
[Federal Register: March 14, 2008 (Volume 73, Number 51)]
[Proposed Rules]               
[Page 13957-14027]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14mr08-24]                         


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Part II





Securities and Exchange Commission





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17 CFR Parts 275 and 279



 Amendments to Form ADV; Proposed Rule


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 275 and 279

[Release No. IA-2711; 34-57419; File No. S7-10-00]
RIN 3235-AI17

 
Amendments to Form ADV

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule and form amendments.

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SUMMARY: The Securities and Exchange Commission is reproposing 
amendments to Part 2 of Form ADV, and related rules under the 
Investment Advisers Act, to require investment advisers registered with 
us to deliver to clients and prospective clients a brochure written in 
plain English. These amendments are designed to require advisers to 
provide clients and prospective clients with clear, current, and more 
meaningful disclosure of the business practices, conflicts of interest 
(including those related to soft dollar practices), and background of 
investment advisers and their advisory personnel. Advisers would file 
their brochures with us electronically, and we would make them 
available to the public through our Web site. The Commission also is 
proposing to withdraw, as duplicative, the Advisers Act rule requiring 
advisers to disclose certain disciplinary and financial information.

DATES: Comments should be received on or before May 16, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-10-00 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-10-00. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method.

    The Commission will post all comments on the Commission's Internet 
Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also 
available for public inspection and copying in the Commission's Public 
Reference Room, 100 F Street, NE., Washington, DC 20549 on official 
business days between the hours of 10 a.m. and 3 p.m. All comments 
received will be posted without change; we do not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: David W. Blass, Assistant Director, 
Daniel S. Kahl, Branch Chief, or Vivien Liu, Senior Counsel, at (202) 
551-6787 or IArules@sec.gov, Office of Investment Adviser Regulation, 
Division of Investment Management, U.S. Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549-5041.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is proposing amendments to rules 203-1, 204-1, 204-2, 
and 204-3 [17 CFR 275.203-1, 275.204-1, 275.204-2, and 275.204-3]; and 
amendments to Form ADV [17 CFR 279.1] under the Investment Advisers Act 
of 1940 [15 U.S.C. 80b] (``Advisers Act'' or ``Act'').\1\ The 
Commission is also proposing to withdraw rule 206(4)-4 [17 CFR 
275.206(4)-4] under the Advisers Act.
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    \1\ Unless otherwise noted, when we refer to rule 203-1, 204-1, 
204-2, or 204-3, or any paragraph of these rules, we are referring 
to 17 CFR 275.203-1, 275.204-1, 275.204-2, or 275.204-3, 
respectively, of the Code of Federal Regulations in which these 
rules are published.
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Table of Contents

I. Background
II. Discussion Of Form Adv, Part 2
    A. Part 2A: The Firm Brochure
    1. Proposed Format
    2. Brochure Items
    3. Delivery and Updating of Brochures
    B. Part 2B: The Brochure Supplement
    1. Delivery and Updating
    2. Format
    3. Supplement Items
    C. Filing Requirements, Public Availability, and Transition
III. Amendments to Form ADV Instructions and Glossary
IV. Amendments to Rule 204-2
V. General Request for Comment
VI. Paperwork Reduction Act
VII. Cost-Benefit Analysis
VIII. Initial Regulatory Flexibility Analysis
IX. Efficiency, Competition, And Capital Formation
X. Statutory Authority

Text of Rule and Form Amendments

I. Background

    Investment advisers provide a wide range of investment advice to 
numerous types of clients. From individuals and families seeking to 
save for college and plan for retirement to multinational institutions 
managing billions of dollars, clients seek the services of investment 
advisers to help them evaluate their investment needs, plan for their 
economic future, develop and implement investment strategies, and cope 
with the ever-growing complexities of the financial markets. Today, the 
more than 10,000 advisers registered with us provide advice to nearly 
20 million clients.\2\
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    \2\ These figures are based on data derived from investment 
advisers' responses to questions on Part 1A of Form ADV reported 
through the Investment Adviser Registration Depository (``IARD'') as 
of January 31, 2008.
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    Unlike the laws of many other countries, the U.S. federal 
securities laws do not prescribe minimum experience or qualification 
requirements for persons providing investment advice. They do not 
establish maximum fees that advisers may charge. Nor do they preclude 
advisers from having substantial conflicts of interest that might 
adversely affect the objectivity of the advice they provide. Rather, 
investors have the responsibility, based on disclosure they receive, 
for selecting their own advisers, negotiating their own fee 
arrangements, and evaluating their advisers' conflicts. Therefore, it 
is critical that clients and prospective clients receive sufficient 
information about the adviser and its personnel to permit them to make 
an informed decision about whether to engage an adviser, and having 
engaged the adviser, how to manage that relationship.
    Since 1979, the Commission has required investment advisers 
registered with us to provide clients and prospective clients with a 
disclosure statement providing information about the adviser, its 
business practices, the fees it charges, and its conflicts of 
interest.\3\ Part 2 of Form ADV, the form advisers use to register with 
us under the Advisers Act, sets out the requirements for the disclosure 
statement.\4\ Today, Part 2 requires

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advisers to respond to a series of multiple-choice and fill-in-the-
blank questions organized in a ``check-the-box'' format, supplemented 
in some cases with brief narrative responses. Advisers have the option 
of providing information in an entirely narrative format in lieu of the 
``check-the-box'' approach, although we believe few do.
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    \3\ Investment Adviser Requirements Concerning Disclosure, 
Recordkeeping, Applications for Registration and Annual Filings, 
Investment Advisers Act Release No. 664 (Jan. 30, 1979) [44 FR 7870 
(Feb. 7, 1979)] (adopting rule 204-3 requiring brochure delivery to 
advisory clients and prospective clients).
    \4\ Advisers use Form ADV to apply for registration with us or 
with state securities authorities, and must keep it current by 
filing periodic amendments as long as they are registered. See rules 
203-1 and 204-1. Form ADV has two parts. Current Part 2 contains the 
requirements for the disclosure statement that advisers must provide 
to prospective clients and offer to clients annually. Part 2 
currently is designated as ``Part II.'' For ease of reference, we 
refer to the second part of Form ADV as ``Part 2'' throughout this 
release. Part 1 of Form ADV provides us with information that we 
need to process registrations and to manage our regulatory and 
examination programs.
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    In April 2000, we proposed to require each adviser registered with 
us to give clients a narrative brochure that describes the adviser's 
business, conflicts of interest (including conflicts resulting from the 
adviser's receipt of ``soft dollar'' benefits), disciplinary history, 
and other important information necessary to make an informed decision 
about whether to rely on the adviser for advice.\5\ Our proposal was 
designed to require advisers to disclose this information in a clearer, 
more meaningful format than the current check-the-box approach.\6\ We 
received more than 70 comments in response to our 2000 proposal.\7\ We 
continue to believe that we need a better approach to client disclosure 
than the current ``check-the-box'' approach. In light of the time that 
has passed since the original proposal, and in order to provide all 
persons who are interested in this matter an opportunity to comment on 
some of the modifications, we have made in response to comments on our 
2000 proposal, we are today reproposing amendments to Part 2 of Form 
ADV and related rules under the Advisers Act.\8\ In light of the 
changes we are proposing to Part 2, the Commission also is proposing to 
withdraw rule 206(4)-4 (requiring advisers to disclose certain 
financial and disciplinary information to clients).
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    \5\ Electronic Filing by Investment Advisers; Proposed 
Amendments to Form ADV, Investment Advisers Act Release No. 1862 
(Apr. 5, 2000) [65 FR 20524 (Apr. 17, 2000)] (``Proposing Release'') 
at Section II.D.2. We noted in the Proposing Release that in some 
cases an adviser's response to a question using a check-the-box 
approach may be accurate but a client may, because of the mandated 
format of the disclosure, not accurately perceive the adviser's 
practices.
    \6\ In the Proposing Release, we also proposed extensive 
amendments to Part 1 of Form ADV, including changes necessary to 
permit advisers to file that part of the form with us 
electronically. In September 2000, we adopted amendments to Part 1A 
and related rules, but, as we noted at the time, we deferred 
adoption of amendments to Part 2 so that we could consider more 
fully the many comments we received on Part 2. Electronic Filing by 
Investment Advisers; Amendments to Form ADV, Investment Advisers Act 
Release No. 1897 (Sept. 12, 2000) [65 FR 57438 (Sept. 22, 2000)] 
(``Electronic Filing Adopting Release''). Today, all SEC-registered 
advisers must file Part 1A (as well as amendments) electronically 
through IARD. IARD was built and is maintained for the Commission 
and the state securities administrators by the Financial Industry 
Regulatory Authority (``FINRA''). In September 2001, we launched a 
Web site (http://www.adviserinfo.sec.gov), which provides free 
public access to information that advisers file on Part 1A. As we 
discuss in more detail in Section II.C below, firms' brochures would 
be available on the Commission's Web site.
    \7\ The comment letters and a summary of the comments prepared 
by Commission staff are available for public inspection and 
photocopying in the Commission's Public Reference Room, 100 F. 
Street, NE., Washington, DC (File No. S7-10-00). Comments submitted 
to us electronically are available at http://www.sec.gov/rules/
proposed/s71000.shtml. The summary of comments is available at 
http://www.sec.gov/rules/extra/iardsumm.htm.
    \8\ In addition, we note that Form ADV is used by advisers both 
to register with the Commission and with state regulatory 
authorities. In general, this Release discusses the Commission's 
proposed rules and amendments that would affect advisers registered 
with the Commission. We understand that the state securities 
authorities intend to make similar changes that affect advisers 
registered with the states. The draft form accompanying today's 
reproposal contains certain proposed items and instructions for Part 
2 (proposed Item 20 of Part 2A, proposed Item 11 of Appendix 1 to 
Part 2A, and proposed Item 7 of Part 2B) that would be applicable 
only to state-registered advisers. State-registered advisers would 
be required by state, rather than federal law, to respond to these 
items. Completion of these items, therefore, would not be an SEC 
requirement, and these items are not included in this Release as a 
proposed SEC rule. We will accept any comments and forward them to 
the North American Securities Administrators Association (``NASAA'') 
for consideration by the state securities authorities. We request 
that you clearly indicate in your comment letter which of your 
comments relate to these items. Commenters alternatively may send 
comments relating to these items directly to NASAA at the following 
e-mail address: part2comments@nasaa.org.
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II. Discussion of Form ADV, Part 2

A. Part 2A: The Firm Brochure

1. Proposed Format
    We are proposing to require registered advisers to provide 
prospective and existing clients with a narrative brochure written in 
plain English.\9\ The brochure would describe the adviser's services, 
fees, business practices, and conflicts of interest with clients. 
Advisers would file their brochures electronically through the IARD, 
and the public would benefit by having access to these brochures 
through the Commission's Web site. We believe that the amendments we 
are proposing today will greatly improve the ability of clients and 
prospective clients to evaluate firms offering advisory services and 
the firms' personnel, and to understand relevant conflicts of interest 
that the firms and their personnel face and their potential effect on 
the firms' services.
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    \9\ Proposed General Instructions 1 and 2 to Part 2 of Form ADV.
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    Commenters supported the narrative format we proposed in 2000 and 
agreed that it would promote more effective client communications.\10\ 
One stated that it would give an adviser ``sufficient flexibility to 
present and explain its business practices in a meaningful way.'' \11\ 
Another stated that the new narrative format would eliminate a number 
of problems identified with the current form.\12\
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    \10\ See, e.g., Comment Letter of Consumer Federation of America 
(June 22, 2000) (``CFA Letter''); Comment Letter of Teachers 
Insurance and Annuity Association and College Retirement Equities 
Fund (June 13, 2000) (``TIAA-CREF Letter'').
    \11\ Comment Letter of Association for Investment Management and 
Research, Advocacy Advisory Committee (June 13, 2000) (``AIMR 
Letter'').
    \12\ TIAA-CREF Letter.
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    We request further comment on the proposed narrative format, 
including comment on whether it is the right approach. Will the 
flexibility of the form allow advisers to present clear and meaningful 
disclosure to their clients? Will this flexibility minimize the burden 
on advisers in preparing their brochures? In considering our proposed 
amendments to Part 2 in their entirety, commenters should consider 
whether there are disclosures that are best made in a tabular or other 
non-narrative format and whether our proposal provides sufficient 
flexibility to permit that type of disclosure.
2. Brochure Items
    We are proposing a Part 2A for advisers that would contain nineteen 
separate items, each covering a different disclosure topic.\13\ The 
topics covered are generally the same as proposed in 2000.\14\ Much of 
the information that

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would be required in the brochure concerns conflicts between an 
adviser's own interests and those of its clients and is disclosure the 
adviser already must make to clients, as a fiduciary, under the Act's 
anti-fraud provisions.\15\ Thus, many of the proposed disclosure 
requirements are designed to give advisers guidance on fulfilling their 
statutory disclosure obligations to clients.\16\
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    \13\ Part 2A would have a main body and an appendix, Appendix 1. 
Appendix 1 contains the requirements for a specialized type of firm 
brochure--a wrap fee program brochure--and would require disclosure 
similar to current Schedule H of Part 2 of Form ADV. We are 
reproposing Appendix 1 with changes described below.
    \14\ Today's proposal does not include an item (which we 
proposed as Item 17 in 2000) that would have required advisers that 
advertise or report their investment performance to describe any 
standards they use to calculate or present that performance. The 
Securities Industry Association (``SIFMA'') argued that the 
disclosure would be voluminous because many advisers use different 
types of composites. Comment Letter of the Securities Industry 
Association (June 13, 2000) (``SIFMA Letter'') (the Securities 
Industry Association has since changed its name to the Securities 
Industry and Financial Markets Association). The Financial Planning 
Association (``FPA'') argued that the disclosure of calculation 
standards may not be helpful to investors (Comment Letter of the 
Financial Planning Association (June 13, 2000) (``FPA Letter'')), 
and the Investment Counsel Association of America (``IAA'') argued 
that clients are not interested in this type of information. Comment 
Letter of the Investment Counsel Association of America (June 13, 
2000) (``June 2000 IAA Letter'') (the Investment Counsel Association 
of America has since changed its name to the Investment Adviser 
Association). In response to the concerns raised by commenters, we 
are not reproposing that item. Today's proposal does, however, 
include a new item on performance fees and side-by-side management 
(Item 6). Additionally, at the request of state securities 
regulators, the form we are proposing today includes a separate item 
containing additional requirements for state-registered advisers 
(Item 20).
    \15\ Under the Advisers Act, an adviser has an affirmative 
obligation of utmost good faith and full and fair disclosure of all 
material facts to its clients, as well as a duty to avoid misleading 
them. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 
(1963); In the Matter of Arleen W. Hughes, Exchange Act Release No. 
4048 (Feb. 18, 1948). See also Advisers Act section 206 [15 U.S.C. 
80b-6].
    \16\ The items in proposed Part 2A will not cover every possible 
conflict. As a result, delivering a brochure prepared in accordance 
with Part 2 may not fully satisfy an adviser's disclosure 
obligations. We make this point clear in both the proposed form and 
the brochure rule. See proposed General Instruction 3 to Part 2; 
proposed rule 204-3(g).
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    Some commenters applauded our 2000 proposal as appropriately 
identifying information that advisers should disclose to clients.\17\ 
Others, however, maintained that the proposed form contained too many 
items and would require too much detailed information, in particular 
with respect to advisers' policies and procedures.\18\ These commenters 
raised legitimate concerns, which we have addressed in three ways. 
First, our instructions to Part 2A would clarify that an adviser must 
respond only to the items that apply to its business.\19\ Second, we 
have incorporated into our proposed Part 2A many suggestions from 
commenters for improving the form, including omitting some information 
that commenters convinced us is not necessary.\20\
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    \17\ See, e.g., CFA Letter; TIAA-CREF Letter.
    \18\ See, e.g., June 2000 IAA Letter; Comment Letter of the 
Investment Company Institute (June 13, 2001) (``ICI Letter'').
    \19\ Proposed General Instruction 1 to Part 2 of Form ADV. An 
adviser whose business is solely financial planning, for example, 
would not need to discuss how it manages client assets in response 
to Items 4.D and 4.E of Part 2A. An adviser that receives only 
asset-based fees need not discuss conflicts resulting from 
commission-based compensation payments in response to Item 5.E of 
Part 2A. An adviser without disciplinary information would not need 
to respond to Item 9 of Part 2A. An adviser that does not have 
custody of client funds or securities would not need to respond to 
Item 15 of Part 2A.
    Additionally, as currently permitted by existing rule 204-3(d), 
an adviser that offers substantially different types of advisory 
services to different advisory clients, would retain the option to 
prepare separate brochures so long as each client receives all 
information about the services and fees that are applicable to that 
client. See proposed rule 204-3(f) and proposed Instruction 6 to 
Part 2A. Each brochure may omit information that does not apply to 
the advisory fees and services it describes. For example, an 
adviser's brochure describing a particular advisory service need not 
include the fee schedule for a different advisory service that is 
not discussed in that particular brochure.
    \20\ For example, in response to comments, we are proposing to 
omit the requirement that advisers list all the wrap fee programs in 
which they participate.
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    Third, we have re-written several items to require advisers to 
explain succinctly how they address the conflicts of interest they 
identify, rather than disclosing their ``policies and procedures'' as 
we originally proposed.\21\ As commenters noted, requiring disclosure 
of policies and procedures could result in disclosure that would be 
lengthy, technical in nature, difficult to read, and that ultimately 
may not help clients understand how firms address their conflicts.\22\ 
As re-written, we believe these items would give advisers the 
flexibility to give clients a general understanding of how they address 
their conflicts. For example, an adviser with an affiliated financial 
service provider might simply explain that it does not recommend 
investment products sold by its affiliate, or an adviser with an 
affiliated broker-dealer might explain that it executes client 
securities transactions through its affiliated broker-dealer only if it 
believes that, in doing so, it would obtain best execution of client 
transactions.\23\
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    \21\ See, e.g., Proposed Items 5, 6, and 11 of Part 2A.
    \22\ June 2000 IAA Letter; ICI Letter; Comment Letter of 
Wellington Management Company, LLP (June 22, 2000) (``Wellington 
Letter'').
    \23\ By giving these examples we do not mean to suggest that 
these are the only ways for an adviser to address these conflicts of 
interest.
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    We request comment on whether our revisions to proposed Part 2A 
adequately respond to commenters' concerns about our 2000 proposal. 
Specifically, we request comment on our new approach regarding 
disclosure of policies and procedures that would require advisers to 
explain generally how they address conflicts of interest, instead of 
requiring them to describe their policies and procedures. Also, we 
request comment on our general instructions that clarify that an 
adviser need not repeat information in its brochure simply because that 
information is responsive to more than one item. Will our proposed 
instruction give advisers sufficient flexibility to avoid unnecessary 
detail while also providing clients and prospective clients with enough 
information to make an informed decision about whether to hire or 
retain an adviser or whether to rely on the investment advice provided 
by the adviser? If not, commenters should suggest alternative 
approaches.
    Below, we discuss each of the items in our proposed form and the 
more significant changes we have made from our 2000 proposal. In 
addition to our specific requests for comment detailed below, we also 
request comment generally on each of the proposed items.
    Item 1. Cover Page. We would require an adviser to disclose on the 
cover page of its brochure the name of the firm, its business address 
and telephone number, and the date of the brochure. The cover page also 
would include a statement that the brochure has not been approved by 
the Commission or any state securities authority.\24\ This information 
already is required by current Part 2 of Form ADV.
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    \24\ If the adviser holds itself out as being ``registered,'' 
the cover page also must explain that registration with the SEC does 
not imply that the adviser possesses a certain level of skill or 
training. We have observed that the emphasis on SEC registration, in 
some advisers' marketing materials, appears to suggest that 
registration either carries some official imprimatur or indicates 
that the adviser has attained a particular level of skill or 
ability. Section 208(a) of the Advisers Act [15 U.S.C. 80b-8(a)] 
makes such suggestions unlawful.
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    In addition, we would require advisers to disclose on the cover 
page the name and telephone number of a person or service center that a 
client or prospective client could contact for further information. At 
the suggestion of commenters, we revised our 2000 proposal to permit an 
adviser to identify a service center, rather than only an individual, 
as a contact for further information.\25\ Other commenters suggested 
that advisers be required to present a home page URL to assist 
investors using electronic search methods.\26\ While we recognize the 
value of this information, we understand that not all advisers maintain 
Web sites. Thus, we are proposing to require advisers to disclose a Web 
site address on the brochure cover page only if they have one.
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    \25\ See FPA Letter; Securities America Advisors, Inc. and 
Securities America, Inc. (June 12, 2000) (``Securities America 
Letter'').
    \26\ See, e.g., CFA Letter.
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    Item 2. Material Changes. We are proposing a requirement that 
advisers provide clients with a summary of any material changes to 
their brochures since the last annual update.\27\ This

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requirement is the same as the one we proposed in 2000, and would help 
clients identify information that has changed since the prior year's 
brochure and that may be important to them.\28\ The summary would 
appear on the cover page of the brochure or immediately thereafter, or 
could be included in a separate communication that would accompany the 
brochure.\29\
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    \27\ As discussed in more detail in Section II.A.3 below, we are 
proposing to require advisers to deliver an updated brochure 
annually within 120 days after the end of the adviser's fiscal year.
    \28\ See Proposing Release at Section II.D.2.a.
    \29\ An adviser would not be required to provide this 
information to a client or prospective client who has not received a 
previous version of the adviser's brochure. See proposed Note to 
Item 2 of Part 2A. Additionally, an adviser would not be required to 
file the summary with us, and therefore it would not be available on 
our public disclosure Web site, if the summary is included in a 
separate communication to clients. This is because the information 
contained in such a summary is intended to provide existing clients 
with means to easily identify changes from one annual brochure 
update to the next. We do not believe that such a summary would be 
relevant to persons who do not have the previous version of an 
adviser's brochure. We are, however, proposing an amendment to our 
recordkeeping rule that would require the adviser to preserve a copy 
of the communication, so that our staff has access to such 
separately provided summaries. See proposed rule 204-2(a)(14)(i). 
See Section IV below.
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    One commenter strongly supported the required summary.\30\ Others 
expressed concern that the summary might be too long.\31\ One 
commenter, the IAA, supported the option of having the summary be a 
separate letter to existing clients rather than part of the brochure. 
We request comment on our proposed approach to highlighting material 
changes to an adviser's brochure. If we do not adopt this approach, how 
else could clients know of potentially significant changes to the 
services they receive or the risk of new conflicts? Should we require 
that it be included in an adviser's brochure? Commenters who believe a 
summary of material changes would result in disclosure that is too 
lengthy should suggest other methods for ensuring that clients are made 
aware of important changes from one year to the next.
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    \30\ CFA Letter.
    \31\ Comment Letter of the Consortium (June 12, 2000) 
(``Consortium Letter''); Comment Letter of Jane Katz Crist (June 12, 
2000) (``Crist Letter''); June 2000 IAA Letter.
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    Item 3. Table of Contents. We propose to require advisers to 
include in their brochures a table of contents detailed enough to 
permit clients and prospective clients to locate topics easily.\32\ In 
response to our 2000 proposal, one commenter, the Consumer Federation 
of America (``CFA''), supported the use of a table of contents but 
urged that the Commission mandate a uniform format so that investors 
could compare brochures of multiple advisers more easily. We are of the 
initial view that the wide variety of business activities of the large 
number of advisers registered with us makes it impractical to develop a 
uniform format. We request comment on whether our view is correct. Is 
there a uniform brochure format that would be useful to clients and 
prospective clients of all the types of advisers registered with us? If 
we were to mandate a uniform format, how should it look? For example, 
should we require advisers to present information in their brochures in 
a standardized order? Should we adopt standardized titles for each 
separate section of a brochure? Do commenters have other suggestions 
for making the brochures easier for clients and prospective clients to 
compare?
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    \32\ Current Part 2 of Form ADV also includes a table of 
contents.
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    Item 4. Advisory Business. Proposed Item 4 would require an adviser 
to describe its advisory business, including the types of advisory 
services offered, whether it holds itself out as specializing in a 
particular type of advisory service, and the amount of client assets 
that it manages. In computing the amount of client assets that it 
manages, an adviser would be permitted, as originally proposed, to use 
a method that differs from the method used in Part 1A of Form ADV to 
report ``assets under management.'' \33\ We believe that because the 
Part 1A methodology for calculating assets is designed for a particular 
purpose (i.e., for making a bright line determination as to whether an 
adviser should register with the Commission or with the states), 
permitting a different methodology for Part 2 disclosure may be 
appropriate to enable advisers to make disclosure that is more 
indicative to clients about the nature of their business.\34\ Although 
we are proposing to permit advisers to choose a different method for 
their brochure disclosure, we also are proposing to require such 
advisers to keep records describing the method used.\35\ We request 
comment on this provision and on the proposed recordkeeping 
requirement. We also request comment as to whether we should require 
such advisers to disclose why they have elected to use a different 
method.
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    \33\ One commenter suggested that advisers be required to use 
the same methodology in their brochures as is required in Part 1A. 
See June 2000 IAA Letter.
    \34\ For example, in calculating ``assets under management,'' 
for purposes of Part 1A, an adviser may include the entire value of 
a managed portfolio, but only if at least 50 percent of the 
portfolio's total value consists of securities. See current Form 
ADV: Instructions for Part 1A. Thus, for Part 1A purposes an adviser 
would not include other assets (including securities) that it 
manages in a ``non-securities'' portfolio. The Part 1A formula for 
calculating assets under management was designed based on 
considerations related to the National Securities Markets 
Improvement Act of 1996 (``NSMIA'') division of responsibility for 
regulation of advisers between the Commission and state securities 
regulatory authorities. Pub. L. 104-290, 110 Stat. 3416 (1996) (as a 
result of NSMIA, advisers with less than $25 million of assets under 
management generally are regulated by one or more state securities 
authority, while the Commission generally regulates those advisers 
with at least $25 million of assets under management).
    \35\ Proposed rule 204-2(a)(14)(ii) and proposed Note to Item 
4.E of Part 2A.
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    Commenters largely supported the proposed item, to which we propose 
to make two revisions.\36\ First, we are not proposing to require 
advisers to list all wrap fee programs in which they participate. 
Commenters persuaded us that this requirement likely would lengthen 
brochures unnecessarily.\37\ Second, we are eliminating the proposed 
requirement that advisers list and describe all periodicals or periodic 
reports that they issue about securities. While Part 2 currently 
requires this, we believe that clients and prospective clients should 
be able to understand the nature of an adviser's services without 
knowing the names of each of its publications.\38\
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    \36\ Current Part 2 presently requires disclosure of similar 
information to that we are now proposing except in a different 
format, including information regarding advisory services provided, 
types of investments that advice is offered on, and investment 
strategies used. See current Form ADV, Part 2, Item 1 and Item 3.
    \37\ See Crist Letter; June 2000 IAA Letter.
    \38\ See Item 1.D of current Part 2 (requiring all advisers to 
name any publication or report they issue for a fee or on a 
subscription basis).
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    Some commenters urged the Commission not to require advisers to 
make additional disclosure if they hold themselves out as specializing 
in a particular type of advisory service, asserting that this could 
mislead clients into believing that advisers who specialize pose a 
greater risk than other advisers.\39\ Our reason for requiring advisers 
to identify their specialized advisory services, however, is not that 
we believe that those specialties inherently pose additional risks to 
clients, although we would expect the adviser to disclose specific 
risks if a specialized advisory service poses those risks. Instead, our 
proposal simply acknowledges that a client likely would want to know 
whether an adviser provides specialized advisory services before 
engaging that adviser.\40\ The

