs, such as brokerage, custody fees and 
fund expenses that clients may pay in connection with the advisory 
services provided to them by the adviser.\51\ An adviser charging fees 
in advance must explain how it calculates and refunds prepaid fees when 
a client contract terminates.\52\
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    \49\ See Item 5.A of Part 2A.
    \50\ See Item 5.B of Part 2A.
    \51\ See Item 5.C of Part 2A.
    \52\ See Item 5.D of Part 2A. Item 18 of Part 2A also requires 
the disclosure of certain financial information about an adviser 
that requires prepayment of fees.
---------------------------------------------------------------------------

    Item 5 also requires an adviser that receives compensation 
attributable to the sale of a security or other investment product 
(e.g., brokerage commissions), or whose personnel receive such 
compensation, to disclose this practice and the conflict of interest it 
creates, and to describe how the adviser addresses this conflict.\53\ 
Such an adviser also must disclose that the client may purchase the 
same security or investment product from a broker that is not 
affiliated with the adviser.\54\
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    \53\ See Item 5.E of Part 2A. Because of this conflict of 
interest, advisers are required by the antifraud provisions of the 
Advisers Act to disclose their receipt of transaction-based 
compensation to clients. We have brought enforcement actions 
charging advisers with failures to make such disclosures. See, e.g., 
In the Matter of Financial Design Associates, Inc. and Albert L. 
Coles, Jr., Investment Advisers Act Release No. 2654 (Sept. 25, 
2007) (settled order); In the Matter of IMS, CPAs & Associates, 
Vernon T. Hall, Stanley E. Hargrave, and Jerome B. Vernazza, 
Investment Advisers Act Release No. 1994 (Nov. 5, 2001) (settled 
order) (petitioners' appeal denied in Vernazza v. SEC, 327 F.3d 851 
(9th Cir. 2003)).
    \54\ See Item 5.E.2 of Part 2A. In addition to the requirement 
in Item 5.E.2 of Part 2A, an adviser that receives more than half of 
its revenue from commissions and other sales-based compensation must 
explain that commissions are the firm's primary (or, if applicable, 
exclusive) form of compensation. See Item 5.E.3 of Part 2A. An 
adviser that charges advisory fees in addition to commissions or 
markups to an individual client must disclose whether it reduces its 
fees to offset the commissions or markups. See Item 5.E.4 of Part 
2A.
---------------------------------------------------------------------------

    Some commenters expressed strong support for these disclosure 
requirements, with one commenter stating that such disclosure is 
``essential to a healthy adviser-client relationship.'' \55\ Others 
argued generally that most of the information is not relevant for many 
clients, and specifically that providing a complete set of fee 
schedules would impose an undue burden on advisers.\56\ We disagree 
with commenters who favored a broad elimination of fee information from 
the brochure. Information about fees is important to clients and can be 
used to compare fees of different advisers.\57\ More persuasive, 
however, were arguments that brochure fee information is likely not 
useful to institutional and large, sophisticated clients who are often 
in a position to negotiate fee arrangements with their adviser and for 
whom, therefore, a fee table would have little utility.\58\ These 
arguments have persuaded us to provide an exception which permits an 
adviser to omit disclosure of its fee schedule and the other 
information in Item 5.A in any brochure provided only to clients who 
are ``qualified purchasers.''\59\
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    \55\ See comment letter of the Certified Financial Planner Board 
of Standards, Inc. (May 29, 2008) (``CFP Board Letter''). The ASG 
Letter, the CFA Institute Letter, the Lininger Letter, and the NRS 
Letter also expressed strong support for most of these requirements.
    \56\ See comment letter of Eric A. Brill (Apr. 26, 2008) 
(``Brill Letter''); IAA Letter. The IAA Letter stated that larger 
firms may have to prepare extremely long fee schedules. They urged 
the Commission to provide flexibility regarding fee schedule 
disclosure as long as the fee is fully disclosed in the advisory 
contract. One commenter suggested that we amend General Instruction 
4, which permits advisers to update any change to its fee schedules 
only annually, reasoning that potential clients would need this 
updated information in selecting advisers. See NASAA Letter. The 
exception contained in the instruction is designed to prevent an 
adviser from having to make multiple interim amendments as a result 
of small changes in a fee schedule each of which may be material 
only to certain affected clients or prospective clients who would 
learn of them when considering whether to enter into an advisory 
agreement that would reflect a revised fee. On balance, we believe 
that an annual update may be sufficient.
    \57\ This information may be particularly useful to clients 
searching for an adviser by comparing information on brochures that 
will be available on the Internet.
    \58\ See IAA letter; Wellington Letter.
    \59\ ``Qualified purchasers,'' as defined under section 
2(a)(51)(A) of the Company Act [15 USC 80a-2(a)(51)(A)], include, 
among others, natural persons who own $5 million or more in 
investments and persons who manage $25 million or more in 
investments for their account or other accounts of other qualified 
purchasers.
---------------------------------------------------------------------------

    A few commenters urged us to not require description of other types 
of fees or expenses because, among other things, such fees may vary 
significantly among clients and disclosure regarding them may confuse 
clients.\60\ However, this simple and brief disclosure (which is not 
required to include the amount or range of the fees) may be helpful to 
investors unacquainted with the practices of an adviser or the 
ancillary costs of actively managed investing. Therefore, we are 
adopting this disclosure requirement, as proposed.
---------------------------------------------------------------------------

    \60\ See NAPFA Letter; NRS Letter; NSCP Letter.
---------------------------------------------------------------------------

    As noted above, Item 5 also requires an adviser that receives 
transaction-based compensation, or whose personnel receive such 
compensation, to disclose this practice and the conflict of interest it 
creates and to describe how the adviser addresses this conflict. Some 
commenters argued that this item inappropriately implies endorsement of 
a ``fee-based'' compensation structure over a ``commission-based'' 
structure.\61\ That is not our intent. The item simply recognizes that 
an adviser that accepts compensation from the sale to a client of 
securities has an incentive to base investment recommendations on the 
amount of compensation it will receive, rather than on the client's 
best interests, and thus involves a significant conflict of 
interest.\62\ As a result, we are adopting the requirement as 
proposed.\63\
---------------------------------------------------------------------------

    \61\ See FSI Letter; Sutherland Letter.
    \62\ Moreover, the item is not, in substance, different from the 
previous Item 9 of Part 2, which, in recognition of this conflict, 
required an adviser to disclose whether the adviser effects 
securities transactions for clients. See also supra note 53; 
Applicability of the Investment Advisers Act to Financial Planners, 
Pension Consultants, and Other Persons Who Provide Investment 
Advisory Services as a Component of Other Financial Services, 
Investment Advisers Act Release No. 1092 (Oct. 16, 1987) [52 FR 
38400 (Oct. 16, 1987)] (``Release 1092'').
    \63\ We note that nothing in the Advisers Act precludes an 
adviser from accepting transaction-based compensation. However, an 
adviser that receives compensation in connection with the purchase 
or sale of securities should carefully consider the applicability of 
the broker-dealer registration requirements of the Securities 
Exchange Act of 1934.
---------------------------------------------------------------------------

    Item 6. Performance-Based Fees and Side-By-Side Management. Item 6 
requires an adviser that charges performance-based fees or that has a 
supervised person who manages an account that pays such fees to 
disclose this fact. If such an adviser also manages accounts that are 
not charged a performance fee, the item also requires the adviser to 
discuss the conflicts of interest that arise from its (or its 
supervised person's) simultaneous management of these accounts, and to 
describe generally how the adviser addresses those conflicts.\64\
---------------------------------------------------------------------------

    \64\ As fiduciaries, advisers must disclose all material 
information regarding any proposed performance fee arrangements as 
well as any material conflicts posed by the arrangements. See 
Exemption To Allow Investment Advisers To Charge Fees Based Upon a 
Share of Capital Gains Upon or Capital Appreciation of a Client's 
Account, Investment Advisers Act Release No. 1731, at nn.13-14 and 
accompanying text (July 15, 1998) [63 FR 39022 (July 21, 1998)].

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[[Page 49239]]

    Two commenters explicitly supported this requirement.\65\ Two other 
commenters urged us to eliminate it, arguing that the required 
disclosure already should be in Item 5 (Fees and Compensation) or is 
required by other items.\66\ As discussed in the Proposing Release, an 
adviser charging performance fees to some accounts but not others faces 
a variety of conflicts of interest.\67\ The number of advisers with 
these arrangements has grown, and we believe that it is important that 
clients and prospective clients receive disclosure regarding these 
conflicts and how the adviser addresses them.\68\ While Item 5 requires 
disclosure of an adviser's fee arrangements, it does not specifically 
require disclosure of the conflicts any particular fee arrangement may 
create other than with respect to transaction-based compensation.
---------------------------------------------------------------------------

    \65\ See CFA Institute Letter; Lininger Letter.
    \66\ See IAA Letter; Schnase Letter.
    \67\ See Proposing Release, at nn.51-53 and accompanying text. 
An adviser charging performance fees to some accounts faces a 
variety of conflicts because the adviser can potentially receive 
greater fees from its accounts having a performance-based 
compensation structure than from those accounts it charges a fee 
unrelated to performance (e.g., an asset-based fee). As a result, 
the adviser may have an incentive to direct the best investment 
ideas to, or to allocate or sequence trades in favor of, the account 
that pays a performance fee. We have brought enforcement actions 
charging advisers with undisclosed conflicts in regard to accounts 
that pay performance fees. See, e.g., In the Matter of Nevis Capital 
Management, LLC, et al., Investment Advisers Act Release No. 2214 
(Feb. 9, 2004) (settled order). See also In the Matter of Alliance 
Capital Management, L.P., Investment Advisers Act Release No. 2205 
(Dec. 18, 2003) (settled order).
    \68\ According to data derived from investment advisers' 
responses to Item 5.E of Part 1A of Form ADV reported through IARD 
as of May 3, 2010, approximately 28% of SEC-registered investment 
advisers reported charging performance-based fees to some accounts 
but not others.
---------------------------------------------------------------------------

    Item 7. Types of Clients. Item 7 requires that the brochure 
describe the types of advisory clients the firm generally has, as well 
as the firm's requirements for opening or maintaining an account, such 
as minimum account size. One commenter recommended that we eliminate 
this proposed disclosure requirement, arguing that the information is 
not material to the decision of whether to hire or retain an investment 
adviser.\69\ We disagree. We believe that many prospective clients 
would consider the type of clients to be an important factor in 
determining whether an adviser's business model is a good fit for 
them.\70\ As a result, we are adopting Item 7 as proposed.
---------------------------------------------------------------------------

    \69\ See Sutherland Letter.
    \70\ We note that disclosure of this information is already 
required in the previous Item 2 of Part 2 of Form ADV.
---------------------------------------------------------------------------

    Item 8. Methods of Analysis, Investment Strategies and Risk of 
Loss. Item 8 requires that advisers describe their methods of analysis 
and investment strategies and disclose that investing in securities 
involves risk of loss which clients should be prepared to bear.\71\ 
Item 8 also requires specific disclosure of how strategies involving 
frequent trading can affect investment performance. Finally, this item 
requires that advisers explain the material risks involved for each 
significant investment strategy or method of analysis they use and 
particular type of security they recommend, with more detail if those 
risks are unusual.
---------------------------------------------------------------------------

    \71\ We have brought enforcement actions charging advisers with 
omissions and misrepresentations regarding investment strategies. 
See, e.g., In the Matter of George F. Fahey, Investment Advisers Act 
Release No. 2196 (Nov. 24, 2003) (settled order); In the Matter of 
Gary L. Hamby and Gary B. Ross, Investment Advisers Act Release No. 
1668 (Sept. 22, 1997) (settled order).
---------------------------------------------------------------------------

    Several commenters supported this proposed disclosure requirement 
as central to the adviser's fiduciary relationship with its client.\72\ 
One objected, stating that the item creates a different disclosure 
obligation for multi-strategy firms because, as proposed, it only 
required advisers primarily using a particular strategy to discuss the 
risks involved in their strategy.\73\ We agree that advisers should 
disclose material risks associated with their strategies that will be 
relevant to most clients, regardless of whether they use one strategy 
or many strategies. We have, therefore, modified the item to require 
that advisers explain the material risks involved for each significant 
investment strategy or method of analysis they use, rather than those 
they primarily use, as we believe this threshold for disclosure better 
captures those methods of analysis or strategies that will be relevant 
to most clients.\74\ However, as we noted in the proposal, the brochure 
may not always be the best place for a multi-strategy adviser to 
disclose risks associated with all of its methods of analysis or 
strategies.\75\ Disclosure of that information likely would lengthen 
the brochure unnecessarily given that different clients will be 
pursuing different strategies, each of which poses specific and 
different risks.
---------------------------------------------------------------------------

    \72\ See CFA Institute Letter; Lininger Letter; NAPFA Letter; 
NRS Letter.
    \73\ See NAPFA Letter.
    \74\ For these purposes, we would view a method of analysis or 
strategy as significant if more than a small portion of the 
adviser's clients' assets are advised using the method or strategy.
    \75\ See Proposing Release at Section II.A.2.
---------------------------------------------------------------------------

    Some commenters urged us to define the term ``frequent trading of 
securities,'' which is used in Item 8.B, but did not suggest a 
definition in response to our request.\76\ As commenters implicitly 
acknowledged, the phrase ``frequent trading'' is hard to define. We 
would expect advisers to respond to this item only if their intended 
investment strategies involve frequent trading of securities that a 
reasonable client would otherwise not expect in light of the other 
disclosures contained in the brochure.
---------------------------------------------------------------------------

    \76\ See comment letter of Gary D. Case (May 12, 2008) (``Case 
Letter''); FSI Letter; IAA Letter; comment letter of ProEquities, 
Inc. (May 21, 2008) (``ProEquities Letter''); comment letter of the 
Trust Advisory Group (May 12, 2008) (``TAG Letter''); T. Rowe Price 
Letter.
---------------------------------------------------------------------------

    Several commenters urged us to not require disclosure in the 
brochure of cash balance practices, arguing that such practices vary 
widely depending on the client, are typically addressed in the client's 
investment advisory agreement, and typically do not involve conflicts 
of interest.\77\ We acknowledge that in many instances such practices 
do not involve conflicts of interest and have omitted the requirement 
from Part 2A. We note, however, that an adviser may have an obligation 
(independent of Part 2A) to disclose material information about its 
policies regarding the management of cash balances where the omission 
of such information would constitute a breach of the adviser's 
fiduciary duty (e.g., where the cash is not managed in the best 
interest of the client).\78\
---------------------------------------------------------------------------

    \77\ See ASG Letter; IAA Letter; T. Rowe Letter.
    \78\ An adviser that is also registered as a broker-dealer may 
also have disclosure obligations relating to its cash balance 
practices arising under Commission and self-regulatory organization 
requirements. See NYSE information Memo No. 05-11 (Customer Account 
Sweeps to Banks) (Feb. 2005).
---------------------------------------------------------------------------

    One commenter noted that, as proposed, Items 8.B and 8.C would 
require disclosure of all risks associated with using a particular 
investment strategy or primarily recommending a particular type of 
security, and not just material risks.\79\ We intended these items to 
require disclosure only of material risks, and have amended these items 
accordingly.\80\
---------------------------------------------------------------------------

    \79\ See Schnase Letter.
    \80\ See Items 8.B and 8.C of Part 2A (requiring disclosure of 
``material risks'').
---------------------------------------------------------------------------

    This commenter also noted that Items 8.B and 8.C call for detailed 
discussions of ``significant or unusual'' risks, inquired whether this 
differed from ``material'' risks, and asked for clarification of this 
terminology. This requirement is intended to elicit from the adviser 
disclosure of significant risks associated with using a particular 
investment strategy or recommending a particular type of security that 
otherwise would not be apparent to the client from reading the 
adviser's

[[Page 49240]]

brochure. An adviser that describes a wide range of investment advisory 
activities in its brochure but, in fact, specializes, for example, in 
investing in leveraged exchange-traded funds should disclose such 
information in response to this item.
    Item 9. Disciplinary Information. Item 9 requires that an adviser 
disclose in its brochure material facts about any legal or disciplinary 
event that is material to a client's (or prospective client's) 
evaluation of the integrity of the adviser or its management personnel. 
These requirements incorporate into the brochure the client disclosure 
regarding disciplinary information required by rule 206(4)-4 under the 
Advisers Act.
    Items 9.A, B, and C provide a list of disciplinary events that are 
presumptively material if they occurred in the previous 10 years. Item 
9 cautions advisers, however, that the events listed in that item are 
those that are presumed to be material and do not constitute an 
exhaustive list of material disciplinary events. The list includes any 
convictions for theft, fraud, bribery, perjury, forgery, 
counterfeiting, extortion and violations of securities laws by the 
adviser or one of its executives. Events such as these reflect on the 
integrity of the adviser and its management personnel and, therefore, 
are presumptively material to clients. The adviser may rebut this 
presumption, in which case no disclosure to clients is required.\81\ An 
adviser rebutting this presumption must document its determination in a 
memorandum and retain that record to enable our staff to monitor 
compliance with this important disclosure requirement.\82\
---------------------------------------------------------------------------

    \81\ Note to Item 9 of Part 2A (explaining four factors an 
adviser should consider when assessing whether the presumption can 
be rebutted).
    \82\ Rule 204-2(a)(14)(iii).
---------------------------------------------------------------------------

    As required by rule 206(4)-4, Item 9 requires that disciplinary 
events more than 10 years old be disclosed if the event is so serious 
that it remains material to a client's or prospective client's 
evaluation of the adviser and the integrity of its management. Three 
commenters requested that the Commission further define and clarify 
what disciplinary information is material in these circumstances.\83\ 
We have determined not to do so, however, as advisers should evaluate 
their obligations to disclose information to clients under existing 
materiality standards adopted by the courts and the Commission.\84\ We 
note that a prior disciplinary event involving an adviser would be 
important to clients for many reasons, including how it may reflect 
upon the adviser's integrity, the effect it may have on the degree of 
trust and confidence a client would place in the adviser, or if it 
imposed limitations on an adviser's activities.\85\
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    \83\ See AICPA Letter; Sutherland Letter; Jackson Letter.
    \84\ See supra note 35 for a discussion of materiality under the 
Advisers Act. See also the note at the end of Item 9 of Part 2A and 
Financial and Disciplinary Information that Investment Advisers Must 
Disclose to Clients, Investment Advisers Act Release No. 1035 (Sept. 
19, 1986) [51 FR 34229 (Sept. 26, 1986)] (`` Rule 206(4)-4 Proposing 
Release''), at nn.12-13 and accompanying text. One commenter noted 
the use of the term ``currently material'' in Item 9 and asked if 
this phrase differed in meaning from ``material.'' See ABA 
Committees Letter. We did not intend this phrase to have a different 
meaning than ``material'' and, therefore, we have deleted the word 
``currently'' in the Item 9 as adopted.
    \85\ See Rule 206(4)-4 Proposing Release, at nn. 12-13 and 
accompanying text. The Commission has long viewed information about 
a prior disciplinary proceeding involving an adviser as important to 
clients and that failure to disclose such a proceeding may violate 
the antifraud provisions of sections 206(1) and 206(2) of the 
Advisers Act. See e.g., In the Matter of Jesse Rosenblum, Investment 
Advisers Act Release No. 913 (May 17, 1984).
---------------------------------------------------------------------------

    Two other commenters addressed the rebuttable presumption of 
materiality under Item 9.\86\ One commenter supported the flexibility 
of allowing advisers to rebut the presumption of materiality.\87\ Other 
commenters suggested, however, that an adviser should not be permitted 
to rebut this presumption, stating that this would give advisers little 
incentive to disclose disciplinary information that may be considered 
material.\88\ We note that an adviser, as a fiduciary, has an 
obligation to disclose material information to clients.\89\ We believe 
that the legal consequences that flow from its failure to meet this 
obligation provide an incentive for an adviser to disclose material 
disciplinary information. Moreover, advisers that seek to exclude 
information from their brochures because they believe that they can 
rebut the presumption of materiality must memorialize the basis for 
that determination, which is subject to review by our staff.\90\
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    \86\ See Morgan Stanley Letter; Sutherland Letter.
    \87\ See IAA Letter.
    \88\ See NASAA Letter; NCS Letter.
    \89\ We note that failure to disclose material information to 
clients constitutes a violation of section 206 of the Advisers Act. 
We have brought enforcement actions charging advisers with failures 
to make such disclosures. See, e.g., Colley Asset Management, Inc., 
and John E. Colley, Investment Advisers Act Release No. 2363 (Feb. 
25, 2005) (settled order).
    \90\ We also note that an adviser is required in Part 1A of Form 
ADV to disclose disciplinary events regardless of whether they are 
material. Part 1A is filed electronically with the Commission and is 
publicly available on our website.
---------------------------------------------------------------------------

    In the Proposing Release, we requested comment on whether we should 
require disclosure about arbitration awards and claims.\91\ A few 
commenters supported arbitration disclosure, arguing that investors 
deserve the most complete information available to build a picture of 
an adviser's integrity.\92\ Others objected, with some reasoning that 
arbitration claims are easy to make and that arbitration settlements 
and awards may not necessarily include findings of wrongdoing (i.e., 
parties may settle arbitration proceedings and/or arbitration awards 
may be granted even in the absence of legal violations).\93\ For this 
reason, we have determined not to require disclosure of arbitration 
awards in the client brochure. Advisers should, however, carefully 
consider whether particular arbitration awards or settlements do, in 
fact, involve or implicate wrongdoing and/or reflect on the integrity 
of the adviser, and should be disclosed to clients in the brochure or 
through other means.\94\ Because many disputes involving securities 
firms (including investment advisers) are resolved through arbitration 
or other methods of alternative dispute resolution, we will continue to 
assess whether we should require that these events be reported by firms 
registered with us.
---------------------------------------------------------------------------

    \91\ See Proposing Release at Section II.A.2. We also requested 
comment in the Proposing Release on whether we should require that 
advisers subject to a Commission administrative order provide 
clients with a copy of that order. Commenters did not support such a 
requirement and stated that, when appropriate, we should require 
delivery of orders in individual proceedings. See Federated Letter; 
Fried Frank Letter; Morgan Stanley Letter; Sutherland Letter. We 
agree with commenters and Part 2A does not require that such orders 
be provided to advisory clients.
    \92\ See Consumer Federation Letter; CFA Institute Letter; CFP 
Board Letter; NASAA Letter.
    \93\ See comment letter from Michael Berlin (Apr. 28, 2008) 
(``Berlin Letter''); Federated Letter; First Allied Letter; Fried 
Frank Letter; IAA Letter; ICI Letter; Janus Letter; Mercer Letter; 
Morgan Stanley Letter; NRS Letter; SIFMA Letter; comment letter of 
R.C. Verbeck (May 12, 2008) (``Verbeck Letter'').
    \94\ We note that failure to disclose material information to 
clients constitutes a violation of section 206 of the Advisers Act.
---------------------------------------------------------------------------

    Item 9 requires that an adviser must disclose if it (or any of its 
management persons) has been involved in one of the events listed in 
that item. ``Involved'' is defined as ``[e]ngaging in any act or 
omission, aiding, abetting, counseling, commanding, inducing, 
conspiring with or failing reasonably to supervise another in doing an 
act.'' \95\ Three commenters requested that we narrow the definition of 
``involved,'' arguing that the proposed definition is both overbroad 
and vague.\96\ Other commenters supported using the term

[[Page 49241]]

``involved,'' as defined.\97\ One of these commenters noted that this 
term also is used in Form BD and in Form U4 and, as such, changing the 
meaning of the term (or eliminating it from Part 2A) would undermine 
uniformity and create disparate reporting between broker-dealers and 
advisers.\98\ We believe that, for purposes of consistency, it is 
appropriate to continue to define the term ``involved'' as currently 
defined in Form ADV. This term and definition has been used in Form ADV 
for over 9 years and on Form BD for over 14 years, and we believe its 
meaning should be well understood.\99\
---------------------------------------------------------------------------

    \95\ See the Glossary to Form ADV.
    \96\ See Federated Letter; IAA Letter; Morgan Stanley Letter.
    \97\ See CFA Institute Letter; NASAA Letter.
    \98\ See NASAA Letter.
    \99\ See Amendments to Form ADV, Investment Advisers Act Release 
No. 1897 (Sept. 12, 2000) [65 FR 57438 (Sept. 22, 2000)]; Form BD 
Amendments, Securities Exchange Act Release No. 37431 (July 12, 
1996) [61 FR 37357 (July 18, 1996)].
---------------------------------------------------------------------------

    Some commenters recommended that advisers be permitted to satisfy 
the obligation to disclose and update disciplinary events by referring 
clients to the Investment Adviser Public Disclosure system (IAPD) to 
obtain the firm's disclosures from Part 1A of Form ADV and providing a 
copy of the disciplinary disclosures to clients who do not have 
Internet access.\100\ One commenter strongly opposed this 
recommendation, however, stating that ``[a]rming investors with this 
information is one of the best tools we have to put investors on their 
guard so that they can protect their own interests.'' \101\
---------------------------------------------------------------------------

    \100\ See comment letter of the Alternative Investment 
Management Association (May 16, 2008) (``AIMA Letter''); ASG Letter; 
Janus Letter; Morgan Stanley Letter; NRS Letter; SIFMA Letter; 
Sutherland Letter.
    \101\ Consumer Federation Letter.
---------------------------------------------------------------------------

    The disciplinary information provided in Part 1A is provided to the 
Commission primarily for registration purposes and not with an eye 
towards client disclosure. Part 1A, therefore, requires disclosure not 
just about the advisory firm and its management personnel, but also 
about all of its ``advisory affiliates.'' A firm's advisory affiliates 
include all of the firm's employees, officers, partners, or directors 
and all persons directly or indirectly controlling or controlled by the 
firm.\102\ Having disciplinary information about this broad group is 
important to the Commission for regulatory purposes. However, many of 
the largest investment advisers may have a large number of advisory 
affiliates and voluminous disciplinary disclosure, much of which may be 
regarding advisory affiliates with no relationship to particular 
clients. Accordingly, we believe that requiring clients to sift through 
an advisory firm's Part 1A disciplinary disclosure is not the most 
effective client disclosure. Therefore, we are adopting the proposed 
requirement that the brochure affirmatively disclose disciplinary 
information about the adviser and its management personnel.
---------------------------------------------------------------------------

    \102\ See Form ADV: Glossary. Firm employees that perform only 
clerical, administrative, support, or similar functions are excluded 
from the definition.
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    Because Part 2A, as amended, incorporates disciplinary disclosures 
formerly required by rule 206(4)-4 directly in the advisory brochure 
requirements, we are rescinding rule 206(4)-4.\103\ The rescission of 
rule 206(4)-4 will be effective, with respect to any particular 
investment adviser, on the date by which that adviser must deliver its 
narrative brochure to existing clients and begin delivering its 
brochure to prospective clients under the rule and form amendments we 
are adopting today.\104\ Some advisers, however, may have clients to 
whom they are not required to deliver a brochure, such as certain 
clients receiving only impersonal investment advice or those that are 
registered investment companies and business development 
companies.\105\ For these advisers, their fiduciary duty of full and 
fair disclosure requires them to continue to disclose to all their 
clients material disciplinary and legal events and their inability to 
meet contractual commitments to their clients.\106\
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    \103\ In addition to requiring disclosure of certain 
disciplinary information, rule 206(4)-4 requires an adviser to 
disclose certain financial information to clients. As with the 
disciplinary disclosure, we have incorporated this requirement into 
the new brochure. Similar to rule 206(4)-4(a)(1), Item 18.B of Part 
2A requires certain advisers to disclose any financial condition 
that is reasonably likely to impair their ability to meet 
contractual commitments to clients. See infra note 177 and 
accompanying text.
    \104\ See infra Section V.
    \105\ Our requirements regarding to which clients an adviser 
must deliver a brochure are discussed in Section II.A.3 below. One 
commenter suggested that we retain rule 206(4)-4 to require only the 
delivery of disciplinary information to clients for whom the 
brochure delivery requirement does not apply. See ABA Committees 
Letter.
    \106\ See Financial and Disciplinary Information that Investment 
Advisers Must Disclose to Clients, Investment Advisers Act Release 
No. 1035 (Sept. 19, 1986) (``Rule 206(4)-4 Adopting Release'') 
(``explaining that rule 206(4)-4 was designed to codify an 
investment adviser's fiduciary obligation to disclose material 
financial and disciplinary information to clients.''). We have 
brought enforcement actions charging advisers with failures to make 
such disclosures. See, e.g., In the Matter of Veritas Financial 
Advisors LLC, Veritas Advisors, Inc., Patrick J. Cox and Rita A. 
White, Investment Advisers Act Release No. 2577 (Dec. 29, 2006) 
(settled order); In the Matter of Harry Michael Schwartz, Investment 
Advisers Act Release No. 1833 (Sept. 27, 1999) (settled order); In 
the Matter of Renaissance Capital Advisors, Inc., and Richard N. 
Fine, Investment Advisers Act Release No. 1688 (Dec. 22, 1997) 
(settled order). In addition, under section 9(a) of the Company Act 
[15 USC 80a-9(a)] an investment adviser to a registered investment 
company may be prohibited from serving in certain capacities with 
the fund as a result of a disciplinary event.
---------------------------------------------------------------------------

