Once an investment adviser achieves effective registration, they’re legally permitted to operate in a state. To keep that registration in good standing, the adviser must meet several post-registration obligations, including:
In an earlier chapter, we covered how broker-dealers must maintain records of numerous business documents. The Uniform Securities Act (USA) imposes a similar recordkeeping requirement on investment advisers.
“Every registered broker-dealer and investment adviser shall make and keep such accounts, correspondence, memoranda, papers, books, and other records as the [Administrator] prescribes by rule or order”
Because the general recordkeeping concept is essentially the same, you can use the broker-dealer post-registration obligations chapter for a refresher.
One key difference is how long records must be kept. Investment advisers must maintain required records for 5 years (instead of 3 years for broker-dealers), and records created within the most recent 2 years must be readily available.
We previously discussed Form ADV Part 2, which consists of the brochure (Part 2A) and the brochure supplement (Part 2B). This document contains key disclosures an adviser provides to clients, including:
Form ADV Part 2A (brochure)*
Form ADV Part 2B (brochure supplement)*
*We’ll refer to Form ADV Parts 2A and 2B simply as “the brochure” for the remainder of this chapter. While only one part is technically considered the brochure (2A), test questions tend to refer to both simply as “the brochure.”
North American Securities Administrators Association (NASAA) rules require advisers to deliver the brochure in a specific way. The brochure-specific rule begins with this general requirement:
"Unless otherwise provided in this rule, an investment adviser… shall… furnish each advisory client and prospective advisory client with a written disclosure statement which may be a copy of Part II of its Form ADV or written documents containing at least the information then so required by Part II of Form ADV, or such other information as the [Administrator] may require.
In other words, advisers must deliver the brochure and brochure supplement to:
NASAA is also very specific about when delivery must happen:
An investment adviser… shall deliver the [brochure]… to an advisory client or prospective advisory client:
- Not less than 48 hours prior to entering into any investment advisory contract with such client or prospective client; or
- At the time of entering into any such contract, if the advisory client has a right to terminate the contract without penalty within five business days after entering into the contract.
This is an either/or rule, not an and rule. The adviser satisfies the brochure delivery requirement by meeting one of the two timing options.
Here’s how that works in practice.
Assume a prospective client comes to your office on Friday to ask about your advisory services. You discuss your firm’s services and provide the brochure at the end of the meeting.
The prospective client wants time to think before signing. On Monday, they return, agree to have your firm manage their account, and sign the advisory contract. In this situation, the first delivery option is satisfied: the client had the brochure for at least 48 hours before entering into the contract (Friday to Monday).
Now change one fact: the client wants to sign the contract on Friday. If the client can’t have the brochure for 48 hours before signing, the adviser can still comply by using the second option:
During the free look period, the adviser may charge for services actually provided (for example, management fees), but may not impose a penalty for canceling. After five business days, surrender or cancellation fees may apply.
The brochure and brochure supplement may be delivered physically or electronically. Electronic delivery requires client consent and verification that the client can access the document. The brochure is also publicly available through the regulators on the Investment Adviser Public Disclosure (IAPD) site.
While Form ADV Part 2 must be delivered to most clients, there are two exceptions.
The delivery of the [brochure and brochure supplement] need not be made in connection with entering into:
- An investment company contract; or
- A contract for impersonal advisory services requiring a payment of less than [$500]*
*The original NASAA brochure rule made reference to impersonal advisory services of less than $200, but the number has since been updated to $500.
An adviser to a registered investment company (for example, a mutual fund or closed-end fund) does not need to deliver a brochure. Also, remember that an adviser hired to provide advice to an investment company would be considered federal-covered. Federal-covered advisers aren’t subject to state regulation (the SEC has its own brochure delivery requirement). Bottom line: there’s no need to deliver the brochure to an investment company client under this state rule.
Impersonal advisory services are defined as:
- Statements which do not purport to meet the objectives or needs of specific individuals or accounts
- Through the issuance of statistical information containing no expression of opinion as to the investment merits of a particular security
- Any combination of the foregoing services.
In plain English, impersonal advisory services don’t provide direct recommendations about specific securities to specific individuals. A common example is a market newsletter that provides general commentary on the securities markets. If an adviser sells subscriptions to a newsletter like this for less than $500, there’s no legal requirement to deliver the brochure to those customers.
Investment advisers must keep their brochure current. That means:
NASAA summarizes the timing requirements in this NASAA FAQ (frequently asked question) page:
When must Form ADV be amended?
A firm should file the annual updating amendment within 90 days of the close of its fiscal year (e.g., by March 31st for firms on a calendar-year basis). The firm should update information that has changed, including recalculating regulatory assets under management. During the year, if there are material changes to the information on the Form ADV, the firm should do an “other-than-annual” amendment within 30 days of the change. State regulators can answer questions about whether a change is deemed material.
Here’s what that means.
First, the adviser must file an annual updating amendment within 90 days after the end of its fiscal year. This amendment reflects changes during the year, such as:
It also includes the adviser’s current assets under management, which helps determine whether the adviser should be registered with the state or the SEC (as a federal-covered adviser).