[[Page 13962]]

proposal was designed to reflect disclosure that we understand most 
advisers typically provide to prospective clients. The proposal also 
was intended to recognize the impracticality of having an adviser that 
offers multiple services describe each one. We request comment on this 
proposed item generally. Does the item accurately reflect the 
disclosure most advisers typically provide? Are there other disclosures 
we should include? Have we included disclosures that are not reflective 
of those typically provided by most advisers?
---------------------------------------------------------------------------

    \39\ See Comment Letter of Greenville Capital Management (May 
12, 2000) (``Greenville Letter''). See also Comment Letter of DE 
Shaw & Co. (July 6, 2000) (``DE Shaw Letter''); Comment Letter of 
Thomson Financial (June 22, 2001) (``Thomson Letter'').
    \40\ We note that one commenter objected to our characterizing 
financial planning as a specialized advisory service. Comment Letter 
of Certified Board of Financial Planners (June 13, 2000) (``CFP 
Board Letter''). By proposing to include financial planning as an 
example of a specialized service we are not suggesting in any way 
that it is a limited service--in fact, we recognize its most marked 
characteristic is that it seeks to address a wide spectrum of 
clients' financial needs. However, we note that financial planning 
has become a distinct profession, and as such, we believe it merits 
detailed description in the adviser's brochure. See, e.g., Conrad S. 
Ciccotello et al., Will Consult For Food! Rethinking Barriers To 
Professional Entry In The Information Age, 40 Am. Bus. L. J. 905 
(2003) at 921 (``Personal financial planning as a distinct 
profession is quite new'').
---------------------------------------------------------------------------

    Item 5. Fees and Compensation. Item 5 would require an adviser to 
describe how it is compensated for providing advisory services and to 
describe the types of other costs, such as brokerage, custody fees, and 
fund expenses, that clients may pay in connection with the advisory 
services provided to them by the adviser.\41\ As we proposed in 2000, 
the adviser would be required to disclose its fee schedule and whether 
its fees are negotiable, discuss whether the firm bills clients or 
deducts fees directly from the clients' accounts, and explain how often 
the firm assesses fees. An adviser charging fees in advance also would 
be required to explain how it calculates and refunds prepaid fees when 
a client contract terminates.
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    \41\ Proposed Items 5.A and 5.C of Part 2A. Part 2 currently 
requires similar disclosure regarding an adviser's fee schedule, how 
fees are charged, whether fees are negotiable, and when and how 
compensation is payable. See Item 1 of current Form ADV.
---------------------------------------------------------------------------

    We are also proposing in Item 5 a requirement that advisers that 
receive compensation attributable to the sale of a security or other 
investment product (e.g., brokerage commissions), or whose personnel 
receive such compensation, must disclose this practice and the conflict 
of interest it creates and describe how the adviser addresses this 
conflict.\42\ Such an adviser also would be required to disclose to 
clients that the client may purchase the same securities or investment 
products from brokers that are not affiliated with that adviser.\43\ 
Some commenters argued that an adviser that receives commissions or 
other payments for sales of securities to clients does not necessarily 
have a conflict of interest with its clients.\44\ This practice, 
however, gives the adviser and its personnel an incentive to base 
investment recommendations on the amount of compensation they will 
receive rather than on the client's best interests.\45\ Moreover, 
disclosure regarding commissions and other similar economic benefits 
already is required by current Part 2.\46\
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    \42\ Proposed Item 5.E of Part 2A. Advisers may engage in 
practices that would be required to be disclosed under multiple 
items. For example, an adviser may have a financial interest in 
securities that it recommends to clients (which would be disclosed 
in response to proposed Items 5 and 10) or the adviser may receive 
an economic benefit from a non-client (which would be disclosed in 
response to proposed Items 5 and 12). As noted above, a brochure 
would not need to repeat information simply because the information 
is responsive to more than one item. Proposed General Instruction 1 
to Part 2.
    \43\ Proposed Item 5.E.2 of Part 2A. In addition, an adviser 
that receives more than half of its revenue from commissions and 
other sales-based compensation would be required to explain that 
commissions are the firm's primary (or, if applicable, exclusive) 
form of compensation. Proposed Item 5.E.3 of Part 2A. An adviser 
that charges both advisory fees and commissions would disclose 
whether it reduces its fees to offset the commissions. Proposed Item 
5.E.4 of Part 2A.
    \44\ E.g., Comment Letter of American Express Financial Advisors 
(June 12, 2000) (``AmEx Letter''); CFP Board Letter; Comment Letter 
of Richard E. Vodra (Apr. 29, 2000).
    \45\ Because of this conflict of interest, advisers are required 
by the anti-fraud provisions of the Advisers Act to disclose their 
receipt of transaction-based compensation to clients. See Proposing 
Release at n. 137-38 and accompanying text.
    \46\ See current Form ADV, Part 2, Item 13.
---------------------------------------------------------------------------

    We are not proposing a requirement that advisers must disclose the 
amount or range of mutual fund fees or other third-party fees that 
clients may pay.\47\ Commenters explained that these expenses vary so 
greatly that attempts to quantify them or describe their range likely 
would not be useful to clients.\48\ Several of these commenters further 
argued that these fees are typically negotiated directly between the 
client and the other service providers, the adviser does not always 
know the amount of the fees, and that the third party often discloses 
the fees directly to the client.\49\ Would our proposed requirement 
that advisers disclose information about mutual fund or other third-
party fees, while not disclosing the range of those fees, adequately 
inform clients that they will bear other costs in addition to advisory 
fees?
---------------------------------------------------------------------------

    \47\ The current version of Part 2 does not require disclosure 
of this information.
    \48\ E.g., AmEx Letter; Consortium Letter; Comment Letter of 
Davis Polk & Wardwell (June 13, 2000) (``DP&W Letter''); ICI Letter; 
June 2000 IAA Letter; Comment Letter of National Regulatory Services 
(June 12, 2000); SIFMA Letter; Comment Letter of T. Rowe Price 
Associates (June 12, 2000) (``T. Rowe Price Letter'').
    \49\ See Greenville Letter; DE Shaw Letter; DP&W Letter; June 
2000 IAA Letter; ICI Letter; SIFMA Letter.
---------------------------------------------------------------------------

    Item 6. Performance Fees and Side-By-Side Management. New Item 6 
would require an adviser that charges performance fees (or who has a 
supervised person who manages an account that charges such fees) to 
disclose this fact.\50\ If such an adviser also manages accounts that 
are not charged a performance fee, the item also would require the 
adviser to discuss the conflicts that arise from its (or its supervised 
persons') simultaneous management of these accounts, and to describe 
generally how the adviser addresses those conflicts.\51\
---------------------------------------------------------------------------

    \50\ Proposed Item 6. ``Performance fees'' would be any fees an 
adviser receives that are based on a share of the capital gains on, 
or capital appreciation of, the assets of a client. Current Form 
ADV, Part 2 does not specifically require similar disclosure of 
performance fees, although an adviser who offers advisory services 
in exchange for such fees would be required to respond accordingly 
by marking ``Other'' in response to current Form ADV, Part 2, Item 
1.C(6).
    \51\ As fiduciaries, advisers must disclose all material 
information regarding any proposed performance fee arrangements as 
well as any material conflicts posed by the arrangements. See 
Exemption To Allow Investment Advisers To Charge Fees Based Upon a 
Share of Capital Gains Upon or Capital Appreciation of a Client's 
Account, Investment Advisers Act Release No. 1731 at n 13-14 and 
accompanying text (July 15, 1998) [63 FR 39022 (July 21, 1998)].
---------------------------------------------------------------------------

    An adviser charging performance fees to some accounts faces a 
variety of conflicts because the adviser can potentially receive 
greater fees from its accounts having a performance-based compensation 
structure than from those accounts it charges a fee unrelated to 
performance (e.g., an asset-based fee). As a result, the adviser may 
have an incentive to direct the best investment ideas to, or to 
allocate or sequence trades in favor of, the account that pays a 
performance fee. Additionally, conflicts stemming from their clients' 
differing investment strategies (e.g., clients that pay performance 
fees who engage in significant short selling) may put an adviser at 
odds with other clients (e.g., clients who hold long positions).\52\ 
The growth in the number of hedge funds, which typically pay 
performance-based fees to advisers that may have other advisory 
clients, makes

[[Page 13963]]

it likely that more advisers today will need to address this 
conflict.\53\ It is important to note that the conflicts of interest 
that result from the simultaneous management of performance fee 
accounts and other accounts are not limited to hedge fund advisers. For 
example, an adviser would face conflicts of interest if it were to 
manage a proprietary account that paid performance fees side-by-side 
other client accounts that did not pay performance fees.
---------------------------------------------------------------------------

    \52\ ``Another concern is the risk that mutual fund [not paying 
a performance fee] trades may appear to benefit a hedge fund [paying 
a performance fee], such as where mutual fund long positions in a 
security are sold after the hedge fund sells the same security 
short, or where large mutual fund purchases of a security are made 
after a hedge fund has purchased the same security.'' Kenneth R. 
Gerstein, Alternative Investments in the Mutual Fund World, 
Materials prepared for ICI/IBA 2001 Mutual Funds and Investment 
Management Conference, at XII-8.
    \53\ In a 2003 report, our Division of Investment Management 
highlighted its concerns regarding disclosure of conflicts of 
interest by advisers that advise hedge funds at the same time they 
advise other clients that do not pay a performance fee. See 
Implications of the Growth of Hedge Funds, Staff Report to the 
United States Securities and Exchange Commission (``Staff Report on 
the Implications of Hedge Funds''), available at http://www.sec.gov/
spotlight/hedgefunds.htm. The staff noted that because performance 
fees paid to hedge fund advisers are significantly higher than the 
asset-based fees paid on traditional accounts, advisers have 
additional incentives to favor their hedge fund clients over other 
clients by allocating investment opportunities to a hedge fund.
---------------------------------------------------------------------------

    We request comment on our approach requiring disclosure of 
conflicts arising from side-by-side management of accounts that pay 
performance fees and those that do not. Would our proposed requirement 
elicit sufficient information to allow a client to understand the 
conflicts that arise when an adviser manages performance fee accounts 
alongside accounts that do not charge performance fees? If not, what 
additional information would be helpful?
    Item 7. Types of Clients. We are proposing Item 7 in the same form 
as we proposed it in 2000.\54\ The one commenter that addressed this 
item, the FPA, commented favorably on it. As proposed, the brochure 
would describe the types of advisory clients the firm generally has, as 
well as the firm's requirements for opening or maintaining an account, 
such as minimum account size.\55\ We request comment on this approach.
---------------------------------------------------------------------------

    \54\ As originally proposed, this was Item 6. Because we have 
added a new proposed Item 6 (described above), this and subsequent 
items have been renumbered.
    \55\ Proposed Item 7 of Part 2A. Current Part 2 requires 
``check-the-box'' disclosure regarding types of advisory clients. 
See current Form ADV, Part 2 Item 2. Existing Part 2 currently also 
requires disclosure regarding whether an adviser providing certain 
advisory services imposes a minimum dollar value of assets or other 
conditions for starting or maintaining accounts. See current Form 
ADV, Part 2 Item 10.
---------------------------------------------------------------------------

    Item 8. Methods of Analysis, Investment Strategies and Risk of 
Loss. We also are proposing Item 8 in the same form as we proposed it 
in 2000. This item would require advisers to describe their methods of 
analysis and investment strategies.\56\ In addition, proposed Item 8 
would require an adviser to discuss the risks clients face in following 
the adviser's advice or permitting the adviser to manage assets. 
Advisers that offer a wide variety of advisory services could simply 
explain that investing in securities involves a risk of loss. Advisers 
that use primarily a particular method of analysis, strategy, or type 
of security would be required to explain the specific material risks 
involved, with more detail if those risks are significant or unusual.
---------------------------------------------------------------------------

    \56\ Presently, Item 4 of current Part 2 requires check-the-box 
disclosure of similar information regarding methods of analysis and 
investment strategies used. See current Form ADV, Part 2 Item 4.
---------------------------------------------------------------------------

    Some commenters supported this proposed disclosure requirement as 
central to the adviser's fiduciary relationship with the client.\57\ 
Others questioned why multi-strategy firms would not be required to 
make the same level of disclosure.\58\ Multi-strategy advisers must 
already disclose the risks associated with strategies that they 
recommend to clients, but the brochure may not be the best place to 
make that disclosure. For example, disclosure of this information may 
lengthen the brochure unnecessarily given that different clients would 
be pursuing different strategies, each of which poses specific and 
different risks, and clients may only need to understand the risks to 
which they are exposed.\59\ Accordingly, we would not require these 
advisers to list in the brochure the risks involved in each type of 
security or trading strategy. In such cases, required risk disclosure 
with respect to particular strategies could be made separately to those 
clients to whom such disclosure is relevant. We request comment on our 
approach. Also, we request comment on whether there are particular 
risks associated with particular strategies, analyses, or securities 
that warrant specific disclosure, and if so what are they?
---------------------------------------------------------------------------

    \57\ AIMR Letter; CFA Letter.
    \58\ DE Shaw Letter; Greenville Letter.
    \59\ Advisers utilizing multiple strategies would, of course, be 
free to disclose in their brochures the risks associated with each 
strategy.
---------------------------------------------------------------------------

    Item 8 also would require specific disclosure of how strategies 
involving frequent trading can affect investment performance. 
Commenters on this proposal in 2000 noted that an amount of trading 
that is inappropriately frequent for one type of security or client may 
be appropriate in the context of a different type of security or 
client.\60\ Does our proposal provide advisers enough flexibility to 
explain the degree to which frequent trading is appropriate in the 
context of their business? Also, two commenters recommended that the 
Commission define the term ``frequent trading of securities.'' \61\ We 
have not proposed a definition, but instead propose to permit firms 
some flexibility in determining whether strategies they employ involve 
frequent trading. As those commenters pointed out, the term 
``frequent'' is relative both to the client (i.e., an investment 
strategy involving frequent trading that is inappropriate for one type 
of client may be appropriate for another), and to the security being 
traded. We are concerned that a definition of the term ``frequent 
trading'' may not be sufficiently flexible to accommodate different 
types of securities or the different types of advisory clients. We 
request comment on our concern. Should we define the term ``frequent 
trading''? If so, commenters are invited to submit suggested text for 
such a definition.
---------------------------------------------------------------------------

    \60\ June 2000 IAA Letter; T. Rowe Price Letter.
    \61\ June 2000 IAA Letter; T. Rowe Price Letter.
---------------------------------------------------------------------------

    Finally, our proposed Item 8 would require advisers to discuss 
their practices regarding cash balances in client accounts. The IAA 
commented that these practices vary depending on the types of accounts 
and directions from clients and that meaningful disclosure about these 
practices would be difficult. Our proposal does not require exhaustive 
disclosure about, for example, all possible directions that all of an 
adviser's clients may give it. Instead, the proposal would require a 
concise, general explanation of the adviser's practices with respect to 
situations in which a particular client has not provided the adviser 
specific directions for handling cash balances. Does our proposal 
provide advisers with enough flexibility to explain their practices in 
a meaningful manner? If not, commenters are invited to suggest how to 
make the disclosures more meaningful.
    Item 9. Disciplinary Information. We are proposing Item 9 to 
require an adviser to disclose in its brochure material facts about any 
legal or disciplinary event that is material to a client's evaluation 
of the integrity of the adviser or its management. These requirements 
are similar, though as discussed below, not identical to those we 
proposed in 2000, and they would continue to incorporate into the 
brochure the disciplinary disclosure currently required by rule 206(4)-
4. Under that rule, advisers can make disciplinary disclosure to 
clients either orally or in writing. Because of the importance of this 
information to clients, we proposed in 2000 and now

[[Page 13964]]

repropose to require advisers to make this disclosure in their 
brochures.\62\
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    \62\ Current Part 2 of Form ADV does not include an item related 
to disciplinary issues, however, Item 11 in Part 1A of Form ADV does 
require disclosure of specified disciplinary events. Such disclosure 
is filed with the Commission as part of the firm's filing on IARD, 
but may not in all cases be provided to clients.
---------------------------------------------------------------------------

    As proposed (and as currently reflected in rule 206(4)-4), Items 
9.A, B, and C would provide a list of disciplinary events that are 
presumptively material if they occurred in the previous 10 years.\63\ 
The list would include, among other events, any convictions for theft, 
fraud, bribery, perjury, forgery, and violations of securities laws by 
the adviser or one of its executives. Disciplinary events such as these 
reflect the integrity of the adviser and its management persons and 
therefore are presumptively material to clients.\64\ The adviser would 
be permitted to rebut this presumption, in which case no disclosure to 
clients would be required. We would, however, require an adviser 
rebutting a presumption of materiality to document that determination 
in a memorandum and retain that record in order to better permit our 
staff to monitor compliance with this important disclosure 
requirement.\65\ A note in Item 9 would explain four factors the 
adviser should consider when assessing whether the presumption can be 
rebutted.\66\
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    \63\ The list of disciplinary events is similar to the list of 
events currently presumed material under existing rule 206(4)-4(b). 
Reproposed Item 9 cautions advisers, however, that the events listed 
in that item are those that are presumed to be material and do not 
constitute an exhaustive list of material disciplinary events.
    \64\ See Proposing Release at n. 145-150 and accompanying text.
    \65\ Proposed rule 204-2(a)(14)(iii), discussed below in Section 
IV. Proposed Item 3 of Part 2B, discussed below, requires a brochure 
supplement to contain disclosure of legal or disciplinary events 
involving the adviser's supervised persons. Proposed rule 204-
2(a)(14)(iii) would require the same memorandum in the event the 
adviser does not disclose an event described in Item 3 of Part 2B.
    \66\ These factors are: (1) The proximity of the person involved 
in the disciplinary event to the advisory function; (2) the nature 
of the infraction that led to the disciplinary event; (3) the 
severity of the disciplinary sanction; and (4) the time elapsed 
since the date of the disciplinary event. These are the same factors 
advisers use to assess materiality under current rule 206(4)-4. See 
Financial and Disciplinary Information that Investment Advisers Must 
Disclose to Clients, Investment Advisers Act Release No. 1083 (Sept. 
25, 1987) [52 FR 36915 (Oct. 2, 1987)] (``Rule 206(4)-4 Adopting 
Release''). We have removed, as unnecessary, a sentence from the 
note that was contained in the Proposing Release that explained that 
an adviser's determination is not binding on us or a court.
---------------------------------------------------------------------------

    We request comment with respect to the list of disciplinary events 
that are presumptively material. Are there additional types of 
disciplinary events that we should list? Are there disciplinary events 
listed that we should remove or modify? Should we expand the list to 
include disclosure of all cease and desist and censure orders entered 
against an adviser or its management persons? In addition, we request 
comment on the terms we use in this item. For example, we propose to 
state in Item 9 that an adviser must disclose if it (or any of its 
management persons) has been involved in one of the events listed in 
that item. We propose to continue to define the term ``involved'' using 
the same definition that currently exists in Form ADV.\67\ We request 
comment on the proposed use of the term ``involved'' in this item and 
our proposed use of the current definition of that term.
---------------------------------------------------------------------------

    \67\ The current Glossary to Form ADV defines the term 
``involved'' to mean ``Engaging in any act or omission, aiding, 
abetting, counseling, commanding, inducing, conspiring with or 
failing reasonably to supervise another in doing an act.''
---------------------------------------------------------------------------

    As proposed in 2000, this item also would have required advisers 
subject to a Commission administrative order to provide clients with a 
copy of that order. Several commenters urged us not to require advisers 
to deliver copies of Commission administrative orders to all clients, 
arguing among other things, that not all orders would be material to 
clients and that rather than imposing a blanket requirement, delivery 
of orders should remain a subject of settlement negotiation.\68\ We are 
not proposing this requirement because we agree with commenters' 
suggestion that we are able to require, where appropriate, delivery of 
orders in individual proceedings. Nonetheless, we request further 
comment as to whether we should require delivery of all or, 
alternatively, some specific category of administrative orders. 
Commenters supporting delivery of orders should explain how clients 
would benefit from delivery.
---------------------------------------------------------------------------

    \68\ E.g., AmEx Letter; ICI Letter; Comment Letter of 
PaineWebber Incorporated and Mitchell Hutchins Asset Management Inc. 
(June 19, 2000) (``Paine Webber Letter''); T. Rowe Price Letter; 
Comment Letter of Wilmer, Cutler & Pickering (June 13, 2000) 
(``Wilmer Letter'').
---------------------------------------------------------------------------

    In the Proposing Release, we also specifically requested comment 
about whether we should require disclosure of certain arbitration 
awards or claims. Several commenters urged us to include arbitration 
claims or awards in the list of disciplinary events because that 
information could be useful to the evaluation of an adviser's 
integrity,\69\ while others urged us not to require that disclosure at 
all, arguing that arbitration claims and awards are not necessarily an 
indication of wrongdoing.\70\ We request further comment on whether we 
should require disclosure of arbitration awards, settlements, or 
claims. Also, should we require disclosure of damages in a civil 
proceeding? Should we require disclosure of such damages, or 
arbitration claims, settlements, or awards above a specified amount? If 
so, would $10,000 be an appropriate amount? If not, what would be an 
appropriate threshold amount?
---------------------------------------------------------------------------

    \69\ AICPA Letter; CFA Letter; Comment Letter of the 
Pennsylvania Securities Commission (June 12, 2000) (``Penn. 
Securities Commission Letter'').
    \70\ See, e.g., Amex Letter; DP&W Letter; Wilmer Letter.
---------------------------------------------------------------------------

    Because advisers would include disciplinary disclosures in their 
advisory brochures if this proposal is adopted, we propose to rescind 
rule 206(4)-4, which requires disclosure of disciplinary information, 
but does not specify the means of conveying this disclosure.\71\ If we 
adopt our proposed amendments to Item 9, we would expect to make 
rescission of rule 206(4)-4 effective on the date by which advisers 
must deliver their narrative brochures to existing clients and begin 
delivering their brochures to prospective clients. Some advisers, 
however, may have clients to whom they are not required to deliver a 
brochure, for example certain clients receiving impersonal investment 
advice or registered investment companies and business development 
companies.\72\ For these advisers, their fiduciary duty of full and 
fair disclosure would require them to continue to disclose to all their 
clients any material disciplinary or legal events or inability to meet 
contractual commitments.\73\ Nonetheless, we request comment about 
whether we should rescind rule 206(4)-4. Should we retain the rule to 
clarify the disclosure obligations of advisers in situations in which 
they have no brochure delivery obligations?
---------------------------------------------------------------------------

    \71\ In addition to requiring disclosure of certain disciplinary 
information, rule 206(4)-4 currently requires an adviser to disclose 
certain financial information to clients. As with the disciplinary 
disclosure, this requirement would also be incorporated into the new 
brochure. Similar to current rule 206(4)-4(a)(1), proposed Item 18.B 
of Part 2A would require certain advisers to disclose any financial 
condition that is reasonably likely to impair their ability to meet 
contractual commitments to clients. See note 125 below and 
accompanying text.
    \72\ Our proposed requirements for which clients an adviser must 
deliver a brochure are discussed in Section II.A.3 below.
    \73\ See generally Rule 206(4)-4 Adopting Release (explaining 
that rule 206(4)-4 was designed to ``remind advisers of their 
obligation to disclose to clients material facts about precarious 
financial conditions and certain disciplinary events'').
---------------------------------------------------------------------------