    Item 10. Other Financial Industry Activities and Affiliations. Item 
10 requires each adviser to describe in its brochure material 
relationships or arrangements the adviser (or any of its management 
persons) has with related financial industry participants, any material 
conflicts of interest that these relationships or arrangements create, 
and how the adviser addresses the conflicts.\107\ In addition, if an 
adviser selects or recommends other advisers for clients, Item 10 
requires that it disclose any compensation arrangements or other 
business relationships between the advisory firms, along with the 
conflicts created, and explain how it addresses these conflicts.\108\ 
The disclosure that Item 10 requires highlights for clients their 
adviser's other financial industry activities and affiliations that can 
create conflicts of interest and may impair the objectivity of the 
adviser's investment advice.
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    \107\ This item is similar to Item 8 of the previous Part 2. Two 
commenters requested that we clarify or provide guidance regarding 
``materiality'' in describing relations and arrangements with 
related persons, and conflicts of interest arising from these 
relations or arrangements. See IAA Letter; NRS Letter. We address 
this comment earlier in this Release. See supra note 35 for a 
further discussion of materiality under the Advisers Act.
    \108\ We have brought enforcement actions charging advisers with 
failures to make such disclosures. See, e.g., In the Matter of 
Morgan Stanley & Co., Incorporated, Investment Advisers Act Release 
No. 2904 (July 20, 2009) (settled order); In the Matter of Yanni 
Partners, Inc. and Theresa A. Scotti, Investment Advisers Act 
Release No. 2642 (Sept. 5, 2007) (settled order).
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    Two commenters explicitly stated that they supported the disclosure 
required by this item.\109\ At the suggestion of one commenter,\110\ we 
have modified Item 10.D to require advisers that recommend other 
advisers to disclose, in particular, payments or business relationships 
that create material conflicts of interest with clients, so as not to 
capture all relationships.
---------------------------------------------------------------------------

    \109\ See CFA Institute Letter; Lininger Letter.
    \110\ See Sutherland Letter.
---------------------------------------------------------------------------

    Item 11. Code of Ethics, Participation or Interest in Client 
Transactions and Personal Trading.
    Code of Ethics. Item 11 requires each adviser to describe briefly 
its code of ethics and state that a copy is available upon 
request.\111\ Two commenters strongly supported the proposed item, 
believing the required disclosure is

[[Page 49242]]

indicative of an adviser's commitment to its fiduciary duties.\112\ One 
recommended that we instead simply require an adviser to note in the 
brochure that a copy of its code of ethics is available upon 
request.\113\ We believe that a brief, concise summary of the code of 
ethics (as the item requires) will be helpful to prospective clients 
who may not wish or feel the need to request the entire code of ethics 
and will assist those clients in determining whether they would like to 
read the entire code of ethics.\114\
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    \111\ This requirement is almost identical to the previous 
disclosure requirement in Item 9 of the previous Part 2.
    \112\ See CFA Institute Letter; CFP Board Letter.
    \113\ See Morgan Stanley Letter.
    \114\ This summary should not be a reiteration of the entire 
code of ethics, but rather should provide enough information for the 
client to determine if it would like to read the full code of ethics 
and to understand generally the adviser's ethical culture and 
standards, how the adviser controls sensitive information, and what 
steps it has taken to prevent employees from misusing their inside 
positions at clients' expense. See Investment Adviser Code of 
Ethics, Investment Advisers Act Release No. 2256 (July 2, 2004), at 
text accompanying notes nn.66-67 [69 FR 41696 (July 9, 2004)].
---------------------------------------------------------------------------

    Participation or Interest in Client Transactions. If the adviser or 
a related person recommends to clients, or buys or sells for client 
accounts, securities in which the adviser or a related person has a 
material financial interest, Item 11.B requires the brochure to discuss 
this practice and the conflicts of interest presented.\115\ Conflicts 
could arise, for example, when an adviser recommends that clients 
invest in a pooled investment vehicle that the firm advises or for 
which it serves as the general partner,\116\ or when an adviser with a 
material financial interest in a company recommends that a client buy 
shares of that company.\117\ The item requires advisers to disclose any 
practices giving rise to these conflicts, the nature of the conflicts 
presented, and how the adviser addresses the conflicts. Two commenters 
expressed support for this requirement.\118\ We are adopting Item 11.B. 
substantially as proposed, except that at the suggestion of three 
commenters, we have omitted the portion of the proposed item that 
required advisers to disclose ``procedures'' for making the disclosures 
to clients.\119\ We agree with these commenters that the requirement 
was inconsistent with the Commission's general approach throughout the 
brochure of requiring disclosure about conflicts and how they are 
addressed, but not about ``procedures.''
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    \115\ An adviser's related persons are: (1) The adviser's 
officers, partners, or directors (or any person performing similar 
functions); (2) all persons directly or indirectly controlling, 
controlled by, or under common control with the adviser; (3) all of 
the adviser's current employees; and (4) any person providing 
investment advice on the adviser's behalf. See Form ADV: Glossary. 
Items 11.B, 11.C, and 11.D are similar to Item 9 of the previous 
Part 2.
    \116\ We have brought enforcement actions charging advisers with 
failures to make such disclosures. See, e.g., In the Matter of 
Thomson McKinnon Asset Management, L.P., Investment Advisers Act 
Release No. 1243 (July 26, 1990) (settled order).
    \117\ We have brought enforcement actions charging advisers with 
failures to make such disclosures. See, e.g., In the Matter of 
Chancellor Capital Management, Inc., et al., Investment Advisers Act 
Release No. 1447 (Oct. 18, 1994) (settled order).
    \118\ See CFA Institute Letter; CFP Board Letter.
    \119\ See IAA Letter; ICI Letter; T. Rowe Letter.
---------------------------------------------------------------------------

    Personal Trading. Items 11.C and 11.D require disclosure of 
personal trading by the adviser and its personnel.\120\ Item 11.C 
requires an adviser to disclose whether it or a related person (e.g., 
advisory personnel) invests (or is permitted to invest) in the same 
securities that it recommends to clients, or in related securities 
(such as options or other derivatives). If so, the brochure must 
discuss the conflicts presented and describe how the firm addresses the 
conflicts. Item 11.D requires a similar discussion, but focuses on the 
specific conflicts an adviser has when it or a related person trades in 
the same securities at or about the same time as a client.\121\ In 
response to this item, an adviser should explain how its internal 
controls, including its code of ethics, prevent the firm and its staff 
from buying or selling securities contemporaneously with client 
transactions.
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    \120\ We have brought enforcement actions charging advisers with 
fraudulent personal trading. See In the Matter of Roger W. Honour, 
Investment Advisers Act Release No. 1527 (Sept. 29, 1995) (settled 
order).
    \121\ We have brought enforcement actions charging advisers with 
inaccurate disclosure in this context. See, e.g., In the Matter of 
Hutchens Investment Management and William Hutchens, Investment 
Advisers Act Release No. 2514 (May 9, 2006) (settled order).
---------------------------------------------------------------------------

    One commenter suggested that we specify a minimum amount of assets 
that must be managed by an adviser in order for that adviser to be 
required to disclose personal securities transactions, arguing that 
small firms' securities transactions are not large enough to generate a 
market impact and thus should not require disclosure.\122\ We disagree. 
A small firm could still place a trade large enough to have a market 
impact, especially in a thinly traded security. In addition, given that 
an adviser's ability to place its own trades before or after client 
trades in the same security may affect the objectivity of the adviser's 
recommendations, we believe disclosure of this practice is warranted. 
As a result, we are adopting Items 11.C and 11.D as proposed.
---------------------------------------------------------------------------

    \122\ See comment letter of Thaddeus Borek, Jr. (May 16, 2008).
---------------------------------------------------------------------------

    Finally, we note that we have modified the note to Item 11 to 
clarify that Items 11.B, 11.C, and 11.D would not require disclosure 
with respect to securities that are not ``reportable securities'' under 
Advisers Act rule 204A-1(e)(10), such as shares in unaffiliated mutual 
funds.\123\ As we indicated in the Proposing Release, such securities 
are not reportable under Advisers Act Rule 204A-1 because they appear 
to present little opportunity for front-running.\124\
---------------------------------------------------------------------------

    \123\ See Code of Ethics Adopting Release, supra note 114 at 
n.42 and accompanying text.
    \124\ See Proposing Release, supra note 2, at n.85.
---------------------------------------------------------------------------

    Item 12. Brokerage Practices. Item 12 requires that advisers 
describe how they select brokers for client transactions and determine 
the reasonableness of brokers' compensation. This item also requires 
advisers to disclose how they address conflicts of interest arising 
from their receipt of soft dollar benefits (i.e., research or other 
products or services they receive in connection with client 
brokerage).\125\
---------------------------------------------------------------------------

    \125\ Item 12 is similar to Item 12.B in the previous Part 2.
---------------------------------------------------------------------------

    Soft Dollar Practices. Many advisers receive brokerage and research 
services in reliance on section 28(e) of the Securities Exchange Act of 
1934 (``Exchange Act''),\126\ as well as other soft dollar products and 
services provided by brokers in connection with client 
transactions.\127\ Use of client securities transactions to obtain 
research and other benefits creates incentives that result in conflicts 
of interest between advisers and their clients.\128\ Because of these

[[Page 49243]]

conflicts, we have long required advisers to disclose their policies 
and practices with respect to their receipt of soft dollar benefits in 
connection with client securities transactions.\129\
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    \126\ Section 28(e) of the Exchange Act provides a limited 
``safe harbor'' for advisers with discretionary authority in 
connection with their receipt of soft dollar benefits. Under section 
28(e), a person who exercises investment discretion over a client 
account has not acted unlawfully or breached a fiduciary duty solely 
by causing the account to pay more than the lowest commission rate 
available, so long as that person determines in good faith that the 
commission amount is reasonable in relation to the value of the 
brokerage and research services provided. Advisers must disclose 
their receipt of soft dollar benefits to clients, regardless of 
whether the benefits fall inside or outside of the safe harbor. See 
Interpretive Release Concerning the Scope of Section 28(e) of the 
Securities Exchange Act of 1934 and Related Matters, Exchange Act 
Release No. 23170 (Apr. 23, 1986) [51 FR 16004 (Apr. 30, 1986)], at 
n.33 and accompanying text.
    \127\ According to IARD data as of May 3, 2010, approximately 
61% of advisers registered with the Commission report on Form ADV, 
Part 1A, Item 8.E that they or related persons receive soft dollar 
benefits in connection with client transactions.
    \128\ Commission Guidance Regarding Client Commission Practices 
Under Section 28(e) of the Securities Exchange Act of 1934, Exchange 
Act Release No. 54165 (July 18, 2006) [71 FR 41978 (July 24, 2006)] 
(``2006 Soft Dollar Release'') (``[u]se of client commissions to pay 
for research and brokerage services presents money managers with 
significant conflicts of interest, and may give incentives for 
managers to disregard their best execution obligations when 
directing orders to obtain client commission services as well as to 
trade client securities inappropriately in order to earn credits for 
client commission services'').
    \129\ See Item 12 of the previous Part 2.
---------------------------------------------------------------------------

    Item 12 requires an adviser that receives soft dollar benefits in 
connection with client securities transactions to disclose its 
practices.\130\ The description must be specific enough for clients and 
prospective clients to understand the types of products or services the 
adviser is acquiring and permit them to evaluate associated conflicts 
of interest. Disclosure must be more detailed for products or services 
that do not qualify for the safe harbor in section 28(e) of the 
Exchange Act, such as services that do not aid in the adviser's 
investment decision-making process.\131\
---------------------------------------------------------------------------

    \130\ See Item 12.A.1 of Part 2A.
    \131\ See note to Item 12.A.1.e of Part 2A.
---------------------------------------------------------------------------

    Item 12 also requires that an adviser discuss in its brochure the 
types of conflicts it has when it accepts soft dollar benefits and 
explain how it addresses those conflicts.\132\ The item requires the 
adviser to explain whether it uses soft dollars to benefit all client 
accounts or only those accounts whose brokerage ``pays'' for the 
benefits, and whether the adviser seeks to allocate the benefits to 
client accounts proportionately to the soft dollar credits those 
accounts generate. The item also requires the adviser to explain 
whether it ``pays up'' for soft dollar benefits.\133\
---------------------------------------------------------------------------

    \132\ See Item 12.A.1. An adviser accepting soft dollar benefits 
must explain that (a) the adviser benefits because it does not have 
to produce or pay for the research or other products or services 
acquired with soft dollars, and (b) the adviser therefore has an 
incentive to select or recommend brokers based on the adviser's 
interest in receiving these benefits, rather than on the client's 
interest in getting the most favorable execution. See Item 12.A.1.a 
and b of Part 2A.
    \133\ ``Paying up'' refers to an adviser causing a client 
account to pay more than the lowest available commission rate in 
exchange for soft dollar products or services.
---------------------------------------------------------------------------

    Some commenters, including one association representing more than 
130 pension funds, expressed their strong support for the soft dollar 
disclosure requirement.\134\ Other commenters objected to various 
portions of this item.\135\ Some of these commenters recommended 
elimination of the proposed requirements to disclose whether an adviser 
allocates soft dollar benefits to client accounts proportionately to 
the brokerage credits those accounts generate,\136\ and to disclose the 
``procedures'' it uses to direct client transactions to a particular 
broker-dealer.\137\ Some of these commenters also questioned the 
conflicts we identified and expressed concern that the item will tend 
to create a misleading impression that the use of soft dollar 
arrangements is harmful.\138\
---------------------------------------------------------------------------

    \134\ See comment letter of the Council of Institutional 
Investors (May 16, 2008) (``CII Letter''); CFA Institute Letter; NRS 
Letter; comment letter of Carolina Capital Markets, Inc. (Aug. 8, 
2008).
    \135\ See, e.g., comment letter of the Alliance in Support of 
Independent Research (May 16, 2008) (``Alliance Letter''); CAPIS 
Letter; IAA Letter; ICI Letter; comment letter of Pickard and Djinis 
LLP (May 14, 2008) (``Pickard Letter''); SIFMA Letter; T. Rowe 
Letter.
    \136\ See Alliance Letter; CAPIS Letter; IAA Letter; ICI Letter; 
Pickard Letter.
    \137\ See Alliance Letter; CAPIS Letter; IAA Letter; ICI Letter.
    \138\ See Alliance Letter; IAA Letter; ICI Letter; SIFMA Letter.
---------------------------------------------------------------------------

    There are significant conflicts associated with soft dollar 
arrangements. Section 28(e) was enacted, in part, to address them.\139\ 
We are not taking a view on the propriety of soft dollar arrangements, 
but rather are requiring full disclosure of arrangements that involve 
significant conflicts of interest.\140\ Moreover, disclosure required 
by Item 12 is similar to disclosure requirements previously required in 
Part 2 of Form ADV.\141\ We are adopting this requirement as proposed.
---------------------------------------------------------------------------

    \139\ See 2006 Soft Dollar Release, supra note 128, at nn.4-6 
and accompanying text.
    \140\ We have brought enforcement actions charging advisers with 
not adequately disclosing soft dollar arrangements and related 
conflicts. See, e.g., In the Matter of Schultze Asset Management LLC 
and George J. Schultze, Investment Advisers Act Release No. 2633 
(Aug. 15, 2007) (settled order); In the Matter of Rudney Associates, 
Inc. et al., Investment Advisers Act Release No. 2300 (Sept. 21, 
2004) (settled order).
    \141\ Item 12.B. of the previous Part 2 required, for example, 
that the adviser describe the factors considered in selecting 
brokers and determining the reasonableness of their commissions. In 
addition, if the value of products, research and services given to 
the adviser is a factor in selecting brokers, the adviser was 
required to, among other things, describe whether clients may pay 
commissions higher than those obtainable from other brokers in 
return for those products and services.
---------------------------------------------------------------------------

    Client Referrals. If an adviser uses client brokerage to compensate 
or otherwise reward brokers for client referrals, it also must disclose 
this practice, the conflicts of interest it creates, and any procedures 
the adviser used to direct client brokerage to referring brokers during 
the last fiscal year (i.e., the system of controls used by the adviser 
when allocating brokerage).\142\ Part 2 previously required that 
advisers disclose these arrangements, but did not specifically require 
that the description discuss the conflicts of interest created.\143\ We 
did not receive any comments relating to this item and are adopting the 
requirement as it was proposed so that clients are aware that their 
adviser may have a bias toward referring brokers, a significant 
conflict of interest.\144\
---------------------------------------------------------------------------

    \142\ Item 12.A.2 of Part 2A.
    \143\ See Item 13.B. of the previous Part 2.
    \144\ We have brought enforcement actions charging advisers with 
failing to disclose to clients that they directed their brokerage 
commissions in return for client referrals. See, e.g., In the Matter 
of Fleet Investment Advisors, Inc., Investment Advisers Act Release 
No. 1821 (Sept. 9, 1999) (settled order).
---------------------------------------------------------------------------

    Directed Brokerage. Item 12 requires an adviser that permits 
clients to direct brokerage to describe its practices in this area. 
Item 12 also requires that such an adviser explain that it may be 
unable to obtain the most favorable execution of client transactions if 
the client directs brokerage and that directing brokerage may be more 
costly for clients.\145\ If, however, an adviser routinely recommends, 
requests or requires clients to direct brokerage, Item 12 also requires 
the adviser to describe this practice in its brochure, to disclose that 
not all advisers require directed brokerage, and to describe any 
relationship with a broker-dealer to which the brokerage may be 
directed that creates a material conflict of interest.\146\ An adviser 
may omit disclosure regarding its inability to obtain best execution if 
directed brokerage arrangements are only conducted subject to the 
adviser's ability to obtain best execution.\147\
---------------------------------------------------------------------------

    \145\ See Item 12.A.3.b of Part 2A. As we discussed in the 
Proposing Release, clients sometimes instruct their adviser to send 
transactions to a specific broker-dealer for execution. Clients may 
initiate this type of arrangement for a variety of reasons, such as 
favoring a family member or friend or compensating the broker-dealer 
indirectly for services it provides to the client. But the 
arrangement also may be initiated by the adviser, who may benefit, 
for example, when brokerage is directed to its affiliated broker-
dealer. In either case, clients directing (or agreeing to direct) 
brokerage need to understand the consequences of directing 
brokerage, including the possibility that their accounts will pay 
higher commissions and receive less favorable execution.
    \146\ See Item 12.A.3.a of Part 2A. We have brought enforcement 
actions charging advisers with failures to make such disclosures. 
See also In the Matter of Callan Associates, Investment Advisers Act 
Release No. 2650 (Sept. 19, 2007) (settled order); In the Matter of 
Jamison, Eaton & Wood, Inc., Investment Advisers Act Release No. 
2129 (May 15, 2003) (settled order).
    \147\ See note to Item 12.A.2 of Part 2A.
---------------------------------------------------------------------------

    Two commenters addressed this requirement. One, representing 
pension funds, endorsed our proposal as supporting transparency in 
brokerage arrangements.\148\ The other urged that we broaden the 
proposed exception in the item to all directed brokerage subject to 
best execution, whether recommended by the adviser or directed by the 
client. The commenter pointed out that such client-imposed limitations 
on direction of brokerage should

[[Page 49244]]

address the Commission's concerns in proposing the item.\149\ We agree, 
and have revised the note following the item accordingly.
---------------------------------------------------------------------------

    \148\ See CII Letter.
    \149\ See Alliance Letter.
---------------------------------------------------------------------------

    Trade Aggregation. Clients engaging an adviser can benefit when the 
adviser aggregates trades to obtain volume discounts on execution 
costs. Item 12 requires the adviser to describe whether and under what 
conditions it aggregates trades. If the adviser does not aggregate 
trades when it has the opportunity to do so, the adviser must explain 
in the brochure that clients may therefore pay higher brokerage costs. 
One commenter supported this disclosure, stating that it is helpful and 
meaningful to clients.\150\ However, another commenter expressed 
concern that such disclosure would suggest that advisers should always 
aggregate orders, and noted that there are circumstances where an 
adviser may decide that it is better for the client not to do so, such 
as with multiple large trades that may create a market impact.\151\ 
Other commenters argued that trade aggregation practices are not 
material to clients.\152\ But aggregation practices may have a material 
effect on the quality of execution. Thus, we believe that such 
practices should be disclosed in the brochure.
---------------------------------------------------------------------------

    \150\ See NRS Letter.
    \151\ See IAA Letter.
    \152\ See Fried Frank Letter.
---------------------------------------------------------------------------

    Finally, one commenter suggested deleting the words ``in quantities 
sufficient to obtain reduced transaction costs'' from the first 
sentence of Item 12.B since there may be other circumstances in which 
advisers may aggregate client trades that should be disclosed to 
clients.\153\ As this item was intended to require advisers to explain 
their aggregation practices along with the reasons for and consequences 
of those practices more generally, we have removed this limiting 
phrase.
---------------------------------------------------------------------------

    \153\ See Schnase Letter.
---------------------------------------------------------------------------

    Item 13. Review of Accounts. Item 13 requires that an adviser 
disclose whether, and how often, it reviews clients' accounts or 
financial plans, and identify who conducts the review.\154\ An adviser 
that reviews accounts other than regularly must explain what 
circumstances trigger an account review.
---------------------------------------------------------------------------

    \154\ Item 13 is similar to Item 11 in the previous Part 2.
---------------------------------------------------------------------------

    Three commenters addressed this item. One supported it as being 
helpful to clients.\155\ Two thought that this item provided non-
critical information that could be eliminated in the interest of 
providing a shorter brochure to clients.\156\ We believe the 
disclosure, which can be brief, provides very useful information to 
clients about their advisers' management of their accounts. As a 
result, we are adopting this item substantially as it was 
proposed.\157\
---------------------------------------------------------------------------

    \155\ See CFA Institute Letter.
    \156\ See SIFMA Letter; Sutherland Letter.
    \157\ The Schnase Letter suggested changing the word 
``employee'' in Item 13.A to ``supervised person.'' As defined in 
the Form ADV Glossary, ``supervised person'' means ``any of your 
officers, partners, directors (or other persons occupying a similar 
status or performing similar functions), or employees, or any other 
person who provides investment advice on your behalf and is subject 
to your supervision or control.'' For purposes of consistency 
throughout Part 2A, we are making the change suggested by the 
commenter. We also are substituting the word ``supervised person'' 
for the word ``employee'' in Item 14.B, Instruction 6 for Part 2A, 
Appendix 1 (the wrap fee program brochure), and Item 6.C of Part 2A, 
Appendix 1.
---------------------------------------------------------------------------

    Item 14. Client Referrals and Other Compensation. Item 14 requires 
an adviser to describe in its brochure any arrangement under which it 
or its related person compensates another for client referrals and 
describe the compensation. The brochure also must disclose any 
arrangement under which the adviser receives any economic benefit, 
including sales awards or prizes, from a person who is not a client for 
providing advisory services to clients.\158\
---------------------------------------------------------------------------

    \158\ Similar disclosure was previously required by Item 13 of 
Part 2.
---------------------------------------------------------------------------

    We received three comments on this item. One supported the proposed 
item, stating that these areas involve practices that raise conflicts 
of interest.\159\ Another suggested that it be omitted because certain 
disclosure required under this item is already required by rule 206(4)-
3 under the Advisers Act (the ``cash solicitation rule'').\160\ The 
cash solicitation rule, however, applies only to certain types of 
payments and requires disclosure by the solicitor rather than the 
adviser.\161\ Finally, one commenter urged that we amend the Item to 
disclose the conflicts of interest associated with these 
arrangements.\162\ We agree. There are significant conflicts of 
interest when an adviser receives benefits from a third party for 
providing advisory services to a client, or when an adviser pays a 
third party for client referrals. We are revising Item 14.A from our 
proposal to require an adviser that accepts benefits from a non-client 
for providing advisory services to clients describe the arrangement, 
any conflicts of interests that arise from the arrangement, and how the 
adviser addresses those conflicts.
---------------------------------------------------------------------------

    \159\ See CFA Institute Letter.
    \160\ See Sutherland Letter.
    \161\ Rule 206(4)-3 applies to advisers paying cash referral 
fees to solicitors, and thus does not require disclosure of non-cash 
benefits. The rule requires, among other things, that an 
unaffiliated solicitor provide the adviser's brochure and a separate 
disclosure document described in the rule to clients or prospective 
clients at the time of any solicitation activities. See rule 206(4)-
3(a)(2)(iii).
    \162\ See Schnase Letter. This commenter also suggested that we 
rename this item since Item 14.B relates only to payment for client 
referrals. In light of this comment, we are renaming this item 
``Client Referrals and Other Compensation.''
---------------------------------------------------------------------------

    Item 15. Custody. Item 15 requires an adviser with custody of 
client funds or securities to explain in its brochure that clients will 
receive account statements directly from the qualified custodian, such 
as a bank or broker-dealer that maintains those assets. Advisers must 
also explain to clients that they should carefully review the account 
statements they receive from the qualified custodian. In addition, if 
an adviser also sends clients account statements, the adviser's 
explanation must include a statement urging clients to compare the 
account statements they receive from the qualified custodian with those 
they receive from the adviser. Comparing statements will allow clients 
to determine whether account transactions, including deductions to pay 
advisory fees, are proper. This disclosure is very similar to the 
statement required to be made by advisers under our recently amended 
custody rule.\163\
---------------------------------------------------------------------------

    \163\ See Custody of Funds or Securities of Clients by 
Investment Advisers, Investment Advisers Act Release No. 2968 (Dec. 
30, 2009) [75 FR 1456 (Jan. 11, 2010)] (``Custody Rule Adopting 
Release'') at section II.A.
---------------------------------------------------------------------------

    We proposed an alternative disclosure requirement in Item 15 that 
we are not adopting today. Proposed Item 15.A. would have required 
that, if clients did not receive account statements from qualified 
custodians, the adviser must disclose the risks that clients would face 
as a result.\164\ This alternative is no longer relevant because the 
amendments to the custody rule eliminated the option that permitted 
advisers to substitute their own account statements for those from a 
qualified custodian.\165\
---------------------------------------------------------------------------

    \164\ Id. We received two comments on proposed Item 15.A. See 
ICI Letter; ABA Committee Letter.
    \165\ Custody Rule Adopting Release, see supra note 163.
---------------------------------------------------------------------------

    Item 16. Investment Discretion. Item 16 requires an adviser with 
discretionary authority over client accounts to disclose this fact in 
its brochure,\166\ and any limitations clients may (or customarily do) 
place on this

[[Page 49245]]

authority.\167\ Two commenters suggested that the Commission not 
require advisers to provide duplicative disclosure regarding 
discretionary authority as it likely would be incorporated into the 
description of the advisory business in Item 4.\168\ We note that if 
the information is provided in response to Item 4, the adviser may 
cross-reference the information. We therefore are adopting this item as 
proposed.
---------------------------------------------------------------------------

