The registration process for federal-covered and state-registered advisers is largely the same. You can assume the same basic process applies whether an adviser registers with the Securities and Exchange Commission (SEC) or the state administrator.

The required disclosures for investment advisers during registration are also similar to the required disclosures for broker-dealers. The main difference is the form used:

• Broker-dealers register on Form BD
• Investment advisers register on 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 1B. On the exam, both are generally referred to as “Part 1.” The purpose of Part 1 is to identify the business, describe its characteristics, and disclose key personnel.

These are the important disclosures in Part 1 (many mirror 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 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 businesses. They may only be offered 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 hold client cash or securities, or have the ability to obtain them. 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. We’ll cover custody rules and requirements for investment advisers in a future chapter. For now, remember this exam point: if an adviser has custody, it must disclose that fact in Part 1 of Form ADV.

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

Form ADV Part 2A (the brochure)

Form ADV Part 2A contains the information a client typically cares most about. It explains how the adviser operates, how it gets paid, what strategies it uses, and what conflicts of interest may exist.

Because this document is meant for investors, the SEC and the North American Securities Administrators Association (NASAA) (the association that represents all state administrators) require Part 2A to follow these standards:

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

In other words, the adviser shouldn’t bury key information in jargon or overly technical language. That’s why Part 2A is commonly called “the brochure” - it’s designed to be readable.

Part 2A must also disclose the adviser’s fiduciary obligation and provide truthful information about the business. NASAA describes the fiduciary duty as:

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

Put simply: the client’s interests come first.

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 ability to put the client first. Examples include:

• 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 acting on the advice, 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 go through the specific disclosures required in the brochure:

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 the 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.

It covers investment adviser representatives (IARs) who provide advice to clients and those who act in a discretionary capacity (for example, an IAR who trades client assets but doesn’t meet with the client). Clients can use Part 2B to learn:

• 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, an investment adviser must sign and submit a consent to service of process with every initial registration application. It does not need to be renewed.

Visit the broker-dealer chapter for a detailed refresher on this document.

Filing fees

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

Sidenote

Form ADV for federal-covered advisers

As noted at the beginning of this chapter, state-registered advisers file Form ADV with the state administrator, while federal-covered advisers file Form ADV with the SEC. Each regulator enforces rules and regulations for the advisers registered with it. That means:

• The SEC provides regulatory oversight over federal-covered advisers and generally avoids state-registered advisers.
• State administrators provide regulatory oversight over state-registered advisers and generally avoid federal-covered advisers.

Even though federal-covered advisers don’t interact much with state administrators, they must still notify each state before doing business 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 adviser generally has little contact with the state administrator. The SEC is the primary regulator that enforces the applicable rules and laws.

Even if a state administrator wanted to direct how a federal-covered adviser runs its business or investigate routine business practices, the administrator generally wouldn’t have the legal authority to do so.

However, state regulators aren’t 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).