    Item 10. Other Financial Industry Activities and Affiliations. We 
are proposing Item 10 to require advisers to describe material 
relationships or arrangements the adviser (or any of its management 
persons) has with related

[[Page 13965]]

financial industry participants, any material conflict of interest that 
the relationships or arrangements create, and how they address the 
conflict.\74\ In addition, if an adviser selects or recommends other 
advisers for clients, proposed Item 10 would require it to disclose any 
compensation arrangements or other business relationships between the 
two advisory firms, as well as the conflicts created.\75\ The 
disclosure that Item 10 would require would help clients be more aware 
of advisers' other financial industry activities and affiliations that 
can create conflicts of interest and impair the objectivity of 
investment advice.
---------------------------------------------------------------------------

    \74\ Currently, Part 2 of Form ADV requires disclosure regarding 
an adviser's other financial industry or affiliations, but does not 
specifically state that an adviser must describe the related 
conflicts of interest and how they are addressed. See current Form 
ADV, Part 2 Item 8.
    \75\ In 2005, our Office of Compliance Inspections and 
Examinations issued a report of their targeted exams of pension 
consultants that highlighted some of the conflicts faced by pension 
consultants who have business relationships with money managers they 
recommend to their pension clients: Staff Report Concerning 
Examinations Of Select Pension Consultants (May 16, 2005), available 
at http://www.sec.gov/news/studies/pensionexamstudy.pdf. The report 
noted that, for a number of pension consulting firms, compensation 
received from money managers comprised a significant part of their 
annual revenue but that pension consultants often did not provide 
adequate disclosure of the conflicts created by this practice to 
pension plan clients. Proposed Item 10 recognizes that these 
potential conflicts of interest are not limited to pension 
consultants and thus, would require disclosure by any adviser to 
whom it is relevant.
---------------------------------------------------------------------------

    One commenter, the CFA, applauded the disclosure required by this 
proposed item, stating that it would ``significantly enhance client 
understanding of these relationships.'' Others requested clarification 
about, among other things, the interaction of the disclosure required 
by this item and that required by other items, the amount of detail 
advisers must provide to clients about their internal procedures, and 
what constitutes a material relationship.\76\ Because of the 
considerable variety among the types of advisers registered with us and 
the diverse range of their relationships and affiliations in the 
financial industry, we do not propose to define which relationships or 
arrangements are material. We request comment on whether, despite the 
breadth of the financial industry, we should attempt to do so. If so, 
commenters are invited to provide suggestions of how to craft such a 
definition so as to capture relationships or arrangements involving 
material conflicts of interest.
---------------------------------------------------------------------------

    \76\ See, e.g., FPA Letter; June 2000 IAA Letter; Thomson 
Letter. We note that Item 8 of current Part 2 already requires an 
adviser to disclose certain relationships with a related person 
``that are material to its advisory business or its clients.''
---------------------------------------------------------------------------

    We request further comment on our proposed Item 10. Will the 
disclosure required by Item 10 be adequate to allow a client to 
evaluate the conflicts of an adviser, and therefore better manage its 
relationship with the adviser? If not, what additional or more specific 
information should an adviser be required to disclose?
    Item 11. Code of Ethics, Participation or Interest in Client 
Transactions and Personal Trading.
    Code of Ethics. Proposed Item 11.A would require each adviser to 
describe briefly its code of ethics and to state that a copy is 
available upon request. In 2004, we adopted rule 204A-1 \77\ under the 
Advisers Act and amended current Item 9, which, as a result, today 
requires advisers to make this same disclosure.\78\ The description of 
an adviser's code of ethics required by proposed Item 11.A may include 
matters also responsive to other items, including those discussed below 
and, in particular, personal trading by advisory personnel. If so, the 
disclosure need not be repeated.\79\
---------------------------------------------------------------------------

    \77\ 17 CFR 275.204A-1.
    \78\ Investment Adviser Codes of Ethics, Investment Advisers Act 
Release No. 2256 (July 2, 2004) [69 FR 41696 (July 9, 2004)] (``Code 
of Ethics Adopting Release'').
    \79\ Proposed General Instruction 1 to Part 2.
---------------------------------------------------------------------------

    Participation or Interest in Client Transactions. If the adviser or 
a related person recommends to clients or buys or sells for clients 
securities in which the adviser or a related person has a material 
financial interest, Item 11.B would require the brochure to discuss 
this practice and the conflicts presented.\80\ Conflicts could arise, 
for example, when an adviser recommends that clients invest in a pooled 
investment vehicle that the firm advises or serves as the general 
partner, or when an adviser with a material financial interest in a 
company recommends that a client buy shares in that company's public 
offering. An adviser engaging in these practices may have an incentive 
to base its advice on its own financial interests rather than the 
interest of clients, and the item is designed to help clients 
understand that conflict. The item would require advisers to disclose 
any practices giving rise to these conflicts, the nature of the 
conflicts presented, and how the adviser addresses the conflicts.\81\ 
The requirements of the proposed item are similar to the disclosures 
presently required under Item 9 of current Part 2.\82\
---------------------------------------------------------------------------

    \80\ Proposed Item 11.B. This item incorporates many of the 
disclosure requirements of current Item 9 of Part 2 and is identical 
to the Item 10.B we proposed in 2000. An adviser's related persons 
are: (1) The adviser's officers, partners, or directors (or any 
person performing similar functions); (2) all persons directly or 
indirectly controlling, controlled by, or under common control with 
the adviser; (3) all of the adviser's current employees; and (4) any 
person providing investment advice on the adviser's behalf. See Form 
ADV: Glossary.
    \81\ We are not proposing to require an adviser that relies on 
our recently adopted rule 206(3)-3T under the Advisers Act with 
respect to its principal trades with its advisory clients to 
disclose in Part 2 of Form ADV the information required by paragraph 
(a)(3) of that rule. Rule 206(3)-3T(a)(3) [17 CFR 275. 206(3)-
3T(a)(3)]. See also Temporary Rule Regarding Principal Trades with 
Certain Advisory Clients, Investment Advisers Act Release No. 2653 
(Sept. 24, 2007) [72 FR 55022 (Sept. 28, 2007)]. Rule 206(3)-3T sets 
out an alternative means for advisers that also are registered 
broker-dealers to comply with their obligations under section 206(3) 
of the Advisers Act with respect to principal trades with their 
clients. One condition of the rule is that an adviser relying on it 
must provide its clients with prospective written disclosure to the 
advisory client explaining (i) the circumstances under which the 
investment adviser directly or indirectly may engage in principal 
transactions, (ii) the nature and significance of conflicts with its 
client's interests as a result of the transactions, and (iii) how 
the investment adviser addresses those conflicts. Although we do not 
propose to require advisers to disclose this information in their 
brochures, they may do so if they wish.
    \82\ See current Form ADV, Part 2 Item 9.
---------------------------------------------------------------------------

    We request that commenters consider the proposed item and evaluate 
whether it would require sufficient disclosure to address our concerns.
    Personal Trading. Items 11.C and 11.D would require disclosure 
regarding personal trading by the adviser and its personnel. Because of 
the information they have, advisers and their personnel are in a 
position to abuse clients' positions by, for example, placing their own 
trades before or after client trades are executed in order to benefit 
from any price movements due to the clients' trades.\83\ These 
practices not only may affect the objectivity of the adviser's 
recommendations, but also can harm clients by adversely affecting the 
prices at which their trades are executed. Item 11.C would require an 
adviser to disclose whether it or a related person (e.g., advisory 
personnel) invests--or is permitted to invest--in the same securities 
that it recommends to clients, or in related securities such as options 
or other derivatives. If so, the brochure must discuss the conflicts 
presented and describe how the firm addresses the conflicts. Item 11.D 
would require a similar discussion, but focuses on the specific 
conflicts an adviser has when it or a related person trades in the same 
securities at or about the same time as a client.\84\ In response to 
this item, an

[[Page 13966]]

adviser might explain how its internal controls, including its code of 
ethics, prevent the firm and its staff from buying or selling 
securities contemporaneously with client transactions.\85\ Similar 
disclosure is already required under Item 9.E of current Part 2.
---------------------------------------------------------------------------

    \83\ This practice is known as ``front-running.'' See Investment 
Adviser Codes of Ethics, Investment Advisers Act Release No. 2209 
(Jan. 20, 2004) [69 FR 4040 (Jan. 27, 2004)] at n. 18 and 
accompanying text.
    \84\ Some situations, such as when an adviser owns shares in a 
company it recommends to clients, may be covered by both proposed 
Items 11.B and 11.C, as well as others, such as Item 5. Other 
situations, such as when an adviser sells its holdings of a security 
it purchases for clients, would come under proposed Item 11.C, and 
potentially 11.D. Further, some of these control procedures may be 
included in the adviser's code of ethics and in the description of 
the code. A brochure would not need to repeat disclosure simply 
because it is responsive to more than one item.
    \85\ Advisers would not be required to provide this disclosure 
with respect to securities that are not ``reportable securities'' 
under rule 204A-1, such as shares in unaffiliated mutual funds. See 
rule 204A-1. Such securities are not reportable under rule 204A-1 
because they appear to present little opportunity for front-running. 
See Code of Ethics Adopting Release, above note 78, at n. 42 and 
accompanying text.
---------------------------------------------------------------------------

    We proposed a similar item in 2000 on which we received no comment. 
Since that time, advisers have adopted codes of ethics that must 
address personal trading by certain advisory personnel and thus must 
address, at least in part, the concerns raised by this item. In light 
of this, should we further revise the item? If so, how?
    Item 12. Brokerage Practices. Proposed Item 12 would require 
advisers to describe how they select brokers for client transactions 
and determine the reasonableness of brokers' compensation. The item 
also would require advisers to disclose how they address conflicts 
arising from their receipt of ``soft dollars,'' i.e., the receipt of 
benefits such as research in connection with client brokerage.
    This item, which we discuss in more detail below, is largely the 
same as originally proposed, but with two changes urged by commenters. 
First, we have omitted a proposed requirement that advisers disclose in 
their brochures whether they negotiate commissions.\86\ Commenters 
informed us that few advisers ``negotiate'' commission rates in the 
literal sense suggested by the Proposing Release.\87\ Second, we have 
omitted the proposed requirement that advisers disclose whether they 
participate in commission recapture programs. We understand that these 
programs are not typically sponsored or promoted by advisers, but are 
more likely driven by client demands. We request comment on our 
understanding of these practices. Should we require brochure disclosure 
in either instance?
---------------------------------------------------------------------------

    \86\ See Proposing Release at n. 178-179 and accompanying text.
    \87\ June 2000 IAA Letter; SIFMA Letter. Of course, advisers 
must consider commission rates as part of their duty to seek best 
execution. See Interpretive Release Concerning the Scope of Section 
28(e) of the Securities Exchange Act of 1934 and Related Matters, 
Exchange Act Release No. 23170 (Apr. 23, 1986) [51 FR 16004 (Apr. 
30, 1986)] (``1986 Soft Dollar Release'') at Section V.
---------------------------------------------------------------------------

    Soft Dollar Practices. Many advisers receive brokerage and research 
services in reliance on section 28(e) of the Exchange Act, as well as 
other ``soft dollar'' products and services, provided by particular 
brokers in connection with client transactions.\88\ As we have 
previously noted, use of client securities transactions to obtain 
research and other benefits creates incentives that can result in 
conflicts of interest between advisers and their clients.\89\ Because 
of these conflicts, we have long required advisers to disclose their 
policies and practices with respect to their receipt of soft dollar 
benefits in connection with client securities transactions.\90\ Some 
commenters questioned the conflicts we identified and complained that 
the item would tend to cast aspersions on the use of soft dollar 
arrangements that are commonplace, such as those that fit within the 
safe harbor established by section 28(e).\91\ Our intent is not to 
create a negative impression regarding soft dollars arrangements, but 
rather to require full disclosure of arrangements that we believe 
involve significant conflicts of interest.
---------------------------------------------------------------------------

    \88\ Nearly 60 percent of advisers registered with the 
Commission report on Form ADV, Part 1A, Item 8.E that they or a 
related person receive soft dollar benefits in connection with 
client transactions. (IARD Data as of Sept. 30, 2007).
    \89\ Commission Guidance Regarding Client Commission Practices 
Under Section 28(e) of the Securities Exchange Act of 1934, Exchange 
Act Release No. 54165 (July 18, 2006) [71 FR 41978 (July 24, 2006)] 
(``2006 Soft Dollar Release'') (``[u]se of client commissions to pay 
for research and brokerage services presents money managers with 
significant conflicts of interest, and may give incentives for 
managers to disregard their best execution obligations when 
directing orders to obtain client commission services as well as to 
trade client securities inappropriately in order to earn credits for 
client commission services''). Section 28(e) of the Exchange Act 
provides a limited ``safe harbor'' for advisers with discretionary 
authority in connection with their receipt of soft dollar benefits. 
Under section 28(e), a person who exercises investment discretion 
over a client account has not acted unlawfully or breached a 
fiduciary duty solely by causing the account to pay more than the 
lowest commission rate available, so long as that person determines 
in good faith that the commission amount is reasonable in relation 
to the value of the brokerage and research services provided. 
Advisers must disclose their receipt of soft dollar benefits to 
clients, regardless of whether the benefits fall inside or outside 
of the safe harbor. See 1986 Soft Dollar Release, above note 87, at 
n. 33.
    \90\ Item 12 of current Part 2.
    \91\ Comment Letter of the Alliance In Support of Independent 
Research (June 13, 2000) (``Alliance Letter''); ICI Letter; SIFMA 
Letter.
---------------------------------------------------------------------------

    Our 2000 proposal responded to a 1998 report from our Office of 
Compliance Inspections and Examinations that concluded that advisers' 
disclosure often failed to provide sufficient information for clients 
or prospective clients to understand the advisers' soft dollar 
practices and the conflicts those practices present.\92\ In its report, 
OCIE noted that most advisers' descriptions were simply boilerplate, 
and urged that we consider amending Form ADV to require better 
disclosure.\93\ We request comment on whether our proposed item would 
achieve this goal.
---------------------------------------------------------------------------

    \92\ Inspection Report on the Soft Dollar Practices of Broker-
Dealers, Investment Advisers and Mutual Funds (Sept. 22, 1998), 
available at http://www.sec.gov/news/studies/softdolr.htm.
    \93\ Id.
---------------------------------------------------------------------------

    Item 12 would require an adviser that receives soft dollar benefits 
in connection with client securities transactions to disclose its 
practices.\94\ The proposed item would require a brochure's description 
of soft dollar practices to be specific enough for clients and 
prospective clients to understand the types of products or services the 
adviser is acquiring and permit them to evaluate conflicts.\95\ 
Disclosure must be more detailed for products or services that do not 
qualify for the safe harbor in section 28(e) of the Exchange Act, such 
as research that does not aid in the adviser's investment decision-
making process. Will the proposed disclosure be sufficient to 
adequately inform clients?
---------------------------------------------------------------------------

    \94\ The soft dollar benefits covered include any research, or 
other products or services, whether created or developed by the 
broker-dealer itself or by a third party. See note to proposed Item 
12.A.1 of Part 2A.
    \95\ In this regard, the proposed item would incorporate the 
standard for advisers we set out in our 1986 Soft Dollar Release. 
Our 2006 Soft Dollar Release preserved this provision of the 1986 
Soft Dollar Release. See 2006 Soft Dollar Release, above note 89, at 
n. 68 and accompanying text.
---------------------------------------------------------------------------

    Item 12 also would require an adviser to describe the types of 
conflicts it has when it accepts soft dollar benefits \96\ and to 
disclose how it addresses those conflicts.\97\ The item would require 
the adviser to explain whether it uses soft dollars to benefit all 
client accounts or only those accounts whose brokerage ``pays'' for the 
benefits, and whether the adviser seeks to allocate the benefits to 
client accounts proportionately to the soft dollar credits those 
accounts generate. The item also would require

[[Page 13967]]

the adviser to explain whether it ``pays up'' for soft dollar 
benefits.\98\ As we noted above, some commenters to our 2000 proposal 
questioned our description of the conflicts of interest identified in 
the item.\99\ We ask commenters to consider these descriptions.
---------------------------------------------------------------------------

    \96\ An adviser accepting soft dollar benefits would have to 
explain that (a) the adviser benefits because it does not have to 
produce or pay for the research or other products or services 
acquired with soft dollars, and (b) the adviser therefore has an 
incentive to select or recommend brokers based on the adviser's 
interest in receiving these benefits, rather than on the client's 
interest in getting the best execution.
    \97\ See proposed Item 12.A.1.f of Part 2A, which is 
substantively the same as Item 12.B of current Part 2.
    \98\ ``Paying up'' refers to a manager causing a client account 
to pay more than the lowest available commission rate in exchange 
for soft dollar products or services. Item 12 of current Part 2 
requires advisers to disclose ``whether clients pay commissions 
higher than those obtainable from other brokers in return for * * * 
products and services.''
    \99\ See above note 91 and accompanying text.
---------------------------------------------------------------------------

    Client Referrals. If an adviser uses client brokerage to reward 
brokers for client referrals, it also would be required to disclose 
this practice, the conflict it creates, and any procedures the adviser 
used to direct client brokerage to referring brokers during the last 
fiscal year, i.e., the system of controls used by the adviser when 
allocating brokerage.\100\ This practice presents advisers with 
significant conflicts of interest because they may have a bias towards 
referring brokers.\101\ Part 2 currently requires advisers to disclose 
these arrangements, but does not specifically require that such 
description discuss the conflicts of interest created.\102\
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    \100\ Proposed Item 12.A.2 of Part 2A.
    \101\ See Proposing Release at n. 177 and accompanying text.
    \102\ See current Form ADV, Part 2, Item 13.B.
---------------------------------------------------------------------------

    Proposed Item 12.A.2 is substantially the same as we proposed in 
2000. The one commenter that addressed it--CFA--expressed support for 
the item as proposed, and we request further comment.
    Trade Aggregation. Clients engaging an adviser can benefit when the 
adviser negotiates lower commissions or ``bunches'' trades to obtain 
volume discounts on execution costs.\103\ Item 12 would require the 
adviser to describe whether and under what conditions it engages in 
these practices. If the adviser does not bunch trades when it has the 
opportunity to obtain discounts, the adviser would be required to 
explain in the brochure that clients may pay higher brokerage costs. We 
request comment on this requirement. Should we also require an adviser 
to discuss whether and under what conditions it breaks up large orders 
to purchase or sell securities (e.g., to mitigate the impact of the 
transaction on the market value of the securities)?
---------------------------------------------------------------------------

    \103\ Broker-dealers may, for example, offer lower commission 
costs.
---------------------------------------------------------------------------

    Directed Brokerage. Clients sometimes instruct their adviser to 
send transactions to a specific broker-dealer for execution. Clients 
may initiate this type of arrangement for a variety of reasons, such as 
favoring a family member or friend or compensating the broker-dealer 
indirectly for services it provides to the client. But the arrangement 
may also be initiated by the adviser, who may benefit, for example, 
when brokerage is directed to its affiliated broker-dealer. In either 
case, clients directing (or agreeing to direct) brokerage need to 
understand the consequences of directing brokerage, including the 
possibility that their accounts will pay higher commissions and receive 
less favorable execution.\104\
---------------------------------------------------------------------------

    \104\ 1986 Soft Dollar Release, above note 87 at n. 44.
---------------------------------------------------------------------------

    If an adviser permits clients to direct brokerage, we would require 
the brochure to explain that the adviser may be unable to obtain best 
execution, and that directing brokerage may cost clients more 
money.\105\ If, however, the adviser routinely recommends, requests or 
requires clients to direct brokerage, the adviser also would be 
required to describe in its brochure the adviser's practice, to 
disclose that not all advisers require directed brokerage, and to 
discuss any broker-dealer relationship that creates a material conflict 
of interest.\106\
---------------------------------------------------------------------------

    \105\ Proposed Item 12.A.3.b of Part 2A.
    \106\ Proposed Item 12.A.3.a of Part 2A. Currently, Item 12 of 
Part 2 requires disclosure of similar information in cases where an 
adviser or a related person suggests brokers to clients and where an 
adviser has authority to determine the broker or dealer to be used.
---------------------------------------------------------------------------

    Commenters favored the item.\107\ One pointed out, however, that 
many clients direct brokerage subject to best execution.\108\ In such 
situations, the disclosure required by proposed Item 12.A.3.b is not 
relevant because the adviser would be required to seek best execution. 
To avoid disclosure that may not be helpful to clients, we have 
modified the item to permit advisers to omit the disclosure if the 
adviser only permits clients to direct brokerage subject to the 
adviser's ability to obtain best execution. We request further comment 
on the proposed disclosures regarding directed brokerage.
---------------------------------------------------------------------------

    \107\ CFA Letter; Comment Letter of the Florida State Board of 
Administration (June 13, 2000) (``Florida Board Letter''); June 2000 
IAA Letter.
    \108\ Comment Letter of Frank Russell Securities (June 13, 
2000).
---------------------------------------------------------------------------

    Item 13. Review of Accounts. Proposed Item 13 would require an 
adviser to disclose whether, and how often, it reviews clients' 
accounts or financial plans, and to identify who conducts the review. 
An adviser that reviews accounts, but not regularly, would explain what 
circumstances trigger an account review. This disclosure is similar to 
that presently required by Item 11 of current Part 2.\109\ Commenters 
who addressed this item supported it as being helpful to clients.\110\ 
We are proposing this item with no change from the 2000 proposal and we 
request further comment on it.
---------------------------------------------------------------------------

    \109\ See current Form ADV, Part 2, Item 11.
    \110\ CFA Letter; FPA Letter.
---------------------------------------------------------------------------

    Item 14. Payment for Client Referrals. Item 14 would require an 
adviser to describe any cash or other payment that it or a related 
person makes for client referrals. The brochure also would disclose 
whether the adviser receives any benefit, including sales awards or 
prizes, from a non-client for providing advisory services to 
clients.\111\ This item is the same as we proposed it in 2000 and we 
request further comment on it. Similar disclosure is already required 
by current Part 2 which requires an adviser to disclose whether it has 
any arrangements where it directly or indirectly compensates any person 
for client referrals and to describe such arrangements.\112\ Current 
Part 2 also requires an adviser to disclose whether it receives a cash 
payment or some economic benefit from non-clients in connection with 
giving advice to clients.\113\ We request further comment on our 
proposed Item 14.
---------------------------------------------------------------------------

    \111\ Proposed Item 14 would require advisory firms to disclose 
economic benefits they receive. As discussed below in Section II.B.3 
of this Release, Part 2B would require advisers to disclose economic 
benefits a supervised person receives.
    \112\ See current Form ADV, Part 2, Item 13.B.
    \113\ See current Form ADV, Part 2, Item 13.A.
---------------------------------------------------------------------------

    Item 15. Custody. We have updated this item from our 2000 proposal 
to reflect subsequent amendments to rule 206(4)-2 (our investment 
adviser custody rule).\114\ The protections afforded clients as a 
result of compliance with the amended rule reduce the need for much of 
the disclosure requirements we proposed in 2000. Today, most advisers 
that have custody of client securities or funds comply with the rule by 
maintaining these client assets with a qualified custodian (such as a 
broker-dealer or bank) that directly sends account

[[Page 13968]]

statements to the adviser's clients.\115\ These advisers would be 
required only to explain that clients will receive these account 
statements from their custodians and should review them carefully. If, 
however, clients do not receive, from one or more qualified custodians, 
account statements covering all of the funds and securities over which 
an adviser has custody, Item 15 would require the adviser to disclose 
that it has custody and to explain the risks that clients will face as 
a result.\116\
---------------------------------------------------------------------------

    \114\ See Custody of Funds or Securities of Clients by 
Investment Advisers, Investment Advisers Act Release No. 2176 (Sep. 
25, 2003) [68 FR 56692 (Oct. 1, 2003)] (``Custody Rule Release''). 
``Custody'' would have the same meaning as it currently has in Form 
ADV and is based on the term as defined in rule 206(4)-2. See Form 
ADV: Glossary. An adviser has custody if it, directly or indirectly, 
holds client funds or securities, has any authority to obtain 
possession of them, or has the ability to appropriate them. For 
example, an adviser has custody if it has a general power of 
attorney over a client's account or signatory power over a client's 
checking account. For a more detailed discussion of what activity 
constitutes ``custody,'' see Custody Rule Release, at Section II.A.
    \115\ Rule 206(4)-2 defines a ``qualified custodian'' as a bank, 
a savings association, a broker-dealer, a futures commission 
merchant (but only with respect to clients' funds, security futures, 
and other securities incidental to transactions in futures), or a 
foreign financial institution that customarily holds financial 
assets for its customers and segregates the advisory clients' assets 
from its proprietary assets. Under the rule, a registered adviser 
with custody must either have a reasonable basis for believing that 
the qualified custodian sends quarterly account statements directly 
to the client or send its own quarterly account statements to the 
client, in which case the adviser must also undergo an annual 
surprise examination by an independent public accountant to verify 
client funds and securities.
    \116\ We note that current Part 2 of Form ADV does not have an 
equivalent to Item 15 of reproposed Part 2A.
---------------------------------------------------------------------------