    \166\ An adviser has ``discretionary authority'' if it is 
authorized to make purchase and sale decisions for client accounts. 
See Form ADV Glossary. This definition of discretionary authority is 
derived from section 3(a)(35) of the Exchange Act [15 U.S.C. 
78c(a)(35)]. An adviser also has discretionary authority if it is 
authorized to select other advisers for the client. This Item is 
similar to Item 12.A of the previous Part 2.
    \167\ For example, clients may not understand that they may ask 
the adviser not to invest in securities of particular issuers.
    \168\ See IAA Letter; Sutherland Letter. They argued that such 
information would already be disclosed under Items 4.B, 4.C and 4.E 
(advisory business) or Item 8 (strategies and risks).
---------------------------------------------------------------------------

    Item 17. Voting Client Securities. Item 17 requires advisers to 
disclose their proxy voting practices. This item parallels rule 206(4)-
6 under the Advisers Act, which, among other things, requires advisers 
registered with the Commission to disclose certain information about 
their proxy voting practices.\169\ Item 17 also requires advisers to 
disclose whether they have or will accept authority to vote client 
securities and, if so, to describe briefly the voting policies they 
adopted under rule 206(4)-6. Each adviser must describe whether (and 
how) clients can direct it to vote in a particular solicitation, how 
the adviser addresses conflicts of interest when it votes securities, 
and how clients can obtain information from the adviser on how the 
adviser voted their securities. Item 17 also requires an adviser to 
explain that clients may obtain a copy of the adviser's proxy voting 
policies and procedures upon request. Advisers that do not accept 
authority to vote securities must disclose how clients receive their 
proxies and other solicitations.\170\
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    \169\ Proxy Voting Release, see supra note 3. Rule 206(4)-6 
requires advisers to adopt and implement written voting policies and 
procedures. Advisers also are required to keep certain records 
relating to their voting. Advisers that exercise voting authority 
over client securities must describe their voting policies and 
procedures to clients and furnish clients with a complete copy upon 
request.
    \170\ If an adviser accepts proxy voting authority for some 
accounts but not others, the adviser should disclose the relevant 
information required by this Item for each type of account unless 
the adviser has prepared separate brochures for the other accounts.
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    Some commenters suggested that we eliminate Item 17 in its 
entirety, arguing either that the required disclosure is not important 
to clients or that most of the information already is available in 
advisory contracts.\171\ Others supported this disclosure requirement, 
noting that clients are interested in understanding the potential 
conflicts of interest that may arise from an adviser's proxy 
voting.\172\ We agree that proxy voting practices and the conflicts 
arising from such practices are important information that should be 
disclosed, and note that rule 206(4)-6 independently would require the 
same disclosure even if we were to eliminate it from the brochure.\173\ 
Accordingly, we are adopting Item 17, but with one modification.
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    \171\ See NAPFA Letter; Morgan Stanley Letter.
    \172\ See CFA Institute Letter; CII Letter.
    \173\ We have brought enforcement actions relating to advisers' 
proxy voting policies and procedures. See, e.g., In the Matter of 
INTECH Investment Management LLC and David E. Hurley, Investment 
Advisers Act Release No. 2872 (May 7, 2009) (settled order).
---------------------------------------------------------------------------

    We had proposed to require detailed information about an adviser's 
use of third-party proxy voting services and how the adviser pays for 
proxy voting services. Most of the commenters addressing this proposed 
requirement argued that the information is not relevant for most 
clients.\174\ In light of the Commission's Concept Release on the U.S. 
proxy system issued on July 14, 2010, which requests comment on a wide 
range of questions and issues relating to proxy advisory firms,\175\ we 
are adopting Item 17 without this requirement. Clients interested in 
this information may obtain it from their advisers upon request.
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    \174\ See ASG Letter; Fried Frank Letter; IAA Letter; ICI 
Letter; Janus Letter; Lininger Letter. A few commenters supported 
this disclosure. See CFA Institute Letter; CII Letter.
    \175\ Concept Release On The U.S. Proxy System, Investment 
Advisers Act Release No. IA-3052 (July 14, 2010) [75 FR 42982 (July 
22, 2010)].
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    Item 18. Financial Information. This item requires disclosure of 
certain financial information about an adviser when material to 
clients. Specifically, an adviser that requires prepayment of fees must 
give clients an audited balance sheet showing the adviser's assets and 
liabilities at the end of its most recent fiscal year.\176\ The item 
also requires an adviser to disclose any financial condition reasonably 
likely to impair the adviser's ability to meet contractual commitments 
to clients if the adviser has discretionary authority over client 
assets, has custody of client funds or securities, or requires or 
solicits prepayment of more than $1,200 in fees per client and six 
months or more in advance.\177\ For instance, disclosure may be 
required where a judgment or arbitration award was sufficiently large 
that payment of it would create such a financial condition. Under these 
circumstances, clients are exposed to the risk that their assets may 
not be properly managed--and prepaid fees may not be returned--if, for 
example, the adviser becomes insolvent and ceases to do business. 
Finally, Item 18 requires an adviser that has been the subject of a 
bankruptcy petition during the past ten years to disclose that fact to 
clients.\178\ As discussed above, although we are rescinding rule 
206(4)-4 we caution advisers that their fiduciary duty of full and fair 
disclosure may require them to continue to disclose any precarious 
financial condition promptly to all clients, even clients to whom they 
may not be required to deliver a brochure or amended brochure.\179\
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    \176\ As proposed, we are increasing the threshold amount from 
the existing threshold, $500, to $1,200 to reflect the effects of 
inflation, based upon the Personal Consumption Expenditures Chain-
Type Price Index as published by the U.S. Department of Commerce, 
since we adopted Form ADV in 1979. We also are requiring, as 
proposed, an audited balance sheet from advisers that solicit 
clients to prepay fees over $1,200. This portion of Item 18 is 
similar to Item 14 in the previous Part 2.
    \177\ This disclosure was previously required by rule 206(4)-4. 
In the release adopting rule 206(4)-4, we noted that a determination 
about what constitutes financial condition reasonably likely to 
impair an adviser's ability to meet contractual commitments is 
inherently factual in nature but will generally include insolvency 
or bankruptcy. See Rule 206(4)-4 Adopting Release, supra note 106 at 
n.6.
    \178\ This includes the obligation of an adviser that is 
organized as a sole proprietorship to disclose a personal 
bankruptcy. This requirement conforms to our view that bankruptcy 
generally constitutes a ``financial condition of the adviser that is 
reasonably likely to impair the ability of the adviser to meet 
contractual commitments to clients'' requiring disclosure under rule 
206(4)-4. See Rule 206(4)-4 Adopting Release, supra note 106.
    \179\ See supra note 106 and accompanying text.
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    One commenter recommended elimination of the balance sheet 
requirement, stating that the balance sheet gives an imperfect picture 
of the financial health of an adviser,\180\ and another was concerned 
that disclosure of financial information would unduly discriminate 
against smaller advisers.\181\ We believe that a client that becomes a 
creditor of an adviser because it prepays fees would want information 
about the adviser's condition. This information is currently required 
to be disclosed to clients, and commenters have not persuaded us that 
it should be omitted. As a result, we are adopting Item 18 as proposed.
---------------------------------------------------------------------------

    \180\ See Fried Frank Letter.
    \181\ See Verbeck Letter.
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    Item 19. Index. We proposed to require that the brochure filed with 
us include an index of the items required by Part 2A indicating where 
in the brochure the adviser addresses each item. This index was 
intended to facilitate review by our staff for compliance with the 
requirements of Part 2A. As discussed above, we are now requiring 
advisers to provide their

[[Page 49246]]

responses to the items in Part 2 in the same order as the items appear 
in the form. As a result, the index would be duplicative of the table 
of contents and is no longer necessary. We therefore are not adopting 
this requirement.
    Part 2A Appendix 1: The Wrap Fee Program Brochure. Advisers that 
sponsor wrap fee programs\182\ continue to be required to prepare a 
separate, specialized firm brochure (a ``wrap fee program brochure'' or 
``wrap brochure'') for clients of the wrap fee program in lieu of the 
sponsor's standard brochure.\183\ The items in Appendix 1 to Part 2A 
contain the requirements for a wrap fee program brochure, and are 
substantially similar to those previously in Schedule H, the separate 
wrap fee program brochure in previous Part 2.\184\ However, we are 
revising the requirements of Schedule H to incorporate many of our 
amendments to the Part 2A firm brochure.
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    \182\ Under wrap fee programs, which also are sometimes referred 
to as ``separately managed accounts,'' advisory clients pay a 
specified fee for investment advisory services and the execution of 
transactions. The advisory services may include portfolio management 
and/or advice concerning selection of other advisers, and the fee is 
not based directly upon transactions in the client's account.
    \183\ We adopted the requirement for a separate brochure for 
wrap fee clients in 1994. See Disclosure by Investment Advisers 
Regarding Wrap Fee Programs, Investment Advisers Act Release No. 
1411 (Apr. 19, 1994) [59 FR 21657 (Apr. 26, 1994)]. Advisers whose 
entire advisory business is sponsoring wrap fee programs will 
prepare a wrap brochure but will not be required to prepare a 
standard advisory firm brochure. See Instruction 10 of Instructions 
for Part 2A of Form ADV. An adviser will have to prepare both a 
standard firm brochure and a wrap fee program brochure if it both 
sponsors a wrap fee program and provides other types of advisory 
services, and will deliver both a standard and a wrap brochure to a 
client who receives both types of services. Wrap fee sponsors would, 
like other advisers, be required to provide brochure supplements to 
their wrap fee clients.
    \184\ We have brought enforcement actions regarding wrap fee 
program disclosure. See, e.g., In re Banc of America Investment 
Services, Inc. and Columbia Management Advisors, LLC (as successor 
in interest to Banc of America Capital Management, LLC), Investment 
Advisers Act Release No. 2733 (May 1, 2008) (settled order).
---------------------------------------------------------------------------

    We also are adopting an additional disclosure requirement to the 
wrap fee program brochure. It requires an adviser to identify whether 
any of its related persons is a portfolio manager in the wrap fee 
program and, if so, to describe the associated conflicts. For example, 
an adviser may have an incentive to select a related person to 
participate as a portfolio manager based on the person's affiliation 
with the adviser, rather than based on expertise or performance. This 
item requires advisers to disclose whether related person portfolio 
managers are subject to the same selection and review criteria as the 
other portfolio managers who participate in the wrap fee program and, 
if they are not, how they are selected and reviewed.
    Two commenters requested clarification that an adviser can delegate 
its brochure delivery requirement to the sponsor of the wrap fee 
program,\185\ and one of these commenters also requested clarification 
that the adviser could satisfy its recordkeeping obligations that 
evidence delivery of the brochure by such records being retained in the 
offices of the sponsor and not the adviser, as long as the adviser was 
able to provide the records to Commission staff upon request.\186\ We 
confirm that a sponsor may deliver the adviser's brochures and maintain 
certain records as long as the sponsor, upon request of the 
Commission's staff, will produce promptly the records for the staff at 
the appropriate office of the adviser or the sponsor. This delegation 
does not relieve the adviser of its legal delivery obligation, however, 
and thus the adviser should take steps to assure itself that the 
sponsor is performing the tasks the adviser has delegated.
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    \185\ See Federated Letter; MMI Letter.
    \186\ See MMI Letter. Rules 204-2(a)(14) and 204-2(e)(1) under 
the Advisers Act describe advisers' recordkeeping obligations 
relating to brochure delivery.
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3. Delivery and Updating of Brochures
    The Commission also is adopting amendments to rule 204-3; our rule 
under the Advisers Act that requires registered advisers to deliver 
their brochures and certain updates to clients and prospective 
clients.\187\
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    \187\ The brochure delivery and updating obligations are the 
same for both a standard brochure and a wrap fee program brochure. 
See rule 204-3.
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a. Delivery to Clients
    Initial Delivery. Rule 204-3, as amended, requires an adviser to 
deliver a current brochure before or at the time it enters into an 
advisory contract with the client.\188\ The rule does not require 
advisers to deliver brochures to certain advisory clients receiving 
only impersonal investment advice\189\ or to clients that are 
investment companies registered under the Investment Company Act of 
1940 (``Company Act'').\190\ As proposed, we have expanded the latter 
exception to cover advisers to business development companies 
(``BDCs'') that are subject to section 15(c) of the Company Act, which 
requires a board of directors to request, and the adviser to furnish, 
information to enable the board to evaluate the terms of the proposed 
advisory contract.\191\ Because of this safeguard, we believe that 
adopting an obligation for these advisers to deliver a brochure to 
these BDC clients is not necessary.\192\ An adviser does not have to 
prepare (or file with us) a brochure if it does not have any clients to 
whom a brochure must be delivered.\193\
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    \188\ See rule 204-3(b). Rule 204-3 requires a registered 
adviser to furnish each client and prospective client with a written 
disclosure statement which may be either a copy of the adviser's 
completed Part 2A or a written document containing the information 
required by Part 2A. Previously, such delivery had to occur at least 
48 hours before entering into the advisory agreement, or at the time 
of entering into the agreement if the client has the right to 
terminate the agreement without penalty within five business days 
thereafter. We received two comments on this proposed change to the 
timing of the required initial brochure delivery, both in support. 
See Pickard Letter; T. Rowe Letter.
    \189\ See rule 204-3(c)(2) and Instruction 1 for Part 2A of Form 
ADV. Advisers are not required to deliver brochures to advisory 
clients receiving only impersonal investment advice for which the 
adviser charges less than $500 per year. As proposed, we increased 
the dollar threshold triggering this exception from $200 to $500 to 
reflect the effects of inflation, based upon the Personal 
Consumption Expenditures Chain-Type Price Index, as published by the 
U.S. Department of Commerce, since rule 204-3 was adopted in 1979. 
We did not receive comments on this change.
    \190\ See rule 204-3(c)(1) and Instruction 1 for Part 2A of Form 
ADV.
    \191\ See supra note 190. As discussed above, an adviser's 
fiduciary duty of full and fair disclosure, however, may require it 
to continue to disclose any material legal event or precarious 
financial condition promptly to all clients, even clients to whom it 
may not be required to deliver a brochure or amended brochure. See 
supra note 106 and accompanying text.
    \192\ Two commenters urged us to adopt an exception for ``hedge 
funds,'' or clarify that advisers to hedge funds are not required to 
deliver copies of brochures to their investors. See ABA Committees 
Letter; Fried Frank Letter. We note that rule 204-3 requires only 
that brochures be delivered to ``clients.'' We further note that the 
Court of Appeals for the D.C. Circuit stated that the ``client'' of 
an investment adviser managing a hedge fund is the fund itself, not 
an investor in the fund. Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 
2006).
    \193\ See Instruction 7 for Part 2A of Form ADV.
---------------------------------------------------------------------------

    Annual Delivery. Advisers must annually provide to each client to 
whom they must deliver a brochure either: (i) A copy of the current 
(updated) brochure that includes or is accompanied by the summary of 
material changes; or (ii) a summary of material changes that includes 
an offer to provide a copy of the current brochure.\194\ As proposed, 
each adviser

[[Page 49247]]

must make this annual delivery no later than 120 days after the end of 
its fiscal year.\195\ Advisers may deliver a brochure and summary of 
material changes or summary of material changes, along with an offer to 
provide the brochure to clients electronically in accordance with the 
Commission's guidelines regarding electronic delivery of 
information.\196\ An adviser that does not include, and therefore file, 
its summary of material changes as part of its brochure (on the cover 
page or the page immediately following the cover) must file its summary 
as an exhibit, included with its brochure when it files its annual 
updating amendment with us, so that the summary of material changes is 
available to the public through IAPD.\197\
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    \194\ See rule 204-3(b) and Item 2 to Part 2A of Form ADV. The 
offer also must be accompanied by a Web site address and a telephone 
number and e-mail address for obtaining the complete brochure 
pursuant to the Instructions for Part 2, as well as the Web site 
address for obtaining information about the adviser through IAPD. We 
also are adopting an amendment to our recordkeeping rule that will 
require the adviser choosing this approach to preserve a copy of the 
summary of material changes, so that our examination staff has 
access to such separately provided summaries. See rule 204-
2(a)(14)(i). See Section IV below.
    If an adviser includes the summary of material changes in its 
brochure, and amends its brochure on an interim basis between annual 
updating amendments, the adviser should consider whether it should 
update its summary of material changes to avoid confusing or 
misleading clients reading the updated brochure.
    \195\ See Rule 204-3(b) and Instruction 2 for Part 2A of Form 
ADV. As discussed below, rule 204-1 requires an adviser registered 
with the Commission to annually revise its Form ADV, including its 
brochure, within 90 days of its fiscal year end. Advisers typically 
provide clients with reports quarterly, and the 120-day period is 
designed to provide sufficient flexibility to allow advisers to 
include the updated brochure or summary in a routine quarterly 
mailing to clients. We expect that permitting an adviser to send 
this document together with these routine mailings could 
substantially reduce delivery costs. See Section VII below.
    \196\ Use of Electronic Media by Broker-Dealers, Transfer 
Agents, and Investment Advisers for Delivery of Information, 
Investment Advisers Act Release No. 1562 (May 9, 1996) [61 FR 24644 
(May 15, 1996)] (``Electronic Media Release'').
    \197\ See Instruction 6 for Part 2A of Form ADV. The adviser 
must upload its brochure and the summary (as an exhibit) together in 
a single, text-searchable file in Adobe Portable Document Format 
(PDF) on IARD. See Instruction 6 for Part 2A of Form ADV.
---------------------------------------------------------------------------

    We proposed that each adviser annually deliver an updated brochure 
to its clients because we were concerned that clients may be relying on 
``stale'' brochures. Many commenters representing advisers objected, 
arguing that this requirement would cause advisers to incur significant 
costs,\198\ and that clients are not interested in receiving an annual 
brochure.\199\ We believe our revised approach--permitting advisers to 
deliver annually the summary of material changes, which was suggested 
by several commenters \200\--addresses our concern that clients may 
today be relying on ``stale'' brochures, while alleviating commenters' 
concerns regarding the costs and burdens of annual delivery of the 
brochure.\201\
---------------------------------------------------------------------------

    \198\ See AICPA Letter; Eddy Letter; FPA Letter; IAA Letter; ICI 
Letter; Mercer Letter; Merrill Lynch Letter; Morgan Stanley Letter; 
MMI Letter; NAPFA Letter; NRS Letter; Pickard Letter; ProEquities 
Letter; Roundtable Letter; Schwab Letter; SIFMA Letter; Sutherland 
Letter; USAA Letter; comment letter of Wachovia Securities LLC (May 
16, 2008) (``Wachovia Letter''); Wellington Letter, comment letter 
of Wall Street Financial Group (May 16, 2008) (``WSFG Letter'').
    \199\ See, e.g., ASG Letter; comment letter of Clifford Swan 
Investment Counsel (May 5, 2008) (``Clifford Letter''); First Allied 
Letter; FPA Letter; FSI Letter; comment letter of Moody Aldrich 
Partners (May 15, 2008) (``Moody Aldrich Letter''); NRS Letter; 
Roundtable Letter; WSFG Letter.
    \200\ See ASG Letter; Clifford Letter; Federated Letter; First 
Allied Letter; FPA Letter; FSI Letter; comment letter of the 
Investment Adviser Association (Aug. 26, 2008); Merrill Lynch 
Letter; Moody Aldrich Letter; NRS Letter; Roundtable Letter; Schnase 
Letter; WSFG Letter.
    \201\ One commenter representing consumers agreed that such an 
approach could minimize the costs of delivery without significantly 
sacrificing investor protection. See Consumer Federation Letter.
---------------------------------------------------------------------------

    Some commenters urged that we revise our electronic delivery 
guidance \202\ so that disclosure placed on the adviser's web page or 
on IARD would be deemed to be delivered to its clients, regardless of 
whether the clients have provided consent to electronic delivery.\203\ 
We note that an adviser's fiduciary duties may require it to obtain 
client consent to many of the disclosures required by Part 2 and that 
electronic access, without evidence that the adviser's delivery 
obligation has been met (such as by obtaining the client's consent to 
electronic delivery along with appropriate notice and access) would 
not, in our judgment, serve to adequately protect client 
interests.\204\
---------------------------------------------------------------------------

    \202\ See Electronic Media Release, see supra note 196.
    \203\ See, e.g., ABA Committees Letter; IAA Letter; Mercer 
Letter; Roundtable Letter; Sutherland Letter; Wachovia Letter.
    \204\ See Electronic Media Release, supra note 196 at Section 
II.A.3.
---------------------------------------------------------------------------

    Some commenters recommended that advisers be required to send 
clients a notice providing a Web site link to where the brochure is 
posted on the Internet, rather than having to deliver the actual 
brochure to clients initially.\205\ Another commenter objected, arguing 
that many investors are not yet willing to use the Internet to receive 
disclosure documents and that an approach that would rely on electronic 
delivery would be premature for retail investors.\206\ We are not 
making such changes at this time, but will continue to consider 
different approaches to delivering financial information to investors.
---------------------------------------------------------------------------

    \205\ See, e.g., ASG Letter; Borek Letter; FSI Letter; ICI 
Letter; Lininger Letter; Merrill Lynch Letter; MMI Letter; Morgan 
Stanley Letter; NAPFA Letter; Pickard Letter; SIFMA Letter; 
Wellington Letter.
    \206\ See Consumer Federation Letter.
---------------------------------------------------------------------------

    Interim Delivery. As proposed, rule 204-3 requires advisers to 
deliver an updated brochure (or a document describing the material 
facts relating to the amended disciplinary event) promptly whenever the 
adviser amends its brochure to add a disciplinary event or to change 
material information already disclosed in response to Item 9 of Part 
2A.\207\ One commenter opposed the interim updating requirement, 
expressing concern that it would result in ``frequent interim 
disclosure of information of minimal relevance to clients.'' \208\ We 
disagree. We believe that disclosure of disciplinary information is 
highly relevant to clients because it reflects on the integrity of the 
investment adviser, may affect a client's trust and confidence in the 
adviser, and may be of even greater interest if the adviser is adding 
disciplinary information frequently. Therefore, we are adopting this 
requirement as proposed.
---------------------------------------------------------------------------

    \207\ See rule 204-3(b)(4).
    \208\ See FSI Letter.
---------------------------------------------------------------------------

b. Updating Part 2A of Form ADV
    Similar to the existing requirements, the amended rules require 
advisers to keep the brochures they file with us current by updating 
them at least annually, and updating them promptly when any information 
in the brochures (except the summary of material changes and the amount 
of assets under management, which only has to be updated annually) 
becomes materially inaccurate.\209\ In the case of both annual and 
interim updates, advisers will make changes to their brochures using 
their own computer systems and then simply file the revised versions of 
their brochures through IARD.\210\
---------------------------------------------------------------------------

    \209\ If an adviser is amending its brochure for a separate 
reason between annual amendments, and the amount of assets under 
management is materially inaccurate, the adviser should amend this 
disclosure. See Instruction 4 for Part 2A of Form ADV.
    \210\ See rule 204-1(b).
---------------------------------------------------------------------------

    In some cases, an adviser filing its annual updating amendment may 
not have any material changes to make to its brochure. If the adviser 
has not filed any interim amendments to its brochure since the last 
annual amendment and the brochure continues to be accurate in all 
material respects, the adviser would not have to prepare or deliver a 
summary of material changes to clients. The adviser also would not have 
to prepare and file an updated firm brochure as part of its annual 
updating amendment. If there was an interim amendment or the brochure 
contained a material inaccuracy, however, the adviser would have to 
file a summary of material changes describing any interim amendment(s) 
along with an updated firm brochure as part of its annual

[[Page 49248]]

amendment filing. Although previously filed versions of an adviser's 
brochures will remain in the IARD system, only the most recent version 
of an adviser's brochure will be available to the public through the 
Commission's Web site.\211\ The purpose of the public disclosure Web 
site is to provide the public with current information about advisers, 
rather than historic information.\212\
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    \211\ In the case of an adviser that prepares, files and 
delivers to clients separate brochures for the various different 
advisory services it offers, the most recent version of each of its 
brochures will be available via the public disclosure Web site.
    \212\ Instructions for obtaining historic brochure filings may 
be found at http://www.sec.gov/answers/publicdocs.htm.
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B. Part 2B: The Brochure Supplement

    Rule 204-3 also requires that each firm brochure be accompanied by 
brochure supplements providing information about the advisory personnel 
on whom the particular client receiving the brochure relies for 
investment advice.\213\ Among other things, the brochure supplements 
will contain information about the educational background, business 
experience, and disciplinary history (if any) of the supervised persons 
who provide advisory services to the client. The brochure supplement 
thus includes information that would not necessarily be included in the 
firm brochure about supervised persons of the adviser who actually 
provide the investment advice and interact with the client.
---------------------------------------------------------------------------

    \213\ See rule 204-3(b)(3). We believe that brochure supplements 
will be important to advisory clients in selecting an adviser 
because clients place great weight on the supervised person's 
qualifications and events that may reflect on the integrity of 
advisory personnel. See Proposing Release, supra note 8, at Section 
II.B.1.
---------------------------------------------------------------------------

    Several commenters supported the brochure supplement 
requirement.\214\ One stated that the brochure supplement's ``greater 
personal relevance to investors will make [it] among the most widely 
read of the disclosure documents they receive, particularly if they 
receive it in a timely fashion.'' \215\ Another stated that the 
brochure items addressed areas of interest to clients and stated that 
``information on the qualifications and background of those who 
influence clients in connection with their investments are as relevant, 
if not more relevant, than the information currently required by Part 2 
on senior executives of the firm that may have little or no direct 
contact with the client.'' \216\
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    \214\ See ASG Letter; Consumer Federation Letter; CFA Institute 
Letter; FPA Letter; IAA Letter; Lininger Letter; NASAA Letter.
    \215\ Consumer Federation Letter.
    \216\ CFA Institute Letter.
---------------------------------------------------------------------------

    Several advisers that also are registered as broker-dealers, 
however, urged that we not require a brochure supplement, arguing that 
the brochure supplement would prove excessively costly, that at least 
some of the information is available on the Financial Industry 
Regulatory Authority's (FINRA) web-based BrokerCheck system,\217\ and 
that information not available through BrokerCheck (such as the 
``Educational Background,'' ``Other Business Activities,'' ``Additional 
Compensation,'' and ``Supervision'' sections) is either not important 
to clients or could be covered by general disclosure in the firm 
brochure about the firm's policies and procedures.\218\ We disagree. We 
believe that the additional information required by the supplement will 
be important to many clients and, particularly for large advisers, 
cannot be sufficiently described by firm policies and procedures. For 
large advisers, such policies will by necessity tend to be general 
because they must cover a large number of supervised persons with a 
range of ancillary activities and conflicts. For example, we do not 
believe that a prospective client would find it particularly helpful to 
read in the firm brochure that all of the adviser's associated persons 
had earned a college degree. Or that some of their associated persons 
had additional business activities that may involve conflicts of 
interest. Disclosure of such generalized information about the firm's 
associated persons is unlikely to be meaningful to clients seeking to 
understand the background, particular conflicts and outside business 
activities of the individual providing investment advice to them.
---------------------------------------------------------------------------

    \217\ Another commenter argued against reliance on BrokerCheck. 
See Consumer Federation Letter.
    \218\ See, e.g., CGMI Letter; Merrill Lynch Letter; Morgan 
Stanley Letter; Schwab Letter; SIFMA Letter. BrokerCheck, which is 
designed to help investors check the professional background of 
current and former FINRA-registered securities firms and brokers, is 
available at http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/index.htm. The following commenters argued that we 
should not require the brochure supplement because it would provide 
little new or useful information but would create significant costs 
and burdens. See, e.g., NAPFA Letter; Pickard Letter; Roundtable 
Letter; USAA Letter; comment letter of John H. Vineyard (Mar. 18, 
2008) (``Vineyard Letter''). For the reasons discussed in the text, 
we disagree.
---------------------------------------------------------------------------

    Commenters have, however, persuaded us to permit advisers to make 
use of BrokerCheck as well as the IAPD system to disclose disciplinary 
information available on those systems when the client has received a 
brochure supplement electronically.\219\ The instructions for Part 2B 
of Form ADV provide that the adviser may disclose in a supplement 
delivered electronically that the supervised person has a disciplinary 
event and provide a hyperlink to either the BrokerCheck or the IAPD 
systems.\220\ We believe that this accommodation addresses commenters' 
concerns regarding duplication of disclosure requirements, while 
meeting our objective of providing advisory clients with convenient 
access to information necessary to assess the individuals they are 
relying on for investment advice.\221\ In addition to this 
accommodation, we have made several other changes to the proposed 
brochure supplement requirements in response to comments, which we 
discuss below.
---------------------------------------------------------------------------

    \219\ IAPD was recently enhanced to allow investors to obtain 
disciplinary history of supervised persons. See http://www.nasaa.org/NASAA_Newsroom/Current_NASAA_Headlines/12811.cfm 
for a press release announcing the launch of an enhancement to IAPD 
to allow users to search for individuals.
    \220\ See Instruction 3 for Part 2B of Form ADV.
    \221\ We also believe that this approach addresses the concern 
expressed by one commenter that reliance on BrokerCheck would hurt 
those investors who are least sophisticated and therefore are most 
likely to need this information, but who are the very ones that are 
least likely to seek it out. See Consumer Federation Letter.
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1. Format
    As proposed, the amendments require advisers to write their 
supplements in plain English, but offer an adviser flexibility in 
presenting information in a format that is best suited to the advisory 
firm. This flexibility is designed to reduce the cost of preparing and 
delivering supplements. Advisers may include supplement information 
within the firm's brochure, an approach that may be attractive to 
smaller firms with few persons for whom they will be required to 
prepare supplements.\222\ Advisers may elect to prepare a supplement 
for each supervised person. Alternatively, they can prepare separate 
supplements for different groups of supervised persons (e.g., all 
supervised persons in a particular office or work group). To promote 
comparability of brochure supplements, we are requiring that a brochure 
supplement must be organized in the same order, and contain the same 
headings, as the items appear in the form, whether provided in a 
brochure or separately.\223\
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    \222\ IARD data as of May 3, 2010 indicate that 81% of advisers 
registered with us have 10 or fewer employees performing investment 
advisory functions on their behalf. Over 65% have five or fewer 
employees performing advisory functions.
    \223\ If provided in a brochure, supplements must be included at 
the end of the brochure and be sequenced for each supervised person. 
See Instruction 1 of General Instructions for Part 2 of Form ADV and 
Instruction 6 for Part 2B of Form ADV.

