The required disclosures for investment advisers during the registration process are similar to the required disclosures for broker-dealers. Broker-dealers register using Form BD, while investment advisers register using Form ADV.

Form ADV has three distinct sections: Part 1, Part 2A, and Part 2B.

Form ADV Part 1

Form ADV Part 1 is divided into two sections: Part 1A and Part 1B. On the exam, both are generally referred to as “Part 1.” The purpose of Part 1 is to identify the firm, describe its business characteristics, and disclose key personnel.

These are the key disclosures on Part 1 (many overlap with broker-dealer disclosures):

Basics of the business

• Name
• EIN (tax reporting number)
• Business address
• Contact person

Other jurisdictions

• Disclosure of registration with other states

Business structure

• Corporation, partnership, sole proprietorship, or LLC

Business dynamics

• Firm executives (officers, directors, partners)
• Types of products and services to be offered
• Amount of assets under management (AUM)
• Whether the adviser maintains custody (discussed below)

Business history

• Qualifications (financial and legal)
• Any legal actions ruled against the firm or its advisory affiliates
• Any regulatory events related to the firm or its advisory affiliates (e.g., another state administrator revoked registration)
• Any criminal events related to the firm or its advisory affiliates

Definitions

Advisory affiliate

Defined as any of the following:

• Any current employee (except for clerical roles)
• All officers, directors, and/or partners
• Any other person controlling the firm (making big business decisions)

A key difference between broker-dealers and investment advisers is what they provide to investors. Broker-dealers generally execute securities transactions and often provide custodial services. Investment advisers primarily provide advice about what securities transactions should be performed.

Investment advisers can offer a wide range of advisory services, including:

• General securities advice and/or market commentary
• Financial planning
• Portfolio management (including discretionary accounts)
• Wrap accounts

Definitions

Discretionary account

An account that provides the adviser with investment control; requires trading authorization or power of attorney (POA). This type of account is required for the adviser to make any of the following choices on behalf of an investor:

• Action (buy or sell)
• Amount (how much)
• Asset (what security)

Wrap account

An investment account that offers a wide range of services, including investment management, trade execution, and financial planning, with all services “wrapped” up into one single fee

All of the products and services listed above are considered advisory business. They may be offered only by registered investment advisers (or those that may claim an exemption or exclusion). In practice, most investment advisers focus on advisory products and services, but an adviser may also operate in ways that resemble a broker-dealer.

One example is custody. An investment adviser may offer custodial services for clients. Regulators define custody as:

Definitions

Custody

Holding, directly or indirectly, client funds or securities, or having any authority to obtain possession of them

Clients need a firm to hold cash and securities, but custody creates additional regulatory responsibilities. Custody rules and requirements are covered in a future chapter. For now, remember this exam takeaway: if an adviser takes custody, it must disclose that fact on Part 1 of Form ADV.

The following video summarizes the key points relating to Form ADV Part 1:

Form ADV Part 2A (the brochure)

The disclosures that matter most to clients are found in Form ADV Part 2A. This section includes the adviser’s compensation structure, investment approach, and conflicts of interest.

The North American Securities Administrators Association (NASAA) (the association that represents all state administrators) wants investors to be able to understand this document. For that reason, NASAA imposes these standards for Part 2A:

• Narrative format
• Plain English
• Disclosure of fiduciary obligations
• Full and truthful disclosure

In other words, Part 2A shouldn’t be packed with jargon or overly technical language. That’s why Form ADV Part 2A is commonly called “the brochure” - it’s meant to be readable.

Part 2A must also disclose the adviser’s fiduciary obligation. NASAA describes the fiduciary duty as:

[The requirement for] the adviser to hold the client’s interest above its own in all matters

A major part of fiduciary duty is disclosing conflicts of interest. A conflict of interest is any circumstance, relationship, or event that could compromise the adviser’s obligation to put the client first. For example:

• An adviser is paid by a third party to recommend a specific security to its clients
• An adviser recommends the securities of an affiliated or parent company
• An adviser recommends a purchase of a security that will be sold from their own inventory

A practical way to think about it: if a reasonable client would want to know about it before accepting the recommendation, it likely needs to be disclosed as a conflict. Advisers must disclose conflicts and also mitigate (reduce) them as much as possible.

Now let’s look at the specific disclosures required in Part 2A:

General business characteristics

• Description of the business
• How long the adviser has been in business
• Types of advisory services offered, including any specialties
• How the advisor tailors their business to clients
• Description of wrap fee programs
• How much of the business is dedicated to discretionary services

Fees and compensation

• How the adviser is compensated
• Payment logistics (how clients may pay)
• Fees collected outside of advisory services
• If fees may be prepaid, and if they are refundable
• If the adviser is paid by parties other than clients

Types of clients

• Type of client the adviser typically handles
• Any prerequisites for doing business with an adviser (e.g. having a minimum amount to invest)

Investment philosophy

• Types of securities recommended
• Methods of securities analysis
• Description of risks clients are exposed to

Disciplinary information

• Convictions of any felony or a securities-related misdemeanor
• Any regulatory action taken against the adviser or its controlling affiliates

Conflicts of interest

• Relationships with relevant third parties
• Payments received by third parties
• Any other item that may compromise the fiduciary obligation

The following video summarizes the key points relating to Form ADV Part 2A:

This video shows a real-world example of Form ADV Part 2A:

Form ADV Part 2B

Form ADV Part 2B is typically called the “brochure supplement.” It’s a personnel disclosure document.

Investment adviser representatives (IARs) who provide advice to clients, and those who act in a discretionary capacity (for example, an IAR who manages client assets but doesn’t meet with the client), are covered by this form.

Part 2B allows clients to review the following information about these employees:

• Educational background*
• Business experience
• Disciplinary information
• Other business activities (outside of the adviser)
• Additional compensation (outside of normal compensation)
• Supervision details

*Although educational background is disclosed on the brochure supplement, there are no minimum educational requirements for IARs

The following video summarizes the key points relating to Form ADV Part 2B:

This video shows a real-world example of Form ADV Part 2B:

Consent to service of process

Like other registrants, investment advisers must sign and submit a consent to service of process with every initial registration application. It does not need to be renewed.

For a refresher on this document, see the broker-dealer chapter.

Filing fees

As with other registrants, a filing fee must be paid with the registration paperwork. To review how filing fees work, see the broker-dealer chapter.

Sidenote

Form ADV for federal-covered advisers

In a previous chapter, we discussed the difference between state-registered and federal-covered advisers. The disclosures discussed above are relevant to state-registered advisers, but the overall process is essentially the same for federal-covered advisers. There are two key differences to know.

First, state-registered advisers file Form ADV with the state administrator, while federal-covered advisers file Form ADV with the SEC. Each regulator oversees the advisers that register with it. That means the SEC generally oversees federal-covered advisers, while state administrators generally oversee state-registered advisers.

Second, even though federal-covered advisers don’t interact much with state administrators, they must still notify each state before operating there. This is called a notice filing. To legally operate in a state, a federal-covered adviser submits the following to that state administrator:

• Copy of Form ADV submitted to the SEC
• Filing fee

After the notice filing, the SEC is the primary regulator enforcing rules and laws for the federal-covered adviser.

However, state regulators are not completely powerless with respect to SEC-registered advisers. If a state administrator suspects a federal-covered adviser is engaging in fraudulent practices in that state, the administrator may investigate and pursue action against the adviser (sometimes in tandem with the SEC).