    We request comment on this proposed disclosure item. In particular, 
we request comment about whether we should further revise this item in 
light of the amended investment adviser custody rule.
    Item 16. Investment Discretion. Item 16 would require advisers with 
discretionary authority over client accounts to disclose these 
arrangements in their brochure,\117\ and any limitations clients may 
(or customarily do) place on this authority.\118\ This item is the same 
as originally proposed. Both of the commenters who addressed the 
proposed item supported it.\119\ We request further comment on our 
proposed Item 16.
---------------------------------------------------------------------------

    \117\ Currently, Items 12.A and 12.B of Part 2 require 
information about the adviser's investment discretion and any 
limitations on it. We propose to continue requiring this information 
but to clarify, through our proposed definitions in Form ADV, that 
an adviser has ``discretionary authority'' if it is authorized to 
make purchase and sale decisions for client accounts. This 
definition of discretionary authority is derived from section 
3(a)(35) of the Exchange Act [15 U.S.C. 78c(a)(35)]. An adviser also 
has discretionary authority if it is authorized to select other 
advisers for the client.
    \118\ For example, clients may not understand that they may ask 
the adviser not to invest in securities of particular issuers.
    \119\ CFA Letter; FPA Letter.
---------------------------------------------------------------------------

    Item 17. Voting Client Securities. Item 17 would require advisers 
to disclose their proxy voting practices. We have revised the item to 
reflect the adoption of rule 206(4)-6 under the Advisers Act, which, 
among other things, requires advisers registered with the Commission to 
disclose certain information about their proxy voting practices.\120\ 
We also have added a new requirement, discussed below, to describe 
information about an adviser's use of third-party proxy voting 
services.
---------------------------------------------------------------------------

    \120\ See Proxy Voting by Investment Advisers, Investment 
Advisers Act Release No. 2106 (Jan. 31, 2003) [68 FR 6585 (Feb. 7, 
2003)]. Rule 206(4)-6 requires advisers to adopt and implement 
written voting policies and procedures. Advisers are also required 
to keep certain records relating to their voting. Advisers that 
exercise voting authority over client securities must describe their 
voting policies and procedures to clients and furnish clients with a 
complete copy upon request.
---------------------------------------------------------------------------

    Item 17 would require advisers to disclose whether they will accept 
authority to vote client securities and, if so, to briefly describe the 
voting policies they adopted under rule 206(4)-6. In addition, each 
adviser must describe whether (and how) clients can direct the advisers 
to vote in a particular solicitation, how the adviser addresses 
conflicts of interest when it votes securities, and how clients can 
obtain information from the adviser on how the adviser voted their 
securities. Item 17 also would require an adviser to explain that 
clients may obtain a copy of the adviser's proxy voting policies and 
procedures upon request. Advisers that do not have authority to vote 
securities would have to disclose how clients will receive their 
proxies and other solicitations.
    Finally, we have added a new paragraph B of Item 17. If advisers 
routinely rely on one or more third-party proxy voting services to 
advise them in connection with voting client securities, then the 
advisers would be required to list the proxy voting services that the 
advisers use and to describe how they select the proxy voting services. 
The paragraph also would require disclosure of whether these advisers 
permit clients to direct the use of a particular proxy voting service 
with respect to the securities held in the clients' accounts. An 
adviser would not need to identify a proxy voting service that a client 
directs the adviser to use unless the adviser uses the service for the 
purpose of voting the securities of other clients. Finally, the new 
paragraph would require advisers to disclose how they pay for proxy 
voting services.
    We believe that clients are interested in knowing whether their 
adviser is outsourcing its proxy analysis or otherwise using third-
party proxy voting services, whether it is doing so in response to 
direction from another client, and how the adviser is paying for those 
services. We believe that clients would want to know of potential 
conflicts of interest that may arise from an adviser's use of proxy 
voting services, including possibly accommodating one client by hiring 
a proxy voting service to influence the voting of another client's 
securities.
    Several commenters favored the item when we proposed it in 
2000.\121\ We request comment on our proposed revisions. Rule 206(4)-6 
already requires advisers to disclose much of the information that the 
proposed item would require. Thus, one principal effect of the item 
would be to require the rule 206(4)-6 disclosure in the brochure. 
Should any of that disclosure not be required in the brochure?
---------------------------------------------------------------------------

    \121\ See Comment Letter of Professor Aaron Brown, Yeshiva 
University (May 10, 2000); Comment Letter of Council of 
Institutional Investors (June 12, 2000); Florida Board Letter; 
Comment Letter of The Corporate Monitoring Project (June 3, 2000); 
Comment Letter of James McRitchie (May 24, 2000); Comment Letter of 
Paul Nissenbaum (May 9, 2000). Four commenters were concerned about 
the length of the disclosure that a description of proxy procedures 
would entail. See AmEx Letter; June IAA 2000 Letter; Comment Letter 
of Charles Schwab & Co. (June 14, 2000) (``Schwab Letter''); Thomson 
Letter; Wellington Letter. We note in response to these commenters' 
concerns that the proposed item would only require a brief 
description of an adviser's policies and procedures and not verbatim 
incorporation of them.
---------------------------------------------------------------------------

    Should we require disclosure of the circumstances relating to an 
adviser's use of third-party proxy voting services? Specifically, would 
clients be interested in knowing the identity of the proxy voting 
services that are utilized by their advisers and how these services are 
selected? Would clients be interested in knowing whether advisers 
permit their clients to direct the use of particular proxy voting 
services? Would clients be interested in knowing the amounts that 
advisers pay third-party proxy voting services? Would clients be 
interested in knowing whether their advisers are paying for the 
services directly or through soft dollars? \122\
---------------------------------------------------------------------------

    \122\ For a discussion of whether proxy voting services and 
other proxy services are within the safe harbor under section 28(e) 
of the Exchange Act, see 2006 Soft Dollar Release, above note 89, at 
section III.C.5.
---------------------------------------------------------------------------

    Item 18. Financial Information. This item would require disclosure 
of certain financial information about the adviser when material to 
clients. Proposed Item 18 of Part 2A would continue to require each 
adviser that requires prepayment of fees to give clients an audited 
balance sheet showing the adviser's assets and liabilities at the end 
of its most recent fiscal year.\123\ Prepayment of fees

[[Page 13969]]

exposes clients to the risk that the firm may become insolvent and 
unable to refund unearned fees. The proposed item also would require 
each adviser to disclose any financial condition reasonably likely to 
impair the adviser's ability to meet contractual commitments to clients 
if the adviser has discretionary authority over client assets, has 
custody of client funds or securities, or requires or solicits 
prepayment of more than $1,200 in fees per client and six months or 
more in advance.\124\ These clients are exposed to the risk that their 
assets may not be properly managed if the adviser becomes insolvent and 
ceases to do business.\125\ Finally, proposed Item 18 would require an 
adviser that has been the subject of a bankruptcy petition during the 
past ten years to disclose that fact to clients.\126\
---------------------------------------------------------------------------

    \123\ Currently, Item 14 of existing Part 2 requires (through 
Schedule G) an audited balance sheet if the adviser requires 
prepayment of more than $500 in fees per client and six or more 
months in advance. We would increase the threshold amount from $500 
to $1,200 to reflect the effects of inflation, based upon the 
Personal Consumption Expenditures Chain-Type Price Index as 
published by the U.S. Department of Commerce, since we adopted Form 
ADV in 1979. As in the 2000 proposal, we also propose to require an 
audited balance sheet from advisers that solicit clients to prepay 
fees over $1,200.
    \124\ This disclosure is currently required by rule 206(4)-4. In 
its release adopting rule 206(4)-4 the Commission noted that a 
determination about what constitutes financial condition reasonably 
likely to impair an adviser's ability to meet contractual 
commitments is inherently factual in nature but would generally 
include insolvency or bankruptcy. See Rule 206(4)-4 Adopting 
Release, above note 66 at n. 6.
    \125\ As discussed above, we propose to rescind rule 206(4)-4. 
We caution advisers, however, that their fiduciary duty of full and 
fair disclosure may require them to continue to disclose any 
material legal event or precarious financial condition promptly to 
all clients, even clients to whom they may not be required to 
deliver a brochure or amended brochure. See Rule 206(4)-4 Adopting 
Release, above note 66 at n. 2-3 and accompanying text.
    \126\ This requirement conforms with our already stated position 
that bankruptcy generally constitutes a `financial condition 
reasonably likely to impair the adviser's ability to meet 
contractual commitments to clients' requiring disclosure under rule 
206(4)-4. See Rule 206(4)-4 Adopting Release, above note 66 at n. 6.
---------------------------------------------------------------------------

    This item is largely the same as the one we proposed in 2000, which 
commenters generally supported.\127\ However, we have made revisions to 
reflect subsequent amendments to Form ADV that were made in conjunction 
with changes to the adviser custody rule.\128\ As a result, Item 18 no 
longer would require an adviser to supply clients with an audited 
balance sheet solely because the adviser has custody. Moreover, we now 
propose to exclude advisers from the balance sheet requirement if they 
require prepaid fees but are qualified custodians or insurance 
companies. These firms are subject to capital and regulatory 
requirements, designed to guard against insolvency, that eliminate the 
need for an adviser to deliver a balance sheet. Are there other 
circumstances in which it would be unnecessary for an adviser to 
deliver a balance sheet to its clients? Alternatively, are there 
additional circumstances in which it would be appropriate for us to 
require an adviser to deliver a balance sheet?
---------------------------------------------------------------------------

    \127\ See, e.g., CFA Letter; June 2000 IAA Letter. Although some 
commenters to our 2000 proposal raised concerns regarding exceptions 
to delivery of balance sheets, the Commission subsequently 
considered and addressed this issue in adopting its changes to the 
custody rule. See Custody Rule Release, above note 114.
    \128\ See Custody Rule Release, above note 114.
---------------------------------------------------------------------------

    Item 19. Index. The brochure filed with us would be required to 
include an index of the items required by Part 2A indicating where in 
the brochure the adviser addresses each item.\129\ This index is 
intended to facilitate review by our staff for compliance with the 
requirements of Part 2A. The adviser would not be required to provide 
the index to its clients. The index would, however, be required to be 
appended to the brochure as filed through the IARD. We proposed the 
same index requirement in 2000.\130\ We request further comment on our 
proposal to require advisers to include an index in their brochures.
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    \129\ Although an index is not required by current Part 2 of 
Form ADV, the requirement in Proposed Item 19 is similar to the 
index that current Schedule H now requires.
    \130\ In their comments responding to the 2000 proposal, the ICI 
and IAA opposed this item, arguing that requiring both an index and 
a table of contents seemed redundant. See ICI Letter; June 2000 IAA 
Letter. The CFA, however, endorsed the requirement. See CFA Letter.
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    Part 2A Appendix 1: The Wrap Fee Program Brochure. Advisers that 
sponsor wrap fee programs \131\ would continue to be required to 
prepare a separate, specialized firm brochure (a ``wrap fee program 
brochure'' or ``wrap brochure'') for clients of the wrap fee program in 
lieu of the sponsor's standard advisory firm brochure.\132\ The items 
in proposed Appendix 1 to Part 2A would contain the requirements for a 
wrap fee program brochure, and would be substantially similar to those 
currently in Schedule H. However, as we did in 2000, today we are 
proposing some changes from current Schedule H to incorporate many of 
our proposed amendments to the Part 2A firm brochure. We also are 
proposing an additional disclosure requirement to the wrap fee 
brochure.
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    \131\ Under wrap fee programs, which are also sometimes referred 
to as ``separately managed accounts,'' advisory clients pay a 
specified fee for investment advisory services and the execution of 
transactions. The advisory services may include portfolio management 
and/or advice concerning selection of other advisers, and the fee is 
not based directly upon transactions in the client's account.
    \132\ We adopted the requirement for a separate brochure for 
wrap fee clients in 1994. See Disclosure by Investment Advisers 
Regarding Wrap Fee Programs, Investment Advisers Act Release No. 
1411 (Apr. 19, 1994) [59 FR 21657 (Apr. 26, 1994)] (adopting rules 
to require wrap fee sponsors to give wrap fee clients separate 
brochures). As proposed in 2000, advisers whose entire advisory 
business is sponsoring wrap fee programs would prepare a wrap 
brochure but would not be required to prepare a standard advisory 
firm brochure. See proposed Instruction 7 to Part 2A of Form ADV. An 
adviser would have to prepare both a standard firm brochure and a 
wrap fee brochure if it both sponsors a wrap fee program and 
provides other types of advisory services, and would deliver both a 
standard and a wrap brochure to a client who receives both types of 
services. Wrap fee sponsors would, like other advisers, be required 
to provide brochure supplements to their wrap fee clients.
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    We propose to require an adviser to disclose whether any of its 
related persons are portfolio managers in the program and to describe 
the conflicts that may be present.\133\ For example, an adviser may 
have an incentive to select a related person to participate as a 
portfolio manager based on the person's affiliation with the adviser, 
rather than based on expertise or performance. The item would require 
advisers to disclose whether related person portfolio managers are 
subject to the same selection and review as the other portfolio 
managers who participate in the wrap fee program and, if they are not, 
how they are selected and reviewed.
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    \133\ Proposed Item 6.B of Appendix 1. We propose to redesignate 
the item originally proposed as Item 6.B (requiring additional 
disclosures if the wrap fee sponsor or any of its employees act as a 
portfolio manager for a wrap fee program described in the wrap 
brochure) as new Item 6.C.
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    We request comment on this proposed modification to Appendix 1 to 
Part 2A. Wrap fee programs have evolved in the marketplace, resulting 
in many different models that all meet the definition of wrap fee 
program.\134\ As a result of these various structures, are there other 
disclosures that we should consider including in Appendix 1 that would 
enhance a client's ability to understand the conflicts of interest in 
wrap fee programs? Are there disclosure items in proposed Appendix 1 
that are unnecessary or would not be useful to clients?
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    \134\ For example, some wrap fee program sponsors have begun to 
transition from platforms offering a selection of individual 
portfolio managers to those instead offering a selection of model 
portfolios.
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3. Delivery and Updating of Brochures
    The Commission also is proposing amendments to rule 204-3, our rule 
under the Advisers Act that requires registered advisers to update and 
deliver their brochures to clients and prospective clients.
a. Delivery to Clients
    Initial Delivery. Similar to the existing requirements, an adviser 
would be required to deliver a current firm brochure before or at the 
time it enters into an advisory contract with the

[[Page 13970]]

client.\135\ As provided under the current rule, advisers would not be 
required to deliver brochures to certain advisory clients receiving 
only impersonal investment advice \136\ or to clients that are 
investment companies registered under the Investment Company Act of 
1940 (``Company Act'').\137\ We propose expanding the latter exception 
to cover advisers to business development companies (``BDCs'') that are 
subject to section 15(c) of the Company Act. That section requires the 
boards of directors to request, and the adviser to furnish, information 
to enable the board to evaluate the terms of the proposed advisory 
contract.\138\ Because of this safeguard, we believe that proposing a 
separate obligation for those types of entities to deliver a brochure 
is not necessary. We note that an adviser would not have to prepare a 
brochure if it does not have any clients to whom a brochure would have 
to be delivered, thus saving advisers time and expense.\139\
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    \135\ Proposed rule 204-3(b)(1). Rule 204-3 currently requires a 
registered adviser to furnish each client and prospective client 
with a written disclosure statement which may be either a copy of 
the adviser's completed Part 2 or a written document containing the 
information required by Part 2. Currently, such delivery must occur 
at least 48 hours before entering into the advisory agreement, or at 
the time of entering into the agreement if the client has the right 
to terminate the agreement without penalty within five business days 
thereafter. We are proposing to simply require that the adviser 
deliver the brochure before or at the time of entering into the 
agreement.
    \136\ Proposed rule 204-3(c)(1) and proposed Instruction 1 to 
Part 2A. Advisers would not be required to deliver brochures to 
advisory clients receiving only impersonal investment advice for 
which the adviser charges less than $500 per year. Currently, the 
dollar amount threshold to trigger this exception is $200. See rule 
204-3. We are proposing to increase this threshold to $500 to 
reflect the effects of inflation, based upon the Personal 
Consumption Expenditures Chain-Type Price Index as published by the 
U.S. Department of Commerce, since rule 204-3 was adopted in 1979.
    \137\ Proposed rule 204-3(c)(1) and proposed Instruction 1 to 
Part 2A. This does not suggest, however, that investment company 
directors would no longer receive the disciplinary and financial 
information that the fund's adviser currently provides under 
existing rule 206(4)-4, which we are proposing to move into the 
brochure. Section 15(c) of the Investment Company Act [15 U.S.C. 
80a-15(c)] separately requires fund directors to request and 
evaluate information about the adviser in connection with annual 
renewal of the advisory contract, and requires the adviser to 
provide it.
    \138\ See note 137 above.
    \139\ Proposed Instruction 5 to Part 2A.
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    Annual and Interim Delivery. Currently, rule 204-3 requires 
advisers to annually deliver, or offer to deliver upon request, a 
written disclosure statement (either a copy of the adviser's Part 2 or 
a brochure containing the information required by Part 2) to each of 
its advisory clients.\140\ In 2000, we proposed to require advisers to 
deliver an updated brochure, or a ``sticker'' identifying the stale 
information and including the updated information, whenever information 
in the brochure became materially incorrect during the year.\141\ We 
expressed concern that few clients requested an updated brochure and 
were instead relying on ``stale'' brochures. We analogized our updating 
proposal to the obligations of mutual funds to update their 
prospectuses and expressed the view that the additional costs the 
proposed updating requirements might impose could be reduced by 
electronic delivery of the updating information. We also pointed out 
that, as fiduciaries, advisers must already provide their clients with 
updated information to comply with their obligations under the anti-
fraud provisions of the Advisers Act.
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    \140\ Rule 204-3(c). An adviser's offer to deliver the 
disclosure statement must be in writing.
    \141\ See Proposing Release at Section II.D.2.
---------------------------------------------------------------------------

    Several commenters supported our proposal, particularly the 
proposal to require advisers to update their brochures throughout the 
year.\142\ Other commenters objected, primarily citing the burden on 
advisers.\143\ Some commenters argued that advisers currently meet 
their obligations under the anti-fraud provisions through different 
types of communications with clients, some of which are informal, and 
urged us not to impose a formal updating requirement.\144\ One 
commenter, the IAA, expressed agreement with our concern that clients 
may be relying on stale information and urged a compromise approach 
under which the Commission would require advisers to deliver their 
brochure to clients annually, but would not specify the means of 
updating information between the annual updates.\145\
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    \142\ See, e.g., AIMR Letter; CFA Letter; Comment Letter of 
Yasmin Mansoor (May 28, 2000); Penn. Securities Commission Letter; 
Securities America Letter.
    \143\ See, e.g., AmEx Letter; Crist Letter; DP&W Letter; ICI 
Letter; SIFMA Letter.
    \144\ See, e.g., Comment Letter of Merrill Lynch, Pierce, Fenner 
& Smith, Inc. (June 22, 2000) (``Merrill Letter''); Paine Webber 
Letter; Schwab Letter.
    \145\ Comment Letter of the IAA (May 24, 2001) (``May 2001 IAA 
Letter'').
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    Today, we are proposing an approach similar to the one suggested by 
the IAA, which we believe may strike an appropriate balance between our 
concerns and those expressed by commenters. In addition to the initial 
delivery requirement, the proposed amendments would require each 
registered adviser to deliver its current brochure to existing clients 
at least once each year no later than 120 days after the end of the 
adviser's fiscal year.\146\ Thus, clients would receive an updated 
brochure about the same time each year (identifying changes from the 
previous year's brochure) shortly after the date by which advisers are 
already required to file their amended Form ADV with us.\147\
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    \146\ Proposed amended rule 204-3(b) and proposed Instruction 2 
to Part 2A.
    \147\ As discussed below, rule 204-1 requires an adviser 
registered with the Commission to annually revise its Form ADV, 
including its brochure, within 90 days of its fiscal year end. 
Advisers typically provide clients with reports quarterly, and the 
proposed 120-day period is designed to provide sufficient 
flexibility to allow advisers to include the updated brochure in a 
routine quarterly mailing to clients. We expect that permitting an 
adviser to send the brochure together with these routine mailings 
could substantially reduce delivery costs. See Section VII below. 
Advisers may, of course, deliver updated brochures electronically 
with client consent, in which case they would bear significantly 
lower delivery costs. Proposed Instruction 3 to Part 2A. See also 
Use of Electronic Media by Broker-Dealers, Transfer Agents, and 
Investment Advisers for Delivery of Information, Investment Advisers 
Act Release No. 1562 (May 9, 1996) [61 FR 24644 (May 15, 1996)] 
(publishing Commission interpretive guidance with respect to use of 
electronic media to fulfill investment advisers' disclosure delivery 
obligations).
---------------------------------------------------------------------------

    We are proposing to require an adviser to deliver an interim update 
to clients only when the adviser amends its brochure to add a 
disciplinary event, or to materially change information already 
disclosed, in response to Item 9 of Part 2A.\148\ We believe that such 
circumstances warrant a formal delivery requirement because of the 
importance of disciplinary information to clients.\149\ We believe such 
disciplinary events are important because, unlike some of the other 
disclosure items, they are more likely to reflect directly upon an 
adviser's integrity and may affect a client's trust and confidence in 
the adviser.
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    \148\ Proposed rule 204-3(e). Nonetheless, as fiduciaries 
advisers have an ongoing obligation to inform their clients of any 
material information that could affect the advisory relationship. As 
a result, advisers may be required to disclose material changes to 
clients between annual updating amendments even if those changes do 
not trigger delivery of an interim update. See Note to Proposed 
Instruction 2 to Part 2A; see also Form ADV: General Instruction 4.
    \149\ Currently, existing rule 206(4)-4 requires disclosure of 
such disciplinary events. The proposed requirement of interim 
updates to the brochure would require that such disclosure be 
written.
---------------------------------------------------------------------------

    We request comment generally on our proposed delivery requirement 
and, in particular, on the proposed requirements regarding delivery of 
updates. Should we require delivery of interim updates of the brochure 
in additional circumstances besides those involving disclosure of 
disciplinary information in response to Item 9? Should we require 
brochure delivery

[[Page 13971]]

more frequently than annually? We also request comment with respect to 
the timing of annual delivery. Is the proposed provision to require 
annual delivery no later than 120 days after the end of the adviser's 
fiscal year reasonable? Does it adequately enable advisers to minimize 
costs by making delivery in conjunction with existing mailings?
b. Updating Part 2 of Form ADV
    Similar to the existing requirements, the proposed rules would 
require advisers to keep the brochures they file with us current by 
updating them at least annually, and updating them promptly when any 
information in the brochures becomes materially inaccurate.\150\ In the 
case of both annual and interim updates, advisers will be able to make 
changes to their brochures using their own computers and then simply 
submit the revised versions of their brochures through IARD.\151\ In 
some cases, an adviser will be required to submit an annual updating 
amendment, but may not have any changes to make to its brochure 
(because the currently filed brochure does not contain any materially 
inaccurate information). The IARD system will give the adviser the 
option of indicating on IARD that its current brochure does not contain 
any materially inaccurate information and that the adviser is not 
attaching another brochure. Although previously-filed versions of an 
adviser's brochures will remain stored as Commission records in the 
IARD system, as with an adviser's Part 1A filings, only the most recent 
version of an adviser's brochure will be available through the 
Commission's public disclosure Web site.\152\ The purpose of the public 
disclosure Web site is to provide the public with current information 
about advisers, rather than historic information.\153\
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    \150\ See proposed amended rule 204-3(g), and proposed 
Instruction 4 to Form ADV, Part 2A. As discussed above, the proposed 
updating requirement would be similar to the existing standard. See 
current rule 204-1 and Form ADV: General Instruction 4. 
Additionally, proposed Instruction 4 to Part 2A and a proposed Note 
to Item 4.E would state that an adviser does not need to update its 
brochure solely because the amount of its client assets has 
materially changed. This proposed instruction reflects our 
understanding that in most cases the amount of an adviser's assets 
under management will likely continually change over the course of a 
year due to market fluctuations, and that requiring advisers to 
update their brochure in each instance would be burdensome and of 
limited value. This approach is similar to that we currently take 
with respect to advisers' obligations to update assets under 
management reported in Item 5 of Form ADV, Part 1A. See Form ADV: 
General Instruction 4. For similar reasons, proposed Instruction 4 
to Part 2A also would state that an adviser does not need to update 
its brochure solely because its fee schedule has changed. Advisers 
would, however, be required to update their brochure to reflect 
material changes with respect to listed assets and fee schedules if 
they are otherwise updating their brochure for a separate reason.
    \151\ Proposed rule 204-1(b).
    \152\ See note 6 above. In the case of an adviser that prepares, 
files and delivers to clients separate brochures for the various 
different advisory services it offers, the most recent version of 
each of its brochures would be available via the public disclosure 
Web site.
    \153\ Advisers' historic brochure filings would be available for 
public inspection and copying in the Commission's Public Reference 
Room, 100 F Street, NE., Washington, DC 20549.
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    We request comment generally with respect to our proposed 
requirements for updating brochures. We request comment specifically 
about the proposal to require ongoing updating. Should we develop 
different updating requirements for the different disclosure items of 
the brochure in a manner similar to the updating requirements for Form 
ADV, Part 1A (e.g., require more frequent updating with respect to 
changes to an adviser's listed fee schedule)? We also request comment 
about whether we should make advisers' historical brochure filings 
available via the Commission's public disclosure Web site.