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[[Page 49249]]

2. Supplement Items
    Part 2B, as we proposed and as we are adopting it today, consists 
of six items. Many commenters who addressed the specific proposed items 
supported the content of the brochure supplements generally.\224\ 
Others offered specific comments on certain items; we address these 
comments below.
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    \224\ See, e.g., CFA Institute Letter, CFP Board Letter; FPA 
Letter.
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    Item 1. Cover Page. Each supplement's cover page must include 
information identifying the supervised person (or persons) covered by 
the supplement as well as the advisory firm. One commenter stated that 
the brochure supplement should not require a separate cover page.\225\ 
We intended Item 1 of the brochure supplement to require that the 
information specified in the item be included on the front page of the 
supplement, not that this be the only information on a cover page. We 
have modified Item 1 accordingly to clarify that the information 
required by the item may be presented either on a separate cover page 
or at the top of the first page of the brochure supplement.
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    \225\ See ASG Letter.
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    Item 2. Educational Background and Business Experience. Item 2 
requires the supplement to describe the supervised person's formal 
education and his or her business background for the past five 
years.\226\ If the supervised person either has no high school 
education, no formal education after high school, or no business 
background, the adviser must disclose this fact in the supplement. The 
business background section must identify the supervised person's 
positions at prior employers and not merely list the names of prior 
employers.\227\
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    \226\ Previously, Item 6 of Part 2 of Form ADV required this 
information about the adviser's principal executive officers and 
about individuals who determine general investment advice on behalf 
of the adviser.
    \227\ For example, clients may be interested in knowing that a 
supervised person was previously employed as an analyst at a hedge 
fund as opposed to being employed as a computer support specialist 
at a hedge fund.
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    Advisers may include information about professional designations in 
the supplement if they so choose. One commenter urged the Commission to 
require the listing of any professional designations held as long as 
the designations conform to the North American Securities 
Administrators Association (NASAA) model rules and state regulations 
that prohibit the misleading use of designations or 
certifications.\228\ A few other commenters encouraged the Commission 
to require disclosure about the minimum qualifications required for any 
disclosed professional designation.\229\ We are not electing to require 
a listing of professional designations as we do not require, nor do we 
endorse, any designations. We are concerned that the Commission 
requiring such disclosure could cause clients to mistakenly believe 
that we do endorse designations. We do believe, however, that some 
clients may be interested in learning of professional designations held 
by the individuals providing them with investment advice. However, we 
do not believe that such disclosure is meaningful without an 
explanation of the minimum qualifications required to obtain the 
designation. Accordingly, we are adding a requirement that if 
professional designations are disclosed in the supplement, the 
supplement must also provide a sufficient explanation of the minimum 
qualifications required for the designation to allow clients and 
potential clients to understand the value of the designation. The 
disclosure, of course, also cannot be materially false or misleading by 
suggesting, for example, that the designation implies more 
qualifications or experience than the actual designation standards 
require.\230\
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    \228\ See CFP Board Letter.
    \229\ See ASG Letter; First Allied Letter; NASAA Letter. But see 
Vineyard Letter (stating that the supplement should not allow 
descriptions of professional designations since such disclosure 
could imply that the Commission advocated obtaining the particular 
designation).
    \230\ We note that our staff and other securities regulators 
have warned that investors may be confused by some professional 
designations, such as those that imply expertise in providing 
services to seniors. See Protecting Senior Investors: Report of 
Securities Firms Providing ``Free Lunch'' Sales Seminars, Joint 
Report by the Staff of the Commission's Office of Compliance 
Inspections and Examinations, NASAA, and FINRA (available at 
http:[sol][sol]www.sec.gov/spotlight/seniors/freelunchreport.pdf); 
Staff Update, ``Senior'' Specialists and Advisors: What You Should 
Know About Professional Designations (available at 
http:[sol][sol]www.sec.gov/investor/pubs/senior-profdes.htm). While 
we acknowledge that a number of well-regarded professional 
designations and attainments exist, the required credentials, 
training, and experience associated with different designations vary 
widely. FINRA has established and maintains a database of 
designations used across the financial services industry that 
contains basic information about the designation, such as the 
issuing organization, prerequisites, and educational requirements. 
http:[sol][sol]apps.finra.org/DataDirectory/1/prodesignations.aspx.
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    Item 3. Disciplinary Information. Item 3 requires disclosure of any 
legal or disciplinary event that is material to a client's evaluation 
of the supervised person's integrity. It includes certain disciplinary 
events that the Commission presumes are material to such an evaluation 
if they occurred during the last 10 years.\231\ Several commenters 
supported this requirement, and stated that such information would be 
of great interest to clients.\232\
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    \231\ This list parallels the list of legal and disciplinary 
events in Item 9 of Part 2A that must be disclosed in the firm 
brochure and which are derived from the prior disclosure 
requirements set out in rule 206(4)-4. The list also is 
substantially similar to the list of disciplinary events advisers 
and their advisory affiliates are already required to disclose in 
response to Item 11 of Form ADV, Part 1A.
    As under Item 9 of Part 2A, Item 3 of Part 2B permits an adviser 
to rebut the presumption with respect to a particular event, in 
which case no disclosure to clients about the event will be 
required. We require an adviser rebutting a presumption of 
materiality to document that determination in a memorandum and 
retain that record in order to better permit our staff to monitor 
compliance with this important disclosure requirement. As under Item 
9 of Part 2A, a note in Item 3 explains four factors the adviser 
should consider when assessing whether the presumption can be 
rebutted.
    \232\ See CFA Institute Letter; CFP Board Letter; Consumer 
Federation Letter; FPA Letter; NASAA Letter.
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    As proposed, Item 3 of the supplement would have required 
disclosure of any event for which the supervised person had ever 
resigned or otherwise relinquished a professional attainment, 
designation or license in anticipation of it being suspended or revoked 
(other than for suspensions or revocations for failure to pay 
membership dues). Two commenters recommended that we not require this 
particular disclosure, stating that an adviser would not know a 
supervised person's reason for relinquishing a designation or 
license.\233\ We recognize that an adviser may not always know why a 
supervised person is relinquishing a designation or license. We are 
modifying this requirement to clarify that this disclosure need only be 
made if the adviser knew or should have known that the supervised 
person relinquished his or her designation or license.
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    \233\ See First Allied Letter; IAA Letter.
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    As discussed above, we are modifying Item 3 to permit advisers that 
send supplements electronically to clients to include hyperlinks to 
disciplinary information available through the FINRA BrokerCheck system 
as well as the IAPD system. A number of supervised persons of 
investment advisers also are registered representatives of a broker-
dealer firm or are subject to state investment adviser reporting 
requirements and thus may have disciplinary disclosure available 
through BrokerCheck or IAPD. Permitting advisers to hyperlink to these 
systems may minimize the costs of brochure supplements by leveraging

[[Page 49250]]

existing infrastructure established by broker-dealer and adviser 
regulation. To take advantage of this provision, the brochure 
supplement must be delivered electronically and must include: (i) A 
statement that the supervised person has a disciplinary history, the 
details of which can be found on BrokerCheck or the IAPD (as the case 
may be); and (ii) a hyperlink to the relevant system with a brief 
explanation of how the client can access the disciplinary history.
    Two commenters recommended that the Commission reconcile the 
disclosure requirements in Item 3 of the brochure supplement with Item 
14 of Form U4, the uniform form used by broker-dealer and state 
investment advisory representatives to register (which includes certain 
disciplinary disclosure and is the source of such information that is 
available on BrokerCheck), stating that a lack of uniformity would 
complicate compliance.\234\ We may consider in the future whether the 
disclosure requirements in Item 3 and in Form U4 should be conformed, 
as we recognize the substantial overlap between these disclosure items. 
We note, however, that although the disclosure requirements are not 
phrased identically, any disclosure required by the brochure supplement 
would also have to be disclosed on Form U4.
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    \234\ See ICI Letter; NASAA Letter.
---------------------------------------------------------------------------

    Item 4. Other Business Activities. Item 4 requires an adviser to 
describe other business activities of its supervised persons. The item 
specifically requires disclosure with respect to other capacities in 
which the supervised person participates in any investment-related 
business and any material conflicts of interest such participation may 
create.\235\ In addition, the item requires the supplement to include 
information about any compensation, including bonuses and non-cash 
compensation, the supervised person receives based on the sales of 
securities or other investment products, as well as an explanation of 
the incentives this type of compensation creates.\236\ We are adopting 
this item substantially as proposed. We believe that disclosure of any 
such compensation is important because it creates an incentive for the 
supervised person to base investment recommendations on his or her own 
compensation rather than on clients' best interests.
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    \235\ See Item 4.A of Part 2B.
    \236\ See Item 4.A.2 of Part 2B.
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    We also are adopting a requirement to disclose other business 
activities or occupations that the supervised person engages in if they 
involve a substantial amount of time or pay.\237\ Clients may have 
different expectations of an individual whose sole business is 
providing investment advice than of an individual who is engaged in 
other substantial business activities. Several commenters supported 
inclusion of this item.\238\ A few commenters urged that we not require 
disclosure of this information,\239\ with one commenter arguing that 
such information is irrelevant to the adviser's competence in providing 
investment advice,\240\ and another stating that such a requirement 
would be burdensome.\241\ We are retaining this requirement because we 
believe that investors will find this information helpful in assessing 
the conflicts created by those activities.
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    \237\ See Item 4.B of Part 2B.
    \238\ See, e.g., Berlin Letter; CFA Institute Letter; CFP Board 
Letter; NASAA Letter. The NASAA Letter urged disclosure of all 
outside business activities regardless of whether they occupied a 
substantial amount of that person's time or income.
    \239\ See IAA Letter; ProEquities Letter; Vineyard Letter.
    \240\ See IAA Letter.
    \241\ See ProEquities Letter.
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    Finally, some commenters stated that the Commission should define 
``substantial sources of income'' and ``substantial amount of time'' by 
reference to specific percentages or in some other manner.\242\ We 
believe that what amounts to ``substantial'' in many cases depends on 
particular facts and circumstances, and thus we are not establishing 
any specific definition of what is and is not substantial. However, we 
do understand the concern that there is likely some level at which a 
source of income or amount of time would rarely interfere or conflict 
with an adviser's business of providing investment advice. Accordingly, 
we are allowing advisers to make a presumption that if the other 
business activities represent less than 10 percent of the supervised 
person's time and income, they are not substantial.\243\
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    \242\ See Case Letter; FSI Letter; ProEquities Letter; TAG 
Letter.
    \243\ See Item 4.B of Part 2B.
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    Item 5. Additional Compensation. This item requires that the 
supplement describe arrangements in which someone other than a client 
gives the supervised person an economic benefit (such as a sales award 
or other prize) for providing advisory services.\244\
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    \244\ Bonuses based (in part or whole) on sales, client 
referrals or new accounts trigger required disclosure, but other 
bonuses do not. Regular salaries need not be disclosed.
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    Two commenters suggested that we not require this disclosure, with 
one of these commenters stating that disclosure of any conflicts 
arising out of such compensation arrangements is already required by an 
adviser's fiduciary duty and that firms should be free to make such 
disclosure in the firm's brochure or investment advisory contract, 
rather than in the brochure supplement.\245\ We are adopting Item 5 as 
proposed. We believe clients need to know if their individual adviser 
has these arrangements in order to assess the advisory services of that 
particular supervised person and that general disclosure of this 
conflict in a firm-wide brochure or advisory contract is not an 
adequate substitute. As we stated above, general disclosure of this 
type of conflict in many firm-wide brochures or advisory contracts will 
by necessity tend to be general because it must cover a variety of 
supervised persons with a range of compensation arrangements. Such 
general disclosure is unlikely to be meaningful to clients seeking to 
understand the particular compensation arrangements and associated 
conflicts of the individual providing investment advice to them.
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    \245\ See Morgan Stanley Letter; Schwab Letter. Morgan Stanley 
made the comment regarding fiduciary duties.
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    Item 6. Supervision. This item requires an adviser to explain how 
the firm monitors the advice provided by the supervised person 
addressed in the brochure supplement. It also requires a firm to 
provide the client with the name, title, and telephone number of the 
person responsible for supervising the advisory activities of the 
supervised person.
    We are adopting Item 6 as proposed. One commenter supported this 
requirement, stating that it is important for clients to have the 
ability to locate a person within a firm to whom they can direct 
questions or voice concerns about their accounts.\246\ Some commenters 
recommended that the Commission not require this item, asserting that 
investors would not be interested in this information and that this 
requirement would not make sense for smaller advisory firms.\247\ We 
believe that it is important for clients to be able to contact an 
appropriate person at an advisory firm, regardless of the firm's size, 
if they have any questions or complaints about the handling of their 
account. This will allow clients to determine appropriate redress for 
their complaints without having to go through the particular supervised 
person that is the focus of the complaint. Therefore, we are requiring 
this disclosure.
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    \246\ See CFA Institute Letter.
    \247\ See FPA Letter; FSI Letter; IAA Letter; Sutherland Letter.
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    Several commenters requested that the Commission permit advisers to

[[Page 49251]]

furnish clients with a general contact number and email address instead 
of the name and contact information for the supervisor because 
supervisory personnel may change frequently, triggering the need for 
updated supplements, and because some supervised persons have multiple 
supervisors.\248\ We do not agree with commenters' suggestion and are 
adopting this requirement as proposed. We believe that providing the 
name and telephone number of a specific individual responsible for 
supervising the representative's advisory activities will ensure that 
the client has ready access to the supervisor if the client has any 
complaints or concerns. In the unlikely event that a supervised person 
has more than one direct supervisor of his or her advisory services, 
the adviser may identify any one of those supervisors as long as that 
supervisor has the authority to respond to the client's question or 
complaint (or can raise the issue to a higher-level supervisor, if 
appropriate).
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    \248\ See FPA Letter; FSI Letter; Roundtable Letter; USAA 
Letter; Wachovia Letter.
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3. Delivery and Updating
a. Delivery
    We are requiring as proposed that a client be given a brochure 
supplement for each supervised person who: (i) Formulates investment 
advice for that client and has direct client contact; or (ii) makes 
discretionary investment decisions for that client's assets, even if 
the supervised person has no direct client contact. We believe that 
clients are most interested in learning about the background and 
experience of these individuals from whom they receive investment 
advice.
    In the Proposing Release, we stated that an adviser would not, 
however, have to provide a supplement for a supervised person who 
provides discretionary advice only as part of a team and has no direct 
client contact.\249\ We explained our view that, when investment advice 
is formulated by a team, specific information about each individual 
team member takes on less importance. A few commenters stated that all 
representatives providing advice as part of a team will likely have 
direct client contact from time to time, and thus that the Commission's 
proposed exemption from the brochure supplement delivery requirement 
for supervised persons that provide advice as part of a team and that 
have no direct client contact, in fact, would not exempt any team 
members from this requirement as a practical matter, despite the 
limited utility of disclosure about each supervised person comprising a 
large advisory team.\250\ We agree with commenters that volumes of 
disclosure about a large group of supervised persons likely would not 
be meaningful to investors. Accordingly, we are modifying this 
requirement, as suggested by one commenter,\251\ based on the approach 
to disclosure under the Company Act where a team of individuals is 
jointly and primarily responsible for the day-to-day management of a 
mutual fund's portfolio.\252\ If investment advice is provided by a 
team comprised of more than five supervised persons, brochure 
supplements need only be provided for the five supervised persons with 
the most significant responsibility for the day-to-day advice provided 
to the client.\253\
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    \249\ See Proposing Release, supra note 8, at n.164.
    \250\ See, e.g., Federated Letter; ICI Letter; NAPFA Letter.
    \251\ See ICI Letter.
    \252\ See Instruction 2 for Item 5(b) of Form N-1A.
    \253\ See rule 204-3(b)(3).
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    Another commenter urged the Commission to exempt from the brochure 
supplement requirement any supervised persons providing non-
discretionary advice (even if not part of a team).\254\ A commenter 
representing investors strongly opposed this recommendation, arguing 
that investors do not differentiate the advice they receive on this 
basis.\255\ We believe that, where a supervised person is providing 
investment advice directly to a client, disclosure relating to the 
background and integrity of that person would be important to a client. 
It assists the client in evaluating the value of that investment 
advice, an evaluation we believe clients make regardless of whether the 
advice is non-discretionary.\256\
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    \254\ See SIFMA Letter.
    \255\ See Consumer Federation Letter.
    \256\ We note that an adviser's fiduciary duties to its clients 
under the Advisers Act do not turn on whether its advice is provided 
on a discretionary or non-discretionary basis.
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    An adviser generally must provide its clients with a brochure 
supplement for each supervised person who provides the advisory 
services as described above. However, advisers are not required to 
deliver supplements to three types of clients: (i) Clients to whom an 
adviser is not required to deliver a firm brochure (e.g., registered 
investment companies and business development companies); (ii) clients 
who receive only impersonal investment advice; \257\ and (iii) certain 
``qualified clients'' who also are officers, directors, employees and 
other persons related to the adviser.\258\ An adviser that does not 
have any clients to whom a supplement will have to be delivered will 
not have to prepare any supplements.\259\ Similarly, an adviser will 
not have to prepare a supplement for any supervised person who does not 
have clients to whom the adviser must deliver a supplement.
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    \257\ This exception from the supplement delivery requirement 
differs slightly from the exception from the brochure delivery 
requirement, in that it does not depend on the cost of the 
impersonal advisory services involved. This is because in situations 
involving impersonal advisory services, the nature of the services 
are such that supervised persons of the adviser are unlikely to be 
directly providing advisory services to clients. As a result, we 
believe that in such situations requiring supplement delivery will 
result in an unnecessary expense with little appreciable benefit. We 
believe, however, that delivery of a firm brochure will be useful 
where the cost of the impersonal advisory services is significant, 
that is $500 or above.
    \258\ Rule 205-3(d)(1)(iii) also defines certain related persons 
of an adviser as ``qualified clients,'' including: (i) Any executive 
officers, directors, trustees, general partners, or persons serving 
in a similar capacity, of the advisory firm; or (ii) any employees 
of the advisory firm (other than employees performing solely 
clerical, secretarial or administrative functions) who, in 
connection with their regular functions or duties, participate in 
the investment activities of the firm and have been performing such 
functions or duties for at least 12 months.
    \259\ See note to rule 203-1(a) and (b); Instruction 1 for Part 
2B of Form ADV.
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    We proposed exempting advisers from delivering the brochure 
supplement to certain sophisticated clients,\260\ and received several 
comments from those representing advisers supporting the exemption or 
urging its expansion.\261\ The brochure supplement is intended to 
contain fundamental information about the qualifications of persons 
providing investment advice. Sophisticated clients are likely to 
request this type of information, even if not affirmatively provided by 
an investment adviser. Given that advisers will be preparing and 
delivering brochure supplements anyway, we believe the incremental 
burden of meeting the rule's obligations with respect to these 
sophisticated clients will be minimal and would not justify an 
exemption. We are therefore requiring that advisers deliver brochure 
supplements to all clients other than, as described above: (i) Those 
clients to whom the adviser is not required to deliver a firm brochure; 
(ii) clients who receive only impersonal investment advice; and (iii) 
certain ``qualified clients'' who also are officers, directors, 
employees and other persons related to the adviser.
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    \260\ See Proposing Release at Section II.B.1.
    \261\ See, e.g., IAA Letter; ICI Letter; Pickard Letter; T. Rowe 
Letter.
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    The supervised person's supplement initially must be given to each 
client at or before the time when that specific supervised person 
begins to provide advisory services to that specific

[[Page 49252]]

client.\262\ A few commenters argued that a large adviser with 
thousands of supervised persons may have staff changes on any given day 
and suggested that delivery be permitted promptly after the time the 
supervised person begins providing advisory services to the 
client.\263\ But the brochure supplement is intended to assist 
investors in determining whether to retain the services of a particular 
adviser and in evaluating the individual advice they are receiving. 
This function could not be fully served if a client did not receive the 
supplement until after the supervised person already had begun 
providing advice to the client. As a result, we are adopting this 
delivery requirement as proposed.
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    \262\ See rule 204-3(b)(3) and Instruction 3 for Part 2B of Form 
ADV.
    \263\ See IAA Letter; ICI Letter.
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b. Updating
    We are adopting as proposed, the requirement that advisers deliver 
an updated supplement to clients only when there is new disclosure of a 
disciplinary event, or a material change to disciplinary information 
already disclosed, in response to Item 3 of Part 2B.\264\ Because the 
final rule allows advisers to reference BrokerCheck or IAPD for 
disclosure of a supervised person's disciplinary information when the 
supplement is delivered electronically, if the supplement refers to 
BrokerCheck or IAPD a change in disclosure required by Part 2B would 
require the adviser to electronically deliver an updated supplement (or 
sticker) to clients when BrokerCheck or IAPD has been updated with new 
disclosure of a disciplinary event, or a material change to 
disciplinary information already disclosed, with the updated supplement 
(or sticker) indicating that the disciplinary information for the 
supervised person has changed and providing a hyperlink to BrokerCheck 
or IAPD. We believe this information is critical for clients because it 
reflects upon the supervised person's integrity and may affect a 
client's trust and confidence in that person and the adviser that 
employs the supervised person.
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    \264\ See rule 204-3(b)(4). We note that an adviser's fiduciary 
duty may require it to inform a client of material changes to 
disclosures in the supplement even if rule 204-3 does not require 
delivery of an updated supplement to clients.
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    As with the brochure, advisers must amend a brochure supplement 
promptly if information in it becomes materially inaccurate.\265\ Any 
new clients to whom the adviser is obligated to deliver a supplement 
under our amended rule must be given an amended supplement (or the 
``old'' supplement and a sticker). Supplements, like brochures, may be 
delivered on paper or electronically.\266\ Because we believe most 
information in the supplement is unlikely to become materially 
inaccurate over time, advisers are not required to deliver supplements 
to existing clients annually. These requirements have not been modified 
from the proposal.
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    \265\ See Instruction 4 for Part 2B of Form ADV.
    \266\ See Instruction 5 for Part 2B of Form ADV.
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C. Filing Requirements, Public Availability

    The Commission is amending rule 204-1 to require advisers to file 
their new brochures with us electronically through the IARD 
system.\267\ Advisers are not required to file brochure supplements or 
supplement amendments with the Commission, and they will not be 
available on the Commission's public website.\268\Advisers are required 
to maintain copies of all supplements and amendments in their 
files.\269\
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    \267\ Rule 204-1 had required advisers to file only ``Part 1A of 
Form ADV'' electronically. We are amending it to require Part 1A and 
Part 2A of Form ADV to be filed electronically.
    \268\ See rules 203-1(a) and 204-1(b) and Instruction 9 for Part 
2B of Form ADV. Because brochure supplements would not be filed with 
us, they would not be deemed filed and would not be required as part 
of any state notice filing. Section 307(a) of the National 
Securities Market Improvement Act of 1996, Public Law 104-290, 110 
Stat. 3416 (1996) (state securities authorities may only require 
SEC-registered advisers to file with the states copies of those 
documents advisers have filed with the Commission).
    \269\ See rule 204-2(a)(14)(i) and Instruction 9 for Part 2B of 
Form ADV.
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    The IARD will accept brochure filings using the text-searchable 
Adobe Portable Document Format (``PDF'').\270\ The IARD provides 
advisers with online access to the Part 2A Items and instructions. 
Instead of completing Part 2A online, advisers will create their 
brochure on their own computers, convert it to a PDF, and then attach 
the completed document to their filing on IARD, much like attaching a 
document to an e-mail. To update brochures, advisers will make the 
necessary changes to the source file on their own computers and then 
attach the revised versions to their IARD filing. The IARD will not 
accept an annual updating amendment without an updated brochure, a 
representation by that adviser that the brochure on file does not 
contain any materially inaccurate information, or a representation that 
the adviser does not have to prepare a brochure because it does not 
have to deliver it to any clients (e.g., the adviser's clients are 
limited to registered investment companies). The IARD also will not 
accept an annual updating amendment without a representation that the 
summary of material changes is attached as an exhibit to or included in 
the updated brochure or a representation that no summary of material 
changes is required because there have been no material changes to the 
adviser's brochure since its last annual updating amendment.\271\ If an 
adviser using multiple brochures discontinues using a particular 
brochure, the IARD system will permit the adviser to eliminate that 
brochure from its current filing.\272\
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    \270\ FINRA will assist investment advisers with converting 
brochures into a text-searchable PDF format using software available 
to the adviser or, if necessary, providing the adviser with PDF 
conversion software.
    \271\ If the adviser's summary of material changes is a separate 
document, the adviser must attach the summary as an exhibit to its 
brochure and upload the brochure and the summary in one single, 
text-searchable, PDF file on IARD.
    \272\ Similarly, if an adviser is no longer required to prepare 
a brochure for delivery, the IARD system will permit the adviser to 
eliminate that brochure from its current filing.
---------------------------------------------------------------------------

    Most commenters addressing electronic filing supported the new 
filing requirement and public availability of the brochures.\273\ Some, 
however, expressed concern that public disclosure of advisers' 
brochures through IAPD could reveal proprietary and confidential 
business information to competitors.\274\ We have reviewed our 
requirements and do not believe that they would require disclosure of 
proprietary or confidential business information. Indeed, the 
information that would be disclosed is very similar to that which we 
have long required to be disclosed by advisers in their brochures and 
which until 2000 was filed in paper with the Commission and publicly 
available.\275\ We believe that there is a substantial public interest 
in having this information readily available to prospective clients, 
which may assist them in their search for an investment adviser. In 
addition, we believe that public disclosure will have a beneficial 
effect on business practices by, for example, discouraging advisers

