The often mundane jobs of compliance officers and forensic auditors have gotten more exciting. Investment advisers registered with the Securities and Exchange Commission (SEC), with few exceptions, must use a newly expanded Form ADV to report on their businesses.

(Estimated reading time: 4 min 30 sec)

With these changes, which took effect Oct. 1, 2017, the Form ADV has become an even more valuable tool for investors and fiduciaries seeking to evaluate their advisers. Managers of private hedge funds make relatively few public filings, so the Form ADV is particularly helpful in learning more about and comparing such advisers.

This blog post summarizes my recent paper on the changes, Form ADVs: Dragnets of Due Diligence.

The Form ADV has two parts:

• Part 1 identifies the adviser’s business, controlling stakeholders, possible conflicts of interest, compliance information, client base, compensation structure, and disciplinary matters, among other attributes.
• Part 2 has two sections. Part 2A (“the Brochure”) requires the adviser to explain its advisory services being rendered, range of fees charged, any conflicts of interest, risks associated with its management style, relationships with third parties, client reporting and proxy voting practices, and other items that may be material to investors and fiduciaries. Part 2B (the “Brochure Supplement”) provides biographical sketches of the firm’s key professionals expected to serve the investor, defined as any “supervised person” who “formulates investment advice for a client and has direct client contact” or is otherwise deemed to have material discretionary authority over that client’s assets. The supplement also lists who supervises these people.

Reviewing Form ADVs and their changes over time, investors conducting due diligence are able to gather important insights on these key features of their investment managers:

Organization

The Form ADV provides basic information about an adviser’s business, highlighting its legal structure, asset size, number of employees, largest offices, and types of advisory activities, as well as other business activities. Also new to the Form ADV is a listing of all of the adviser’s websites and accounts on Twitter, Facebook, LinkedIn, and any other publicly available social media platform on which it controls the content.

Fees and Compensation

While Part 1 (Item 5) discloses types of compensation arrangements used with clients, the adviser provides a more detailed explanation of its fees and compensation in Part 2A (Item 5). Compensation paid to the firm by sources other than clients, such as an underlying manager, must be disclosed. Financial relationships with third-party marketers are also disclosed.

Key Personnel

Under Schedule A of Part 1, the adviser provides identifying information about the firm’s direct owners and executive officers, including their ownership interests. Schedule B shows the firm’s indirect owners and their ownership interests with a view toward drilling up to controlling individuals.

Regulation

The Form ADV provides disclosures of the adviser’s registrations with regulatory authorities besides the SEC. New to the Form ADV is a provision for affiliated private fund advisers to reference an “umbrella registration” upon which they can rely for their registration disclosures. Each affiliated adviser then is linked to a single Form ADV that has the full set of disclosures.

Compliance

The Form ADV now requests more identifying information regarding the firm’s chief compliance officer (CCO), including a question related to whether the CCO is compensated or employed by someone other than the firm, such as a third-party vendor that provides compliance-related services.

Assets Under Management

A firm’s regulatory assets under management (RAUM) is defined as the “securities portfolios for which you provide continuous and regular supervisory or management services.” New to the Form ADV is more specific detail for each type of client being advised regarding the number of accounts and dollar amount of assets under management, including an overall percentage exposure to non-U.S. clients. Previously, the form only requested a percentage range attributable to each client type. Supplementing the adviser’s disclosed RAUM is the firm’s exposure to clients for which the firm provides advisory services without attribution under RAUM. Also new to the Form ADV are detailed disclosures regarding the firm’s separately managed accounts (SMAs).

Private Funds

In Part 1’s Private Fund Reporting section (Schedule D, Section 7.B), detailed disclosures on hedge funds and other unregistered pooled investment vehicles enable a myriad of insights:

• Are disclosed fund assets consistent with other sources?
• How much of the private fund assets continue to be owned by related persons of the adviser?
• Was the fund’s annual financial statement qualified by the auditor?
• Do the fund’s prime broker, auditor, custodian, and fund administrator have good industry reputations?
• Have any of them been replaced since the last Form ADV filing?

Disciplinary Disclosures

Based on a long list of probing questions, Item 11 of Part 1 requires important disclosures of any regulatory, criminal, or civil judicial disciplinary actions against the firm or advisory affiliates over the prior 10 years. The answers to these questions are usually “No,” but any “Yes” is an unambiguous flag signaling the need for further understanding.

As I mentioned, this blog post is a quick summary of the Form ADV and its recent changes. To explore more on this topic, check out my paper.

One final thought worth noting here is that third-party software solutions can make the due diligence process even easier by scraping this treasure trove of public data off the SEC website and analyzing the changes over time. Instead of devoting resources to download and process this data, investors can be more productive focused on issues raised by changing data. These third-party solutions can be particularly important for organizations needing to monitor hundreds, if not thousands, of investment managers.