B. Part 2B: The Brochure Supplement

    In 2000, we expressed our concern that, because the information in 
current Part 2 concerns the advisory firm, clients may not receive 
information they want and need about the firm's employees with whom 
they have contact and on whom they rely for investment advice.\154\ In 
the case of smaller advisers, the current disclosure requirements, 
which focus on the senior executives of the advisory firm, may be 
adequate. But in large advisory firms, which account for a significant 
number of SEC-registered advisers, clients may never meet the firm's 
senior executives, who may be located in a different city and may have 
only an indirect effect on the advice given to the client.\155\ We 
believe clients of these firms also are interested in the background, 
disciplinary record (if any), and qualifications of the individuals 
with whom they are dealing.
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    \154\ For example, current Part 2 requires background 
information only on firm executives and members of the firm's 
``investment committee.'' Item 6 of Part 2 of Form ADV.
    \155\ Based on advisers' responses to questions on Part 1A of 
Form ADV as of September 30, 2007, more than 475 of the investment 
advisers registered with the Commission report on Part 1A of their 
Form ADV that they have more than 50 employees who perform 
investment advisory functions on behalf of the firm. (IARD Data as 
of Sept. 30, 2007).
---------------------------------------------------------------------------

    Therefore, we proposed in 2000, and are today reproposing, a 
requirement that adviser brochures be accompanied by brochure 
supplements that provide information about the advisory personnel on 
whom clients rely for investment advice. A brochure supplement 
ordinarily would be less than a page long and would contain information 
about the educational background, business experience, and disciplinary 
history (if any) of the supervised person who provides advisory 
services to that client.\156\
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    \156\ 156 Proposed rule 204-3(b)(2).
---------------------------------------------------------------------------

    We received a large number of comments on the brochure supplement 
proposal. Several commenters, including those representing financial 
planners, investment consultants, and consumer groups, praised the 
supplement as a highly practical and beneficial tool for informing 
clients about the qualifications and background of the individuals on 
whom they rely for investment advice.\157\ Several others, including a 
number of investment advisers, argued that ensuring proper distribution 
of supplements at large firms would be costly and burdensome.\158\ Some 
maintained that clients do not want the information that would be 
contained in a supplement.\159\ Another commenter, the IAA, 
acknowledged that consumers hiring professionals in any field often 
inquire about the individuals' credentials in addition to the firm's 
reputation, but urged that we narrow the rule so as not to require 
advisers to deliver the supplement to institutional clients.\160\
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    \157\ E.g., AIMR Letter; CFA Letter; Consortium Letter; FPA 
Letter; Comment Letter of the Investment Management Consultants 
Association (June 12, 2000).
    \158\ E.g., AmEx Letter; June 2000 IAA Letter; ICI Letter; 
Comment Letter of Legg Mason, Inc. (June 13, 2000) (``Legg Mason 
Letter''); Merrill Letter; Paine Webber Letter; Comment Letter of 
Salomon Smith Barney Inc. (June 13, 2000) (``Salomon Letter''); 
Schwab Letter; SIFMA Letter; TIAA-CREF Letter; T. Rowe Price Letter; 
Comment Letter of United Services Planning Association, Inc. and 
Independent Research Agency for Life Insurance, Inc. (June 12, 2000) 
(``USPA Letter''); Wellington Letter.
    \159\ Merrill Letter; Salomon Letter; Schwab Letter; SIFMA 
Letter.
    \160\ May 2001 IAA Letter.
---------------------------------------------------------------------------

    We continue to believe that information contained in the brochure 
supplement may be very important to clients. In response to commenters' 
concerns, however, we have made a number of changes that are intended 
to reduce burdens on advisers subject to the rule. As discussed in more 
detail below, we would modify the delivery requirement, reduce the 
number of types of clients to whom advisers would be required to 
provide supplements, clarify the format of the supplements to maximize 
the amount of flexibility advisers have in preparing a supplement, and 
limit the information

[[Page 13972]]

that would have to be included in the supplement.
1. Delivery and Updating
    We originally proposed to require that each adviser provide its 
clients with a brochure supplement for each supervised person who 
provides advisory services to that client.\161\ In response to 
comments, we are limiting the circumstances in which an adviser would 
be required to deliver the supplement.\162\
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    \161\ See Proposing Release at Section II.D.2.
    \162\ See note 158 above. A number of commenters argued that 
advisers should only be required to deliver brochure supplements of 
supervised persons who actually formulated investment advice. Crist 
Letter; June 2000 IAA Letter; ICI Letter; TIAA-CREF Letter; T. Rowe 
Price Letter. Nine commenters argued that brochure supplements 
should not be required of supervised persons who act as solicitors. 
Crist Letter; DP&W Letter; Comment Letter of Federated Investors 
Inc. (June 13, 2000) (``Federated Letter''); FPA Letter; June 2000 
IAA Letter; ICI Letter; TIAA-CREF Letter; T. Rowe Price Letter; USPA 
Letter. Some commenters urged limiting delivery to certain types of 
clients, such as ``retail'' clients, but not to sophisticated or 
institutional clients.
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    The proposed amendments would require that a client be given a 
brochure supplement for each supervised person who (i) formulates 
investment advice for that client and has direct client contact,\163\ 
or (ii) makes discretionary investment decisions for that client's 
assets, even if the supervised person has no direct client 
contact.\164\ We believe that requiring supplements for these 
categories of supervised persons would provide clients with the 
information they want and need about the particular individuals on whom 
they will rely for investment advice. We originally proposed, but have 
eliminated, a provision requiring delivery of a supplement for a 
supervised person who merely communicates investment advice. Commenters 
pointed out that our original proposal would have required disclosure 
of the backgrounds of client service representatives who transmit 
investment advice to clients, but who have no influence on the advice 
given. To limit disclosure about employees with whom a client may have 
no contact or about employees who do not influence the advice given to 
the client, we have more narrowly tailored the proposed supplement 
delivery requirements so that a particular client would receive 
disclosure specifically about those persons on whom he relies for 
investment advice.
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    \163\ An adviser would not have to provide a supplement for a 
third-party solicitor because solicitors already must deliver a 
disclosure document to potential advisory clients. Rule 206(4)-3 [17 
CFR 275.206(4)-3].
    \164\ An adviser would not, however, have to provide a 
supplement for a supervised person who provides discretionary advice 
only as part of a team and has no direct client contact as we 
believe that when investment advice is formulated by a team, 
specific information about each individual team member takes on less 
importance. Proposed Instruction 1 to Part 2B.
    The supervised person's supplement must be given to the client 
at or before the time that supervised person begins to provide 
advisory services to that client. Proposed rule 204-3(b)(2) and 
proposed Instruction 3 to Part 2B. Although the amendments we are 
proposing today would require the advisory firm to deliver the 
brochure supplement, we recognize that in most cases advisers' 
supervised persons will actually deliver the required supplements to 
clients on behalf of the advisory firm.
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    As reproposed, an adviser generally would be required to provide 
its clients with a brochure supplement for each supervised person who 
provides advisory services as described above. However, advisers would 
not be required to deliver supplements to four types of clients: (i) 
Clients to whom an adviser is not required to deliver a firm brochure 
(e.g., registered investment companies and business development 
companies); (ii) clients who receive only impersonal investment advice; 
\165\ (iii) clients who are ``qualified purchasers;'' \166\ and (iv) 
certain ``qualified clients'' who also are officers, directors, 
employees and other persons related to the adviser.\167\ An adviser 
that does not have any clients to whom a supplement would have to be 
delivered would not have to prepare any supplements. Similarly, an 
adviser would not have to prepare a supplement for any supervised 
person who does not have clients to whom the adviser must deliver a 
supplement.
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    \165\ This exception from the supplement delivery requirement 
differs slightly from the exception from the brochure delivery 
requirement, in that it does not depend on the cost of the 
impersonal advisory services involved. This is because in situations 
involving impersonal advisory services, the nature of the services 
are such that supervised persons of the adviser are unlikely to be 
directly providing advisory services to clients. As a result, we 
believe that in such situations requiring supplement delivery would 
result in an unnecessary expense with little appreciable benefit. We 
believe, however, that delivery of a firm brochure would be useful 
where the cost of the impersonal advisory services is significant, 
that is $500 or above.
    \166\ ``Qualified purchasers,'' as defined under section 
2(a)(51)(A) of the Investment Company Act of 1940 [15 U.S.C. 80a-
2(a)(51)(A)], include, among others, natural persons who own $5 
million or more in investments and persons who manage $25 million or 
more in investments for their account or other accounts of other 
qualified purchasers.
    \167\ Rule 205-3(d)(1)(iii) defines certain related persons of 
an adviser as ``qualified clients,'' including: (i) Any executive 
officers, directors, trustees, general partners, or persons serving 
in a similar capacity, of the advisory firm; and (ii) any employees 
of the advisory firm (other than employees performing solely 
clerical, secretarial or administrative functions) who, in 
connection with their regular functions or duties, participate in 
the investment activities of the firm and have been performing such 
functions or duties for at least 12 months.
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    The first two categories of clients were included in our 2000 
proposal. Commenters did not address these exceptions to the supplement 
delivery requirement. We propose to add the latter two exceptions in 
response to several commenters' arguments that certain institutional 
and sophisticated clients do not need the protections of the brochure 
supplement requirement because they are in a position to obtain, and 
frequently do obtain, information about the advisory personnel on whom 
they rely for investment advice.\168\
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    \168\ See DE Shaw; Federated Letter; June 2000 IAA Letter; T. 
Rowe Price Letter; Wellington Letter.
---------------------------------------------------------------------------

    We request comment on our assumption that some clients do not need 
the protections afforded by a requirement that an adviser deliver a 
brochure supplement even though we would continue to require delivery 
of the brochure. Should we use a higher threshold to exclude clients, 
such as ``Qualified Institutional Buyers?'' \169\ Should we use a lower 
one, and exclude all clients who are ``qualified clients'' under rule 
205-3, rather than just those qualified clients that are officers, 
directors and employees of the adviser? \170\ In December 2006, the 
Commission proposed, but has not adopted, new rules 509 and 216 under 
the Securities Act of 1933, that would define the term ``accredited 
natural person.'' \171\ We ask for comment on whether we should create 
an exclusion from supplement delivery for accredited natural persons. 
In particular, with respect to natural persons, we request comment on 
whether ``accredited

[[Page 13973]]

natural person'' or ``qualified client'' is the appropriate standard to 
use or whether it would be more appropriate to use the higher 
``qualified purchaser'' standard.\172\
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    \169\ ``Qualified Institutional Buyer,'' as defined under rule 
144a of the Securities Act of 1933 [17 CFR 230.144a], includes 
entities that own and invest on a discretionary basis at least $100 
million in securities.
    \170\ ``Qualified client,'' as defined under rule 205-3 of the 
Advisers Act [17 CFR 275.205-3], includes natural persons with 
$750,000 under management with the adviser and individuals who have 
a net worth of $1.5 million.
    \171\ Proposed new rules 509 and 216 under the Securities Act of 
1933 would add to the existing definition of ``accredited investor'' 
and apply to private offerings of certain unregistered investment 
pools. As proposed, these rules would define the term ``accredited 
natural person'' under Regulation D and Section 4(6) of the 
Securities Act. ``Accredited natural person'' would be any natural 
person who meets either the net worth or income test specified in 
rule 501(a) or rule 215, as applicable, and who owns at least $2.5 
million in investments. See Prohibition of Fraud by Advisers to 
Certain Pooled Investment Vehicles; Accredited Investors in Certain 
Private Investment Vehicles, Investment Advisers Act Release No. 
2576 (Dec. 27, 2006) [72 FR 400 (Jan. 4, 2007)]. In August 2007, we 
proposed further general amendments to the definition of accredited 
investor. See Revisions of Limited Offering Exemptions in Regulation 
D, Securities Act Release No. 8828 (Aug. 3, 2007) [72 FR 45116 (Aug. 
10, 2007)].
    \172\ See note 166 above.
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    In 2000, we proposed to require that advisers promptly deliver to 
existing clients a revised supplement (or a sticker) whenever 
information in the supplement became materially inaccurate.\173\ Today, 
we propose to reduce the frequency with which advisers would have to 
deliver clients an updated supplement so that they would only deliver 
them to existing clients when new disclosure of a disciplinary event, 
or a material change to disciplinary information already disclosed, in 
response to proposed Part 2B, Item 3, which we believe is critical 
information for clients. As we noted above, we believe disciplinary 
information is important because it reflects upon the supervised 
person's integrity and may affect a client's trust and confidence in 
that person.
---------------------------------------------------------------------------

    \173\ Proposing Release at n. 215.
---------------------------------------------------------------------------

    As with the brochure, advisers would have to amend a brochure 
supplement promptly if information in it becomes materially inaccurate, 
and any new clients who would be required to receive that supplement 
must be given the amended version (or the ``old'' supplement and a 
sticker). Supplements, like brochures, could be delivered on paper or 
electronically.\174\ However, unlike the delivery requirement for firm 
brochures, and because we believe most information in the supplement is 
less likely to become materially inaccurate over time, advisers would 
not be required to deliver supplements to existing clients annually. We 
request comment generally on the proposed updating and delivery 
requirements for brochure supplements. We also request comment on our 
proposal to require advisers to deliver updated supplements to clients 
describing changes to disciplinary information. Should we also require 
updated supplements to be delivered if other information changes?
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    \174\ Proposed Instruction 4 to Part 2B.
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2. Format
    The proposed amendments would require advisers to write their 
supplements in plain English, but would give advisers considerable 
flexibility in presenting information in a format that best suits their 
firms.\175\ This flexibility is designed to reduce the cost of 
preparing and delivering supplements. Advisers would be permitted to 
include supplement information in the firm's brochure, an approach that 
may be attractive to smaller firms with few persons for whom they would 
be required to prepare supplements.\176\ Advisers could also elect to 
prepare a supplement for each supervised person, or alternatively, they 
could prepare separate supplements for different groups of supervised 
persons (e.g., all supervised persons in a particular office or work 
group). We request comment generally on the proposed format for 
brochure supplements.
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    \175\ See Proposed Instruction 6 to Part 2B.
    \176\ IARD data as of September 30, 2007 indicate that nearly 82 
percent of advisers registered with us have 10 or fewer employees 
performing investment advisory functions on their behalf. Over 67 
percent have five or fewer employees performing advisory functions.
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3. Supplement Items
    Most commenters who addressed the proposed items supported the 
proposed content of the brochure supplements.\177\ As we are proposing 
it today, Part 2B would consist of six items. We are proposing to omit 
two that we originally proposed in 2000. We would omit originally 
proposed Item 7, which would have required disclosure if the supervised 
person had been the subject of a bankruptcy petition during the past 10 
years.\178\ Commenters asserted that a personal bankruptcy is not 
necessarily indicative of a supervised person's investment advisory 
skills and thus need not be disclosed in the brochure supplement. In 
light of these comments, we have eliminated this item. Should we 
require disclosure of personal bankruptcies in supplements and, if so, 
why? We are proposing most of the other items, each of which we discuss 
below, as originally proposed. In addition to our specific requests for 
comment, we request comment generally on each of these items.
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    \177\ E.g., AIMR Letter; CFA Letter; CFP Board Letter.
    \178\ In 2000, we proposed disclosure of bankruptcy filings of 
supervised persons. We are, as discussed above, proposing Item 18 of 
Part 2A, which would require the firm's brochure to disclose whether 
the advisory firm has been the subject of a bankruptcy petition 
during the past 10 years.
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    Item 1. Cover Page. The supplement's cover page would include 
information identifying the supervised person and the advisory firm.
    Item 2. Educational Background and Business Experience. Item 2 
would require the supplement to describe the supervised person's formal 
education and his or her business background for the past five 
years.\179\ If the supervised person either has no formal education 
after high school or has no business background, the adviser would have 
to disclose this fact in the supplement.
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    \179\ Currently, Item 6 of Part 2 of Form ADV requires this 
information about the adviser's principal executive officers and 
about individuals who determine general investment advice on behalf 
of the adviser.
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    We are not, as originally proposed, including the requirement to 
describe professional designations or attainments. Advisers would be 
permitted, however, to include information about professional 
designations and attainments in the supplement if they so choose.\180\ 
We are concerned that in light of the already large number and variety 
of existing designations, requiring such information may encourage the 
proliferation of fictitious and meaningless designations. In addition, 
our staff and other securities regulators have warned that investors 
may be confused by some professional designations, such as those that 
imply expertise in providing services to seniors.\181\ We request 
comment about this approach. Should we require disclosure about 
professional designations and attainments? Are there additional items 
related to educational background and business experience that we 
should include? Have we included disclosure items that are not 
relevant?
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    \180\ Some commenters, however, supported disclosure of 
professional designations (AIMR Letter; CFP Board Letter; FPA 
Letter).
    \181\ See Protecting Senior Investors: Report of Securities 
Firms Providing ``Free Lunch'' Sales Seminars, Joint Report by the 
Staff of the Commission's Office of Compliance Inspections and 
Examinations, NASAA, and FINRA (available at http://www.sec.gov/
spotlight/seniors/freelunchreport.pdf); Staff Update, ``Senior'' 
Specialists and Advisors: What You Should Know About Professional 
Designations (available at http://www.sec.gov/investor/pubs/senior-
profdes.htm). While we acknowledge that a number of well-regarded 
professional designations and attainments exist, the required 
credentials, training, and experience associated with different 
designations varies widely.
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    Item 3. Disciplinary Information. Item 3 would require disclosure 
of any legal or disciplinary event that is material to a client's 
evaluation of the supervised person's integrity. Many commenters 
supported our 2000 proposal.\182\ One commenter, the United Services 
Planning Association, opposed it, saying that such disclosure would be 
punitive and unnecessary. Some others suggested that the scope of the 
required disciplinary disclosure be narrowed, or that advisers might 
not have the information about their supervised persons' disciplinary 
history.\183\ Two

[[Page 13974]]

commenters, SIFMA and the FPA, recommended limiting the disclosure to 
events that are the subject of a final order or judgment, and not 
requiring disclosure if the supervised person is named in a pending 
criminal proceeding. Four commenters supported our proposal to require 
disclosure if a supervised person's professional designations are 
suspended or revoked, arguing that consumers would benefit from having 
full disclosure of all relevant information.\184\ Three commenters 
opposed that disclosure, arguing among other things, that suspension or 
revocation proceedings do not ``guarantee due process'' and could occur 
for ``mundane'' reasons (e.g., failure to pay dues).\185\
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    \182\ AIMR Letter; CFA Letter; CFP Board Letter; FPA Letter.
    \183\ E.g., AmEx Letter; ICI Letter; Greenville Letter; Legg 
Mason Letter; Securities America Letter.
    \184\ AIMR Letter; CFA Letter; CFP Board Letter; FPA Letter.
    \185\ AmEx Letter; June 2000 IAA Letter; T. Rowe Price Letter.
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    In general, we believe that advisory clients would consider the 
listed disciplinary events critically important in determining whether 
to hire or retain an adviser or any specific supervised person of that 
adviser. We believe it is important that clients have information 
concerning disciplinary events that involve the persons who are 
substantially responsible for the investment advice that clients 
receive. Thus, we are proposing Item 3 largely as we proposed it in 
2000 to require substantially the same disclosure requirements for the 
supervised person's disciplinary history as we are proposing for the 
firm's disciplinary history.\186\
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    \186\ As in proposed Item 9 of Part 2A, proposed Item 3 of Part 
2B would include a list of events that are presumptively material if 
they occurred in the prior 10 years. The list parallels the proposed 
list of legal and disciplinary events in Item 9 of Part 2A that must 
be disclosed in the firm brochure and which are derived from the 
existing disclosure requirements set out in rule 206(4)-4. The list 
also is substantially similar to the list of disciplinary events 
advisers are already required to disclose in response to Item 11 of 
Form ADV, Part 1A. With respect to commenter's concerns regarding 
the burdens of requiring disclosure of ``pending criminal 
proceedings,'' the required disclosure is narrow, as it would not 
include other investigations, or arrests or similar charges effected 
in the absence of a formal criminal indictment or information (or 
equivalent formal charge). See Form ADV: Glossary.
    As under proposed Item 9 of Part 2A, proposed Item 3 of Part 2B 
would permit an adviser to rebut the presumption with respect to a 
particular event, in which case no disclosure to clients about the 
event would be required. We would, however, require an adviser 
rebutting a presumption of materiality to document that 
determination in a memorandum and retain that record in order to 
better permit our staff to monitor compliance with this important 
disclosure requirement. The same standard as under Item 9 would 
apply, and similarly, a note in Item 3 would explain four factors 
the adviser should consider when assessing whether the presumption 
can be rebutted.
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    In response to comments, we have clarified that an adviser would be 
required to disclose a proceeding that revoked or suspended the 
supervised person's professional attainment, designation, or license 
only if the action was a result of a violation of rules relating to 
professional conduct.\187\ We also added a proposed requirement that 
the supplement describe any event over which the supervised person has 
ever resigned or otherwise relinquished a professional attainment, 
designation or license in anticipation of it being suspended or revoked 
(other than for suspensions or revocations for failure to pay 
membership dues). We believe clients would wish to know about these 
kinds of events as they may reflect on the integrity of the supervised 
person.
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    \187\ See CFP Board Letter; T. Rowe Price Letter.
---------------------------------------------------------------------------

    We believe our proposal strikes an appropriate balance among the 
concerns raised by commenters. We request comment on whether it does. 
Are there listed disciplinary events that we should remove or modify? 
Are there additional types of disciplinary events that we should list? 
For example, should we require disclosure of all cease and desist and 
censure orders? Are there other events, such as arbitration claims or 
awards, which could be characterized as disciplinary and should be 
disclosed in a supplement? If we were to require advisers to make 
disclosure regarding arbitration claims or awards, should we require 
such disclosure only if the award or claim exceeds a specified amount? 
If so, what should that amount be? \188\ Is any of the proposed 
information not useful to advisory clients?
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    \188\ Determining whether to include disclosure of arbitration 
proceedings in brochure supplements raises the same issues as would 
be involved in requiring such disclosure in firm brochures. See 
discussion above at notes 69-70 and accompanying text.
---------------------------------------------------------------------------

    Item 4. Other Business Activities. Item 4 would require an adviser 
to describe other business activities of its supervised person. The 
item specifically would require disclosure with respect to other 
capacities in which the supervised person participates in any 
investment-related business and any conflicts of interest such 
participation may create.\189\ In addition, we would require the 
supplement to include information about any compensation, including 
bonuses and non-cash compensation, the supervised person receives based 
on the sales of securities as well as an explanation of the incentives 
this type of compensation creates.\190\ As we noted in the Proposing 
Release, this practice creates an incentive for the supervised person 
to base investment recommendations on his own compensation rather than 
on clients' best interests.\191\ We are also proposing, with some 
revisions, a requirement to disclose other business activities or 
occupations that the supervised person engages in for pay.\192\ Clients 
may have different expectations of an individual whose sole business is 
providing investment advice than of an individual who is engaged in 
other substantial business activities.
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    \189\ Proposed Item 4.A of Part 2B.
    \190\ Proposed Item 4.A.2 of Part 2B.
    \191\ See Proposing Release at n. 219 and accompanying text.
    \192\ Proposed Item 4.B of Part 2B.
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    One commenter, the CFA, enthusiastically supported our proposal, 
stating that clients would benefit greatly from disclosures about a 
supervised person's other business activities. Two others, T. Rowe and 
the IAA, argued that disclosure of other business activities should be 
limited to substantial investment-related activities that provide a 
major source of that person's income. We would continue to require 
disclosure of other business activities because we believe that, as 
reflected in the CFA's comments, investors would find this information 
helpful in assessing the conflicts created by those activities. We are 
not limiting the proposed disclosure of other investment-related 
activities to those characterized as ``substantial,'' because we 
believe the client is in the best position to assess the significance 
of any other business activities and the impact that they may have on 
their advisory relationship.
    We are, however, proposing to require disclosure about only those 
non-investment-related business activities or occupations that provide 
a substantial source of the supervised person's income or that involve 
a substantial amount of the supervised person's time. We believe this 
responds to commenters' concerns by eliminating unnecessary disclosure 
about relatively insignificant other business activities, while still 
requiring important disclosures that inform clients of the supervised 
person's primary business activities. We request comment as to this 
approach. We request comment specifically with regard to whether this 
information would be useful to a client's evaluation of a supervised 
person's competence. Further, we have not defined ``substantial'' for 
purposes of this item, preferring instead to leave some flexibility for 
advisers to determine whether their supervised person's non-investment-
related business provides a substantial source

[[Page 13975]]

of income or involves a substantial amount of time. Is our approach 
appropriate?
    Item 5. Additional Compensation. This proposed item would require 
that the supplement describe arrangements in which someone other than a 
client gives the supervised person an economic benefit (such as a sales 
award or other prize) for providing advisory services.\193\ The 
proposed item would specify that regular salary need not be disclosed.
---------------------------------------------------------------------------