[[Page 49253]]

from engaging in certain practices because those practices would have 
to be publicly disclosed.
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    \273\ See CGMI Letter; Fried Frank Letter; CFA Institute Letter; 
Katten Letter; NAPFA Letter; NASAA Letter; NRS Letter; NSCP Letter; 
Sidley Letter.
    \274\ See comment letter of Brown & Brown Financial Services, 
Inc. (Mar. 27, 2008) (``Brown Letter''), comment letter of Executive 
Advisers, Inc. (May 14, 2008); comment letter of Larry Laws and 
Associates, Inc. (May 14, 2008); comment letter of James E. Wernli 
(May 20, 2008) (``Wernli Letter'').
    \275\ Until 2000, our rules required advisers to file both Part 
I and Part 2 of Form ADV with us and it was available in our public 
reference room. See Section I.C.2 of Electronic Filing by Investment 
Advisers; Amendments to Form ADV, Investment Advisers Act Release 
No. 1897 (Sept. 12, 2000) [65 FR 57438 (Sept. 22, 2000)].
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    Other commenters expressed concern that a fund adviser's required 
public disclosure of Part 2 through IAPD could jeopardize the reliance 
of any private funds that it advised on the private offering exemption 
in the Securities Act of 1933 and the safe harbor for offshore 
transactions from the registration provisions in Section 5 of that 
statute.\276\ We believe registrants can provide information required 
by Part 2 without jeopardizing reliance on those exemptions. The 
inclusion of private fund information beyond that required in Part 2, 
however, such as subscription instructions, performance information, 
and financial statements, may jeopardize such reliance by constituting 
a public offering or conditioning the market for the securities issued 
by those funds.
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    \276\ 15 U.S.C. 77e. Some expressed specific concern that the 
public disclosure may be deemed to violate the prohibition on 
``general solicitation'' and ``general advertising'' that applies to 
private offerings conducted in accordance with Rule 506 of 
Regulation D. See AICA Letter; AIMA Letter; Fried Frank Letter; 
Janus Letter; NSCP Letter. One mentioned that the public disclosure 
could raise questions as to whether there are ``directed selling 
efforts'' in the United States, which would be inconsistent with the 
rules applicable to offshore offerings under Regulation S under the 
Securities Act. See Sidley Letter.
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D. Transition to New Requirements

    As discussed below in the discussion of compliance and effective 
dates,\277\ we are adopting transition requirements that, as proposed, 
provide advisers with at least six months to comply with the amended 
rules and forms.\278\ While a few commenters asked for more time to 
prepare the brochures and brochure supplements,\279\ we believe the 
proposed transition period is sufficient. Advisers that are currently 
registered with us will have at least 8 months (from the end of July 
2010 through the end of March 2011) to prepare and file narrative 
brochures as a result of the compliance dates discussed below. We also 
note that we have changed the period by which firms must deliver the 
new brochure and brochure supplements to their existing clients after 
this electronic filing compliance date from 30 days to 60 days to make 
sure that advisers have enough time to comply with the 
requirement.\280\
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    \277\ See Section V of this Release.
    \278\ Rule 204-1(c). We proposed a transition schedule requiring 
advisers to comply with the new Part 2 requirements by the date they 
must make their next annual updating amendment to Form ADV following 
six months after the date the revised form becomes effective.
    \279\ See AICPA Letter; First Allied Letter; NAPFA Letter; T. 
Rowe Letter.
    \280\ Two commenters suggested a rolling transition over several 
months to avoid an inordinate demand on outside consulting and legal 
services by many advisers at the same time. See Fried Frank Letter; 
NAPFA Letter. We believe that the transition period we have provided 
to comply with the new Part 2 requirement permits advisers to work 
with their service providers in advance of the date their filings 
are required.
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III. Amendments to Form ADV Instructions and Glossary

    Together with the Part 2 amendments, we also are making conforming 
amendments to the General Instructions and the Glossary of Terms for 
Form ADV. We are amending the General Instructions to Form ADV to 
include instructions regarding brochure filing requirements. Similarly, 
we are amending the Glossary of Terms to add the following five terms 
that are used in Part 2: (i) ``brochure;'' \281\ (ii) ``brochure 
supplement;'' \282\ (iii) ``custody;'' \283\ (iv) ``investment adviser 
representative;'' \284\ (v) ``supervised person;'' \285\ and (vi) 
``wrap brochure or wrap fee program brochure.'' \286\ We also are 
updating the Glossary to reflect cross-references to these new terms, 
and cross-references to existing Glossary entries used in the revised 
portions of the Form.
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    \281\ ``Brochure'' means: ``A written disclosure statement that 
you must provide to clients and prospective clients.'' See Form ADV: 
Glossary.
    \282\ ``Brochure supplement'' means: ``A written disclosure 
statement containing information about certain of your supervised 
persons that your firm is required by Part 2B of Form ADV to provide 
to clients and prospective clients.'' See Form ADV: Glossary.
    \283\ ``Custody'' means ``holding, directly or indirectly, 
client funds or securities, or having any authority to obtain 
possession of them. You have custody if a related person holds, 
directly or indirectly, client funds or securities, or has any 
authority to obtain possession of them, in connection with advisory 
services you provide to clients. Custody includes: (i) Possession of 
client funds or securities (but not of checks drawn by clients and 
made payable to third parties) unless you receive them inadvertently 
and you return them to the sender promptly but in any case within 
three business days of receiving them; (ii) Any arrangement 
(including a general power of attorney) under which you are 
authorized or permitted to withdraw client funds or securities 
maintained with a custodian upon your instruction to the custodian; 
and (iii) Any capacity (such as general partner of a limited 
partnership, managing member of a limited liability company or a 
comparable position for another type of pooled investment vehicle, 
or trustee of a trust) that gives you or your supervised person 
legal ownership of or access to client funds or securities.'' See 
rule 206(4)-2(d)(2).
    \284\ ``Investment adviser representative'' means: ``Any of your 
firm's supervised persons (except those that provide only impersonal 
investment advice) is an investment adviser representative, if--(i) 
the supervised person regularly solicits, meets with, or otherwise 
communicates with your firm's clients, (ii) the supervised person 
has more than five clients who are natural persons and not high net 
worth individuals, and (iii) more than ten percent of the supervised 
person's clients are natural persons and not high net worth 
individuals.'' See Form ADV: Glossary. Cf. rule 203A-3(a).
    \285\ ``Supervised person'' means: ``Any of your officers, 
partners, directors (or other persons occupying a similar status or 
performing similar functions), or employees, or any other person who 
provides investment advice on your behalf and is subject to your 
supervision or control.'' See Form ADV: Glossary.
    \286\ ``Wrap brochure or wrap fee program brochure'' means: 
``The written disclosure statement that sponsors of wrap fee 
programs are required to provide to each of their wrap fee program 
clients.'' See Form ADV: Glossary.
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    We also are updating the Glossary to correct a discrepancy in the 
definition of ``Non-Resident'' to make it consistent with the 
definition in rule 0-2, the Advisers Act rule related to the procedures 
for serving process, pleadings, and other papers on non-resident 
investment advisers, and advisers' non-resident general partners and 
managing agents. This revision properly reflects the Commission's 
intent at the time the Glossary was originally adopted, that the 
definition of ``Non-Resident'' in the Glossary be the same as that in 
rule 0-2.\287\ Although technical in nature, this amendment may 
potentially result in an increased number of corporate entities 
qualifying as non-resident general partners or managing agents of 
registered advisers. Certain entities will need to file Form ADV-NR 
with the Commission to appoint agents for service of process because 
they relied on the glossary definition and therefore were not required 
to file the form. We received no comments on these changes and are 
adopting them as proposed.
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    \287\ This amendment will change the definition of ``Non-
Resident'' to include ``a corporation incorporated in or having its 
principal place of business in any place not subject to the 
jurisdiction of the United States.'' (emphasis added). See rule 0-
2(b)(2) [17 CFR 275.0-2(b)(2)].
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IV. Amendments to Rule 204-2

    We also are adopting conforming amendments to Advisers Act rule 
204-2, the rule that sets forth the requirements for maintaining and 
preserving specified books and records, to require registered 
investment advisers to retain copies of each brochure, brochure 
supplement, and each amendment to the brochure and supplements that are 
prepared as required under the rule 204-3.\288\ Additionally, the 
amendments require registered advisers to prepare and preserve 
documentation of the method they use to calculate managed assets for 
purposes of Item 4.E in Part 2A of Form

[[Page 49254]]

ADV, if that method differs from the method used to calculate ``assets 
under management'' in Part 1A of Form ADV.\289\ The amendments also 
require advisers to prepare and preserve a memorandum describing any 
legal or disciplinary event listed in Item 9 in Part 2A and Item 3 in 
Part 2B for the period the event is presumed material, if the event is 
not disclosed in the adviser's brochure or the relevant brochure 
supplement.\290\ These records will be required to be maintained in the 
same manner, and for the same period of time, as other books and 
records required to be maintained under rule 204-2(a). We received no 
comments on these changes and are adopting them as proposed.
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    \288\ See rule 204-2(a)(14)(i). The rule also will require 
advisers to keep and maintain a copy of the summary of material 
changes that is not included in the brochure, as well as a record of 
the dates that each brochure, amendment, and summary of material 
change was given to any client.
    \289\ See discussion at supra note 40 and accompanying text.
    \290\ See discussion at supra notes 86--89 and accompanying 
text.
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V. Effective and Compliance Dates

    The amended rules and forms will be effective on October 12, 2010.

A. New Investment Advisers

    Each adviser applying for registration with the Commission after 
January 1, 2011 must file a brochure or brochures that meet the 
requirements of amended Part 2A as part of the application for 
registration on Form ADV.\291\ Such advisers must, upon registering, 
begin to deliver to their clients and prospective clients a brochure 
and brochure supplements that meet the requirements of the amended form 
in accordance with the amended rules discussed above.\292\
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    \291\ Rule 203-1(b). This requirement applies only if the 
adviser is required to deliver a brochure. See note to Rule 203-1.
    \292\ Rule 204-3(b).
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B. Registered Advisers

    Each adviser registered with the Commission whose fiscal year ends 
on or after December 31, 2010, must include in its next annual updating 
amendment to its Form ADV a brochure or brochures that meet the 
requirements of the amended form.\293\ Accordingly, each adviser with a 
fiscal year end of December 31, 2010 must file an annual updating 
amendment with the new brochures no later than March 31, 2011. Within 
60 days of filing such amendment, the adviser must deliver to its 
existing clients a brochure and brochure supplement that meet the 
requirements of amended Form ADV.\294\ Each adviser must, after the 
initial filing of the brochures, begin to deliver to new clients and 
prospective clients a new brochure and brochure supplements in order to 
satisfy its obligations under the brochure rule.\295\
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    \293\ Rule 204-1(c). This filing requirement applies only if the 
adviser is required to deliver a brochure. See note to Rule 203-1.
    \294\ Rule 204-3(g)(1).
    \295\ Rule 204-3(g)(2).
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VI. Paperwork Reduction Act

    As explained in the Proposing Release, certain provisions of the 
rule and form amendments that we are adopting today contain 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (``PRA'').\296\ In the Proposing 
Release, the Commission published notice soliciting comment on the 
collection of information requirements. The Commission submitted the 
collection of information requirements to the Office of Management and 
Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 
CFR 1320.11, and OMB approved these collections of information under 
control numbers 3235-0049 (expiring 2/28/2011), 3235-0278 (expiring 3/
31/2011), 3235-0047 (expiring 2/28/2011), and 3235-0345 (expiring 3/31/
2011). The titles for these collections of information are ``Form 
ADV,'' ``Rule 204-2,'' ``Rule 204-3,'' and ``Rule 206(4)-4,'' 
respectively, all under the Advisers Act. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid control number.
---------------------------------------------------------------------------

    \296\ 44 U.S.C. 3501.
---------------------------------------------------------------------------

    The respondents to the collections of information are investment 
advisers registered or applying for registration with us. We use the 
information to determine eligibility for registration with us and to 
manage our regulatory and examination programs. Clients use certain of 
the information to determine whether to hire or retain an adviser.
    The rule and form amendments that we are adopting involve three 
distinct ``collections of information'' for purposes of the Paperwork 
Reduction Act. The first is the collection of information connected 
with Form ADV itself, specifically our amendments to Part 2 of Form 
ADV. The second collection of information involved is that under the 
amendment to rule 204-2, which requires advisers to maintain and 
preserve specified books and records. The third collection involved is 
that related to an amendment to rule 204-3, which requires advisers to 
deliver certain information required under Form ADV to their clients.
    In addition, we are withdrawing rule 206(4)-4, the rule requiring 
advisers to disclose certain disciplinary and financial information, 
because the disclosure required by that rule is incorporated into the 
amendments to Part 2 of Form ADV that we are adopting.

A. Summary of Comment Letters

    We requested comment on the Paperwork Reduction Act analysis 
contained in the Proposing Release. A number of commenters expressed 
concerns that the paperwork burdens associated with our proposed 
amendments to Part 2 of Form ADV were understated.\297\ Several 
commenters stated that our estimates of the burdens of preparing and 
delivering brochure supplements were too low and that the requirement 
would impose heavy burdens on advisers, in particular, large advisory 
firms with thousands of employees and clients.\298\ Several commenters 
noted that these costs would increase particularly in the context of 
wrap fee programs.\299\ In response to comments on the requirements of 
Form ADV Part 2, we have made several substantive modifications to the 
proposed amendments that we believe in general will reduce the 
paperwork burdens associated with the rule and form amendments. For 
example, we have modified the annual brochure delivery requirement to 
allow it to be satisfied by delivering just a summary of material 
changes in the brochure. We have revised Item 5 so that advisers do not 
need to include a fee schedule in brochures provided only to clients 
that are ``qualified purchasers.'' We have not adopted proposed 
disclosure of cash balance practices and proxy voting services from 
Items 8 and 17, respectively. We are permitting supervised persons with 
certain disciplinary information disclosed through FINRA's BrokerCheck 
system or the IAPD system to refer clients to that information in their 
brochure supplements (if they are provided electronically and contain a 
hyperlink to the BrokerCheck or the IAPD system, as relevant) rather 
than reproducing that information. When investment advice is provided 
to a client by a team, we are requiring that brochure supplements need 
only be provided for the five supervised persons with the most 
significant responsibility for the day-to-day advice provided to the 
client.
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    \297\ See ASG Letter; Berlin Letter; Federated Letter; First 
Allied Letter; Fried Frank Letter; FSI Letter; IAA Letter; Jackson 
Letter; NAPFA Letter; NRS Letter; Pickard Letter; Sutherland Letter; 
Vineyard Letter.
    \298\ See Merrill Lynch Letter; Morgan Stanley Letter; Schwab 
Letter; SIFMA Letter; Sutherland Letter.
    \299\ See Federated Letter; MMI Letter; Morgan Stanley Letter.

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[[Page 49255]]

B. Revisions to Paperwork Reduction Act Burden Estimates

    After considering commenters' concerns that the Commission's 
estimated paperwork burdens for firms complying with the amended Form 
ADV Part 2 were too low, and in light of revisions we have made to our 
proposed amendments to Part 2, we are revising our estimates for 
purposes of the Paperwork Reduction Act.
1. Amendments to Form ADV
a. Part 2 of Form ADV
    The information required by the amendments to Form ADV is 
mandatory. Advisers are required to disclose this information to their 
clients and, therefore, it is not kept confidential. The currently 
approved total annual burden for all advisers completing, amending, and 
filing revised Form ADV with us is 132,599 hours. As stated in the 
Proposing Release, we continue to believe that most of the paperwork 
burden will be incurred in advisers' initial preparation of a revised 
brochure and brochure supplements, as most advisers will have to draft 
a narrative brochure and all advisers will have to prepare new brochure 
supplements, and that over time this burden will decrease substantially 
because the paperwork burden will be limited to updating information. 
The paperwork burdens of preparing a narrative firm brochure and 
brochure supplements are likely to vary substantially among advisers, 
because Part 2 gives an adviser considerable flexibility in structuring 
its disclosure, the amount of disclosure required will vary among 
advisers, and the number of supplements that will need to be prepared 
depends on the number of supervised persons at a firm that provide 
investment advice. We believe that the revisions to Part 2 will impose 
a small burden on advisers in collecting information because there is a 
significant overlap between the information required by the previous 
Part 2 and the new Part 2A requirements and because advisers already 
collect information on the business background and disciplinary 
histories of their supervised persons to comply with state investment 
adviser representative registration requirements.\300\ Accordingly, we 
expect that most of the paperwork burden from amended Part 2 will arise 
from an adviser drafting the narrative disclosure for its brochure and 
brochure supplements based on disclosures it and its supervised persons 
already made in Schedule F of Part 2 and in Form U4, and in expanding 
its discussion of how the adviser addresses certain conflicts of 
interest.
---------------------------------------------------------------------------

    \300\ There are three entirely new items in the Part 2A we are 
adopting today--Item 2's summary of material changes, Item 6's 
performance fee disclosure requirement, and Item 15's custody 
disclosure requirement. The remainder of the items in Part 2A either 
were generally covered by the previous Part 2 or were required 
disclosure under other Advisers Act rules, such as rule 206(4)-6 
regarding proxy voting and rule 206(4)-4 regarding financial and 
disciplinary information. In addition, most states require that 
supervised persons of SEC-registered investment advisers that are 
investment adviser representatives file Form U4, which requires 
similar business background and disciplinary information as the 
brochure supplement.
---------------------------------------------------------------------------

    As noted above, we have revised our estimated burdens for purposes 
of the Paperwork Reduction Act to take into account comments received 
as well as substantive modifications to Part 2 from the form that was 
proposed.
    In the Proposing Release, we estimated the average initial annual 
burden associated with Form ADV to be 5 hours for smaller 
advisers.\301\ We received several comments that provided estimates of 
the paperwork burden associated with the proposed rule and form 
amendments for small advisers. One commenter estimated that preparing 
the initial Form ADV Part 2 would require 16 to 40 hours, depending on 
the nature of the firm's business, and that each subsequent amendment 
to that form would take 10 to 32 hours, depending on the nature of the 
amendments.\302\ Another said that a small firm would take 60 hours to 
draft the initial brochure.\303\ A small firm commenter estimated that 
it would take 40 to 60 hours to prepare the initial brochure and 
another 20 to 40 hours per year thereafter to update it.\304\ A 
compliance consulting firm estimated that it would take on average 15 
hours for a small firm to prepare the initial brochure.\305\ One law 
firm estimated that smaller advisers would spend at least 44.5 hours 
preparing the new brochure.\306\ We do not believe that small advisers 
will require as many as 60 hours for their initial revision of Part 2A 
because, as discussed above, firms already have collected much of the 
information for Part 2A, many of the disclosures were already required 
under previous Part 2 requirements or other Advisers Act rules or as a 
result of the adviser's fiduciary obligations, and small advisers are 
unlikely to have extensive conflicts of interest that would necessitate 
lengthy brochure disclosures. We have reviewed several brochures of 
small investment advisers drafted in a narrative format that would 
appear to be generally responsive to the requirements we are adopting 
today, and these brochures are short, likely because of the relative 
simplicity of most small advisers' business models.\307\ We also do not 
believe that small advisers will spend significant amounts of time 
preparing brochure supplements because they have a small number of 
supervised persons. Based on these considerations, we estimate that the 
average initial annual burden associated with Form ADV to be at the low 
end of the 15 to 60 hour range provided by commenters, or 15 hours for 
each small adviser.
---------------------------------------------------------------------------

    \301\ For purposes of the estimates in this section, we have 
categorized small advisers as those with 10 or fewer employees, 
medium-sized advisers as those with between 11 and 1,000 employees, 
and large advisers as those with over 1,000 employees. Unless 
otherwise noted, the IARD data cited below is based on advisers' 
responses to questions on Part 1A of Form ADV as of May 3, 2010.
    \302\ ASG Letter.
    \303\ NAPFA Letter.
    \304\ Jackson Letter.
    \305\ NCS Letter.
    \306\ Fried Frank Letter.
    \307\ We note that advisers that choose to disclose more than is 
required by Part 2A (or their fiduciary obligations) will create 
lengthier brochures than those that take a more focused approach.
---------------------------------------------------------------------------

    In the Proposing Release, we estimated that the average initial 
annual burden associated with Form ADV for medium-sized advisers would 
be approximately 50 hours. We received a comment from a medium-sized 
adviser stating that it currently spends approximately 45 hours per 
year to update its Part 2 brochure.\308\ This commenter did not 
estimate how long it took to prepare its initial Part 2 brochure under 
the prior format and did not estimate how long it would take to prepare 
or update the new Part 2A brochure and brochure supplements. We 
received a comment from another medium-sized adviser estimating that it 
would take a minimum of 163 hours for the initial preparation and 
internal handling of the brochure supplement.\309\ Most of our medium-
sized advisers are closer to the size of small advisers than large 
advisers, with 77% of medium-sized advisers having between 11 and 50 
employees.\310\ Accordingly, we expect that while these advisers will 
have a higher burden than smaller advisers due to the greater size and 
complexity of their business model, the majority will not have burdens 
dramatically greater than small advisers. We also estimated that each 
medium adviser, on average, will require 30 minutes to prepare each 
brochure supplement, based on an estimate of

[[Page 49256]]

brochure supplement preparation time provided by one medium adviser 
commenter.\311\ Based on these considerations and the comments on small 
firm burdens, we have revised our estimate of the average initial 
annual burden associated with Form ADV for each medium-sized adviser to 
be 97.5 hours.\312\
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    \308\ See Federated Letter.
    \309\ See First Allied Letter. The First Allied Letter stated 
that it had approximately 325 investment advisory representatives 
and assumed that each supplement would take 30 minutes to prepare.
    \310\ Based on IARD data as of May 3, 2010.
    \311\ First Allied Letter.
    \312\ We assume that preparing Part 1 and Part 2A of Form ADV 
would take each medium adviser on average 60 hours per year based on 
our estimate for smaller advisers, the fact that the average medium 
adviser is closer in size to a small adviser than a large adviser, 
the discussion above that advisers already have much of the 
information required by the new Part 2A and it is largely a matter 
of converting it to a narrative format, and the one comment we did 
receive from a medium sized adviser on the time it took to amend its 
brochure annually. We estimate that each medium adviser, on average, 
has 75 supervised persons based on the average number of employees 
performing investment advisory functions at medium sized advisers 
according to IARD data. We thus estimated that each medium adviser 
on average would spend 37.5 hours preparing the initial brochure 
supplements (75 supervised persons x 30 minutes per supervised 
person = 37.5 hours per year), for a total of 97.5 hours for the 
initial preparation of all of Form ADV.
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    Finally, in the Proposing Release we estimated that the average 
initial annual burden associated with Form ADV for large advisers would 
be approximately 3,300 hours. We received no estimates from commenters 
of the burden on large advisers from preparing the new brochure. We 
received estimates from two of the largest advisers that the brochure 
supplement would require between 30,000 to 45,000 hours initially.\313\ 
Unlike with respect to small and medium advisers, the brochure 
supplement dramatically increases the estimated burden associated with 
preparing Form ADV for large advisers because of their significantly 
larger number of employees that provide investment advice (some with 
over 1,000 per firm according to IARD data). The primary difference 
between the burden associated with preparing the brochure for large and 
smaller firms is the likelihood that there will be additional items to 
which large firms will have to respond and the likelihood that large 
firms will have additional conflicts of interest to address. We 
estimate that these additional brochure disclosures will add a 
relatively small amount compared to the burden estimate for medium 
advisers, but that the brochure supplement requirement will add a 
significant burden compared to medium advisers. We do not expect the 
burden for most large firms to be as substantial, on average, as 
estimated in the Merrill Lynch and Morgan Stanley comment letters, 
however, because these firms based their estimate on substantially more 
supervised persons providing investment advisory services than an 
average large adviser.\314\ We estimate that preparing Part 1 and Part 
2A of Form ADV would take each large adviser on average 100 hours per 
year.\315\ Based on commenters' estimates, we now estimate that the 
brochure supplement will take each large adviser on average 30 minutes 
per supervised person to collect and prepare a supplement.\316\ As a 
result, we now estimate the initial average burden associated with 
preparing Form ADV for each large adviser to be 1,989 hours.\317\
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    \313\ The Merrill Lynch Letter estimated that the brochure 
supplement requirement would require 45,000 hours per year. The 
Morgan Stanley Letter estimated that it would take in the range of 
30,000 to 35,000 hours for it to comply with the brochure supplement 
requirement initially and 8,000 to 10,000 hours annually to comply 
going forward. In their comment letters, Merrill Lynch and Morgan 
Stanley stated that approximately 8,000 and 14,000 employees, 
respectively, performed investment advisory functions at their 
firms. These employee numbers place these two commenters at the 
highest end of the range of the 36 advisers in our large category 
with only four other firms reporting as of May 3, 2010 that they had 
8,000 or more employees performing such functions.
    \314\ See supra note 114.
    \315\ This estimate is based on our estimate for medium 
advisers, the discussion above that advisers already have much of 
the information required by the new Part 2A and it is largely a 
matter of converting it to a narrative format, and our view that the 
additional disclosure required by large advisers' business models is 
not so substantial as to require dramatically more brochure 
preparation time than medium advisers.
    \316\ We estimate that each large adviser, on average, has 3,777 
supervised persons based on the average number of employees 
performing investment advisory functions at large advisers according 
to IARD data. The Merrill Lynch Letter estimated that each 
supplement would require 3 hours to prepare. We believe that this 
estimate includes the burden to track and update brochure 
supplements which we discuss and account for separately, and which 
are not part of this burden estimate. We do not expect that brochure 
supplements for supervised persons at large advisers are likely to 
require more preparation time than supplements at medium advisers, 
particularly when more supervised persons at large advisers than 
medium advisers are likely to have information available through 
BrokerCheck or the IAPD that can be referenced in those supervised 
persons' supplements, reducing supplement preparation time. Brochure 
supplements consist of only 6 disclosure items, several of which 
(i.e., cover page, supervision, education) are simple to collect and 
draft in a few minutes). Accordingly, we estimate that an adviser 
would spend 30 minutes per supervised person to collect and prepare 
a supplement.
    \317\ We estimate that each large adviser on average would spend 
1,889 hours preparing the initial brochure supplements (3,777 
supervised persons x 30 minutes per supervised person = 1,889 hours 
per year), for a total of 1,989 hours per year on average per large 
adviser for the initial preparation of all of Form ADV.
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    In the Proposing Release, we estimated that an average investment 
adviser's collection of information burden associated with initial 
preparation of Form ADV would be 22.25 hours per year. According to 
IARD data, there are 9,482 small advisers, 2,140 medium-sized advisers, 
and 36 large advisers. Based on the revised hourly burden estimates 
discussed above, we now believe that 36.24 hours is an accurate 
reflection of the time that it will take the average adviser to 
initially complete revised Form ADV (including both Parts 1 and 
2).\318\ This is an increase of 13.99 hours over our initial estimate.
---------------------------------------------------------------------------

    \318\ 9,482 small advisers x an estimated 15 hours/adviser + 
2,140 medium-sized advisers x an estimated 97.5 hours/adviser + 36 
large advisers x an estimated 1,989 hours/adviser = 422,484 hours 
total. 422,484 hours/11,658 total advisers = 36.24 hours/adviser.
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    Respondents under this collection of information will be advisers 
registered with the Commission as well as new applicants for investment 
adviser registration with the Commission. We estimate that 
approximately 1000 new investment advisers will register with us each 
year.\319\ Thus, in combination with the approximately 11,658 existing 
investment advisers registered with the Commission, we estimate that 
the total number of respondents under this collection of information 
will be 12,658 advisers. Based on the estimated average collection of 
information burden of 36.24 hours per adviser, the total initial 
collection of information would amount to 458,726 hours for new 
registrants and for currently registered advisers that re-file Form ADV 
(including Part 2) through the IARD system.\320\ Amortizing this total 
burden imposed by Form ADV over a three-year period to reflect the 
anticipated period of time that advisers would use the revised Form 
would result in an average burden of an estimated 152,909 hours per 
year,\321\ or 12.08 hours per year for each new applicant and for each 
adviser currently registered with the Commission that would re-file 
through the IARD.\322\
---------------------------------------------------------------------------

