Fun with Form ADV Part 2

There are several testable points concerning the adviser's disclosure brochure, which is usually just a copy of Form ADV Part 2. Let's look at a possible test question:

Which of the following is/are accurate of Form ADV Part 2?
I. it must be delivered within 48 hours after signing the advisory agreement with a new client
II. it must be delivered to existing clients requesting it in writing within 5 days
III. it must be filed with the Administrator
IV. it must be delivered to all prospects

A. I
B. III
C. I, IV
D. II, IV

EXPLANATION: if this particular question showed up on the exam, it would be one of the hardest-hitting questions in the batch. Choice I looks good--but it's backwards; the disclosure contained in the brochure must be delivered 48 hours before you sign the agreement with clients, or at the time of signing if they have 5 days to cancel without losing any prepayment. Advisers offer to send the thing to existing clients, and if clients send a written request, advisers must send it within 7--not 5--days. In the old days ADV 2 did not have to be filed with the Administrator, but now it does. Finally, the brochure is not required if the client is a registered investment company or if the advice is considered "impersonal," meaning that it does not purport to be specific to individual clients.

ANSWER: b

You can view an actual ADV Part 2 at www.passthe65.com/extra

Registration Forms

Investment advisers register electronically through IARD, which is the Investment Adviser Registration Depository. Although FINRA (formerly NASD) does not have authority over advisers, they are really good at administering a big, ever-changing database like this one. FINRA also maintains a registration system for broker-dealers and their associated persons, called the CRD, which is short for Central Registration Depository. An agent of a broker-dealer remains in the system for two years after leaving the business, so arbitration decisions and disciplinary actions will be viewable during his career, and for two years after it ends. This is why the "broker check" feature at www.finra.org is the first stop for many investors. If they see that the name on the business card is associated with all sorts of industry violations and arbitration awards to upset customers, it could be tough for that name to get his foot inside the door.
Investment advisers file a "form" called Form ADV. ADV Part 1 is filed with the regulators, and it provides the essential information about the adviser: how it does business, who its clients are, whether it has custody and/or discretion over client assets, information on the officers and directors, etc. ADV Part 2 is the adviser's disclosure brochure, which is delivered to prospects before they sign the advisory agreement. ADV Part 2 gives the prospect enough material information to decide whether to use the adviser. This is where the potential conflicts of interest are disclosed, and if there is any disciplinary activity in the past 10 years, the adviser has to add disclosure pages about that. In other words, ADV Part 2 can end up scaring some prospects away. But, that's okay. Acting as somebody's investment adviser is a very big responsibility--investors must be able to trust their adviser, or keep looking.
The adviser (the firm) registers with Form ADV. They register their investment adviser representatives through Form U-4. Form U-4 is also used by broker-dealers to register principals and agents. The firm itself registers with Form BD. When an "associated person" of a broker-dealer leaves the firm, a Form U-5 is filed. That means that a U-5 is also used when an investment adviser representative leaves the adviser. Sometimes the termination is on good terms--sometimes the individual is being fired for cause. If the agent's license is suspended over a rule violation, that must be indicated on the U-5, which means that the public can find out about it through FINRA's broker-check at www.finra.org
If you would like more information on these testable registration forms, use the NASAA website at the following link: http://www.nasaa.org//Industry___Regulatory_Resources/Uniform_Forms/

ADV Part 2, Disclosure Brochure

A Series 65 customer just emailed a great question:

What is the practical application of this rule?
New Clients: The brochure must be provided at least 48 hours before entering into an advisory contract, OR at the time of entering into a contract, if the client has the right to terminate the contract without penalty within five business days.

RESPONSE:
The practical application is this: give the prospect at least two business days to review the brochure (ADV Part 2) before he comes in and signs the advisory agreement/contract. Why? As you see at www.passthe65.com/extra, AdV II gives the prospect important info on your firm--who you are, what you do, how you charge compensation, who your other clients are, your disciplinary history, whether you have discretion, etc. So, the prospect needs time to review it before signing the contract.

The latest that the brochure can be provided is at the time the client signs, IF he can cancel within 5 days without losing any prepayment to the adviser. Some advisers accept a "prepayment" or upfront fee before doing any actual advising. If they take, say, $1,000 just to sit down and start looking at the client's situation, then they could give ADV 2 to the client when they sign, IF the client could cancel in 5 days and get all her money back.
Most advisers avoid the prepayment because if you take >$500 six or more months in advance, you have "custody" and you have to provide the client and the Administrator with your balance sheet, and if the liabilities EVER exceed the assets for even ONE DAY, you have big problems on your hands.

So, like most things, it's simpler than it sounds--give the client 2 business days to consider your brochure before they sign the advisory agreement. If you want to give them the brochure when they sign, you have to know that they might cancel in 5 days, and any prepayment you took has to be paid right back out.