    \193\ Bonuses based (in part or whole) on sales, client 
referrals or new accounts would trigger required disclosure, but 
other bonuses would not.
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    One commenter, the CFA, strongly supported this proposed item, 
while two others objected, arguing that it would require disclosure of 
confidential and proprietary business information of the adviser.\194\ 
While we understand that firms may wish to keep sales awards or prizes, 
and similar incentive structures, confidential, these types of 
arrangements can create significant and material conflicts of interest 
that may bias the advice being presented. We believe clients need to 
know about these arrangements in order to assess the advisory services 
of a firm's supervised person. Are we correct? In addition, we request 
comment on alternatives that might strike a different balance between 
concerns about disclosure of advisers' confidential and proprietary 
business information with clients' need to be informed of material 
conflicts of interest.
---------------------------------------------------------------------------

    \194\ DE Shaw Letter; DP&W Letter.
---------------------------------------------------------------------------

    Item 6. Supervision. This item would require an adviser to explain 
how the firm monitors the advice provided by its supervised 
person.\195\ It also would require a firm to provide the client with 
the name, title and telephone number of the person responsible for 
supervising the advisory activities of the supervised person. This 
information would permit the client to contact other advisory personnel 
when necessary to address any problems in the advisory relationship. We 
are proposing this item in the same form as we proposed it in 2000. 
Commenters who addressed the item supported disclosure of information 
on the supervision of the individual that is the subject of the 
supplement.\196\
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    \195\ As we discuss in more detail above in Section II.B.1 of 
this Release, we have narrowed the scope of supervised persons who 
would need a supplement. As a result, we do not believe it is 
necessary to propose, as we did in 2000, to require the supplement 
to discuss who formulates the advice a supervised person gives to 
clients.
    \196\ See AIMR Letter; CFA Letter.
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C. Filing Requirements, Public Availability, and Transition

    We propose to amend our rules to require advisers to file their new 
brochures with us electronically through the IARD system, which would 
permit us to make them publicly available through our Web site.\197\ 
Part 1 of Form ADV has been filed electronically and the information 
contained in it publicly available since 2001. At the time we adopted 
the amendments to Part 1, we exempted advisers from submitting Part 2 
to us because the IARD was not ready to accept those filings.\198\ The 
required system functionality is now available, and we therefore 
propose to reinstate the filing requirement so that we, and members of 
the public, may have ready access to adviser brochures.
---------------------------------------------------------------------------

    \197\ Proposed rule 204-1(b). In some cases an adviser will not 
have to file a brochure because it is not required to deliver one. 
See above Section II.A.3 of this Release. When an adviser has not 
submitted a brochure as part of its Form ADV filing, the IARD system 
will generate an automated message asking an adviser that has not 
attached a brochure to its filing to confirm that it is not required 
to prepare a brochure.
    \198\ See Note to current rule 204-1(c).
---------------------------------------------------------------------------

    The IARD is able to accept brochure filings using the Adobe 
Portable Document Format (``PDF''), which would allow advisers to 
capture information from any application on any computer system.\199\ 
Utilizing PDF format would promote accessibility to brochure filings by 
enabling users of our public disclosure Web site to access and read 
brochures filed on IARD without having to possess the particular 
software used by each adviser to prepare its brochure.\200\ The PDF 
format, which limits transferability of computer viruses, also permits 
full-text search features that make it easy to locate words, bookmarks, 
and data fields within a brochure, and it permits the IARD to accept 
brochures that include graphics and charts, so that advisers who choose 
to use more elaborate brochures need not also prepare a plain text 
version solely for purposes of filing it with the Commission. We 
believe that the ability to accept PDF filings presents the most 
flexible and cost-efficient approach.\201\ We request comment about 
whether advisers currently have access to PDF conversion software. We 
also request comment, however, on whether we should permit advisers to 
file their brochures in other electronic formats. If so, which ones and 
why? Should we consider requiring advisers to file brochure information 
that makes use of data tagging technologies and taxonomies such as 
eXtensible Business Reporting Language (``XBRL'')? \202\
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    \199\ IARD system functionality for electronic filing of 
brochures is currently operational and the state securities 
regulators have been running a voluntary pilot program for advisers 
to file the current version of Part 2 using PDF.
    \200\ PDF reader software is widely available and is a standard 
feature on most word processing software. Additionally, users may 
download this software for free from the Internet.
    \201\ PDF converter software is already widely available and in 
many cases comes as a standard feature on word processing software. 
We anticipate that most, if not all, investment advisers will have 
access to such software, and thus would not need to incur additional 
expense associated with filing their brochure in PDF format were we 
to adopt this proposal. We are currently exploring options with the 
FINRA for making PDF converter software available to those 
investment advisers that do not already have it.
    \202\ Data tagging uses standard definitions (or data tags) to 
translate text-based information into data that is interactive, 
i.e., data that can be retrieved, searched, and analyzed through 
automated means. XBRL is a language for the electronic communication 
of business and financial data that was developed as an open source 
specification that describes a standard format for tagging financial 
and other information to facilitate the preparation, publication, 
and analysis of that information by software applications. In 2005 
we adopted rules instituting a program that permits certain filers, 
on a voluntary basis, to submit specified, supplemental disclosure 
tagged in XBRL format as an exhibit to certain filings on the 
Commission's Electronic Data Gathering, Analysis and Retrieval 
System (``EDGAR''). See XBRL Voluntary Financial Reporting Program 
on the EDGAR System, Securities Act Release No. 8529 (Feb. 3, 2005) 
[70 FR 6556 (Feb. 8, 2005)]. In July 2007, we extended the voluntary 
reporting program to enable mutual funds to submit supplemental 
tagged information contained in the risk/return summary section of 
their prospectuses. Extension Of Interactive Data Voluntary 
Reporting Program On The EDGAR System To Include Mutual Fund Risk/
Return Summary Information, Securities Act Release No. 8823 (July 
11, 2007) [72 FR 39290 (July 17, 2007)].
---------------------------------------------------------------------------

    The IARD will provide advisers with access to the Part 2 Items and 
instructions. Instead of completing Part 2 on-line, advisers will 
create their brochure on their own computers and then attach the 
completed document to their filing on IARD, much like attaching a 
document to an e-mail. To update brochures, advisers will make the 
necessary changes on their own computers and then attach the revised 
versions to an IARD filing. The IARD will not accept an annual updating 
amendment without an updated brochure. However, if no changes are 
necessary when an adviser is submitting its annual updating amendment, 
an adviser will have the option of indicating on IARD that its current 
brochure does not contain any materially inaccurate information. If an 
adviser ceases to use a particular brochure, it will be able to 
eliminate it from its current filing. Our Web site will make only the 
firm's current filings publicly available because that filing

[[Page 13976]]

should contain the most up-to-date information about the adviser.\203\
---------------------------------------------------------------------------

    \203\ As discussed above, historical filings would nonetheless 
be available for public inspection and copying in the Commission's 
Public Reference Room. See above note 153.
---------------------------------------------------------------------------

    As proposed, advisers would not be required to file brochure 
supplements or supplement amendments with the Commission and therefore 
they will not be available on the Commission's public disclosure Web 
site.\204\ We are not proposing to require filing of supplements so as 
to reduce the potential burdens on advisers and because the supplement 
disclosure requirement is designed primarily to provide advisers' 
clients with background information about the particular supervised 
persons with whom they are dealing. We believe this information is less 
likely to be of interest to the general investing public.\205\ Advisers 
would be required, however, to maintain copies of all supplements and 
amendments in their files.\206\ We request comment on our approach. 
Should we require brochure supplements and amendments to brochure 
supplements to be filed with us through the IARD system and be made to 
available to the public through our Web site?
---------------------------------------------------------------------------

    \204\ Proposed rules 203-1(b) and 204-1(c) and proposed 
Instruction 8 to Part 2B of Form ADV. Because brochure supplements 
would not be filed with us, they would not be required as part of 
any state notice filing. Section 307(a) of the National Securities 
Market Improvement Act of 1996, Public Law 104-290, 110 Stat. 3416 
(1996) (state securities authorities may only require SEC-registered 
advisers to file with the states copies of those documents advisers 
have filed with the Commission).
    \205\ We note that the disciplinary history of an adviser's 
supervised persons is required to be reported as part of the 
adviser's filing of Part 1 of Form ADV, and is available to the 
Commission through the IARD and to the public via the Commission's 
public disclosure Web site.
    \206\ Proposed rules 203-1(b) and 204-1(c) and proposed 
Instruction 8 to Part 2B of Form ADV.
---------------------------------------------------------------------------

    To provide adequate notice and opportunity to comply with the 
proposed brochure filing requirements, new applicants for registration 
with us as investment advisers would not be required to include their 
brochures as part of their initial application for registration until 
the date six months after the effective date of the amendments. After 
that date, however, the Commission would not accept any initial 
application for registration as an investment adviser that does not 
include a brochure that satisfies the requirements of Part 2A of Form 
ADV.\207\
---------------------------------------------------------------------------

    \207\ Proposed rule 203-1(a)(2).
---------------------------------------------------------------------------

    Similarly, we believe it would be helpful to provide sufficient 
time for advisers already registered with us to prepare the new 
brochure and brochure supplements. Accordingly, we propose to implement 
a transition schedule requiring advisers to comply with the new Part 2 
requirements by the date they must make their next annual updating 
amendment to Form ADV following the date the revised form becomes 
effective. In no case, however, would any adviser be required to comply 
with the new requirements earlier than six months after they become 
effective.\208\ We request comment on our proposed implementation plan. 
Would a six-month period from the effective date of the revised form 
provide enough time for advisers to complete their new brochures? If 
not, please explain why and how much time advisers would need to 
complete their new brochures. Should implementation of the brochure 
requirements be on a separate timetable from implementation of the 
brochure supplement requirements?
---------------------------------------------------------------------------

    \208\ Proposed rule 204-1(b)(2).
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III. Amendments to Form ADV Instructions and Glossary

    In conjunction with the proposed Part 2 amendments, we are also 
proposing to make conforming amendments to the General Instructions and 
the Glossary of Terms for Form ADV. We propose amending the General 
Instructions to Form ADV to include instructions regarding brochure 
filing requirements. Similarly, we would amend the Glossary of Terms to 
add the following five terms that are used in proposed Part 2: (i) 
``Brochure;'' \209\ (ii) ``brochure supplement;'' \210\ (iii) 
``investment adviser representative;'' \211\ (iv) ``supervised 
person;'' \212\ and (v) ``wrap brochure or wrap fee program brochure.'' 
\213\ We also would update the Glossary to reflect cross-references to 
these new terms, and cross-references to existing Glossary entries used 
in the revised portions of the Form.
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    \209\ ``Brochure'' would mean: ``A written disclosure statement 
that your firm is required to provide to clients and prospective 
clients.'' See Form ADV: Glossary.
    \210\ ``Brochure supplement'' would mean: ``A written disclosure 
statement containing information about certain of your supervised 
persons that your firm is required by Part 2B of Form ADV to provide 
to clients and prospective clients.'' See Form ADV: Glossary.
    \211\ ``Investment adviser representative'' would mean:
    Any of your firm's supervised persons (except those that provide 
only impersonal investment advice) is an investment adviser 
representative, if --
     the supervised person regularly solicits, meets with, 
or otherwise communicates with your firm's clients,
     the supervised person has more than five clients who 
are natural persons and not high net worth individuals, and
     more than ten percent of the supervised person's 
clients are natural persons and not high net worth individuals. See 
Form ADV: Glossary.
    \212\ ``Supervised person'' would mean: ``Any of your officers, 
partners, directors (or other persons occupying a similar status or 
performing similar functions), or employees, or any other person who 
provides investment advice on your behalf and is subject to your 
supervision or control.'' See Form ADV: Glossary.
    \213\ ``Wrap brochure or wrap fee program brochure'' would mean: 
``The written disclosure statement that sponsors of wrap fee 
programs are required to provide to each of their wrap fee program 
clients.'' See Form ADV: Glossary.
---------------------------------------------------------------------------

    We also are proposing to update the Glossary to correct a 
discrepancy in the definition of ``Non-Resident'' to make it consistent 
with the definition in rule 0-2, the Advisers Act rule related to the 
procedures for serving process, pleadings, and other papers on non-
resident investment advisers, and advisers' non-resident general 
partners and managing agents. This proposed revision would properly 
effect the Commission's intent at the time the Glossary was originally 
adopted, that the definition of ``Non-Resident'' in the Glossary be the 
same as that in rule 0-2.\214\ Although technical in nature, this 
amendment may potentially result in an increased number of corporate 
entities qualifying as non-resident general partners or managing agents 
of SEC-registered advisers. Certain entities would be required to file 
Form ADV-NR with the Commission to appoint agents for service of 
process because they relied on the glossary definition and did not 
previously file the form.
---------------------------------------------------------------------------

    \214\ This proposed amendment would change the definition of 
``Non-Resident'' to include ``a corporation incorporated in or 
having its principal place of business in any place not subject to 
the jurisdiction of the United States.'' (Emphasis added). See rule 
0-2(b)(2) [17 CFR 275.0-3(b)(2)]. The current Glossary definition 
includes a ``corporation incorporated in and having its principal 
place of business in any place not subject to the jurisdiction of 
the United States.'' (Emphasis added). See Form ADV: Glossary. 
Inclusion in the current Glossary definition of the conjunctive 
``and'' rather than the disjunctive ``or'' was unintentional.
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    We request comment on these proposed amendments.

IV. Amendments to Rule 204-2

    We also are proposing conforming amendments to Advisers Act rule 
204-2, the rule that sets forth the requirements for maintaining and 
preserving specified books and records, to require SEC-registered 
investment advisers to retain copies of each brochure, brochure 
supplement, and each amendment to the brochure and supplements that are 
prepared as required under the rule 204-3.\215\ This

[[Page 13977]]

proposed change is designed to update the books and records rule in 
light of our proposed changes to Part 2.\216\ Additionally, the 
proposed amendments would require SEC-registered advisers to prepare 
and preserve documentation of the method they use to compute managed 
assets for purposes of Item 4.E in Part 2A of Form ADV, if that method 
differs from the method used to calculate ``assets under management'' 
in Part 1A of Form ADV.\217\ The amendments also would require advisers 
to prepare and preserve a memorandum describing any legal or 
disciplinary event listed in Item 9 in Part 2A and Item 3 in Part 2B of 
Form ADV for the period the event is presumed material, if the event is 
not disclosed in the adviser's brochure or the relevant brochure 
supplement.\218\ These records would be required to be maintained in 
the same manner, and for the same period of time, as other books and 
records required to be maintained under rule 204-2(a). We request 
comment on these proposed amendments.
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    \215\ Proposed rule 204-2(a)(14)(i). The proposed rule also 
would require advisers to keep and maintain a copy of any summary of 
material changes that is not included in the brochure or brochure 
supplements, as well as a record of the dates that each brochure, 
supplement, amendment, and summary of material change was given to 
any client. See discussion above at notes 27-29 and accompanying 
text.
    \216\ Currently, rule 204-2(a)(14) requires advisers to maintain 
copies of written statements and amendments given or delivered to 
any client or prospective client under existing rule 204-3. Thus, 
advisers already are required to maintain copies of their brochures.
    \217\ See discussion above at note 33.
    \218\ See discussion above at notes 65-66 and accompanying text, 
and note 186.
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V. General Request for Comment

    The Commission requests comment on the amendments proposed in this 
Release, suggestions for other additions to the amendments, and comment 
on other matters that might have an effect on the proposals contained 
in this Release. For purposes of the Small Business Regulatory 
Enforcement Fairness Act of 1996, the Commission also requests 
information regarding the potential impact of the proposed amendments 
on the economy on an annual basis. Commenters should provide empirical 
data to support their views.

VI. Paperwork Reduction Act

    Certain provisions of the rule and form amendments that we are 
proposing today contain ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\219\ The Commission is submitting these proposed amendments 
to the Office of Management and Budget (``OMB'') for review in 
accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The titles for 
these collections of information are ``Form ADV,'' ``Rule 204-2,'' 
``Rule 204-3,'' and ``Rule 206(4)-4,'' all under the Advisers Act. 
These rules and forms contain currently approved collection of 
information numbers under OMB control numbers 3235-0049, 3235-0278, 
3235-0047, and 3235-0345, respectively. An agency may not sponsor, 
conduct, or require response to an information collection unless it 
displays a currently valid OMB number.
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    \219\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    The respondents to the collections of information are investment 
advisers registered or applying for registration with us. We use the 
information to determine eligibility for registration with us and to 
manage our regulatory and examination programs. Clients use certain of 
the information to determine whether to hire or retain an adviser.
    The amendments to Form ADV we are proposing involve three distinct 
``collections of information'' for purposes of the Paperwork Reduction 
Act. The first is the collection of information connected with Form ADV 
itself, specifically our proposed amendments to Part 2 of Form ADV. The 
second collection of information involved is that under the proposed 
amendment to rule 204-2, which requires advisers to maintain and 
preserve specified books and records. The third collection involved is 
that related to a proposed amendment to rule 204-3, which requires 
advisers to deliver certain of the information required under Form ADV 
to their clients.
    In addition, we are proposing to withdraw rule 206(4)-4, the rule 
requiring advisers to disclose certain disciplinary and financial 
information, because that rule will become duplicative if the 
amendments to Part 2 of Form ADV are adopted. We incorporate the 
discussion of our proposed withdrawal of rule 206(4)-4 into the 
discussion of Part 2 of Form ADV below.

A. Amendments to Form ADV (17 CFR 275.203-1, 275.204-1, and 279.1)

    We are proposing amendments to Part 2 of Form ADV to provide 
advisory clients with clear, current, and more meaningful disclosure in 
a narrative, plain English format. Rules 203-1 and 204-1 already 
require every applicant for investment adviser registration with us to 
file Form ADV through the IARD and require every investment adviser 
registered with us to file amendments to Form ADV through the IARD at 
least annually.\220\ As proposed, the amendments to rules 203-1 and 
204-1 and to Part 2 of Form ADV also would require advisers registered 
with us to prepare and electronically file firm brochures required by 
Part 2A, and to maintain copies of brochure supplements that they 
deliver to clients.
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    \220\ Presently, advisers must submit Part 1 of Form ADV to us 
through the IARD system, but are not required to submit a copy of 
current Part 2 of Form ADV to the Commission if they maintain in 
their files a copy of their Part 2 (and of any brochure they deliver 
to clients). The copy they maintain in their files is considered 
filed with the Commission.
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    The information required by the proposed amendments to Form ADV is 
mandatory. Responses are not kept confidential. Under section 204 of 
the Advisers Act, investment advisers required to register with the 
Commission must make and keep certain records, including those related 
to Form ADV, for prescribed periods, generally for a period of at least 
five years, and must make and disseminate certain reports. In 2000, 
when we originally proposed revisions to Form ADV (including Part 2), 
we sought OMB approval of the increased burden stemming from the 
revised form.\221\ The collection of information was approved and has 
subsequently been amended. The currently approved total annual burden 
for all advisers completing, amending, and filing revised Form ADV 
(Parts 1 and 2) with us, is 109,678 hours.\222\ Because of the passage 
of time and modifications to the original proposal, we intend to 
resubmit the collection of information under Form ADV to OMB for 
approval.
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    \221\ See Proposing Release, above note 5.
    \222\ The paperwork burdens associated with rules 203-1 and 204-
1 are included in the approved annual burden associated with Form 
ADV and thus, do not entail a separate collection of information.
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1. Part 2 of Form ADV
    In the Proposing Release, we acknowledged that the proposed 
amendments to Form ADV (including those to Part 2) would at first 
increase the then-current paperwork burden because most advisers would 
have to redraft and disseminate a narrative brochure and brochure 
supplements. We noted that most of the new paperwork burden would be 
incurred in this initial preparation, specifically in drafting the 
narrative text. We further observed that once the adviser has redrafted 
its narrative brochure, proposed Parts 2A and 2B were not expected to 
result in any significant burden increase over time (except for changes 
to the brochure that are necessitated by changes in the adviser's 
business). We continue to believe that the initial paperwork burden 
will be

[[Page 13978]]

higher and that the efficiencies of filing through IARD, over time, are 
expected to reduce the initial burdens associated with completing the 
revised Form ADV.
    The Commission staff previously estimated that during the first 
year that an adviser responds to Form ADV, including amended Part 2, an 
average investment adviser's total collection of information burden 
would be 22.25 hours per adviser.\223\ We estimated that this average 
annual burden per adviser would apply to both new registrants applying 
for registration with us, as well as to current registrants required to 
amend their Form ADVs as a result of the proposed revisions. This 
estimate included time for preparation of brochures and brochure 
supplements in addition to the burden of preparing Part 1A. A few 
commenters, particularly those representing large advisory firms, 
disagreed with the Commission staff's estimate, arguing that it would 
take advisers much more time to complete and distribute their new 
narrative brochure and brochure supplements.\224\ Large firms asserted 
that they would have ``thousands'' of employees for whom supplements 
would have to be prepared.
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    \223\ In the Proposing Release we estimated that during the 
first year, advisers' use of the revised form would result in an 
average annual collection burden of 22 hours per adviser. See 
Section IV of the Proposing Release. In conjunction with adoption of 
our rule requiring advisers to adopt codes of ethics, we amended 
this estimated burden by adding 0.25 hours to reflect the 
requirement that an adviser's Part 2 contain a description of its 
code of ethics and a statement that a copy of the code is available 
upon request. See Code of Ethics Adopting Release above note 78.
    \224\ See, e.g., Crist Letter; SIFMA Letter; Comment Letter 
Dechert Price and Rhoads (June 14, 2000).
---------------------------------------------------------------------------

    We appreciate the different costs that small versus large firms may 
experience, and so we have made it clear that our estimate is an 
average that takes into consideration the thousands of advisers that 
have a small number of employees as well as the few advisers that have 
thousands of employees. As of September 30, 2007, there were 10,817 
investment advisers registered with the Commission, and nearly 82 
percent of these advisers have 10 or fewer employees performing 
advisory functions on their behalf compared to less than one third of 
one percent of advisers who have more than 1,000 employees.\225\ 
Moreover, the paperwork burden of preparing a narrative firm brochure 
is likely to vary substantially among advisers, in part because 
proposed Part 2A would give an adviser considerable flexibility in 
structuring its disclosure, and also because the amount of disclosure 
required would vary among advisers.\226\ The burdens associated with 
preparing the new brochures will depend on the size of the adviser, the 
complexity of its operations, and the extent to which its operations 
present conflicts of interest with clients. Many of the new items 
imposing the most rigorous disclosure requirements may not apply to 
certain small advisers because, for example, those advisers may not 
have soft dollar or directed brokerage arrangements, or may not have 
custody of client assets. Accordingly, based on our consultations with 
industry representatives, we estimate that the average initial annual 
burden associated with Form ADV may range from as little as 5 hours for 
smaller advisers, to approximately 50 hours for medium-sized advisers, 
to as much as nearly 3,300 hours for larger advisers.\227\ Based on 
IARD data, we estimate that there are approximately 8,835 small 
advisers, 1,952 medium-sized advisers, and 30 large advisers.\228\ As 
such, we believe that 22.25 hours remains an accurate reflection of the 
time that it will take the average adviser to complete revised Form ADV 
(including both Parts 1 and 2).\229\
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    \225\ See note 176 above.
    \226\ Additionally, since the 2000 proposal, we have made 
certain revisions to the proposed form that scale back the types of 
clients for whom brochures and supplements must be delivered. These 
revisions should actually have the effect of reducing the number of 
advisers who are required to prepare and update brochures, and thus 
may actually reduce somewhat the burden of the revised Form ADV from 
what was originally proposed.
    \227\ For purposes of this estimate, we have categorized small 
advisers as those with 10 or fewer employees, medium-sized advisers 
as those with between 11 and 999 employees, and large advisers as 
those with 1,000 or more employees.
    \228\ Unless otherwise noted, the IARD data cited below is based 
on advisers' responses to questions on Part 1A of Form ADV as of 
September 30, 2007.
    \229\ [8,835 small advisers x an estimated 5 hours/adviser] + 
[1,952 medium-sized advisers x an estimated 50 hours/adviser] + [30 
large advisers x an estimated 3,296 hours/adviser] = 240,655 hours 
total. 240,655 hours/10,817 total advisers = 22.25 hours/adviser.
---------------------------------------------------------------------------

    As under the currently approved collection, the estimated initial 
burdens associated with using the revised form would be amortized over 
the estimated period that advisers would use their revised brochure. 
Thus, we have amortized the paperwork burdens of the revised form over 
a three-year period.\230\ Respondents under this collection of 
information would be advisers currently registered with the Commission 
as well as new applicants for investment adviser registration with the 
Commission. We estimate that approximately 1,000 new applicants apply 
for registration as investment advisers each year. Thus, in combination 
with the approximately 10,817 existing investment advisers registered 
with the Commission, we estimate that the total number of respondents 
under this collection of information would be 11,817 advisers. Based on 
the estimated average collection of information burden of 22.25 hours 
per adviser, the total initial collection of information would amount 
to 22,250 hours for new registrants and 240,678.25 hours for currently 
registered advisers that re-file Form ADV (including Part 2) through 
the IARD system, for a total of 262,928.25 hours.\231\ Amortizing this 
total burden imposed by Form ADV over a three-year period would result 
in an average burden of an estimated 87,643 hours per year,\232\ or of 
7.42 hours per year for each new applicant and for each adviser 
currently registered with the Commission that would re-file through the 
IARD.\233\
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    \230\ In the Proposing Release, the Commission staff chose a 
fifteen-year amortization period to reflect the anticipated period 
of time that advisers would use the revised form. However, for 
purposes of our current proposal, we are amortizing the estimated 
burden over a shorter period of time--three years--and have 
submitted to OMB an amendment to this collection of information to 
reflect this approach.
    \231\ Based on historic IARD registration data, we estimate that 
approximately 1,000 new applicants for registration with the 
Commission each year. (10,817 current registrants x 22.25 hours) + 
(1,000 new applicants x 22.25 hours) = 240,678.25 hours + 22,250 
hours = 262,928.25 hours.
    \232\ 262,928.25 hours/3 years = 87,642.75 hours/year.
    \233\ 87,643 hours/11,817 advisers = 7.42 hours/adviser.
---------------------------------------------------------------------------