    \319\ Based on IARD data over the last five years.
    \320\ (12,658 advisers x 36.24 hours) = 458,726 hours.
    \321\ 458,726 hours/3 years = 152,909 hours/year.
    \322\ 152,909 hours/12,658 advisers = 12.08 hours/adviser.
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    We estimate that some advisers may incur a one-time initial cost 
for outside legal and compliance consulting fees in connection with 
preparation of Part 2 of Form ADV. While we received no specific 
comments on our estimate regarding outside legal costs in the Proposing 
Release, one commenter did state that compliance consultants assist a 
significant percentage of advisers in preparing their Form ADV.\323\ As 
a result, we are changing our estimate to reflect a quarter of small 
advisers using compliance consulting services and a

[[Page 49257]]

quarter of small advisers using outside legal services and to reflect 
half of medium advisers using compliance consulting services in lieu of 
outside legal services and a quarter of medium advisers still using 
outside legal services. We estimate that the initial per adviser cost 
for legal services related to preparation of Part 2 of Form ADV would 
be $3,200 for small advisers, $4,400 for medium-sized advisers, and 
$10,400 for larger advisers.\324\ We estimate that the initial per 
adviser cost for compliance consulting services related to initial 
preparation of the amended Form ADV will range from $3,000 for smaller 
advisers to $5,000 for medium-sized advisers.\325\ We estimate that a 
quarter of small and half of medium advisers, or 2,371 and 1,070 
advisers, respectively, are likely to seek outside compliance 
consulting services in their preparation of Form ADV.\326\ We estimate 
that a quarter of small advisers, or 2,370 advisers, and a quarter of 
medium advisers, or 535 advisers, are likely to engage outside legal 
services.\327\ We estimate that all of the 36 large advisers will 
engage outside legal services in preparation of Form ADV. Thus, we 
estimate that approximately 2,941 advisers will elect to obtain outside 
legal assistance and approximately 3,441 advisers will elect to obtain 
outside consulting services, for a total cost among all respondents of 
$22,775,400.\328\
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    \323\ See NCS Letter.
    \324\ Outside legal fees are in addition to the projected hourly 
per adviser burden discussed above. $400 per hour for legal services 
x 8 hours per small adviser = $3,200. $400 per hour for legal 
services x 11 hours per medium-sized adviser = $4,400. $400 per hour 
for legal services x 26 hours per large adviser = $10,400. The 
hourly cost estimate of $400 on average is based on our consultation 
with advisers and law firms who regularly assist them in compliance 
matters.
    \325\ Outside compliance consulting fees are in addition to the 
projected hourly per adviser burden discussed above. Based on 
consultation with compliance consulting firms who regularly assist 
investment advisers in Form ADV preparation, we estimate that small 
advisers will incur expenses of $3000 per year for the initial 
preparation of the new Form ADV and medium advisers will incur 
expenses of $5000 per year for the initial preparation of the new 
Form ADV.
    \326\ 9,482 small advisers x 0.25 = 2,371. 2,140 medium-sized 
advisers x 0.5 = 1,070.
    \327\ 2,140 medium-sized advisers x 0.25 = 535.
    \328\ For outside legal services, ($4,400 x 535 medium advisers) 
+ ($3,200 x 2,370 small advisers)) + ($10,400 x 36 large advisers) = 
$ 10,312,400. For compliance consulting services, ($3,000 x 2,371 
small advisers) + ($5,000 x 1,070 medium advisers) = $12,463,000. 
$10,312,400+$12,463,000 = $22,775,400
---------------------------------------------------------------------------

    In addition to the burdens associated with initial completion and 
filing of the revised form, we estimate that, on average, each adviser 
filing Form ADV through the IARD system will likely amend its form two 
times during the year.\329\ A few commenters believed that we had 
underestimated the information burden associated with amending Form 
ADV.\330\ As a result, we are revising our estimate of the collection 
of information burden for preparing amendments. One of the two 
amendments that firms on average make each year will be an interim 
updating amendment, and we estimate that this amendment will require 
0.5 hours per amendment because interim amendments typically only amend 
one or two items \331\ in Form ADV and thus should not require much 
time to prepare. The other amendment is the firm's annual updating 
amendment of Form ADV. Part 2A requires only a few additional 
requirements with the annual updating amendment than is required 
throughout the year--the summary of material changes since the last 
annual updating amendment, an updated fee schedule, and an updated 
figure for assets under management. We also expect that advisers will 
not have to spend a significant amount of time generally reviewing 
their brochure before filing their annual updating amendment as the 
instructions to the form and their fiduciary obligations require them 
to keep information they provide to clients free of material 
inaccuracies. Based on these considerations, we estimate that the 
average adviser will spend 6 hours per year completing their annual 
updating amendment to Form ADV. Finally, we believe that the 
information required in the brochure supplements is unlikely to change 
frequently for any particular supervised person, and, as a result, that 
brochure supplements will be amended infrequently.\332\ We also 
estimate that changes to most of the supplement information is already 
tracked by advisers in order to allow them to keep Forms U4 for their 
investment advisory representatives current, and that tracking changes 
to this information for brochure supplement purposes as well will 
impose negligible additional costs. Accordingly, we estimate that it 
will require an average burden per adviser of one hour per year for 
interim amendments to brochure supplements, for a total burden on all 
advisers of 11,658 hours per year.\333\ Thus, we estimate that the 
total paperwork burden on advisers of amendments to Form ADV will be 
87,435 hours per year.\334\
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    \329\ In the Proposing Release, we estimated that each adviser, 
on average, filing Form ADV through the IARD system amended its form 
1.5 times per year. We have updated this estimate based on IARD 
system data regarding the number of filings of Form ADV amendments.
    \330\ In the Proposing Release, we estimated that each adviser, 
on average, would spend 0.75 hours per year amending its Form ADV. 
The ASG Letter estimated that amendments to Part 2 would take 10 to 
32 hours, depending on the nature of the amendments. The Jackson 
Letter estimated that it would take small firms 20 to 40 hours per 
year to update Part 2. The Federated Letter stated that they 
currently spend approximately 45 hours per year amending the 
previous Part 2.
    \331\ Based on IARD system data.
    \332\ Largely for this reason, we have not broken down our 
estimated burden for preparing the annual updating amendment to Form 
ADV based on the size of the adviser since most of the difference in 
the initial Form ADV preparation burden was driven by the brochure 
supplement. We also do not believe that the burden for preparing an 
annual updating amendment to Part 2A of Form ADV will vary 
significantly based on the size of the adviser.
    \333\ 1 hour per year x 11,658 advisers = 11,658 hours per year.
    \334\ 11,658 advisers x 1 interim brochure amendment per year x 
0.5 hours = 5,829 hours per year for interim amendments. 11,658 
advisers x 1 annual brochure amendment per year x 6 hours = 69,948 
hours per year for annual amendments. 11,658 advisers x 1 hour per 
year for supplement amendments = 11,658 hours per year for 
supplement amendments. 5,829 + 69,948 + 11,658 = 87,435 hours.
---------------------------------------------------------------------------

    Commenters also highlighted the fact that the particular supervised 
persons for whom the adviser will have to deliver brochure supplements 
to particular clients will change over time and that these changes will 
generate costs.\335\ The adviser may hire new employees who may begin 
providing investment advisory services that require preparation of a 
brochure supplement. We estimate that advisers on average will hire two 
new supervised persons each year for which a brochure supplement would 
have to be prepared.\336\ We further estimate that, on average, an 
adviser will spend 0.5 hours preparing each new brochure 
supplement.\337\ Preparation of these new supplements thus would 
require all advisers to spend 11,658 hours per year.\338\
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    \335\ See, e.g., Schwab Letter; SIFMA Letter; Sutherland Letter.
    \336\ Estimate is weighted average based on analysis of changes 
in aggregate responses to Item 5.B(1) of Part 1A of Form ADV over 
the last 5 years and the number of investment advisers registered 
with the Commission.
    \337\ See discussion at supra note 311 and accompanying text.
    \338\ Two new supervised persons per year x 0.5 hours per 
supplement x 11,658 investment advisers = 11,658.
---------------------------------------------------------------------------

    The revised total annual collection of information burden for 
advisers to file and complete the revised Form ADV (Parts 1 and 2), 
including the initial burden for both existing and anticipated new 
registrants plus the burden associated with amendments to the form as 
well as creating new supplements for new employees, is estimated to be 
approximately 252,002 hours per

[[Page 49258]]

year.\339\ This burden represents an increase of 151,026 hours over 
that estimated in the Proposing Release.\340\ This increase is 
attributable primarily to our increased estimates of the hourly 
preparation burden associated with Part 2 in response to comments. As 
discussed in the Proposing Release, in addition to these estimated 
burdens, under this collection of information there is also a burden of 
16,455 hours associated with advisers' obligations to deliver to 
clients copies of their adviser codes of ethics upon request.\341\ 
Thus, the estimated revised total annual hourly burden under this 
collection of information would be 268,457 hours.\342\ This represents 
an increase of 135,858 hours per year from the currently approved 
burden.\343\
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    \339\ 152,909 hours per year attributable initial preparation of 
Form ADV + 87,435 hours per year for amendments to Form ADV + 11,658 
hours per year for supplements for new employees = 252,002 hours.
    \340\ Revised burden 252,002 hours - proposing release burden of 
100,976 hours = 151,026 hours.
    \341\ See Code of Ethics Adopting Release, supra note 114. As we 
estimated in the Proposing Release (and on which we received no 
comment), we estimate that only one percent of an adviser's clients 
actually request a copy the adviser's code of ethics. 0.01 x 1,300 
(the estimated average number of clients per adviser) = 13 requests 
per registrant. See infra note 357 regarding the estimated average 
number of clients. We continue to estimate that responding to each 
such request involves a burden of 0.10 hours, amounting to an annual 
burden of 1.3 hours for each adviser stemming from the obligation to 
deliver copies of their codes of ethics to clients. 13 requests per 
adviser x 0.10 hours = 1.3 hours/adviser. This obligation applies to 
both currently-registered (11,658 respondents) and newly-registered 
advisers (1000 respondents), for a total annual burden of 16,455 
hours. 12,658 respondents x 1.3 hours = 16,455 hours.
    \342\ 16,455 hours + 252,002 hours = 268,457 hours.
    \343\ Revised burden 268,457 hours - currently approved burden 
of 132,599 hours = 135,858 hours.
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b. Rule 206(4)-4
    Rule 206(4)-4 currently requires advisers to disclose certain 
disciplinary and financial information to clients. We are rescinding 
rule 206(4)-4 and incorporating its substantive provisions into Part 2 
of Form ADV. The collection of information burden associated with the 
requirements of rule 206(4)-4 has been incorporated into the collection 
of information requirements for Form ADV, discussed above. Thus, the 
currently approved burden estimate for Form ADV already includes an 
estimate of the burdens associated with the disclosure of disciplinary 
and financial information connected with Part 2.
2. Rule 204-2
    This requirement is found at 17 CFR 275.204-2 and is mandatory. The 
Commission staff uses the collection of information in its examination 
and oversight program, and the information generally is kept 
confidential.\344\ The likely respondents to this collection of 
information requirement are all of the approximately 11,658 advisers 
currently registered with the Commission.
---------------------------------------------------------------------------

    \344\ See section 210(b) of the Advisers Act (15 U.S.C. 80b-
10(b)).
---------------------------------------------------------------------------

    The amendments to rule 204-2 require advisers to prepare and 
preserve a memorandum describing any legal or disciplinary event listed 
in Item 9 in Part 2A of Form ADV and Item 3 in Part 2B of Form ADV, if 
the event is not disclosed in the adviser's brochure or the relevant 
brochure supplement. Additionally, the amendments require advisers to 
prepare and preserve documentation of the method they use to calculate 
managed assets for purposes of Item 4.E. in Part 2A of Form ADV, if 
that method differs from the method used to calculate ``assets under 
management'' in Part 1A of Form ADV. These records are required to be 
maintained in the same manner, and for the same period of time, as 
other books and records required to be maintained under rule 204-2(a).
    As we stated in the Proposing Release, we believe that the 
amendments to rule 204-2 will result in an increased burden of four 
hours for each adviser subject to the additional requirements. We 
received no comments on the Commission's burden estimates relating to 
rule 204-2 and are leaving these estimates unchanged, except to update 
collection estimates based on IARD data.
    We estimate that 350 advisers will use a method for calculating 
managed assets in Part 2A that differs from the method used to compute 
assets under management in Part 1A and thus would be required to 
prepare and preserve documentation describing the method used in Part 
2A.\345\ We also estimate that 156 advisers will conclude that the 
materiality presumption in Part 2 has been overcome with respect to a 
legal or disciplinary event, will determine not to disclose that event, 
and therefore would be required to prepare and preserve a memorandum 
describing the event.\346\
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    \345\ Based on the Commission staff's conversations with 
industry professionals, we anticipate that approximately three 
percent of the 11,658 advisers registered with us as of May 3, 2010 
will use a method for computing managed assets in Part 2A of Form 
ADV that differs from the method used to compute assets under 
management in Part 1A of Form ADV. 11,658 advisers x 0.03 = 350 
advisers.
    \346\ Approximately 1,559 advisers registered with the 
Commission report disciplinary information in Part 1A of their Form 
ADV as of May 3, 2010. We anticipate that most of these advisers 
will include all disciplinary information in their brochures and 
supplements, but that approximately 10% of these advisers, or 156, 
will need to prepare and preserve a memorandum explaining their 
basis for not disclosing a legal or disciplinary event listed in 
Part 2 in their brochures and supplements. 1,559 advisers x 0.10 = 
156 advisers.
---------------------------------------------------------------------------

    We estimate that a total of 506 advisers will have to prepare and 
preserve additional records in accordance with amendments to rule 204-
2.\347\ Only 487 of these are already accounted for in the currently 
approved burden estimate. We estimate that adding 19 advisers to those 
subject to the amended provisions of rule 204-2 will yield a 76 hour 
increase in burden under the rule.\348\
---------------------------------------------------------------------------

    \347\ 350 advisers that we estimate would prepare memoranda 
regarding an alternative method for calculating assets under 
management + 156 advisers that we estimate would prepare memoranda 
regarding unreported nonmaterial disciplinary events = 506 advisers.
    \348\ 506 advisers-487 advisers = 19 advisers. 19 advisers x 4.0 
hours = 76 hours.
---------------------------------------------------------------------------

    The approved annual aggregate burden for rule 204-2 is currently 
1,954,109 hours based on an estimate of 10,787 registered advisers, or 
181.15 per registered adviser.\349\ Taking into account the estimated 
increased burden of 76 hours as discussed above, as well as an increase 
of 871 registered advisers,\350\ the revised annual aggregate burden 
for all respondents to the recordkeeping requirements under rule 204-2 
is therefore estimated to be 2,111,967 total hours.\351\
---------------------------------------------------------------------------

    \349\ 1,954,109 hours/10,787 registered advisers = 181.15 hours 
per adviser.
    \350\ As stated above, our IARD data show that as of May 3, 2010 
there were 11,658 advisers registered with the SEC. 11,658-10,787 = 
871.
    \351\ (1,954,109 current burden hours + 76 hours due to an 
increase in the estimated number of registered advisers subject to 
additional recordkeeping under the amendments + (871 due to an 
increase of total number of registered advisers x 181.15 hours per 
adviser)) = 2,111,967. The annual average burden per registered 
adviser is therefore 181.16 hours. 2,111,967 total hours/11,658 
advisers = 181.16 hours per adviser.
---------------------------------------------------------------------------

    We further estimate that some advisers may incur a one-time cost 
for outside legal fees in connection with preparing a memorandum 
explaining their basis for not disclosing a legal event listed in Part 
2 in their brochures and supplements. We estimate this one-time cost 
would include fees for approximately three hours of outside legal 
review and would amount on average to approximately $1,200 per 
adviser.\352\ We believe that approximately 80 percent of the advisers 
preparing such memoranda would likely engage outside legal services to 
assist in their preparation.\353\

[[Page 49259]]

Thus, we estimate that approximately 125 advisers will incur these 
costs, for a total cost among all respondents of $150,000.\354\
---------------------------------------------------------------------------

    \352\ Outside legal fees are in addition to the projected hourly 
per adviser burden discussed above. $400 per hour for legal services 
x 3 hours per adviser = $1,200. The hourly cost estimate is based on 
our consultation with advisers and law firms who regularly assist 
them in compliance matters.
    \353\ We made the same estimate in the Proposing Release and 
received no comment on this estimate.
    \354\ 156 advisers x 0.80 = 125. $1,200 x 125 = $150,000.
---------------------------------------------------------------------------

3. Rule 204-3
    Rule 204-3 contains a collection of information requirement. This 
collection of information is found at 17 CFR 275.204-3 and is 
mandatory. Responses are not kept confidential. The likely respondents 
to this information collection are the approximately 11,658 investment 
advisers registered with the Commission.
    Rule 204-3 previously required an investment adviser to deliver to 
clients, at the start of an advisory relationship, a copy of Part 2 of 
Form ADV or a written document containing at least the information 
required by Part 2. The rule previously required no further brochure 
delivery unless the client accepted the adviser's required annual 
offer. The brochure assists the client in determining whether to hire 
or retain an adviser.
    The amendments to rule 204-3 require advisers to deliver their 
brochures and brochure supplements at the start of an advisory 
relationship and to deliver annually thereafter the full updated 
brochure or a summary of material changes to their brochure.\355\ The 
amendments also require that advisers deliver an amended brochure or 
brochure supplement (or just a statement describing the amendment) to 
clients only when disciplinary information in the brochure or 
supplement becomes materially inaccurate.\356\
---------------------------------------------------------------------------

    \355\ See rule 204-3(b).
    \356\ See rule 204-3(b).
---------------------------------------------------------------------------

    The total annual burden currently approved by OMB for rule 204-3 is 
6,902,278 hours. This currently approved burden is based on each 
adviser having, on average, an estimated 670 clients. Our records now 
currently indicate that the 11,658 advisers registered with the 
Commission have, on average, 1,300 clients.\357\ This change, along 
with our amendments permitting annual delivery of a summary of material 
changes to the brochure (instead of the entire brochure) alters the 
collection of information burden from that currently approved.
---------------------------------------------------------------------------

    \357\ This average is based on advisers' responses to Item 5.C 
of Part 1A of Form ADV as of May 3, 2010, excluding the three 
advisers that reported the largest number of clients. Those advisers 
account for over 50% of all advisory clients of SEC registrants and 
not excluding them would raise the average client count to 2,576 
clients. These three firms provide advisory services primarily over 
the Internet and currently meet their brochure obligations 
electronically, thus essentially entirely eliminating for these 
advisers any PRA burden associated with delivery under this rule. 
Therefore, we believe that it is appropriate to exclude these firms 
from our calculations.
---------------------------------------------------------------------------

    We expect that advisers will send their brochure or summary of 
material changes annually in a ``bulk mailing'' to clients that may 
include clients' account statements, periodic reports, or other 
important documents. We estimate that, with a bulk mailing, an adviser 
will require no more than 0.02 hours to send the adviser's brochure or 
summary of material changes to each client, or an annual burden of 26 
hours per adviser.\358\ Thus, we estimate the total burden hours for 
11,658 advisers to distribute their firm brochure to existing clients 
initially and annually thereafter to be 303,108 hours per year.\359\ We 
have revised our estimate of the amount of time it will take an adviser 
to deliver its brochure or summary of material changes based on our 
view that most advisers will make their annual delivery as part of the 
mailing of an account statement or other periodic report that they 
already make to clients, and thus the additional burden will be adding 
a few pages to the mailing.
---------------------------------------------------------------------------

    \358\ (0.02 hours per client x 1,300 clients per adviser based 
on IARD data as of May 3, 2010) = 26 hours per adviser. We note that 
the burden for preparing brochures is already incorporated into the 
burden estimate for Form ADV discussed above. The Proposing Release 
estimated that it would require 0.25 hours to send the adviser's 
brochure to each client. Upon further consideration we determined 
that it would not take an adviser 15 minutes to mail or e-mail an 
adviser's brochure to a client.
    \359\ (0.02 hours per client x 1,300 clients per adviser) x 
11,658 advisers based on IARD data as of May 3, 2010 = 303,108 
hours.
---------------------------------------------------------------------------

    Advisers also will be required to distribute interim updates 
disclosing new or revised disciplinary information in their brochure or 
supplements. We anticipate that in any given year, the number of such 
interim updates that advisers will be required to deliver is 
approximately 583.\360\ We further estimate that an adviser will 
require no more than 0.1 hours per client for delivery of each such 
update.\361\ This represents about 130 hours per interim update.\362\ 
Thus, the aggregate annual hour burden for affected advisers to deliver 
interim updates to their brochures or supplements will be approximately 
75,790 hours per year.\363\
---------------------------------------------------------------------------

    \360\ Of the advisers registered with the Commission, 13% report 
disciplinary events on their Form ADVs (as of May 10, 2010, only 
1,559 of all 11,658 registered advisers indicated at least one 
``yes'' answer to a question related to disciplinary events in Form 
ADV, Part 1A, Item 11). Thus, we anticipate that a correspondingly 
small number of advisers will be required to disclose new or updated 
disciplinary information. The Commission staff estimates that in any 
given year, 5% of advisers will be required to deliver a single 
interim update to each of their clients, resulting in a total of 
approximately 583 interim updates per year. 0.05 x 11,658 x 1 update 
= 583 updates.
    \361\ This burden estimate relates only to the amount of time it 
will take advisers to deliver interim updates to clients, as 
required by the rule amendments. The burden for preparing interim 
updates is already incorporated into the burden estimate for Form 
ADV discussed above. Since this mailing may not be included with a 
mailing of a statement or other periodic report, we estimate that it 
will take slightly more time than to deliver the annual brochure or 
summary of material changes. We also revised this estimate based on 
our belief that it would only take one or two minutes, not fifteen 
minutes to mail a brochure or summary of material changes. See supra 
note 358.
    \362\ 0.1 hours per client x 1,300 clients per adviser = 130 
hours per update.
    \363\ 583 updates x 130 hours = 75,790 hours.
---------------------------------------------------------------------------

    Several commenters noted that some advisers will incur costs in 
creating systems to track which brochure supplements need to be 
delivered to which clients as supervised persons providing investment 
advice to particular clients change over time.\364\ Because most medium 
advisers tend to resemble small advisers in terms of the number of 
employees providing investment advisory services,\365\ we estimate that 
only large advisers will need to design and implement systems to track 
changes in supervised persons providing investment advice to particular 
clients. We estimate that on average each of the 36 large advisers will 
spend 200 hours per year designing and implementing such systems, for a 
total of 7,200 hours per year.\366\
---------------------------------------------------------------------------

    \364\ See, e.g., Schwab Letter; SIFMA Letter; Sutherland Letter.
    \365\ According to IARD data, only 4% of medium advisers report 
in response to Item 5.B(1) of Part 1A of Form ADV that more than 250 
employees perform investment advisory functions.
    \366\ 36 large advisers x 200 hours per year per large adviser = 
7,200 hours per year.
---------------------------------------------------------------------------

    Thus, the rule amendments requiring annual delivery and interim 
updating of advisers' brochures and supplements yields a total 
collection of information burden for rule 204-3 of 386,098 hours per 
year, or 33.1 hours per adviser.\367\ This represents a decrease of 
6,516,180 hours from the currently approved PRA burden.\368\ The 
decreased burden results primarily from our revised estimate of the 
time it will take firms to deliver their brochures, supplements and 
amendments.
---------------------------------------------------------------------------

    \367\ 303,108 hours (initial and annual delivery) + 75,790 hours 
(interim delivery of updates to disciplinary information) + 7,200 
(supplement tracking systems) = 386,098 hours. 386,098 hours/11,658 
advisers = 33.1 hours per adviser.
    \368\ 6,902,278 hours - 386,098 hours = 6,516,180 hours.
---------------------------------------------------------------------------

VII. Cost-Benefit Analysis

A. Background

    The Commission is sensitive to the costs and benefits of its rules. 
This rulemaking will revise Part 2 of Form

[[Page 49260]]

ADV to require advisers to prepare plain English narrative brochures 
discussing their business practices and conflicts of interest and to 
prepare brochure supplements discussing the background and disciplinary 
history of certain supervised persons who formulate investment advice 
or exercise investment discretion for clients. The revisions to the 
form also essentially move into the form itself existing rule 
provisions that require advisers to disclose certain disciplinary and 
financial information.\369\
---------------------------------------------------------------------------

    \369\ Accordingly, the Commission is withdrawing rule 206(4)-4 
as duplicative.
---------------------------------------------------------------------------

    The amendments require that advisers deliver this narrative 
brochure to clients at the outset of the advisory relationship and 
deliver an updated brochure or a summary of material changes to that 
brochure annually thereafter. Advisers generally will have to deliver 
to each client an initial brochure supplement for each supervised 
person who provides advisory services to that client. Advisers must 
deliver to clients interim updates to their brochure and brochure 
supplements that involve a change to disciplinary information required 
by Part 2. The rules provide exceptions to the brochure and supplement 
delivery requirements for certain types of clients, and excuse the 
adviser from preparing a brochure and supplements if there is no client 
to whom they must be delivered. The rule amendments also require 
advisers to file their narrative brochures electronically through the 
IARD, and to keep certain records relating to the brochures and 
supplements.
    We have identified certain costs and benefits, discussed below, 
that may result from the rule and form amendments. In the Proposing 
Release,\370\ we analyzed costs and benefits of the proposed amendments 
to Part 2 and the related rules and requested comment and data on the 
effect they would have on individual investment advisers and on the 
advisory industry as a whole. Several commenters thought that the costs 
of the proposed annual brochure delivery requirement would be 
substantial and would not be offset by a significant corresponding 
benefit since they believed that few clients would read the brochure on 
an annual basis.\371\ We note that, in response to these concerns, we 
have made several changes that are designed to reduce costs to 
advisers, including eliminating the proposed requirement for advisers 
to deliver an updated brochure annually to clients and instead allowing 
advisers to deliver to clients a summary of the material changes made 
to the brochure. Several commenters also argued that the Proposing 
Release had underestimated the costs of the brochure supplement, and 
urged that we not impose this disclosure requirement.\372\ For many of 
the same reasons we discussed in the Paperwork Reduction Act section 
above, we are revising certain estimates of costs as described below.
---------------------------------------------------------------------------

    \370\ See supra note 8.
    \371\ See, e.g., Berlin Letter; CGMI Letter; FSI Letter; Jackson 
Letter; Merrill Lynch Letter.
    \372\ See supra note 298 and accompanying text. These commenters 
often asserted that the costs of the supplement outweighed any 
benefits but did not discuss the benefits the supplement would 
provide to clients and how these benefits may outweigh the costs. In 
addition to the supplement cost estimates in the Merrill Lynch 
Letter and the Morgan Stanley Letter discussed above, the Schwab 
Letter estimated that it would cost it in excess of $5 million to 
design, build, and implement systems associated with supplement 
creation and compliance for its approximately 1,600 investment 
advisory representatives. The SIFMA Letter estimated that the 
supplement would impose industry-wide costs in excess of $100 
million.
---------------------------------------------------------------------------

B. Form ADV Part 2 and IARD Filing

    As discussed above, the revisions to Part 2 require substantially 
all advisers to prepare plain English narrative brochures.\373\ 
Advisers file their brochures electronically through the IARD in a 
process much like attaching a file to an e-mail.
---------------------------------------------------------------------------

    \373\ Under the amendments, advisers that are not required to 
deliver a brochure to clients are not required to prepare one. 
Advisers that provide only impersonal advice costing less than $500 
per year per client, and advisers only to registered investment 
companies or business development companies, therefore, are not 
required to prepare a brochure. We estimate, based on information 
filed with us on Form ADV, that approximately 292 advisers provide 
their services only to registered investment companies and therefore 
would not need to prepare a brochure. Based on Form ADV filings, we 
estimate that 14 advisers offer advisory services only by publishing 
periodicals and newsletters. We estimate that approximately half of 
these charge less than $500 per year per client and would not need 
to prepare a brochure. Moreover, because advisers need not deliver 
supplements to clients that do not receive a brochure, these 
advisers also would be excused from preparing any brochure 
supplements.
---------------------------------------------------------------------------

    The new narrative brochures and electronic filing provide 
substantial benefits to advisory clients and prospective clients. The 
brochures present clients with critically important information they 
need to determine whether to hire or continue the services of a 
particular adviser. This information will be presented in a uniform 
format easy for most investors to understand. Investors searching for 
an adviser will be able to access the firm's brochures through our 
public disclosure Web site even before contacting the firm, and thus 
will be in a better position to know whether they wish to inquire 
further about the services the firm is offering or conflicts raised by 
the adviser's business activities or practices. The narrative brochure 
will enable prospective clients to determine more easily whether they 
wish to engage an adviser that does not have certain conflicts, that 
does not have a disciplinary history, or that does not engage in 
certain business practices. The electronic availability of the 
brochures will provide further benefits. Clients will be able to 
compare business practices, strategies, and conflicts of a number of 
advisers, which may help them to select the most appropriate adviser 
for them. Third parties will be able to access adviser brochure 
information, which would allow academics, businesses and others to 
access additional information about registered investment advisers, 
which they can use to study the industry.
    Brochure supplements will provide benefits to clients and 
prospective clients by providing them, for the first time, with 
information about the educational background, business experience, 
disciplinary history (if any) and conflicts of the individuals 
providing them with investment advice. This information will allow 
clients and prospective clients to determine whether there are 
safeguards or precautions that they would like to take before receiving 
investment advice from that person or whether they would prefer to 
receive investment advice from someone else. A prospective client could 
be satisfied with its selection of an advisory firm based on the firm 
brochure disclosures, but then determine that the firm is not the right 
fit once he or she reviewed the supplements of the actual individuals 
that would provide investment advice to him or her. Alternatively, the 
prospective client could retain the firm but request that other 
individuals provide advice in their place, potentially preventing 
costly or disruptive replacement or termination at a later date. This 
is a substantial improvement over the more limited information 
available today to clients and prospective clients about individuals in 
which clients place great trust.
    To the extent that clients and prospective clients feel more 
confident as a result of the revised brochure that they understand the 
business, practices, and conflicts of an adviser, these clients may be 
more willing to place their trust in investment advisers, seek 
professional investment advice, and invest their financial assets. This 
could have benefits for the clients, and possibly impact capital 
formation and the economy.

