In addition to making disclosures to the state administrator and/or the Securities and Exchange Commission (SEC) during the registration process, broker-dealers and investment advisers must also make ongoing disclosures to their clients. This chapter covers three categories of ongoing disclosures:
In a future chapter, we’ll discuss various fees broker-dealers may charge outside of commissions, markups, and markdowns. These fees are disclosed in fee schedules that must be made available to customers. The North American Securities Administrators Association (NASAA) provides a model fee disclosure template that many broker-dealers use. Firms commonly provide this information in account applications and on their websites.
Agents representing broker-dealers must create an order ticket for each order they place. The order ticket creates a historical record of the trade and includes key details such as:
After an order ticket is submitted, the agent’s supervisor must review it “promptly,” which typically means by the end of the day. When an agent places orders for customers, the supervisor (often called the principal) reviews the ticket to confirm the order was entered correctly. If there’s an error, the principal can update the order ticket. Even if the agent notices the mistake first, any changes to the ticket must be approved by the principal.
Agents may also encounter situations where a customer wants to place an unsuitable order. For example, a retired customer with limited resources may insist on buying a very risky stock. Financial professionals must explain the risks involved. However, if the customer still insists on placing the order, the order must be entered. The customer ultimately controls their own securities transactions.
In these situations, it’s a best practice for agents to document the discussion. Firms maintain files on each customer that include transaction history and notes from prior interactions. If a customer’s expectations are unrealistic and the trade results in significant losses, detailed notes can help address questions about what was discussed and disclosed. If the trade resulted from a recommendation, the firm could be held liable if the recommendation was unsuitable.
The most important disclosures made by an investment adviser are typically presented in the brochure. This disclosure package has three key parts:
The purpose of these documents is to help clients understand the person they’re trusting with their money. They describe the firm’s products and services and provide background information on the firm and its investment adviser representatives (IARs). If an adviser has a disciplinary history, or employs an IAR with a criminal record, that information can be found in the brochure materials.
NASAA disclosure-related rules also regulate solicitors, sometimes called promoters. NASAA defines a solicitor as:
“Solicitor” means any individual, person, or entity who, directly or indirectly, receives a cash fee or any other economic benefit for soliciting, referring, offering or otherwise negotiating for the sale or selling of investment advisory services to clients on behalf of an investment adviser.
In practical terms, a solicitor is anyone who is compensated for connecting prospective clients with an investment adviser. A solicitor might be an employee of the adviser, or a third party. For example, someone with a marketing background might network locally and refer potential clients to an adviser.
This arrangement is legal and ethical as long as required procedures are followed and disclosures are made. Under the rules for solicitors of state-registered advisers, the solicitor:
Be registered as an IAR
The solicitor must be registered as an IAR of the firm for which they are soliciting business.
Not be subject to a statutory disqualification
Promoters are treated like other financial professionals. If they are subject to a statutory disqualification, they can’t solicit on behalf of an adviser. Statutory disqualifications (covered in a previous chapter) are past actions or sanctions that prevent a person from becoming registered. A person is statutorily disqualified if they are:
Maintains a written agreement with the adviser
The adviser and the promoter must enter into a written agreement. The adviser must keep this agreement in its records, and the state administrator may request it. The agreement must describe:
Must deliver brochures
When soliciting a prospective client, the solicitor must deliver two brochures. The solicitor must provide the adviser’s brochure (Form ADV Part 2A) in writing. The solicitor must also create and deliver a solicitor’s brochure in writing. The solicitor’s brochure must disclose:
Obtains signed receipt of brochures from a prospective client
After delivering both the adviser’s brochure and the solicitor’s brochure, the promoter must obtain a signed receipt from the prospective client confirming both disclosures were received. The investment adviser must maintain the signed receipt in its records.
Before 2020, solicitor rules for federal-covered advisers were largely similar to state rules. In 2020, the Securities and Exchange Commission (SEC) adopted a new rule that simplified how solicitors are regulated. You’ll notice some overlap with the state requirements.
The solicitor must disclose:
Additionally, these rules must be followed:
*Essentially the same items that must be in the agreement between a state-registered adviser and their solicitor (discussed above) are the same here.
Last, the solicitor may not*:
*Although these prohibitions are specifically for solicitors of federal-covered advisers, you can assume the same applies at the state level.
Two major items from the state-based solicitor rule are not included here. First, solicitors are not required to be registered as IARs. Second, there is no brochure delivery requirement for promoters. Because the adviser must provide the brochure to the client, the SEC viewed a separate brochure-delivery requirement for the solicitor as redundant. As discussed above, the promoter must still make disclosures at the time of solicitation. The SEC rule says these disclosures must be made “clearly and prominently,” but it does not explicitly require them to be in writing.
Securities rules and regulations have increasingly emphasized transparency in investment advice. One key concern is whether an IAR’s personal holdings could influence recommendations to clients. For example, suppose an IAR owns stock in a thinly traded company. If the IAR knows that additional demand could raise the market price, they might recommend the stock to multiple clients - even when it isn’t appropriate for those clients. That creates a clear conflict.
Rules for both federal-covered and state-registered advisers are designed to reduce this risk. Employees of advisers (typically IARs) who have access to certain nonpublic information must regularly disclose their personal securities holdings to their compliance departments. Here’s how the requirement works.
These disclosure rules apply only to access persons.
Most (and often all) IARs of a registered adviser qualify as access persons because they can access client accounts, portfolio holdings, and recommendation details. To support transparency, regulators require access persons to disclose their personal holdings and transactions to their employing firms. This allows compliance staff to compare client recommendations with the access person’s personal trading activity.
Access persons must file two types of reports:
Holdings reports
A holdings report provides a snapshot of an access person’s personal portfolio. It includes:
Holdings reports must be filed:
Transaction reports
Transaction reports disclose personal securities transactions. They must include:
Transaction reports must be filed no later than 30 days after the end of the quarter in which the transactions occurred.
Regulators provide three exceptions to the holdings and transaction reporting requirements. No filing is required for:
Sign up for free to take 22 quiz questions on this topic