    We further estimate that some advisers may incur a one-time initial 
cost including outside legal fees in connection with preparation of 
Form ADV (including preparation of Part 2). As we discuss above, 
advisers subject to the Form ADV requirements vary widely in terms of 
the size, complexity and nature of their advisory business, and thus, 
the amount of disclosure required, would vary substantially among 
advisers. Accordingly, the amount of time, and thus cost, required for 
outside legal review is likely to vary substantially among those 
advisers who elect to obtain outside legal assistance. We estimate that 
the initial per adviser cost related to preparation of Form ADV may 
range from as little as $1,200 for smaller advisers, to $4,400 for 
medium-sized advisers, to as much as $10,400 for larger advisers.\234\ 
Similarly, whether an

[[Page 13979]]

adviser even seeks outside legal services in drafting their Form ADV 
will depend on the size, complexity and nature of their advisory 
business. We believe that a substantial percentage of advisers, 
particularly smaller advisers, are unlikely to seek such outside legal 
services. We estimate that only a quarter of smaller advisers, or about 
2,209 advisers, are likely to seek outside legal services. Similarly, 
we estimate that approximately half of medium-sized advisers, or 976 
advisers, are likely to seek such services.\235\ On the other hand, 
advisers with more significant conflicts are more likely to engage 
outside legal services to assist in preparation of Form ADV. On this 
basis we estimate that all of the 30 larger advisers registered with 
the Commission are likely to incur costs related to such outside legal 
services. Thus, we estimate that approximately 3,215 advisers, will 
elect to obtain outside legal assistance, for a total cost among all 
respondents of $7,257,200.\236\
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    \234\ Outside legal fees are in addition to the projected hourly 
per adviser burden discussed above. $400 per hour for legal services 
x 3.0 hours per small adviser = $1,200. $400 per hour for legal 
services x 11 hours per medium-sized adviser = $4,400. $400 per hour 
for legal services x 26 hours per large adviser = $10,400. The 
hourly cost estimate of $400 is based on our consultation with 
advisers and law firms who regularly assist them in compliance 
matters.
    \235\ 8,835 small advisers x 0.25 = 2,208.75. 1,952 medium-sized 
advisers x 0.5 = 976.
    \236\ ($1,200 x 2,209 advisers) + ($4,400 x 976 advisers) + 
($10,400 x 30 advisers) = $7,257,200.
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    In addition to the burdens associated with initial completion and 
filing of the revised form, we estimate that on average, each adviser 
filing Form ADV through the IARD system will likely amend its form 1.5 
times during the year.\237\ We estimate that the collection of 
information burden for amendments would be 0.75 hours per amendment. 
Thus, we estimate that advisers will file an estimated total of 
17,725.5 amendments per year for an estimated total paperwork burden of 
13,294 hours per year.\238\
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    \237\ This estimate is based on IARD system data regarding the 
number of filings of Form ADV amendments.
    \238\ 11,817 advisers x 1.5 amendments per year = 17,725.5 
amendments per year. 17,725.5 amendments x 0.75 hours = 13,294.125 
hours.
---------------------------------------------------------------------------

    Therefore the total annual collection of information burden for 
advisers to file and complete the revised Form ADV (Parts 1 and 2), 
including the initial burden for both existing and anticipated new 
registrants plus the burden associated with amendments to the form, is 
estimated to be approximately 100,976 hours per year.\239\ In addition 
to these estimated burdens, under this collection of information there 
is also a burden of 11,971 hours associated with advisers' obligations 
to deliver to clients copies of their adviser codes of ethics.\240\ 
Thus, the estimated revised total annual hourly burden under this 
collection of information would be 112,947 hours.\241\ This represents 
an increase of 3,269 hours per year from the currently approved 
burden.\242\
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    \239\ 13,294 hours per year attributable to amendments + (1,000 
new registrants each year x 7.42 hours) + (10,817 currently-
registered advisers x 7.42 hours) = 13,294 hours + 7,420 hours + 
80,262.14 hours = 100,976.14 hours.
    \240\ See Code of Ethics Adopting Release, above note 78. The 
current approval of this collection estimates that ten percent of an 
adviser's clients would make such requests, however, subsequently 
obtained information based on discussions with the industry 
regarding actual practice indicates that such requests occur 
significantly less frequently than previously estimated, thus, we 
have modified our estimate. We now estimate that only one percent of 
an adviser's clients actually request a copy the adviser's code of 
ethics. 0.01 x 1,013 (the estimated average number of clients per 
adviser) = 10.13 requests per registrant. See note 258 below 
regarding the estimated average number of clients. We continue to 
estimate that responding to each such request involves a burden of 
0.10 hours, amounting to an annual burden of 1.013 hours for each 
adviser stemming from the obligation to deliver copies of their 
codes of ethics to clients. 10.13 requests per adviser x 0.10 hours 
= 1.013 hours/adviser. This obligation applies to both currently-
registered (10,817 respondents) and newly-registered advisers (1,000 
respondents), for a total annual burden of 11,971 hours. 11,817 
respondents x 1.013 hours = 11,970.621 hours.
    \241\ 11,971 hours + 100,976 hours = 112,947 hours.
    \242\ Revised burden 112,947 hours - currently approved burden 
of 109,678 hours = 3,269 hours. As discussed above, the currently 
approved burden includes the estimated paperwork burdens associated 
with all the revisions to Form ADV that were proposed in 2000.
---------------------------------------------------------------------------

2. Rule 206(4)-4
    Rule 206(4)-4 currently requires advisers to disclose certain 
disciplinary and financial information to clients. We are proposing to 
rescind rule 206(4)-4 and to incorporate its substantive provisions 
into Part 2A of Form ADV. The collection of information burden 
associated with the requirements of rule 206(4)-4 has been incorporated 
into the collection of information requirements for Form ADV, discussed 
above. Thus, the currently approved burden estimate for Form ADV 
already includes an estimate of the burdens associated with the 
disclosure of disciplinary and financial information connected with 
proposed Part 2.

B. Rule 204-2

    This requirement is found at 17 CFR 275.204-2 and is mandatory. The 
Commission staff uses the collection of information in its examination 
and oversight program, and the information generally is kept 
confidential.\243\ The likely respondents to this collection of 
information requirement are all of the approximately 10,817 advisers 
currently registered with the Commission.
---------------------------------------------------------------------------

    \243\ See section 210(b) of the Advisers Act (15 U.S.C. 80b-
10(b)).
---------------------------------------------------------------------------

    Under section 204 of the Advisers Act, investment advisers required 
to register with the Commission must make and keep certain records for 
prescribed periods, generally for a period of at least five years, and 
must make and disseminate certain reports. Rule 204-2 sets forth the 
requirements for maintaining and preserving specified books and 
records.
    The amendments to rule 204-2 that we are proposing today would 
require SEC-registered advisers to prepare and preserve a memorandum 
describing any legal or disciplinary event listed in Item 9 in Part 2A 
and Item 3 in Part 2B of Form ADV, if the event is not disclosed in the 
adviser's brochure or the relevant brochure supplement. This revision 
is the same as originally proposed. Additionally, the amendments would 
also require SEC-registered investment advisers to prepare and preserve 
documentation of the method they use to compute managed assets for 
purposes of Item 4.E. in Part 2 of Form ADV, if that method differs 
from the method used to calculate ``assets under management'' in Part 
1A of Form ADV. These records would be required to be maintained in the 
same manner, and for the same period of time, as other books and 
records required to be maintained under rule 204-2(a).
    As discussed in the Proposing Release, Commission staff had 
estimated that the proposed amendments to rule 204-2 would result in a 
burden increase of four hours for each of the then estimated 110 
Commission-registered advisers that would be required to prepare and 
preserve additional records as a result of the amendments. We continue 
to believe that the proposed amendments to rule 204-2 will result in an 
increased burden of four hours for each adviser subject to the 
additional requirements.\244\
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    \244\ The proposed rule did not require documentation for Item 
4.E computations that differed from Part 1A, Item 5.F of Form ADV. 
We estimate that the additional recordkeeping requirement applicable 
to advisers who use an alternative method of asset calculation will 
take approximately the same amount of time (4.0 hrs) as that 
required by advisers who compose memoranda with respect to 
undisclosed legal/disciplinary events.
---------------------------------------------------------------------------

    We estimate that 325 advisers will use a method for computing 
managed assets in Part 2 that differs from the method used to compute 
assets under management in Part 1A and thus would be required to 
prepare and preserve documentation describing the method used in Part 
2.\245\ We also estimate that

[[Page 13980]]

162 advisers will conclude that the materiality presumption in Part 2 
is overcome with respect to a legal or disciplinary event, will 
determine not to disclose that event, and therefore would be required 
to prepare and preserve a memorandum describing the event.\246\
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    \245\ Based on the Commission staff's conversations with 
industry professionals, we anticipate that approximately three 
percent of the 10,817 advisers registered with us as of September 
30, 2007 will use a method for computing managed assets in Part 2 of 
Form ADV that differs from the method used to compute assets under 
management in Part 1A of Form ADV. 10,817 advisers x 0.03 = 324.51 
advisers.
    \246\ Approximately 1,620 advisers registered with the 
Commission report disciplinary information in Part 1A of their Form 
ADV as of September 30, 2007. We anticipate that most of these 
advisers will include all disciplinary information in their 
brochures and supplements, but that approximately 10 percent of 
these advisers, or 162, will need to prepare and preserve a 
memorandum explaining their basis for not disclosing a legal or 
disciplinary event listed in Part 2 that is not disclosed in their 
brochures and supplements. 1,620 advisers x 0.10 = 162 advisers.
---------------------------------------------------------------------------

    As discussed earlier, in the Proposing Release Commission staff had 
estimated that 110 advisers would have to prepare and preserve 
additional records in accordance with the amendments to rule 204-2. 
However, we now estimate that a total of 487 advisers will have to 
prepare and preserve additional records in accordance with amendments 
to rule 204-2.\247\ Only 110 of these are already accounted for in the 
currently approved burden estimate. We estimate that the additional 377 
advisers whom we anticipate will be subject to the amended provisions 
of rule 204-2, will yield a 1,508 hour burden increase under rule.\248\
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    \247\ 325 advisers that we estimate would prepare memoranda 
regarding alternative method for calculating assets under management 
+ 162 advisers that we estimate would prepare memoranda regarding 
unreported nonmaterial disciplinary events = 487 advisers.
    \248\ 487 advisers - 110 advisers = 377 advisers. 377 advisers x 
4.0 hours = 1,508 hours.
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    The approved annual aggregate burden for rule 204-2 is currently 
1,762,267 hours based on an estimate of 9,728 registered advisers, or 
181.15 per registered adviser.\249\ Taking into account the estimated 
increased burden of 1,508 hours as discussed above, as well as an 
increase of 1,089 registered advisers,\250\ the revised annual 
aggregate burden for all respondents to the recordkeeping requirements 
under rule 204-2 is therefore estimated to be 1,961,048 total 
hours.\251\
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    \249\ 1,762,267 hours / 9,728 registered advisers = 181.15 hours 
per adviser.
    \250\ As stated above, our IARD data show that as of September 
30, 2007 there were 10,817 advisers registered with the SEC. 10,817 
- 9,728 = 1,089.
    \251\ 1,762,267 current burden hours + 1,508 hours due to an 
increase in the estimated number of registered advisers subject to 
additional recordkeeping under the amendments + (1,089 due to an 
increase of total number of registered advisers x 181.15 hours per 
adviser) = 1,961,048. The annual average burden per SEC-registered 
adviser is therefore 181.29 hours. 1,961,048 total hours / 10,817 
advisers = 181.29 hours per adviser.
---------------------------------------------------------------------------

    We further estimate that some advisers may incur a one-time cost 
including outside legal fees in connection with preparation of a 
memorandum explaining their basis for not disclosing a legal event 
listed in Part 2 in their brochures or supplements. We estimate this 
one-time cost would include fees for approximately three hours of 
outside legal review and would amount on average to approximately 
$1,200 per adviser.\252\ We believe that approximately 80 percent of 
the advisers preparing such memoranda would likely to engage outside 
legal services to assist in their preparation. Thus, we estimate that 
approximately 130 advisers, will incur these costs, for a total cost 
among all respondents of $156,000.\253\
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    \252\ Outside legal fees are in addition to the projected hourly 
per adviser burden discussed above. $400 per hour for legal services 
x 3 hours per adviser = $1,200. The hourly cost estimate is based on 
our consultation with advisers and law firms who regularly assist 
them in compliance matters.
    \253\ 162 advisers x 0.80 = 129.6. $1,200 x 130 = $156,000.
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C. Rule 204-3

    Rule 204-3 contains a collection of information requirement. This 
collection of information is found at 17 CFR 275.204-3 and is 
mandatory. Responses are not kept confidential. The likely respondents 
to this information collection are the approximately 10,817 investment 
advisers registered with the Commission.
    Rule 204-3 currently requires an investment adviser to deliver to 
clients, at the start of an advisory relationship, a copy of Part 2 of 
Form ADV or a written document containing at least the information 
required by Part 2 of Form ADV. The rule currently requires no further 
brochure delivery unless the client accepts the adviser's required 
annual offer. The brochure assists the client in determining whether to 
hire or retain an adviser.
    The amendments to rule 204-3 would require advisers registered with 
us to deliver their brochures and brochure supplements at the start of 
an advisory relationship and to deliver their firm brochure annually 
thereafter.\254\ The amendments also would require that advisers 
deliver updates of the brochure and brochure supplements to clients 
only when disciplinary information in the brochure or supplements 
becomes materially inaccurate.\255\ The updates could take the form of 
a revised brochure (or supplement) or a ``sticker'' containing the 
updated information. This represents a departure from the originally 
proposed requirements which would have required an ongoing obligation 
to deliver updates involving any material information in the brochure 
or supplement, not just disciplinary information.
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    \254\ Proposed rule 204-3(b).
    \255\ Proposed rule 204-3(e). We received comments that were 
critical of that proposal and that also suggested alternative 
approaches. In response to those comments, we are now proposing a 
narrower scope of the updating requirement.
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    The total annual burden currently approved by OMB for rule 204-3 is 
6,902,278 hours and is based on the requirements of the rule as 
proposed in 2000.\256\ This currently approved burden is based on each 
adviser having, on average, an estimated 670 clients.\257\ Our records 
now currently indicate that the 10,817 advisers registered with the 
Commission have, on average, 1,013 clients.;\258\ These changes, along 
with our proposal to require annual brochure delivery along with 
interim delivery only of brochure and supplement updates that involve 
disciplinary information (in lieu of the originally proposed ongoing 
delivery obligation)

[[Page 13981]]

alter the collection of information burden from that currently 
approved.
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    \256\ Following issuance of the Proposing Release, OMB approved 
a burden of 411,075 hours. That estimate assumed, in part, that 
approximately 8,100 advisers were registered with us and that each 
adviser had, on average, 49 clients. OMB subsequently approved an 
increase in the annual burden to 6,902,278 hours to reflect 
assumptions regarding an increased number of SEC-registered advisory 
firms and an increased estimate with respect to the average number 
of clients per adviser. This currently approved burden is based on 
the proposed delivery requirements (initial delivery plus interim 
stickering) and assumptions (an initial bulk mailing at 0.25 hours 
and 2 stickers per year for each SEC-registered firm at 0.5 hours 
per sticker) that were discussed in the Proposing Release.
    \257\ This average was based on advisers' responses to Item 5.C 
of Part 1A of Form ADV as of October 5, 2001.
    \258\ This average is based on advisers' responses to Item 5.C 
of Part 1A of Form ADV as of September 30, 2007, excluding the two 
advisers that reported the largest number of clients. Those advisers 
account for over 43 percent of all advisory clients of SEC 
registrants and not excluding them would raise the average client 
count to 1,778 clients. These two firms provide advisory services 
primarily over the Internet and currently meet their brochure 
obligations electronically, thus essentially entirely eliminating 
for these advisers any PRA burden associated with delivery under 
this rule. Therefore, we believe that it is appropriate to exclude 
these firms from our calculations. Even removing these advisers 
discussed above, the ``typical'' adviser registered with the 
Commission, has far fewer clients than suggested by this average. 
The average is still heavily weighted by the responses received from 
the few largest advisers. We note that the next five advisory firms 
with the largest numbers of clients account for more than an 
additional 15 percent of all clients. In contrast, the majority 
(over 60 percent) of advisers registered with us have 100 or fewer 
clients, and the vast majority (over 90 percent) have 500 or fewer. 
Based on a median, we estimate that the ``typical'' adviser 
registered with us has approximately 63 clients--that is, half of 
Commission-registered advisers have more than 63 clients and half 
have fewer. This median is consistent with advisers' modal response 
(the most common response) to Item 5.C of Part 1A, which was ``26 to 
100 clients.''
---------------------------------------------------------------------------

    We expect that advisers will send their brochures annually in a 
``bulk mailing'' to clients. We estimate that, with a bulk mailing, an 
adviser will require no more than 0.25 hours to send the adviser's firm 
brochure to each client, or an annual burden of 253.25 hours per 
adviser.\259\ Thus, we estimate the total burden hours for 10,817 
advisers to distribute their firm brochure to existing clients 
initially and annually thereafter to be 2,739,405 hours per year.\260\
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    \259\ (0.25 hours per client x 1,013 clients per adviser) = 
253.25 hours per adviser. This is the same estimate we made in the 
2000 proposal and for which we received no comment. We note that the 
burden for preparing brochures is already incorporated into the 
burden estimate for Form ADV discussed above. We anticipate that 
most advisers will make their annual delivery of their brochure as 
part of the annual bulk mailings they already make to clients.
    \260\ (0.25 hours per client x 1,013 clients per adviser) x 
10,817 advisers = 2,739,405.25 hours.
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    Advisers also will be required to distribute interim updates 
disclosing new or revised disciplinary information in their brochure or 
supplements. We anticipate that in any given year, the number of such 
interim updates that advisers will be required to deliver is 
approximately 541.\261\ We further estimate that an adviser will 
require no more than 0.5 hours per client for delivery of each such 
update.\262\ This represents about 507 hours per interim update.\263\ 
Thus, the aggregate annual hour burden for affected advisers to deliver 
interim updates to their brochures and supplements will be 
approximately 274,287 hours per year.\264\
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    \261\ Just under fifteen percent of the advisers currently 
registered with the Commission report any disciplinary events at all 
on their Form ADVs (as of September 30, 2007, only 1,620 of all 
10,817 registered advisers indicated at least one ``yes'' answer to 
a question related to disciplinary events in Form ADV, Part 1A, Item 
11). Thus, we anticipate that a correspondingly small number of 
advisers will be required to disclose new or updated disciplinary 
information. The Commission staff estimates that in any given year, 
five percent of advisers, will be required to deliver a single 
interim update to each of their clients, resulting in a total of 
approximately 522 interim updates per year. 0.05 x 10,817 x 1 update 
= 540.85 updates.
    \262\ This burden estimate relates only to the amount of time it 
will take advisers to deliver interim updates to clients, as 
required by the rule amendments. The burden for preparing interim 
updates is already incorporated into the burden estimate for Form 
ADV discussed above.
    \263\ 0.5 hours per client x 1,013 clients per adviser = 506.5 
hours per update.
    \264\ 541 updates x 507 hours = 274,287 hours.
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    Thus, the rule amendments requiring annual delivery and interim 
updating of advisers' brochures and supplements yields a total 
collection of information burden for rule 204-3 of 3,013,692 hours per 
year, or 279 hours per respondent.\265\ This represents a decrease of 
3,888,586 hours from the currently approved PRA burden.\266\ The 
reduced burden results primarily from our proposal to replace the 
originally proposed requirement to deliver brochure and supplement 
updates on an ongoing basis, with a requirement to only deliver 
brochure updates once annually and interim amendments to brochures and 
supplements only when such updates involve disciplinary information. 
This change thus significantly reduces the estimated total number of 
updates advisers will be required to deliver annually.\267\
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    \265\ 2,739,405 hours (initial and annual delivery) + 274,287 
hours (interim delivery of updates to disciplinary information) = 
3,013,692 hours. 3,013,692 hours / 10,817 advisers = 278.61 hours 
per adviser.
    \266\ 6,902,278 hours - 3,013,692 hours = 3,888,586 hours.
    \267\ This reduction in hours is offset somewhat by the fact 
that we have increased the estimated number of clients per adviser 
who will receive brochures and supplements and interim updates to 
these.
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D. Request for Comment

    With respect to the above-described collections of information and 
pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments 
to: (i) Evaluate whether the proposed collections of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information shall have practical utility; (ii) 
evaluate the accuracy of the Commission's estimates of the burdens of 
the proposed collections of information; (iii) determine whether there 
are ways to enhance the quality, utility, and clarity of the 
information to be collected; and (iv) evaluate whether there are ways 
to minimize the burdens of the collections of information on those who 
are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons submitting comments on these collections of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090, with reference to File No. S7-10-00. 
Requests for materials submitted to OMB by the Commission with regard 
to these collections of information should be in writing, with 
reference to File No. S7-10-00, and be submitted to the Securities and 
Exchange Commission, Records Management, Office of Filings and 
Information Services, 100 F Street, NE., Washington, DC 20549-1090. As 
OMB is required to make a decision concerning the collections of 
information between 30 and 60 days after publication, a comment to OMB 
is best assured of having its full effect if OMB receives it within 30 
days of publication.

