Saturday, January 24, 2009

Form ADV

Investment Advisers register with either state regulators or the SEC. Either way, they register through Form ADV. Form ADV is for adv-isers. It has two parts. Part 1 is what the adviser files with the regulators. Part 2 is what the adviser gives to prospects. The two parts of Form ADV have much overlap. And, if there are discrepancies between the information filed with the regulators on ADV Part 1 and the information shown to prospects on ADV Part 2, the adviser could be subject to harsh disciplinary action. For example, it they tell the regulators that the firm does not charge performance-based compensation, when, in fact, ADV Part 2 explains in detail how the performance-based compensation works, well that's going to generate some swift and terrifying legal action on the part of the state regulators or the SEC.
Advisers register electronically through a system called the "IARD," which stands for "Investment Adviser Registration Depository." It's administered by NASD, which is now called FINRA since people were actually starting to understand what the heck is going on, which is never tolerated long in this industry. Form ADV contains basic information on the adviser, which is usually a firm and occasionally an individual. Either way, the regulators want to know the name of the business, the ownership structure, how the firm operates, who the principals are, how much control the adviser has over client accounts and client assets, etc. If there have been disciplinary problems or lawsuits against the principals, there may be some explaining to do on Form ADV Part 1 and Part 2. If any of the information filed is misleading or false, the person filing it is subject to disciplinary action, civil penalties, and, in some cases, criminal prosecution. The "form" is filed with the initial registration, and it must be updated each year within 90 days of the close of the firm's fiscal year. Also, if a "material change" in any of the information on file occurs at any point, the firm must file an updated Form ADV promptly. So, there's the annual update that all advisers perform, and there is also the requirement to update any material information that has changed since their last filing. For example, if the firm moves, or acquires a financial planning company, or suddenly starts using discretion over client accounts, their ADV Part 1 would need to be updated promptly.
Form ADV Part 2 is the adviser's "disclosure brochure" given to prospects 48 hours before they sign an advisory contract or "at the time of signing, if the client has 5 days to cancel without financial penalty." In other words, give the prospect time to consider your advisory firm, warts and all, before he or she lets you take over the awesome responsibility of managing their money.
You could easily request a copy of a paper-based Form ADV on any adviser registered with the SEC. And, most advisers would be happy to send you a PDF of Form ADV. If you would like to view an actual Form ADV Part 2, I have one at Notice how this adviser avoids virtually all potential conflicts of interest and goes out of his way to avoid being "deemed to have custody." Notice how he clearly explains how fees are charged, and how minimum investments and advisory fees are negotiable. I'll let you take it from here. As always, if you have questions, post a comment. Chances are, if it's on your mind, other test-takers are wondering about it, too.

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