Most of this chapter covers post-registration obligations for state-registered advisers. The rules are virtually identical for federal-covered advisers. There’s one exception related to brochure delivery requirements, noted below.
Once an investment adviser achieves effective registration, the adviser is legally permitted to operate. To keep that registration in good standing, the adviser must meet several ongoing obligations, including:
We previously covered that broker-dealers must maintain records of numerous business documents. The Uniform Securities Act (USA) imposes a similar 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 overall recordkeeping concept is so similar, use the broker-dealer post-registration obligations chapter if you want a refresher.
One key difference: investment advisers must keep records for 5 years (instead of 3 years for broker-dealers). 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 much of the information an adviser must disclose 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 Part 2A is technically the brochure, exam questions often use “the brochure” to mean both Parts 2A and 2B.
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, the adviser must deliver the brochure and brochure supplement to:
NASAA is also very specific about when delivery must occur:
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 requirement by meeting one of the two timing options.
Here’s an example.
Assume a prospective client comes to your office on a Friday to ask about your firm’s advisory services. After discussing your services, you give the prospective client the brochure.
The prospective client wants time to think and doesn’t sign right away. On Monday, the client returns and signs the advisory contract.
That’s at least 48 hours before the contract, so the adviser has met the first delivery option.
Now change one fact: the client wants to sign the contract on Friday.
If the client can’t have the brochure for at least 48 hours before signing, the adviser can still comply by using the second option:
The adviser may charge for services actually provided (for example, management fees for the days the contract was in effect), but the adviser can’t impose a penalty for canceling within the five-business-day window. 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 Investment Adviser Public Disclosure (IAPD) website.
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 payment of less than [$500]*
*The original NASAA brochure rule referenced impersonal advisory services of less than $200, but that amount 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 note: an adviser hired to advise an investment company would be federal-covered, so state brochure delivery rules wouldn’t apply anyway. The practical takeaway is simple: no brochure delivery is required for an investment company client.
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 tailored recommendations to specific individuals. A common example is a market newsletter that offers general market commentary. 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 on its 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 in practice.
First, the adviser must file an annual updating amendment within 90 days after the end of its fiscal year. This annual amendment includes changes such as:
When the annual update is made, the brochure is updated and must also be provided to clients. The filing deadline and the client-delivery deadline are different:
Second, if a material change occurs during the year, the adviser must amend Form ADV promptly (typically interpreted as within 30 days). NASAA doesn’t give a single fixed definition of “material,” but the idea is any significant change that regulators and/or clients should know about. Examples include:
We’ve discussed custody earlier in this material. Here’s the definition again:
NASAA rules expand on what counts as custody. 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, suppose the adviser recommends a Vanguard mutual fund and the client mistakenly sends the payment to the adviser instead of to Vanguard. If the adviser returns the payment to the client or forwards it to the correct destination within three business days, custody has not occurred.
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 would put the adviser in violation.
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
Even without physically holding assets, authority to access or withdraw client funds or securities is custody. For example, having the ability to pull funds directly from a client’s bank account would be custody.
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 trustee of a trust. Trusts are legal entities set up to benefit a beneficiary (for example, a family trust). Trustees are legally appointed to manage the trust and have access to the trust’s assets. If an adviser is appointed as trustee, the adviser has custody of the trust.
Investment advisers often use unaffiliated broker-dealers to maintain custody on their behalf. Although it’s uncommon, an adviser may take custody directly (or through an affiliated business). If the adviser takes custody, these obligations apply:
Confirm state administrator allows custody
While most states allow custody, 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 adviser must disclose custody to the state administrator on Form ADV. This disclosure appears in multiple parts of the form, including the brochure (Form ADV Part 2A).
Place funds with qualified custodian
An 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 qualify. 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 must be able to track activity in their accounts. Even though many accounts can be viewed online at any time, advisers that take custody must provide statements showing balances and account activity at least quarterly (every three months).
Balance sheet disclosure (state only)
State-registered 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 disclosure.
Annual surprise audit
NASAA rules also 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 adviser.
Investment advisers often avoid taking custody because of the additional 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 operate ethically. Still, advisers do shut down for many reasons (for example, retirement or an inability to attract enough clients). When an adviser withdraws, the adviser must notify the state administrator.
This disclosure is made on Form ADV-W. Withdrawal typically becomes effective 30 days after filing. Once registration is withdrawn, the adviser 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 the adviser’s registration. This has two practical effects:
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