Institutional investors this year will find significant changes to the Form ADV — filed by investment and fund managers to register with the U.S. Securities and Exchange Commission — due to amendments adopted by the SEC in 2016 and that took effect last October.
Among the many changes made, the most significant are found in Part 1 and require:
- Greater specificity concerning separately managed accounts serviced by the manager and the gross notional exposure from borrowings and derivatives used in the manager's strategy.
- Information concerning "umbrella registrations" for private fund sponsors and any "relying advisers" registered under this ADV.
- Specific identifying information for custodians, compliance consultants and broker-dealers used by the manager.
These changes provide a welcome increase in transparency with respect to the investment strategy and business operations of investment managers. Institutional investors would be well-served to review the new information and compare it to information previously received from their managers.
Separately managed accounts Item 5 of Part 1 requires an investment manager to provide information about its advisory business. In the newly added subsection 5.K., institutional investors will find detailed information on the management of SMAs, including the total assets under management in such accounts and an approximate dollar and percentage breakdown of how this AUM is allocated across 12 predefined asset categories as of the fiscal year-end. If the investment manager has more than $10 billion in assets under management through SMAs, the breakdown must be provided for both the midyear and year-end periods.
Additionally, subsection 5.K. provides information on the use of borrowings and derivatives in the SMAs, including the "gross notional exposure" of such borrowings and the "gross notional value" of the derivatives held in such accounts.
Managers with at least $500 million but less than $10 billion in AUM managed through separately managed accounts provide the year-end breakdown of such dollar amounts among three broad categories of gross notional exposure: less than 10%, 10% to 149% and 150% or more. However, those with at least $10 billion in AUM are also required to report the midyear and year-end gross notional value of derivatives across six categories of exposure: interest rate, foreign exchange, credit, equity, commodity and "other." A manager may also include a narrative description of its use of borrowings and derivatives in its strategies if it believes the gross notional metrics, by themselves, are misleading without further explanation.
After the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which required private investment fund managers to register with the SEC, it was unclear whether separate but affiliated legal entities operating with the manager as a single investment management business were required to register separately. In 2012, the SEC staff issued a no-action letter stating it would not seek enforcement if investment fund managers filed a Form ADV on their own behalf and on behalf of other "relying advisers," such as the affiliated general partners of investment funds.
The recent amendments to the ADV codify this "umbrella registration," provided that a filing manager and relying adviser:
- Only manage private investment funds and separately managed accounts for "qualified clients" as defined under the Investment Advisers Act of 1940.
- Use substantially similar investment strategies.
- Are essentially under common control.
The amended Part 1 Item 1.B. and the new Schedule R provide a list of those entities the manager considers "relying advisers" and information about each. This list includes identifying information, the basis for the relying adviser's SEC registration and information about its direct and indirect ownership. If the relying adviser is associated with a private investment fund listed on Schedule D of the ADV, this is indicated and cross-referenced, providing institutional investors a clearer picture of the structure of its manager's private investment funds.
In addition to the new information regarding SMAs and relying advisers, institutional investors will find greater detail throughout Part 1 regarding disclosure of any social media accounts where a manager controls the content and the address of each such website or social media page, as well as a breakdown of the number of clients and the amount of AUM among 12 predetermined categories, and the number of clients for whom advisory services are provided but for which there is no AUM (e.g., research and reporting clients).
Institutional investors also will discover whether the manager outsources the role of chief compliance officer rather appointing an employee of the firm and be provided with the SEC's (and the Public Company Accounting Oversight Board's) identifying numbers for custodians, accounting and audit firms, and any relying advisers and private investment funds managed by the investment manager.
The new information provided in the amended Form ADV will certainly help institutional investors with their initial and ongoing due diligence.
Careful review will provide greater insight into the business and investment strategies of an investment or fund manager and will provide valuable insight into the manager's use of borrowings and derivatives with respect to its separately managed account investment strategies. Investors should be prepared to follow up with further questions after they have digested all that is new in the ADV.
James W. Van Horn Jr. is a partner in the Richmond, Va., office of Hirschler Fleischer and co-chair of its investment management and private funds practice group. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.