[[Page 49261]]

    Most commenters strongly supported the narrative, plain English 
format, and viewed it as a significant improvement over the current 
form.\374\ They agreed that the new brochures would greatly benefit 
clients by requiring advisers to present important information about 
their firms in a clear and more meaningful way.\375\ They observed that 
the enhanced disclosure required by the revised form would benefit 
clients by improving their ability to thoroughly evaluate advisers, 
their business practices and their conflicts of interest,\376\ and by 
better equipping them with the knowledge to make informed decisions 
about whether to hire or retain a particular adviser.\377\ Commenters 
also generally supported making the brochures available to the public 
through the Commission's Web site.\378\
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    \374\ See supra note 16.
    \375\ See, e.g., ICI Letter; MMI Letter; NASAA Letter; 
Wellington Letter.
    \376\ See, e.g., AICPA Letter; Janus Letter.
    \377\ See Consumer Federation Letter.
    \378\ See, e.g., AICPA Letter; CAPIS Letter; CFA Institute 
Letter; CGMI Letter; Fried Frank Letter; NAPFA Letter; NASAA Letter; 
NRS Letter. But see, e.g., Brown Letter; Wernli Letter (stating that 
public Web site disclosure of Part 2 was a violation of an adviser's 
privacy).
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    The new amendments provide significant guidance to advisers in 
terms of highlighting the types of disclosures they, as fiduciaries, 
are already required to make. We believe the enhanced clarity provided 
by the new form will yield substantial benefits for advisers.
    We recognize, however, that revised Part 2 also imposes costs on 
advisers. Advisers will be required to replace their previous Part 2 
with the new narrative brochure and brochure supplements, and will be 
required to file their brochures electronically with us. In addition, 
the disclosure in the new brochure may be more extensive than what was 
previously required, although there is significant overlap between the 
items in new and old Part 2. Drafting the new narrative brochure will 
likely entail additional expenses. As discussed above, we believe that 
most of the costs that advisers will incur in connection with preparing 
the new narrative firm brochure and supplements will be in the initial 
drafting of these documents. We do not, however, expect advisers to 
face substantial costs in gathering the required disclosure. Advisers 
already are required to provide us and/or their clients with much of 
the information required in the new narrative brochure. In addition, 
much of the information needed for the brochure supplements can be 
found in an adviser's current Form ADV or an investment adviser 
representative's registration application (i.e., Form U4) filed with 
state securities authorities.
    The cost of preparing a narrative brochure likely will vary 
significantly among advisers, depending on the complexity of their 
operations and the choices advisers make about how to structure their 
disclosure given the flexibility permitted by Part 2. Some firms may 
choose to prepare multiple brochures for several different services. 
These firms likely will face only incrementally higher drafting costs 
than an advisory firm that uses a single brochure to make the required 
disclosure about the services it provides because there will be 
substantial overlap between the multiple brochures of such advisers. We 
understand that some smaller- and medium-sized firms outsource the 
initial preparation of their brochures to compliance consultants. These 
compliance consultants likely will achieve certain economies of scale 
in preparing many brochures complying with the new Form ADV Part 2 
requirements which may lessen the costs imposed by the amendments on 
these advisers. Because compliance consultants work on many firms Part 
2 disclosures and are familiar with industry practices generally, they 
will begin their review of a firm's Part 2 with more familiarity with 
the requirements of Part 2 and conflicts that should be addressed.
    Most of the comments relating to the costs of the brochure focused 
not on the costs of brochure preparation, but rather on the costs of 
annual delivery of an updated brochure. As noted above, in the rule 
amendments we are adopting today, we are permitting advisers to satisfy 
their annual brochure delivery obligation by delivering a summary of 
material changes to the brochure with information about how clients can 
receive the full updated brochure if they desire. This change should 
reduce costs significantly for advisers relating to annual brochure 
delivery but should improve client experiences with the disclosures 
they receive by focusing their attention on the material changes in the 
brochure. The timing of brochure and supplement delivery should allow 
these documents to be included in other packages that the adviser is 
already mailing to clients, providing additional cost savings. The 
primary comment we received on brochure preparation cost was that we 
had underestimated the time and thus costs of drafting the new 
narrative brochure. As noted above, we have increased this estimate in 
response to these comments.
    Similarly, the costs of preparing brochure supplements will vary 
from one adviser to the next. Costs will vary most significantly 
depending on the number of supervised persons for whom an adviser must 
provide disclosure. An adviser with very few supervised persons for 
whom a supplement must be prepared will incur lower costs than a large 
adviser. Costs associated with preparing supplements also will vary 
greatly depending on the amount of disciplinary information, if any, 
required to be disclosed about a particular supervised person. Many 
large advisers, who will have to prepare the largest number of brochure 
supplements, have significant numbers of supervised persons that are 
also registered representatives of broker-dealers and thus may be able 
to reference the BrokerCheck or IAPD systems for disciplinary 
disclosure, which will reduce preparation costs of the supplement for 
these firms. The preparation of brochure supplements would be most 
demanding for those few advisers whose supervised persons have 
disciplinary records that must be disclosed, and less taxing for the 
vast majority of advisers, whose supervised persons have no 
disciplinary records and whose supplements would therefore likely be a 
page or less in length.\379\
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    \379\ As of May 3, 2010, IARD data indicate that in response to 
Item 11 in Part 1A of Form ADV, only 1,559, or 13%, of the 11,658 
advisers registered with us report any disciplinary information 
about their firms or advisory affiliates, including their advisory 
employees.
---------------------------------------------------------------------------

    Many comments on the brochure supplement asserted that for a large 
adviser registered both as an investment adviser and as a broker-
dealer, the supplement would impose substantial costs in creating 
systems to track this information among a changing group of supervised 
persons providing investment advice. Yet these same commenters also 
often stated that much of the information required by the supplement is 
available on FINRA's BrokerCheck system and thus collected on Form U4. 
Accordingly, we assume that these firms already have in place systems 
to track much of this information for a changing workforce (because 
Form U4 also must be updated as responses to its information requests 
change). Therefore, we believe that the supplement should impose 
negligible new costs in this regard since we believe these same systems 
could be used for supplement information tracking at negligible 
additional costs. We also are allowing advisers that have supervised 
persons with disciplinary information available through

[[Page 49262]]

BrokerCheck or IAPD to reference that information in their 
electronically delivered supplements rather than reproducing that 
information in the supplement. This also should further decrease the 
costs and burdens cited by these firms in their comment letters. We do 
recognize, however, that large advisers may need to implement systems 
to track which supplements need to be provided to which clients as 
personnel advising clients will change from time to time. In our 
Paperwork Reduction Act analysis, we added an estimate of the burden 
for designing and implementing these systems and the cost estimate for 
this burden is reflected below.
    We expect that only a few advisers would incur substantial costs in 
preparing supplements. IARD data indicate that less than one third of 
one percent of advisers registered with us has over 1,000 employees 
performing investment advisory functions on their behalf.\380\ Indeed, 
less than five percent of our registrants have over 50 employees 
performing investment advisory functions. The vast majority of SEC-
registered advisers--approximately 81 percent--have 10 or fewer 
employees performing advisory functions on their behalf. We believe 
most, if not all, of these firms may choose to incorporate required 
information about their supervised persons into their firm brochures 
instead of preparing separate brochure supplements, thus reducing costs 
of preparation.
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    \380\ Moreover, it may not be necessary to prepare a brochure 
supplement for all of these employees.
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    For purposes of the Paperwork Reduction Act, we have estimated the 
number of hours the average adviser would spend in the initial 
preparation of its brochure and supplements.\381\ Based on those 
estimates, we estimate that advisers would incur costs of approximately 
$33,639,980 in drafting these documents in the first year.\382\ 
Furthermore, for Paperwork Reduction Act purposes we also have 
estimated that advisers may incur costs of approximately $22,775,400 in 
connection with their use of outside legal services and compliance 
consulting services to assist in preparation of their Form ADV.
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    \381\ See Section VI.A of this Release. Unless otherwise noted, 
the IARD data cited below is based on advisers' responses to 
questions on Part 1A of Form ADV as of May 3, 2010.
    \382\ We expect that this function will most likely be performed 
by a senior compliance examiner at small firms, a compliance manager 
at medium firms, and a compliance attorney at large firms. Data from 
the Securities Industry and Financial Markets Association's Report 
on Management & Professional Earnings in the Securities Industry 
2008, modified to account for an 1,800-hour work-year and multiplied 
by 5.35 to account for bonuses, firm size, employee benefits and 
overhead, suggest that costs for these positions are $212, $258, and 
$270 per hour, respectively. Based on the number of small, medium 
and large advisers (and assuming that the 1,000 additional advisers 
per year are small advisers as is typically the case), this results 
in a blended rate of $220 per hour. ((10,482 small advisers x $212) 
+ (2,140 medium advisers x $258) + (36 large advisers x $270)) 
divided by 12,658 advisers = $220. 152,909 hours x $220 per hour = 
$33,639,980.
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    Advisers will incur annual expenses in addition to the initial 
costs of preparing firm brochures and supplements, but we believe these 
costs will be modest and similar to current costs. The rule amendments, 
similar to the current requirements, would require advisers to revise 
their disclosure documents promptly when any information in them 
becomes materially inaccurate, and would require advisers to update 
their brochures each year at the time of their required annual updating 
amendment. For Paperwork Reduction Act purposes, we have estimated that 
advisers in the aggregate would spend 87,435 hours per year on Part 2 
amendments. We estimate that advisers would incur annual costs of 
$12,153,465 in meeting these requirements.\383\ We also estimated for 
Paperwork Reduction Act purposes that advisers would spend some time 
creating brochure supplements for new employees hired each year. We 
estimate that advisers would incur annual costs of $1,620,462 in 
creating these new supplements.\384\
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    \383\ We expect that preparing the amendments to Part 2 will 
also most likely be performed equally by compliance managers (as 
described in supra note 382) and compliance clerks. Data from the 
Securities Industry and Financial Markets Association's Report on 
Management & Professional Earnings in the Securities Industry 2008, 
modified to account for an 1,800-hour work-year and multiplied by 
2.93 to account for bonuses, firm size, employee benefits and 
overhead, suggest that costs for a compliance clerk is $63 per hour. 
Blending this rate with the blended rate for a compliance manager of 
$215 per hour results in a cost per hour of $139. ($63 x 0.5) + 
($215 x 0.5) = $139. 87,435 hours per year for amendments x $139 per 
hour = $12,153,465.
    \384\ We expect that preparing the new supplements will most 
likely be performed equally by compliance managers (as described in 
supra note 382) and compliance clerks. The blended rate for this 
work is $139 per year. See supra note 383. 11,658 hours per year for 
new supplements x $139 per hour = $1,620,462.
---------------------------------------------------------------------------

    Finally, advisers would incur some costs in filing their brochures 
with us through the IARD. Advisers would prepare their brochures on 
their own computers and, as noted earlier, the filing of a brochure 
would be similar to attaching a file to an email.\385\ We believe 
conversion of an adviser's brochure to PDF format and filing of that 
brochure through the IARD would impose minimal costs on advisers.
---------------------------------------------------------------------------

    \385\ We note that all advisers registered with the Commission 
currently file Form ADV electronically via the IARD system and, 
since implementation of the electronic filing requirements in 2000, 
no adviser has applied for a permanent hardship exemption available 
to advisers for whom filing electronically would constitute an undue 
hardship. See rule 203-3(b) [17 CFR 275.203-3(b)].
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C. Brochure and Supplement Delivery

    Advisers will be required to deliver their updated brochure or a 
summary of material changes in their brochure to clients annually. The 
amended rules require that, between annual brochure deliveries, 
advisers deliver brochure and supplement amendments to existing clients 
only if there is an addition or change to disciplinary disclosure.
    Advisers already are required to deliver a copy of Part 2 to new 
clients. Thus, this requirement should present no new costs to 
advisers. Moreover, we believe that because advisers must deliver 
brochures to new clients, the cost of delivering brochure supplements 
to new clients should not increase the existing cost of delivery. 
Annual delivery of the updated brochures or summary of material changes 
in the advisers' brochures will benefit advisory clients by ensuring 
that they are kept apprised of material changes to their advisers' 
business practices and procedures for managing conflicts and will 
enable clients to make decisions with respect to the adviser using the 
most currently available information. The shorter summary will focus 
clients' attention on the material changes in its adviser's business 
practices and conflicts and, unlike the prior annual offer requirement, 
permit them to evaluate when they would like a full copy of the 
brochure or to determine whether they want to take some other action in 
response to the change. Previously, clients were just given notice that 
they could request an updated brochure. In those circumstances, the 
client would have to read through the entire brochure and try to 
determine what had changed. Many clients may have determined that this 
would not be a fruitful exercise and thus declined to request the 
brochure. Now clients will be able to easily determine what has changed 
in the brochure and thus decide if they would like to take any action 
in response.
    In addition, we believe that changes to disciplinary information 
disclosed in the brochure and supplements are of such importance to 
clients that they merit interim delivery of these amendments. This 
disciplinary information reflects on the integrity of the advisory firm 
and the individuals providing the client with advice. Given

[[Page 49263]]

that clients entrust their financial assets and financial well being to 
these firms and individuals, this information is vital to clients. 
Moreover, advisers are already required to make disclosures regarding 
disciplinary information under rule 206(4)-4. Based on the experiences 
of examination staff, we believe that most advisers likely already make 
these disclosures in writing so that they can demonstrate compliance 
with the requirements of rule 206(4)-4 and thus are unlikely to incur 
additional costs as a result of this requirement. The brochure 
supplement will increase costs relating to disseminating disciplinary 
disclosure, but it will not impose new costs in collecting this 
information since firms already had to collect this information to 
respond to Part 1A of Form ADV. The cost of disseminating brochure 
supplements is reflected below.
    For Paperwork Reduction Act Purposes, we have estimated that the 
total annual paperwork burden associated with annual and interim 
delivery of brochures, supplements and the summary of material changes 
is approximately 386,098 hours. This includes estimated time for large 
advisers to design and implement systems to track that the right 
supplements are delivered to the right clients as personnel providing 
investment advice to those clients change. We estimate the burden 
associated with annual and interim delivery of brochures, supplements 
and the summary of material changes would represent an annual cost of 
$18,918,802.\386\
---------------------------------------------------------------------------

    \386\ Based on data from the Securities Industry and Financial 
Markets Association's Report on Management & Professional Earnings 
in the Securities Industry 2008, modified to account for an 1,800-
hour work-year and multiplied by 2.93 to account for bonuses, firm 
size, employee benefits and overhead, we expect that delivery of 
amendments to Part 2 will also most likely be performed by a clerk 
at an estimated cost for a general clerk of $49 per hour. 386,098 
hours x $49 = $18,918,802. We estimate that advisers will not incur 
any incremental postage costs in these mailings because we assume 
that advisers will mail annual summary of material changes with 
another mailing the adviser was already delivering to clients and 
that advisers were already delivering to clients disclosure of new 
material disciplinary events on an interim basis under rule 206(4)-
4.
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    Advisers may significantly minimize the costs associated with 
delivery of brochures, supplements and the summary of material changes 
by arranging to deliver these documents to some or all clients by 
electronic media.\387\ Advisers also may minimize delivery costs by 
mailing some of these documents along with quarterly statements or 
other routine mailings they already send to clients. No commenters 
indicated the extent to which they collectively mail such documents. 
Our rule and form amendments do not require advisers to take advantage 
of any of these cost saving options--advisers alone bear this choice. 
Accordingly, the extent to which advisers will take advantage of these 
and other techniques to reduce costs is difficult to predict, but we 
believe it will be significant.
---------------------------------------------------------------------------

    \387\ See Instruction 3 for Part 2A of Form ADV, which refers to 
the Commission's interpretive guidance on electronic delivery. See 
also supra note 198 for additional discussion of electronic 
delivery.
---------------------------------------------------------------------------

D. Amendments to Rule 204-2

    The amendments to rule 204-2 require registered advisers to retain 
certain records relating to brochures and supplements. These records 
will benefit our examination staff by enhancing their ability to 
determine advisers' compliance with Form ADV's requirements. One of the 
revisions to the rule requires advisers to retain copies of brochure 
supplements and separate summaries of material changes prepared as 
required by Part 2. This provision generally imposes no additional 
costs because advisers currently are required to retain records 
relating to materials they distribute to their clients. Other revisions 
to the rule require advisers to maintain certain records in the event 
they use an alternative method to calculate assets under management in 
response to Item 4.E of Part 2A and if they do not disclose in their 
brochure a presumptively material legal or disciplinary event listed in 
Item 9 of Part 2A or Item 3 of Part 2B. These provisions benefit 
advisers by permitting them flexibility in drafting their firm 
brochures and supplements while providing for maintenance of records 
needed by our examination staff. Because we anticipate that only a 
relatively small number of advisers will be subject to these 
provisions, we expect that the cost of maintaining these records will 
be relatively minimal. We estimate that advisers would incur annual 
costs of $595,280 in meeting these requirements.\388\
---------------------------------------------------------------------------

    \388\ For Paperwork Reduction Act purposes we estimate that only 
506 advisers will be required to prepare additional records in 
accordance with the amendment to rule 204-2 and that each adviser 
would spend approximately four hours to satisfy the obligation for a 
total burden of 2,024 hours per year and that such advisers will 
incur $150,000 per year in outside legal expenses relating to such 
records. We expect that preparing the records will most likely be 
performed by compliance managers (as described in supra note 382). 
2,024 hours x $220 per hour = $445,280. $445,280 + $150,000 = 
$595,280.
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VIII. Final Regulatory Flexibility Analysis

    We have prepared this Final Regulatory Flexibility Analysis (FRFA) 
in accordance with section 4(a) of the Regulatory Flexibility Act 
(RFA).\389\ It relates to the amendments to rules 203-1, 204-1, 204-2, 
204-3, and 206(4)-4, and Form ADV under the Advisers Act. The rule and 
form amendments are designed to improve the disclosure that investment 
advisers provide to their clients. These amendments also revise the 
instructions for updating and filing Form ADV (including adviser 
brochures). We also are adopting conforming rule amendments that revise 
the recordkeeping requirements relating to Part 2 of Form ADV.
---------------------------------------------------------------------------

    \389\ 5 U.S.C. 604(a).
---------------------------------------------------------------------------

    We included in the Proposing Release an Initial Regulatory 
Flexibility Analysis (IFRA). We received no comments specifically on 
that IRFA.

A. Need for the Rule and Form Amendments

    The rule and form amendments are necessary to improve the quality 
of disclosure that advisers provide to their clients.\390\ Form ADV 
with its two parts was adopted by the Commission in 1979 and advisers 
use it to register with the Commission (Part 1A) and to provide clients 
disclosure about their advisory firm and personnel (Part 2).\391\ Over 
the years, however, experience has shown that the format and content of 
the previous Part 2 of Form ADV did not lend themselves to disclosure 
that is easy for clients to understand. Clients need clearer 
information about an adviser's services, fees, business practices, and 
conflicts of interests to be able to make an informed decision about 
whether to hire or retain that adviser.
---------------------------------------------------------------------------

    \390\ Sections I through IV of this Release describe in more 
detail the reasons for the amendments.
    \391\ See 1979 Adopting Release, supra note 6.
---------------------------------------------------------------------------

B. Significant Issues Raised by Public Comment

    In the Proposing Release, we requested comment on the IRFA. None of 
the comment letters specifically addressed the IRFA. A few commenters 
made specific comments about the proposed rule and form amendments' 
impact on smaller advisers. One commenter was concerned that disclosure 
of assets under management and financial information would unduly 
discriminate against smaller advisers.\392\ As we discussed above with 
respect to Item 18 of Part 2, we believe that a client that becomes a 
creditor of an adviser because it prepays fees would

[[Page 49264]]

want information about the adviser's financial condition. In addition, 
this information is currently required to be disclosed to clients, and 
the commenter did not persuade us that it should be omitted. Another 
commenter stated that Item 8's requirement that advisers primarily 
using a particular strategy discuss the risks involved in its strategy 
discriminates against smaller firms who are less likely to be multi-
strategy firms.\393\ As discussed earlier in this Release,\394\ we 
agree that advisers should disclose material risks associated with 
their strategies, regardless of whether they use one strategy or many 
strategies but believe that the brochure may not always be the best 
place for a multi-strategy adviser to disclose these risks. Another 
commenter suggested that we permit smaller advisers to provide short-
form brochures.\395\ As discussed earlier in the release,\396\ we have 
not determined to shorten the brochure for any type of advisers because 
we believe that the brochure contains important information upon which 
clients rely and much of which advisers are already required to make to 
satisfy their fiduciary duty to their clients. We have, however, 
allowed advisers to satisfy their annual brochure delivery obligation 
by delivering a summary of material changes in their brochure to their 
clients.
---------------------------------------------------------------------------

    \392\ Verbeck Letter.
    \393\ NAPFA Letter.
    \394\ See supra notes 71-75 and accompanying text.
    \395\ NSCP Letter.
    \396\ See supra notes 25-28 and accompanying text.
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C. Small Entities Subject to the Rules

    In developing the amendments, we have considered their potential 
impact on small entities that may be affected. The rule and form 
amendments will affect all advisers registered with the Commission, 
including small entities. Under Commission rules, for purposes of the 
Regulatory Flexibility Act, an investment adviser generally is a small 
entity if it: (i) Has assets under management having a total value of 
less than $25 million; (ii) did not have total assets of $5 million or 
more on the last day of its most recent fiscal year; and (iii) does not 
control, is not controlled by, and is not under common control with 
another investment adviser that has assets under management of $25 
million or more, or any person (other than a natural person) that had 
$5 million or more on the last day of its most recent fiscal year.\397\
---------------------------------------------------------------------------

    \397\ See rule 0-7 [17 CFR 275.0-7].
---------------------------------------------------------------------------

    Our rule and form amendments will not affect most advisers that are 
small entities (``small advisers'') because they are generally 
registered with one or more state securities authorities and not with 
us. Under section 203A of the Advisers Act, most small advisers are 
prohibited from registering with the Commission and are regulated by 
state regulators.\398\ The Commission estimates that as of May 3, 2010, 
of the 11,658 registered with us, there were approximately 708 that 
were small entities that would be affected by the amendments.\399\
---------------------------------------------------------------------------

    \398\ National Securities Markets Improvement Act of 1996 (Pub. 
L. 104-290, 110 Stat. 3438) (1996) (``NSMIA''). As a result of 
NSMIA, advisers with less than $25 million of assets under 
management generally are regulated by one or more state securities 
authority, while the Commission generally regulates those advisers 
with at least $25 million of assets under management. See section 
203A of the Advisers Act [15 USC 80b-3a].
    \399\ This estimate is based on information advisers have filed 
with the Commission on Part 1A of Form ADV as of May 3, 2010.
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D. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements

    The rule and form amendments impose certain reporting and 
compliance requirements on small advisers, requiring them to create and 
update narrative brochures containing certain information regarding 
their advisory business. The amendments also require advisers to 
deliver their brochures to clients and to file them electronically 
through the IARD. The amendments also impose new recordkeeping 
requirements. These requirements and the burdens on small advisers are 
discussed below.\400\
---------------------------------------------------------------------------

    \400\ Sections I through IV of this Release describe these 
requirements in more detail.
---------------------------------------------------------------------------

1. Amendments to Part 2 of Form ADV
    The amendments to Part 2, because they require registered advisers 
to prepare and disseminate narrative brochures, impose additional costs 
on all registered advisers, including small advisers. We assume that 
all small advisers previously distributed Part 2 of Form ADV and did 
not draft the optional narrative brochure. If our assumption is 
correct, these advisers would have to redraft their brochures 
completely to comply with the new format, although a lot of information 
in the previous Part 2 will be transferable to the new narrative 
brochures.
    The costs associated with preparing the new brochures will depend 
on the size of the adviser, the complexity of its operations, and the 
extent to which its operations present conflicts of interest with 
clients. Many of the new items imposing the most rigorous disclosure 
requirements may not apply to certain small advisers because, for 
example, those advisers may not have soft dollar or directed brokerage 
arrangements, or may not have custody of client assets. However, 
certain of the brochure compliance costs may be fixed and thus impose a 
disproportionate impact on small advisers. To the extent that some of 
the new disclosure burdens would apply to small advisers, these 
advisers are already obligated to make the disclosures to clients under 
the Advisers Act's antifraud provisions, although the disclosure 
currently is not required to be in the firm's written brochure.
    For the first time, advisers also will be required to prepare and 
disseminate brochure supplements for certain supervised persons of 
their firm. To reduce the burdens on small advisers, however, we have 
drafted the new supplement rules so that firms with few employees would 
be permitted to include supplement information in their firm brochures 
and may choose to avoid preparing and distributing separate brochure 
supplements. We believe many small advisers would take advantage of 
this option and reduce their compliance burden. We also note that small 
advisers are unlikely to have many supervised persons for whom a 
brochure supplement is required, so the supplement should impose a 
proportionately smaller burden on small advisers. The rule amendments 
may increase compliance costs for investment advisers. Certain of these 
increased compliance costs attributable to supplements may be fixed and 
thus impose a disproportionate impact on small advisers.
2. Updating and Delivery Requirements
    The amended rules, like the prior rules, require advisers to update 
their brochures and supplements whenever information in them becomes 
materially inaccurate. In updating its brochure and supplements on an 
interim basis, an adviser may minimize its burden by delivering a 
statement describing this updated information instead of reprinting its 
entire brochure or supplement.
    The amendments require advisers to deliver an updated brochure or a 
summary of material changes in the adviser's brochure to clients 
annually and to deliver interim updates of the brochure and supplements 
to clients to disclose new or revised disciplinary information. To 
minimize the burden of delivery, advisers are permitted with client 
consent to deliver brochures, supplements and the summary of material 
changes, as well as updates, electronically.\401\ To the extent that 
small advisers are more likely to have

[[Page 49265]]

fewer advisory clients than larger advisers, the delivery requirements 
should impose lower costs on small advisers than on larger firms.
---------------------------------------------------------------------------

    \401\ See supra notes 196-198.
---------------------------------------------------------------------------

3. Recordkeeping Requirements
    The amendments impose new recordkeeping requirements on advisers, 
including small advisers. As under the previous rules, advisers will be 
required to maintain copies of their brochures. The amendments also 
require all advisers to maintain copies of their brochure supplements. 
Advisers will be required to maintain a copy of any summary of material 
changes in their brochure that is separate from the brochure. In 
addition, the amendments require advisers, including small advisers, to 
maintain certain records if they determine that a disciplinary event 
that is presumptively material does not have to be disclosed, or if 
they calculate their managed assets for purpose of their brochures 
differently than in Part 1A of Form ADV.