When the annual update is made, the brochure is updated and must be sent to clients as well. The timing differs slightly:
Second, if a material change occurs during the year, the adviser must file an “other-than-annual” amendment promptly (within 30 days).
NASAA doesn’t give a single, fixed definition of “material change” (“state regulators can answer questions about whether a change is deemed material”). In practice, it means a significant change that should be reported to the state administrator(s) and/or disclosed to clients. Examples include:
We’ve already discussed custody in a few places. Here’s the definition again:
NASAA rules expand on that definition. Custody also includes:
Possession of client funds or securities unless the investment adviser receives them inadvertently and returns them to the sender within three business days of receiving them and the investment adviser maintains the records
Custody can arise if a client mistakenly sends a check, wires funds, or transfers securities to the adviser. For example, if the adviser recommends a Vanguard mutual fund and the client mistakenly sends payment to the adviser instead of to Vanguard, custody has not occurred as long as the payment is returned to the client or forwarded to the proper destination within three business days.
If more than three business days pass, the adviser has taken custody. Later in this chapter, you’ll see the steps an adviser must take before taking custody. Those steps won’t be met if the adviser simply holds a check too long, which can result in a custody violation.
NASAA also treats certain authority arrangements as custody:
Any arrangement… under which the investment adviser is authorized or permitted to withdraw client funds or securities maintained with a custodian upon the investment adviser’s instruction to the custodian
So, merely having the ability to access client funds or securities can be custody - for example, the ability to pull funds directly from a client’s bank account.
Any capacity… that gives the investment adviser or its supervised person legal ownership of or access to client funds or securities.
Custody also includes situations where the adviser has legal ownership or legal authority over client assets. A common example is serving as the trustee of a trust. Trusts are legal entities set up to benefit a specific beneficiary (for example, a family trust). Trustees are legally appointed to manage the trust and have access to the trust’s funds and securities. If an adviser is appointed as trustee, the adviser has custody of the trust.
Investment advisers often have unaffiliated broker-dealers maintain custody on their behalf. Although it’s uncommon, an adviser can take custody directly (or through an affiliated business). If an adviser takes custody, these obligations must be met:
Confirm state administrator allows custody
While most states allow it, a number of states (roughly 13 at the time of this writing) prohibit investment advisers from taking custody. In those states, the adviser simply cannot take custody.
Notify state administrator
If the state allows custody, the investment adviser must disclose custody to the state administrator on Form ADV. Multiple parts of the form require this disclosure, including the brochure (Form ADV Part 2A).
Place funds with qualified custodian
An investment adviser can’t simply “hold” client funds or securities. The assets must be placed with a qualified custodian, an organization that specializes in holding client assets. Banks, savings associations, broker-dealers*, and other financial institutions typically meet the definition of a qualified custodian. If an adviser wants to take custody itself, it must place those funds with an affiliated entity (another part of the company) that is qualified to take those deposits.
*When we’ve discussed broker-dealers typically maintaining custody for investment advisers, we’re referring to unaffiliated broker-dealers (meaning they’re not part of the same organization or company). If an adviser wants to take custody themselves, they may have an affiliated broker-dealer that’s owned by the same parent company do it for them.
Provide quarterly statements
Clients need regular visibility into account balances and activity. Even though many accounts can be checked online at any time, investment advisers must send statements showing balances and account activity at least quarterly (every three months).
Balance sheet disclosure (state only)
State-registered investment advisers that maintain custody must also include a balance sheet in their brochure. This requirement applies only to state-registered advisers. The Investment Advisers Act of 1940 (which governs federal-covered advisers) does not require this additional disclosure.
Annual surprise audit
NASAA rules require an annual surprise audit of the adviser’s books and records to confirm compliance with recordkeeping and custody requirements. Each year, an independent auditor (typically a CPA) arrives without prior notice. If the auditor finds something materially wrong with the adviser’s custody system, the auditor must notify the administrator within one business day. If nothing appears out of place, the auditor files Form ADV-E (E stands for “examination”) with the state administrator within 120 days of the audit. This is the only relevant version of Form ADV that is not filed by the investment advisers.
Investment advisers often avoid taking custody because of the extensive obligations listed above. In most cases, custody is handled by broker-dealers and other financial institutions whose business is built around custodial services. Advisers primarily provide securities advice and collect advisory fees.
Investment advisers can operate indefinitely as long as they maintain registration, follow applicable rules and regulations, and act ethically. Still, advisers may close their businesses for many reasons (for example, retirement or a lack of clients). When an adviser withdraws, they must notify the state administrator.
This disclosure is made on Form ADV-W. The withdrawal typically becomes effective 30 days after filing. Once registration is withdrawn, the business can no longer legally operate.
Even after withdrawal, the adviser remains subject to regulatory action for up to one year. If the adviser engaged in unethical or improper conduct before withdrawing, the administrator may suspend or revoke their registration. This serves two purposes:
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