E. Agency Action To Minimize Effect on Small Entities

    We have considered various alternatives in connection with the rule 
and form amendments that might minimize their effect on small advisers, 
including: (i) Establishing different compliance or reporting 
requirements or timetables that take into account the resources 
available to small advisers; (ii) clarifying, consolidating, or 
simplifying compliance and reporting requirements under the proposed 
amendments for small advisers; (iii) using performance rather than 
design standards; and (iv) exempting small advisers from coverage of 
all or part of the proposed amendments.
    Regarding the first alternative, the Commission believes that 
establishing different compliance or reporting requirements for small 
advisers would be inappropriate under these circumstances. The 
amendments are designed to improve the quality and timeliness of 
critically important disclosure that advisory clients receive from 
their advisers. To establish different disclosure requirements for 
small entities would diminish this investor protection for clients of 
small advisers. We note, however, that small advisers, by the nature of 
their business, likely would spend fewer resources in completing their 
brochures and any brochure supplements. Small advisers have few 
supervised persons providing investment advice, so they will need to 
prepare few brochure supplements. Moreover, certain rule and form 
amendments were designed specifically to reduce the burden on small 
advisers. For example, the Part 2 instructions give advisers the 
flexibility to incorporate required information about their supervised 
persons into their firm brochures rather than presenting it in separate 
brochure supplements, thereby saving additional printing and mailing 
costs.
    Regarding the second alternative, the amendments clarify 
requirements for all advisers, including small advisers. The amended 
Part 2 instructions are designed to present requirements for advisers' 
brochures and supplements clearly and simply to all advisers, including 
small entities.
    Regarding the third alternative, the Commission believes that the 
amendments already appropriately use performance rather than design 
standards in many instances. The amendments permit advisers flexibility 
in designing their brochures and supplements so as best to communicate 
the required information to clients. In preparing brochure supplements, 
advisers also have the flexibility of adapting the format of the 
supplements to best suit their firm. An adviser may: (i) Prepare a 
separate supplement for each supervised person; (ii) prepare a single 
supplement containing the required information for all of its 
supervised persons; (iii) prepare multiple supplements for groups of 
supervised persons (e.g., all supervised persons in a particular office 
or work group); or (iv) include all information about supervised 
persons in the firm brochure and prepare no separate supplements.\402\ 
The amendments clarify that advisers may, with client consent, deliver 
their brochures and supplements, along with any updates, to clients 
electronically.\403\ Advisers may incorporate their supplements into 
the brochure or provide them separately.
---------------------------------------------------------------------------

    \402\ See Section II.B of this Release. A brochure supplement, 
however, must be organized in the same order, and use the same 
headings, as the items appear in the form, whether incorporated in a 
brochure or provided separately. See Instruction 1 of General 
Instructions for Part 2 of Form ADV.
    \403\ See supra notes 196-198.
---------------------------------------------------------------------------

    Regarding the fourth alternative, it would be inconsistent with the 
purposes of the Advisers Act to exempt small advisers from the rule and 
form amendments. The information in an adviser's brochure is necessary 
for the client to evaluate the adviser's services, fees, and business 
practices, and to apprise the client of potential conflicts of interest 
and, when necessary, of the adviser's financial condition. Since we 
view the protections of the Advisers Act to apply equally to clients of 
both large and small advisers, it would be inconsistent with the 
purposes of the Act to specify different requirements for small 
entities.

IX. Efficiency, Competition, and Capital Formation

    Section 23(a)(2) of the Exchange Act requires the Commission, in 
adopting rules under the Exchange Act, to consider the impact that any 
new rule would have on competition, and prohibits the Commission from 
adopting any rule that would impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.\404\ Section 3(f) of the Exchange Act requires the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest to 
consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital 
formation.\405\ Section 202(c) of the Advisers Act requires the 
Commission, when engaging in rulemaking that requires it to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to consider, in addition to the protection of investors, 
whether the action will promote efficiency, competition, and capital 
formation.\406\
---------------------------------------------------------------------------

    \404\ 15 U.S.C. 78w(a)(2).
    \405\ 15 U.S.C. 78c(f).
    \406\ 15 U.S.C. 80b-2(c).
---------------------------------------------------------------------------

    In the Proposing Release, we solicited comment on whether, if 
adopted, the proposed rule and form amendments would promote 
efficiency, competition and capital formation. We further encouraged 
commenters to provide empirical data to support their views on any 
burdens on efficiency, competition or capital formation that might 
result from adoption of the proposed amendments. We did not receive any 
empirical data in this regard concerning the proposed amendments. We 
received one comment stating that the proposed amendments would not 
promote efficiency, competition, and capital formation, but the 
commenter did not state why.\407\ Accordingly, since the

[[Page 49266]]

adopted rule and form amendments are similar to the proposed rule and 
amendments, we continue to believe the amendments will contribute to 
efficiency, competition and capital formation.
---------------------------------------------------------------------------

    \407\ Jackson Letter. Another commenter stated that the 
requirement to disclose the amount of assets under management in the 
brochure would discriminate against smaller firms because of a 
perceived notion that a larger company does a better job. See 
Verbeck Letter. As discussed at supra 181 and accompanying text, 
assets under management is an objective measure that provides 
important information to clients. Clients have different preferences 
and some, for example, may view a smaller adviser as being more 
likely to provide more personal service. In addition, the NAPFA 
Letter stated that Item 8's requirement that advisers primarily 
using a particular strategy discuss the risks involved in its 
strategy discriminates against smaller firms who are less likely to 
be multi-strategy firms. As discussed at supra notes 72-75 and 
accompanying text, we disagree.
---------------------------------------------------------------------------

    Today the Commission is adopting amendments to Part 2 of Form ADV 
and related Advisers Act rules that would require investment advisers 
registered with us to deliver to clients and prospective clients 
brochures and brochure supplements written in plain English. We believe 
that the rule and form amendments that we are adopting today are likely 
to promote efficiency and competition in the marketplace for advisory 
services provided by advisers registered with us by improving the 
disclosure that they must provide to clients.\408\ These amendments are 
designed to require advisers to provide clients and prospective clients 
with clear, current, and more meaningful disclosure of the business 
practices, conflicts of interest, and background of investment advisers 
and the advisory personnel on whom clients rely for investment advice. 
As a result, we believe that advisory clients will be provided with 
improved disclosure from advisers that will allow them to select an 
adviser based on a clearer and more thorough understanding of the 
business practices, conflicts of interest, and disciplinary information 
than exists with the check-the-box format of the current brochure. 
While advisers currently have the option of providing a narrative 
brochure, few do so. Absent the actions we are taking today, based on 
our experience with administering the Advisers Act brochure requirement 
and inefficiencies in the marketplace, we do not believe that advisers 
have adequate incentives to produce clear and understandable brochures. 
We expect the amendments we are adopting today, by requiring clearer 
and more understandable brochures, are likely to increase competition 
among advisers.
---------------------------------------------------------------------------

    \408\ Along with the brochure amendments, the Commission also is 
adopting conforming amendments to the General Instructions and 
Glossary of Form ADV to include instructions regarding brochure 
filing requirements and to add glossary terms and definitions that 
are used in Part 2. Additionally, the Commission also is adopting 
conforming amendments to the Advisers Act books and records rule. 
These amendments require advisers to maintain copies of their 
brochures, brochure supplements, amendments, and summaries of 
material changes, and are intended to update the books and records 
rule in light of our changes to Part 2. None of these conforming 
amendments are expected to have an independent impact on efficiency, 
competition, or capital formation. To the extent that they 
facilitate the purposes of the amendments, the conforming amendments 
may, however, contribute to the expected effects on efficiency, 
competition and capital formation that would stem from the 
amendments and which are discussed below.
---------------------------------------------------------------------------

    Advisers will file their brochures with us electronically, and we 
will make them available to the public through our website. Today, 
while advisers' brochures are ``deemed'' filed with us, it is difficult 
for the public to obtain them unless the adviser provides a brochure 
upon request or makes it available on its own website, which also makes 
it very difficult for prospective clients to compare more than a few 
investment advisers. With the public availability through our website 
of more thorough and current disclosure of advisers' services, fees, 
business practices and conflicts of interests, investors will be able 
to make more informed decisions about whether to hire or retain a 
particular adviser and will have an easier time comparing investment 
advisers. The supplements will allow clients and prospective clients to 
compare the qualifications and conflicts not only of the advisory firm 
but also of the personnel that will be providing investment advice to 
them. By having more information about the individuals and firms 
providing investment advice to them, as well as the ability to compare 
advisory firms, a client may be more likely to select initially an 
appropriate investment adviser for that client, promoting competition 
on the basis of improved disclosure of conflicts of interest and 
business practices and avoiding the burdens and costs associated with 
switching advisers or supervised persons at a later date, and thereby 
potentially creating efficiency gains in the marketplace. The 
availability of this information about advisers and their personnel 
also may enhance competition if, for example, firms and personnel with 
better disciplinary records outcompete those with worse records. 
Secondarily, the electronic filing requirements are expected to 
expedite and simplify the process of filing firm brochures and 
amendments for the advisory firms, thus improving the efficiency of 
advisers that are required to file and update the brochure.
    A few commenters stated that certain information required to be 
disclosed in the brochure is duplicative of information required to be 
reported in Part 1A of Form ADV and that such information should only 
be required disclosure in one place in Form ADV.\409\ While we are 
conscious of these commenters' goal of generating efficiency by 
eliminating duplicative disclosure in Form ADV, we do not believe that 
it is appropriate to allow disclosure in Part 1A to satisfy disclosure 
obligations in Part 2B, or vice versa, because, these parts serve 
different functions and clients and prospective clients access these 
documents in different ways. Part 1A is used for regulatory purposes 
and thus the information it collects is that which our examination 
staff has identified as important for us to have for our examination 
program and other regulatory functions. While an adviser's responses to 
Part 1A of Form ADV generally are available to the public through our 
website, they are not delivered to clients or prospective clients and 
they are not written in a manner designed to be meaningful to clients 
or prospective clients--rather they are largely a series of ``check-
the-box'' responses. Part 2A of Form ADV, on the other hand, is 
disclosure aimed at and delivered to clients and prospective clients. 
Accordingly, while certain topics of disclosure may be covered by both 
parts, we believe the different functions of, and delivery methods for, 
these two parts justifies the replication of disclosure topics.
---------------------------------------------------------------------------

    \409\ See, e.g., ACLI Letter; IAA Letter.
---------------------------------------------------------------------------

    On the other hand, the amendments we are adopting today are 
designed to generate efficiencies and reduce duplicative disclosure by 
allowing an adviser who sends supplements electronically, and whose 
supervised persons have disciplinary disclosure available on FINRA's 
BrokerCheck system or the IAPD system, to respond to those portions of 
Item 3 of the brochure supplement by including in the brochure 
supplement (i) a statement that the supervised person has a 
disciplinary history, the details of which can be found on FINRA's 
BrokerCheck system or the IAPD, and (ii) a hyperlink to the relevant 
system with a brief explanation of how the client can access the 
disciplinary history. In this instance, we believe that permitting 
cross-referencing is appropriate since it will only be allowed if the 
supplement is delivered electronically and the disclosure is 
duplicative. The BrokerCheck and IAPD systems are aimed at investor 
disclosure and are designed to be user-friendly, and clients will still 
receive delivery of a supplement which contains the other information 
(e.g., educational background and other business activities) about that 
supervised person.
    In addition to the competitive impact mentioned above, we believe 
that the rule amendments may have certain other impacts on competition. 
The brochure supplement may impose greater costs on larger advisers 
that have

[[Page 49267]]

to create systems to track appropriate delivery of supplements that 
smaller advisers would not need. To the extent these costs are passed 
on to clients, a client's choice of investment advisers may be 
impacted. As we noted in the Cost-Benefit Analysis section above, 
however, many of these systems costs should be mitigated by systems 
that large advisers already have in place to track Form U4 information 
for their investment advisory representatives and broker-dealer 
registered representatives, which these firms should be able to 
leverage for use in the brochure supplement context. The rule 
amendments also may increase compliance costs for investment advisers. 
Certain of these increased compliance costs may be fixed and thus 
impose a disproportionate impact on small advisers, which may have 
anticompetitive impacts on small advisers.
    The competitive impacts discussed previously primarily focused on 
the impact of the rule amendments on investment advisers that are 
registered with us. We acknowledge that there may also be competitive 
impacts as a result of the amendments between those persons providing 
investment advice that are, and those that are not, registered with us 
as investment advisers. For example, banks, insurance companies, 
broker-dealers, and exempt advisers provide financial services that may 
compete, in some cases, for the same clients that would retain SEC-
registered investment advisers. We have carefully considered the 
potential competitive implications of these rule amendments and do not 
believe that they will put advisers registered with us at a significant 
competitive disadvantage. Moreover, notwithstanding the potential 
competitive effect, we believe that the concerns that the amendments 
are designed to address justify adoption of the rule amendments. 
Pursuant to Section 23(a)(2) of the Exchange Act, the Commission does 
not believe that the amendments to Form ADV impose a burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.
    As stated previously, the rule amendments are designed to provide 
advisory clients with clearer, more concise and understandable 
information regarding the business practices and conflicts of interest 
of investment advisers. Improved disclosure by SEC-registered 
investment advisers could result in enhanced efficiencies for clients 
in selecting an investment adviser and improved allocation of client 
assets among investment advisers. To a more limited extent, if better 
disclosure increases clients' and prospective clients' trust in 
investment advisers, it may encourage them to seek professional 
investment advice and encourage them to invest their financial assets. 
This also may enhance capital formation by making more funds available 
for investment and enhancing the allocation of capital generally. On 
the other hand, if the rule amendments increase costs at investment 
advisers and these costs increases are passed on to clients, this may 
deter clients from seeking professional investment advice and investing 
their financial assets. This may result in inefficiencies in the market 
for advisory services and hinder capital formation.

X. Statutory Authority

    We are adopting amendments to rule 203-1 under sections 203(c)(1), 
204, and 211(a) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-
3(c)(1), 80b-4, and 80b-11(a)].
    We are adopting amendments to rule 204-1 under sections 203(c)(1) 
and 204 of the Investment Advisers Act of 1940 [15 U.S.C. 80b-3(c)(1) 
and 80b-4].
    We are adopting amendments to rule 204-2 under sections 204 and 
206(4) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-4 and 80b-
6(4)].
    We are adopting amendments to rule 204-3 under sections 204, 
206(4), and 211(a) of the Investment Advisers Act of 1940 [15 U.S.C. 
80b-4, 80b-6(4), and 80b-11(a)].
    We are adopting amendments to rule 279.1, Form ADV, under section 
19(a) of the Securities Act of 1933 [15 U.S.C. 77s(a)], sections 23(a) 
and 28(e)(2) of the Securities Exchange Act of 1934 [15 U.S.C. 78w(a) 
and 78bb(e)(2)], section 319(a) of the Trust Indenture Act of 1939 [15 
U.S.C. 77sss(a)], section 38(a) of the Investment Company Act of 1940 
[15 U.S.C. 78a-37(a)], and sections 203(c)(1), 204, and 211(a) of the 
Investment Advisers Act of 1940 [15 U.S.C. 80b-3(c)(1), 80b-4, and 80b-
11(a)].
    We are removing and reserving rule 206(4)-4 under section 206(4) of 
the Investment Advisers Act of 1940 [15 U.S.C. 80b-6(4)].

List of Subjects in 17 CFR Parts 275 and 279

    Reporting and recordkeeping requirements; Securities.

Text of Rule and Form Amendments

0
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

0
1. The general authority citation for Part 275 continues to read as 
follows:

    Authority:  15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.

* * * * *

0
2. Section 275.203-1 is amended by revising paragraphs (a) and (b) to 
read as follows:


Sec.  275.203-1  Application for investment adviser registration.

    (a) Form ADV. Subject to paragraph (b), to apply for registration 
with the Commission as an investment adviser, you must complete Form 
ADV [17 CFR 279.1] by following the instructions in the form and you 
must file Part 1A of Form ADV and the firm brochure(s) required by Part 
2A of Form ADV electronically with the Investment Adviser Registration 
Depository (IARD) unless you have received a hardship exemption under 
Sec.  275.203-3. You are not required to file with the Commission the 
brochure supplements required by Part 2B of Form ADV.
    (b) Transition to electronic filing. If you apply for registration 
after January 1, 2011, you must file a brochure(s) that satisfies the 
requirements of Part 2A of Form ADV electronically with the IARD, 
unless you have received a continuing hardship exemption under Sec.  
275.203-3.
    Note to paragraphs (a) and (b): Information on how to file with the 
IARD is available on the Commission's Web site at http://www.sec.gov/iard. If you are not required to deliver a brochure to any clients, you 
are not required to prepare or file a brochure with the Commission. If 
you are not required to deliver a brochure supplement to any clients 
for any particular supervised person, you are not required to prepare a 
brochure supplement for that supervised person.
* * * * *

0
3. Section 275.204-1 is amended by removing the notes to paragraphs (a) 
and (c) and revising paragraphs (b) and (c) to read as follows:


Sec.  275.204-1  Amendments to application for registration.

* * * * *
    (b) Electronic filing of amendments. (1) Subject to paragraph (c), 
you must file all amendments to Part 1A of Form ADV and Part 2A of Form 
ADV electronically with the IARD, unless you have received a continuing 
hardship exemption under Sec.  275.203-3. You are not required to file 
with the Commission amendments to brochure

[[Page 49268]]

supplements required by Part 2B of Form ADV.
    (2) If you have received a continuing hardship exemption under 
Sec.  275.203-3, you must, when you are required to amend your Form 
ADV, file a completed Part 1A and Part 2A of Form ADV on paper with the 
SEC by mailing it to FINRA.
    Note to paragraphs (a) and (b): Information on how to file with the 
IARD is available on our Web site at http://www.sec.gov/iard. For the 
annual updating amendment: summaries of material changes that are not 
included in the adviser's brochure must be filed with the Commission as 
an exhibit to Part 2A in the same electronic file; and if you are not 
required to prepare a summary of material changes or an annual updating 
amendment to your brochure, you are not required to file them with the 
Commission. See the instructions for Part 2A of Form ADV.
    (c) Transition to electronic filing. If your fiscal year ends on or 
after December 31, 2010, you must amend your Form ADV by electronically 
filing with the IARD one or more brochures that satisfy the 
requirements of Part 2A of Form ADV (as amended effective October 12, 
2010) as part of the next annual updating amendment that you are 
required to file.
* * * * *

0
4. Section 275.204-2is amended by revising paragraph (a)(14) to read as 
follows:


Sec.  275.204-2  Books and records to be maintained by investment 
advisers.

    (a) * * *
    (14)(i) A copy of each brochure and brochure supplement, and each 
amendment or revision to the brochure and brochure supplement, that 
satisfies the requirements of Part 2 of Form ADV [17 CFR 279.1]; any 
summary of material changes that satisfies the requirements of Part 2 
of Form ADV but is not contained in the brochure; and a record of the 
dates that each brochure and brochure supplement, each amendment or 
revision thereto, and each summary of material changes not contained in 
a brochure was given to any client or to any prospective client who 
subsequently becomes a client.
    (ii) Documentation describing the method used to compute managed 
assets for purposes of Item 4.E of Part 2A of Form ADV, if the method 
differs from the method used to compute assets under management in Item 
5.F of Part 1A of Form ADV.
    (iii) A memorandum describing any legal or disciplinary event 
listed in Item 9 of Part 2A or Item 3 of Part 2B (Disciplinary 
Information) and presumed to be material, if the event involved the 
investment adviser or any of its supervised persons and is not 
disclosed in the brochure or brochure supplement described in paragraph 
(a)(14)(i) of this section. The memorandum must explain the investment 
adviser's determination that the presumption of materiality is 
overcome, and must discuss the factors described in Item 9 of Part 2A 
of Form ADV or Item 3 of Part 2B of Form ADV.
* * * * *

0
5. Section 275.204-3 is revised to read as follows:


Sec.  275.204-3  Delivery of brochures and brochure supplements.

    (a) General requirements. If you are registered under the Act as an 
investment adviser, you must deliver a brochure and one or more 
brochure supplements to each client or prospective client that contains 
all information required by Part 2 of Form ADV [17 CFR 279.1].
    (b) Delivery requirements. Subject to paragraph (g), you (or a 
supervised person acting on your behalf) must:
    (1) Deliver to a client or prospective client your current brochure 
before or at the time you enter into an investment advisory contract 
with that client.
    (2) Deliver to each client, annually within 120 days after the end 
of your fiscal year and without charge, if there are material changes 
in your brochure since your last annual updating amendment:
    (i) A current brochure, or
    (ii) The summary of material changes to the brochure as required by 
Item 2 of Form ADV, Part 2A that offers to provide your current 
brochure without charge, accompanied by the Web site address (if 
available) and an e-mail address (if available) and telephone number by 
which a client may obtain the current brochure from you, and the Web 
site address for obtaining information about you through the Investment 
Adviser Public Disclosure (IAPD) system.
    (3) Deliver to each client or prospective client a current brochure 
supplement for a supervised person before or at the time that 
supervised person begins to provide advisory services to the client; 
provided, however, that if investment advice for a client is provided 
by a team comprised of more than five supervised persons, a current 
brochure supplement need only be delivered to that client for the five 
supervised persons with the most significant responsibility for the 
day-to-day advice provided to that client. For purposes of this 
section, a supervised person will provide advisory services to a client 
if that supervised person will:
    (i) Formulate investment advice for the client and have direct 
client contact; or
    (ii) Make discretionary investment decisions for the client, even 
if the supervised person will have no direct client contact.
    (4) Deliver the following to each client promptly after you create 
an amended brochure or brochure supplement, as applicable, if the 
amendment adds disclosure of an event, or materially revises 
information already disclosed about an event, in response to Item 9 of 
Part 2A of Form ADV or Item 3 of Part 2B of Form ADV (Disciplinary 
Information), respectively, (i) the amended brochure or brochure 
supplement, as applicable, along with a statement describing the 
material facts relating to the change in disciplinary information, or 
(ii) a statement describing the material facts relating to the change 
in disciplinary information.
    (c) Exceptions to delivery requirement. (1) You are not required to 
deliver a brochure to a client:
    (i) That is an investment company registered under the Investment 
Company Act of 1940 [15 U.S.C. 80a-1 to 80a-64] or a business 
development company as defined in that Act, provided that the advisory 
contract with that client meets the requirements of section 15(c) of 
that Act [15 U.S.C. 80a-15(c)]; or
    (ii) Who receives only impersonal investment advice for which you 
charge less than $500 per year.
    (2) You are not required to deliver a brochure supplement to a 
client:
    (i) To whom you are not required to deliver a brochure under 
subparagraph (c)(1) of this section;
    (ii) Who receives only impersonal investment advice; or
    (iii) Who is an officer, employee, or other person related to the 
adviser that would be a ``qualified client'' of your firm under Sec.  
275.205-3(d)(1)(iii).
    (d) Wrap fee program brochures. (1) If you are a sponsor of a wrap 
fee program, then the brochure that paragraph (b) of this section 
requires you to deliver to a client or prospective client of the wrap 
fee program must be a wrap fee program brochure containing all the 
information required by Part 2A, Appendix 1 of Form ADV. Any additional 
information in a wrap fee program brochure must be limited to 
information applicable to wrap fee programs that you sponsor.
    (2) You do not have to deliver a wrap fee program brochure if 
another sponsor of the wrap fee program delivers, to the client or 
prospective client of the wrap fee program, a wrap fee program

[[Page 49269]]

brochure containing all the information required by Part 2A, Appendix 1 
of Form ADV.
    Note to paragraph (d): A wrap fee program brochure does not take 
the place of any brochure supplements that you are required to deliver 
under paragraph (b) of this section.
    (e) Multiple brochures. If you provide substantially different 
advisory services to different clients, you may provide them with 
different brochures, so long as each client receives all information 
about the services and fees that are applicable to that client. The 
brochure you deliver to a client may omit any information required by 
Part 2A of Form ADV if the information does not apply to the advisory 
services or fees that you will provide or charge, or that you propose 
to provide or charge, to that client.
    (f) Other disclosure obligations. Delivering a brochure or brochure 
supplement in compliance with this section does not relieve you of any 
other disclosure obligations you have to your advisory clients or 
prospective clients under any federal or state laws or regulations.
    (g) Transition rule. (1) Within 60 days after the date by which you 
are first required by Sec.  275.204-1(c) to electronically file your 
brochure(s) with the Commission, you must deliver to each of your 
existing clients your current brochure and all current brochure 
supplements as required by Part 2 of Form ADV.
    (2) As of the date by which you are first required to 
electronically file your brochure(s) with the Commission, you must 
begin using your current brochure and current brochure supplements as 
required by Part 2 of Form ADV to comply with the requirements of this 
section pertaining to initial delivery to new and prospective clients.
    (h) Definitions. For purposes of this section:
    (1) Impersonal investment advice means investment advisory services 
that do not purport to meet the objectives or needs of specific 
individuals or accounts.
    (2) Current brochure and current brochure supplement mean the most 
recent revision of the brochure or brochure supplement, including all 
amendments to date.
    (3) Sponsor of a wrap fee program means an investment adviser 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.
    (4) Supervised person means any of your officers, partners or 
directors (or other persons occupying a similar status or performing 
similar functions) or employees, or any other person who provides 
investment advice on your behalf.
    (5) Wrap fee program means an advisory 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 the execution of client transactions.


Sec.  275.206(4)-4  [Removed and Reserved]

0
6. Section 275.206(4)-4 is removed and reserved.

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

0
7. The authority citation for Part 279 continues to read as follows:

    Authority:  15 U.S.C. 80b-1, et seq.

0
8. Form ADV [referenced in Sec.  279.1] is amended by:
0
a. In the instructions to the form, revising the section entitled 
``Form ADV: General Instructions.'' The revised version of Form ADV: 
General Instructions is attached as Appendix A;
0
b. In the instructions to the form, revising the section entitled 
``Glossary of Terms.'' The revised version of Glossary of Terms is 
attached as Appendix B; and
0
c. Removing Form ADV, Part II, and adding Form ADV, Part 2. Form ADV, 
Part 2 is attached as Appendix C.

    Note:  The amendments to and text of Form ADV will not appear in 
the Code of Federal Regulations.

* * * * *
BILLING CODE 8011-01-P

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    Dated: July 28, 2010.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-19617 Filed 8-11-10; 8:45 am]
BILLING CODE 8011-01-C