VII. Cost-Benefit Analysis

A. Background

    The Commission is sensitive to the costs and benefits of its rules. 
As proposed, this rulemaking would revise Part 2 of Form ADV to require 
advisers to prepare plain English narrative brochures discussing their 
business practices and conflicts of interest and to prepare brochure 
supplements discussing the background and disciplinary history of 
certain supervised persons who formulate investment advice or exercise 
investment discretion for clients. The revisions to the form would 
essentially move into the form itself existing rule provisions that 
require advisers to disclose certain disciplinary and financial 
information. In conjunction with these revisions the Commission is 
proposing to withdraw rule 206(4)-4 as duplicative.
    The proposed rulemaking would require advisers to deliver the 
narrative brochures to clients at the outset of the advisory 
relationship and annually thereafter, and to deliver to each client an 
initial brochure supplement for each supervised person who provides 
advisory services to that client. Advisers would be required to deliver 
to clients interim updates to their brochure and brochure supplements 
that involve a change to certain disciplinary information required by 
Part 2. The rules would provide exceptions to the brochure and 
supplement delivery requirements for certain types of clients, and 
would excuse the adviser from preparing a brochure or supplement if 
there is no client to whom it must be delivered. The proposed rule 
amendments would also require advisers to file their narrative 
brochures electronically through the IARD, and to keep certain records 
relating to the brochures and supplements.
    We have identified certain costs and benefits, discussed below, 
that may result from the proposed rule and form amendments. In the 
Proposing

[[Page 13982]]

Release,\268\ we analyzed costs and benefits of the proposed amendments 
to Part 2 and the related rules and requested comment and data on the 
effect they would have on individual investment advisers and on the 
advisory industry as a whole. We are now able to make more detailed 
estimates of costs, based on data available through the IARD system, 
and we provide those below.\269\ We request comment on the costs and 
benefits of the proposed amendments. We encourage commenters to 
identify, discuss, analyze, and supply relevant data regarding these or 
any additional costs and benefits.
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    \268\ See above note 5.
    \269\ As discussed above in note 2 of this Release and unless 
otherwise noted, the IARD data cited below is based on advisers' 
responses to questions on Part 1A of Form ADV as of September 30, 
2007.
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B. Form ADV Part 2 and IARD Filing

    As discussed above, the proposed revisions to Part 2 would require 
most advisers to prepare plain English narrative brochures.\270\ 
Advisers would file their brochures electronically through the IARD in 
a process much like attaching a file to an e-mail.
---------------------------------------------------------------------------

    \270\ Under the amendments, advisers that are not required to 
deliver a brochure to clients would not be required to prepare one. 
Advisers that provide only impersonal advice costing less than $500 
per year per client, and advisers only to registered investment 
companies, would therefore not be required to prepare a brochure. We 
estimate, based on information filed with us on Form ADV, that 
approximately 295 advisers provide their services only to registered 
investment companies and therefore would not need to prepare a 
brochure. Based on Form ADV filings, we estimate that less than 10 
advisers offer advisory services only by publishing periodicals and 
newsletters; we estimate that approximately half of these charge 
less than $500 per year per client and would not need to prepare a 
brochure. Moreover, because advisers need not deliver supplements to 
clients that do not receive a brochure, these advisers would also be 
excused from preparing any brochure supplements.
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    The new narrative brochures and electronic filing would provide 
substantial benefits to advisory clients. The brochures would present 
clients with critically important information they need to determine 
whether to hire or continue the services of a particular adviser. This 
information would be presented in a format easy for most investors to 
understand. Investors searching for an adviser would be able to access 
the firm's brochures through our public disclosure Web site even before 
contacting the firm, and thus would be in a better position to know 
whether they wish to inquire further about the services the firm is 
offering. We believe these benefits to advisory clients will be a 
significant enhancement to the adviser disclosure regime. These 
benefits, while substantial, are difficult to quantify. Most commenters 
strongly supported the narrative, plain English format, and viewed it 
as an improvement over the current form. They agreed that the new 
brochures would greatly benefit clients by requiring advisers to 
present important information about their firms in a clear and more 
meaningful way. They observed that the enhanced disclosure required by 
the revised form would benefit clients by better equipping them with 
the knowledge to make informed decisions about whether to hire or 
retain a particular adviser.
    Advisers themselves would also benefit from the flexibility the new 
narrative brochures would give them. Advisers would be able to organize 
their brochures in the manner that they believe best communicates the 
required disclosure to their clients. Advisers would also only be 
required to respond to items that apply to their business, thus 
substantially enhancing the efficiency and minimizing the costs of 
preparing brochures and supplements. Moreover, the new amendments 
provide significant guidance to advisers in terms of highlighting the 
types of disclosures they, as fiduciaries, are already required to 
make. We believe the flexibility created by the revisions, as well as 
the enhanced clarity the new form provides will yield substantial 
benefits for advisers.
    We recognize, however, that revised Part 2 would also impose costs 
on advisers. Advisers would be required to replace their current Part 2 
with the new narrative brochure and supplements, and would be required 
to file their brochures with us. In addition, the disclosure in the new 
brochure may be more complete than that existing Form ADV Part 2 
currently requires. Thus, drafting the new narrative brochure will 
likely entail additional expenses. As discussed in the Proposing 
Release, we believe that most of the costs that advisers will incur in 
connection with preparation of the new narrative firm brochure and 
brochure supplements will be in the initial drafting of these 
documents.\271\ We do not expect that revised Part 2 would result in a 
significant cost increase on a long-term basis.
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    \271\ Proposing Release at Section III.B.2. We do not, however, 
expect advisers to face substantial costs in gathering the required 
disclosure. Advisers already are required to provide us and/or their 
clients with much of the information required in the new narrative 
brochure. In addition, much of the information needed for the 
brochure supplements can be found in an adviser's current Form ADV 
or an investment adviser representative's registration application 
(i.e., Form U-4) filed with state securities authorities.
---------------------------------------------------------------------------

    The cost of preparing a narrative brochure likely would vary 
significantly among advisers, depending on the complexity of their 
operations and because Part 2 would give advisers considerable 
flexibility in structuring their disclosure. Some firms may choose to 
prepare multiple brochures for several different services. These firms 
likely would face only incrementally higher drafting costs than an 
advisory firm that uses a single brochure to make the required 
disclosure about the services it provides.
    Similarly, the costs of preparing brochure supplements would vary 
from one adviser to the next. Costs would vary most significantly 
depending on the number of supervised persons for whom an adviser must 
provide disclosure.\272\ An adviser with very few supervised persons 
for whom a supplement must be prepared would incur lower costs than a 
large adviser. Costs associated with preparing supplements also would 
vary greatly depending on the amount of disciplinary information, if 
any, required to be disclosed about a particular supervised person. The 
preparation of brochure supplements would be most demanding for those 
few advisers whose supervised persons have lengthy disciplinary records 
that must be disclosed, and less taxing for the vast majority of 
advisers, whose supervised persons have no disciplinary records and 
whose supplements would therefore likely be a page or less in 
length.\273\
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    \272\ In response to comments we received, we narrowed the scope 
of supervised persons for whom a brochure supplement must be 
delivered. In addition, an adviser that is not required to deliver a 
brochure supplement for a particular supervised person is not 
required to prepare a supplement for that individual. See Section 
II.B of this Release.
    \273\ IARD data indicate that in response to Item 11 in Part 1A 
of Form ADV, only 1,620, or just under 15 percent, of the 10,817 
advisers registered with us report any disciplinary information 
about their firms or advisory affiliates, including their advisory 
employees.
---------------------------------------------------------------------------

    We expect that only a few advisers would incur substantial costs in 
preparing supplements. Although some commenters representing large 
advisers argued that the supplement proposal would unduly burden 
advisers that have ``thousands'' of employees, IARD data indicate that 
fewer than one third of one percent of advisers registered with us have 
over 1,000 employees performing investment advisory functions on their 
behalf.\274\ Indeed, less than five percent of our registrants have 
over 50 employees performing investment advisory functions. The vast 
majority of

[[Page 13983]]

SEC-registered advisers--nearly 82 percent--have 10 or fewer employees 
performing advisory functions on their behalf. We believe most, if not 
all, of these firms may choose to incorporate required information 
about their supervised persons into their firm brochures instead of 
preparing separate brochure supplements, thus reducing costs of 
preparation. We request comment on the number of supplements that 
advisers of varying sizes would need to prepare, and how that number 
compares to the number of advisory employees at the firm.
---------------------------------------------------------------------------

    \274\ Moreover, it may not be necessary to prepare a brochure 
supplement for all of these employees.
---------------------------------------------------------------------------

    For purposes of the Paperwork Reduction Act and taking into account 
the widely varying numbers of advisory employees among the thousands of 
different advisory firms registered with us, we have estimated the 
number of hours the average adviser would spend in the initial 
preparation of their brochures and supplements.\275\ Based on those 
estimates, we estimate that advisers would incur costs of approximately 
$14,723,982 in drafting these documents in the first year.\276\ 
Furthermore, for Paperwork Reduction Act purposes we also have 
estimated that advisers may incur approximately costs of $7,257,200 in 
connection with their use of outside legal services to assist in 
preparation of their Form ADV.
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    \275\ See Section VI.A of this Release.
    \276\ We expect that this function will most likely be performed 
by compliance professionals. Data from SIFMA's Report on Office 
Salaries in the Securities Industry 2006, modified to account for an 
1,800-hour work-year and multiplied by 2.93 to account for bonuses, 
firm size, employee benefits and overhead, suggest that cost for a 
Compliance Clerk is approximately $56 per hour. 262,928.25 hours x 
$56 per hour = $14,723,982.
---------------------------------------------------------------------------

    Advisers would incur annual expenses in addition to the initial 
costs of preparing firm brochures and brochure supplements, but we 
believe these costs would be modest and similar to current costs. The 
rule amendments, similar to the current requirements, would require 
advisers to revise their disclosure documents promptly when any 
information in them becomes materially inaccurate, and would require 
advisers to update their brochures and brochure supplements each year 
at the time of their required annual updating amendment. For Paperwork 
Reduction Act purposes, we have estimated that advisers would need to 
prepare brochure amendments, on average, one and one half times per 
year, and spend three quarters of an hour on each amendment. We 
estimate that advisers would incur annual costs of $744,471 in meeting 
these requirements.\277\
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    \277\ Similarly, we expect that amendments to Part 2 will also 
most likely be performed by compliance professionals at an estimated 
cost for a Compliance Clerk of $56 per hour. 17,725.5 amendments x 
0.75 hours per amendment x $56 = $744,471.
---------------------------------------------------------------------------

    Finally, advisers would incur some costs in filing their brochures 
with us through the IARD. Advisers would prepare their brochures on 
their own computers, and as noted earlier, the filing of a brochure 
would be similar to attaching a file to an e-mail.\278\ We believe 
conversion of an adviser's brochure to PDF format and filing of that 
brochure through the IARD would impose minimal costs on advisers.
---------------------------------------------------------------------------

    \278\ We note that all advisers registered with the Commission 
currently file Form ADV electronically via the IARD system and that 
since implementation of the electronic filing requirements in 2000 
no adviser has applied for a permanent hardship exemption available 
to advisers for whom filing electronically would constitute an undue 
hardship. See rule 203-3(b) [17 CFR 275.203-3(b)].
---------------------------------------------------------------------------

C. Brochure and Supplement Delivery

    Advisers would be required to deliver their revised brochures to 
existing clients annually.\279\ The amended rules would require that, 
between annual deliveries, advisers deliver brochure and supplement 
amendments to existing clients only if there is an addition or change 
to disciplinary disclosure. Advisers already are required to deliver a 
copy of Part 2 to new clients. Thus, this requirement should present no 
new costs to advisers. Moreover, we believe that because advisers must 
deliver brochures to new clients, the cost of delivering brochure 
supplements to new clients should increase the existing cost of 
delivery only incrementally. New clients would receive brochures and 
supplements that are current as of the time of delivery.
---------------------------------------------------------------------------

    \279\ Currently, an adviser must offer its brochure to clients 
annually, and must deliver a revised brochure only if the client 
accepts the adviser's offer.
---------------------------------------------------------------------------

    Annual brochure delivery would benefit advisory clients by ensuring 
that they are kept apprised of their advisers' business practices and 
procedures for managing conflicts and enable clients to make decisions 
with respect to the adviser with the most currently available 
information. Changes to disciplinary information disclosed in the 
brochure and supplement are of such importance to clients that we 
believe interim delivery of these amendments is necessary. Moreover, 
advisers currently are already required to make disclosures regarding 
disciplinary information under existing rule 206(4)-4. Based on the 
experiences of examination staff, we believe that most advisers likely 
already make these disclosures in writing so that they can demonstrate 
compliance with the requirements of rule 206(4)-4. Thus, we believe 
that it is unlikely that there will be any new costs associated with 
delivery of this information.
    As discussed above, delivery of the new narrative brochures would 
provide substantial benefits to advisory clients. The brochures would 
present clients with important information they need to determine 
whether to hire or continue the services of a particular adviser. 
Currently, advisers must annually offer to deliver their brochure to 
existing clients, however, clients who never request a brochure may not 
necessarily see important amendments. Under the proposed approach, each 
year clients would automatically receive advisers' brochures and the 
valuable information contained therein. Although we believe these 
benefits to advisory clients will be substantial, they are difficult to 
quantify.
    Although advisers are already currently required to deliver a 
revised brochure to clients upon request, advisers would incur 
additional delivery costs under the amended rule (particularly in 
connection with the initial and annual delivery obligations). We expect 
these additional costs, however, to be less than under the original 
proposal.\280\ Certain commenters raised particular concerns about the 
scope of the brochure supplement and its delivery, and the costs 
associated with ensuring proper distribution of supplements. In 
response to comments, we have both proposed to narrow the group of 
supervised persons who would need a brochure supplement, and to 
eliminate the need to send supplements to certain institutional or 
sophisticated clients. For Paperwork Reduction Act Purposes, we have 
estimated that the total annual paperwork burden associated with annual 
and interim delivery of brochures and supplements is approximately 
3,013,692 hours. We estimate this would represent an annual cost of 
$168,766,752.\281\
---------------------------------------------------------------------------

    \280\ We are proposing the annual brochure delivery requirement 
(and the requirement that advisers deliver any interim amendments 
that disclose additional or revised disciplinary information) in 
lieu of our original proposal, which would have required advisers to 
deliver all brochure and supplement updates to clients on a 
continuous basis whenever any information in their brochures or 
supplements became materially inaccurate.
    \281\ We expect that delivery of amendments to Part 2 will also 
most likely be performed by compliance professionals at an estimated 
cost for a Compliance Clerk of $56 per hour. 3,013,692 hours x $56 = 
$168,766,752.
---------------------------------------------------------------------------

    Advisers may significantly minimize the costs associated with 
annual delivery of their brochures and supplements by arranging to 
deliver

[[Page 13984]]

their brochures and supplements to some or all clients by electronic 
media.\282\ Advisers also may minimize delivery costs by mailing their 
brochures and supplements along with quarterly statements or other 
routine mailings they already send to clients.\283\ The extent to which 
advisers will take advantage of these and other techniques to reduce 
costs is difficult to predict but we believe it will be significant. We 
request comment about the percentage of clients to whom advisers are 
likely to make electronic delivery. We also request comment about the 
extent to which advisers may minimize delivery costs by mailing their 
brochures and supplements along with quarterly statements or other 
routine mailings.
---------------------------------------------------------------------------

    \282\ Proposed Instruction 3 for Part 2A of Form ADV expressly 
notes that Commission interpretive guidance permits advisers to 
deliver their brochures electronically upon client consent.
    \283\ As noted above, annual brochure delivery must be made 
within 120 days of the adviser's fiscal year end. We have designed 
this deadline so that advisers can include the brochure in a routine 
mailing to clients.
---------------------------------------------------------------------------

D. Amendments to Rule 204-2

    The proposed amendments to rule 204-2 would require SEC-registered 
advisers to retain certain records relating to brochures and 
supplements. One of the proposed revisions to the rule would require 
advisers to retain copies of brochures and supplements prepared as 
required by Part 2. This provision is designed to conform that rule to 
our proposed changes to Form ADV and generally would impose no 
additional costs because advisers are already currently required to 
retain records relating to materials they distribute to their clients. 
Other proposed revisions to the rule would require advisers to maintain 
certain records in the event they use an alternative method to 
calculate assets under management in response to Item 4.E of Part 2A 
and if they do not disclose in their brochure any legal or disciplinary 
event listed in Part 2. These provisions would benefit advisers by 
permitting them flexibility in drafting their firm brochures while 
providing for maintenance of records needed by our examination staff. 
Moreover, because we anticipate that only a relatively small number of 
advisers would be subject to these provisions we expect that the cost 
of maintaining these records will be relatively minimal.\284\
---------------------------------------------------------------------------

    \284\ For Paperwork Reduction Act purposes we estimate that only 
487 advisers would be required to prepare additional records in 
accordance with the amendment to rule 204-2 and that each adviser 
would spend approximately four hours to satisfy the obligation for a 
total burden of 1,948 hours per year.
---------------------------------------------------------------------------

E. Total Estimated Costs and Benefits of This Rulemaking

    As discussed above, the proposed rule and form amendments are 
expected to have both benefits and costs for investors and the advisory 
industry as a whole. We believe the benefits to advisory clients in the 
form of significant enhancements to the adviser disclosure regime will 
be quite substantial, but are difficult to quantify. Similarly 
difficult to quantify are the expected benefits to the advisory 
industry that we believe would result from the proposed rules in the 
form of enhanced flexibility with respect to their obligations to 
prepare and deliver brochures and supplements. Moreover, not all of the 
costs we anticipate to result from this rulemaking are quantifiable. 
Based on the figures discussed above, however, we estimate that the 
first year quantifiable costs related to this proposed rulemaking to be 
approximately $191,492,405.\285\
---------------------------------------------------------------------------

    \285\ Estimated costs related to initial preparation of Form ADV 
(including Part 2) of $14,723,982 + estimated one-time outside legal 
costs associated with this initial preparation of $7,257,200 + 
estimated costs of $744,471 related to annual updating of Form ADV 
(including Part 2) + estimated costs associated with delivery of 
brochures and supplements of $168,766,752 = $191,492,405.
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VIII. Initial Regulatory Flexibility Analysis

    We have prepared this Initial Regulatory Flexibility Analysis 
(IRFA) in accordance with section 3(a) of the Regulatory Flexibility 
Act (RFA).\286\ It relates to proposed amendments to rules 203-1, 204-
1, 204-2, 204-3, and 206(4)-4, and Form ADV under the Advisers Act. The 
rule and form amendments are designed to improve the disclosure that 
investment advisers provide to their clients. These proposed amendments 
would also revise the instructions for updating and filing Form ADV 
(including adviser brochures). We also are proposing conforming rule 
amendments that would revise the recordkeeping requirements relating to 
Part 2 of Form ADV.
---------------------------------------------------------------------------

    \286\ 5 U.S.C. 603(a).
---------------------------------------------------------------------------

    We prepared an IRFA in conjunction with the release proposing 
amendments to Part 2 of Form ADV in April 2000, and made it available 
to the public. A summary of that IRFA was published with the Proposing 
Release.\287\ We received no comments specifically on that IRFA.
---------------------------------------------------------------------------

    \287\ See above note 5.
---------------------------------------------------------------------------

A. Need for the Rule and Form Amendments

    The proposed rule and form amendments are necessary to improve the 
quality of disclosure that advisers provide to their clients.\288\ Form 
ADV was adopted by the Commission in 1985 \289\ and advisers currently 
use it to register with the Commission (Part 1) and to provide clients 
disclosure about their advisory firm and personnel (Part 2). Over the 
years, however, experience has shown that the format and content of 
current Part 2 of Form ADV do not lend themselves to disclosure that is 
easy for clients to understand. Clients need clearer information about 
an adviser's services, fees, business practices, and conflicts of 
interests to be able to make an informed decision about whether to hire 
or retain that adviser.
---------------------------------------------------------------------------

    \288\ Sections I through IV, above, of this Release, describe in 
more detail the reasons for the proposed amendments.
    \289\ Uniform Investment Adviser Registration Application Form, 
Investment Advisers Act Release No. 991 (Oct. 15, 1985) [50 FR 42903 
(Oct. 23, 1985)].
---------------------------------------------------------------------------

B. Objectives and Legal Basis

    The primary objective of the proposed form and rule amendments is 
to provide advisory clients and prospective clients with access to 
meaningful and up-to-date disclosure, as well as to provide for filing 
of this disclosure with the Commission.\290\ By requiring advisers to 
provide current narrative brochures and brochure supplements written in 
plain English, the amendments are intended to improve the quality of 
information investors receive from advisers about their services, fees, 
business practices and conflicts of interest. Also, by requiring 
advisers to file their brochures (and any amendments) with the 
Commission electronically using IARD, the proposal would make full use 
of existing and new information technologies to aid the Commission 
staff in its oversight efforts and provide ready public access to 
advisers' brochures.
---------------------------------------------------------------------------

    \290\ Sections I through IV, above, of this Release, describe in 
more detail the objectives of the proposed amendments.
---------------------------------------------------------------------------

    We are proposing these amendments under section 19(a) of the 
Securities Act of 1933 [15 U.S.C. 77s(a)], sections 23(a) and 28(e)(2) 
of the Securities Exchange Act of 1934 [15 U.S.C. 78w(a) and 
78bb(e)(2)], section 319(a) of the Trust Indenture Act of 1939 [15 
U.S.C. 77sss(a)], section 38(a) of the Investment Company Act of 1940 
[15 U.S.C. 78a-37(a)], and sections 203(c)(1), 204, 206(4), and 211(a) 
of the Investment Advisers Act of 1940 [15 U.S.C. 80b-3(c)(1), 80b-4, 
80b-6(4), and 80b-11(a)].

[[Page 13985]]

C. Small Entities Subject to the Rules

    In developing the proposals, we have considered their potential 
impact on small entities that may be affected. The proposed rule and 
form amendments would affect all advisers registered with the 
Commission, including small entities. Under Commission rules, for 
purposes of the Regulatory Flexibility Act, an investment adviser 
generally is a small entity if it: (i) Has assets under management 
having a total value of less than $25 million; (ii) did not have total 
assets of $5 million or more on the last day of its most recent fiscal 
year; and (iii) does not control, is not controlled by, and is not 
under common control with another investment adviser that has assets 
under management of $25 million or more, or any person (other than a 
natural person) that had $5 million or more on the last day of its most 
recent fiscal year.\291\
---------------------------------------------------------------------------

    \291\ Rule 0-7 [17 CFR 275.0-7].
---------------------------------------------------------------------------

    Our rule and form amendments would not affect most advisers that 
are small entities (``small advisers'') because they are generally 
registered with one or more state securities authorities and not with 
us. Under section 203A of the Advisers Act, most small advisers are 
prohibited from registering with the Commission and are regulated by 
state regulators.\292\ Those small advisers that register with us are 
located in Wyoming (which does not have an investment adviser statute), 
or are eligible for an exemption that permits SEC registration. The 
Commission estimates that as of September 30, 2007, of the 10,449 
registered with us, there were approximately 634 that were small 
entities that would be affected by the proposed amendments.\293\ We 
request comment on the effect and costs of the proposed amendments on 
small entities.
---------------------------------------------------------------------------

    \292\ National Securities Markets Improvement Act of 1996 (Pub. 
L. 104-290, 110 Stat. 3438) (1996) (``NSMIA''). As a result of 
NSMIA, advisers with less than $25 million of assets under 
management generally are regulated by one or more state securities 
authority, while the Commission generally regulates those advisers 
with at least $25 million of assets under management. See section 
203A of the Advisers Act [15 U.S.C. 80b-3a].
    \293\ This estimate is based on information advisers have filed 
with the Commission on Part 1A of Form ADV.
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D. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposed rule and form amendments would impose certain 
reporting and compliance requirements on small advisers, requiring them 
to create and update narrative brochures containing certain information 
regarding their advisory business. The amendments also would require 
advisers to deliver their brochures to clients and to file them 
electronically through the IARD. The proposals would also impose new 
recordkeeping requirements. These requirements and the burdens on small 
advisers are discussed below.\294\
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    \294\ Sections I through IV, above, of this Release, describe 
these requirements in more detail.
---------------------------------------------------------------------------

1. Amendments to Part 2 of Form ADV
    The amendments to Part 2, because they require registered advisers 
to prepare and disseminate narrative brochures, would impose additional 
costs on all registered advisers, including small advisers. We assume 
that all small advisers currently distribute Part 2 of Form ADV and 
would have to redraft their brochures completely to comply with the 
proposed new format, although some information in current Part 2 may be 
transferable to the new narrative brochures.
    The costs associated with preparing the new brochures will depend 
on the size of the adviser, the complexity of its operations, and the 
extent to which its operations present conflicts of interest with 
clients. Many of the new items imposing the most rigorous disclosure 
requirements may not apply to certain small advisers because, for 
example, those advisers may not have soft dollar or directed brokerage 
arrangements, or may not have custody of client assets. To the extent 
that some of the new disclosure burdens would apply to small advisers, 
these advisers are already obligated to make the disclosures to clients 
under the Advisers Act's anti-fraud provisions, although the disclosure 
is not required to be in the firm's written brochure.
    For the first time, advisers also would be required to prepare and 
disseminate brochure supplements for certain supervised persons of 
their firm. To reduce the burdens on small advisers, however, we have 
drafted the new supplement rules so that firms with few employees would 
be permitted to include supplement information in their firm brochures 
and avoid preparing and distributing separate brochure supplements. We 
believe many small advisers would take advantage of this option and 
reduce their compliance burden.
2. Updating and Delivery Requirements
    The amended rules, like the current rules, would require advisers 
to update their brochures whenever information in them becomes 
materially inaccurate. The proposed amendments would also implement the 
same updating requirements for supplements. In updating its brochure 
and supplements, an adviser may minimize its burden by using a 
``sticker'' containing the updated information instead of reprinting 
its entire brochure and supplements.
    The amendments would require advisers to deliver a current brochure 
to clients annually and to deliver interim updates of the brochure and 
supplements to clients to disclose new or revised disciplinary 
information. These delivery requirements would replace the current 
requirement that advisers offer clients a revised brochure annually. To 
minimize the burden of delivery, advisers would be permitted with 
client consent to deliver brochures and supplements, as well as 
updates, electronically. To the extent that small advisers are more 
likely to have fewer advisory clients (and fewer supervised persons) 
than larger advisers, the proposed delivery requirements should impose 
lower variable costs on small advisers than on larger firms.
3. Recordkeeping Requirements
    The proposed amendments would impose new recordkeeping requirements 
on advisers, including small advisers. As under the current rules, 
advisers would be required to maintain copies of their brochures. The 
proposed amendments would also require all advisers to maintain copies 
of their brochure supplements. In addition, the proposed amendments 
would require advisers, including small advisers, to maintain certain 
records if they determine that a disciplinary event that is 
presumptively material does not have to be disclosed, or if they 
calculate their managed assets for purpose of their brochures 
differently than in Part 1A of Form ADV.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate or 
conflict with the proposed rule.\295\
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    \295\ As discussed above, the Commission is proposing to 
withdraw as duplicative current rule 206(4)-4.
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F. Significant Alternatives

    We have considered various alternatives in connection with the 
proposed rule and form amendments that might minimize their effect on 
small advisers, including: (i) Establishing different compliance or 
reporting requirements or timetables that take into account the 
resources available to small advisers; (ii) clarifying, consolidating, 
or simplifying compliance and reporting requirements under the proposed 
amendments for small advisers; (iii) using performance

[[Page 13986]]

rather than design standards; and (iv) exempting small advisers from 
coverage of all or part of the proposed amendments.
    Regarding the first alternative, the Commission believes that 
establishing different compliance or reporting requirements for small 
advisers would be inappropriate under these circumstances. The 
amendments are designed to improve the quality and timeliness of 
critically important disclosure that advisory clients receive from 
their advisers. To establish different disclosure requirements for 
small entities would diminish this investor protection for clients of 
small advisers. We note, however, that small advisers, by the nature of 
their business, likely would spend fewer resources in completing their 
brochures and any brochure supplements. Moreover, certain rule and form 
amendments were designed specifically to reduce the burden on small 
advisers. For example, the proposed Part 2 instructions would give 
advisers the flexibility to incorporate required information about 
their supervised persons into their firm brochures rather than 
presenting it in separate brochure supplements, thereby saving 
additional printing and mailing costs.
    Regarding the second alternative, the proposed amendments would 
clarify requirements for all advisers, including small advisers. The 
proposed Part 2 instructions are designed to present requirements for 
advisers' brochures and supplements clearly and simply to all advisers, 
including small entities.
    Regarding the third alternative, the Commission believes that the 
proposed amendments already appropriately use performance rather than 
design standards in many instances. The amendments would permit 
advisers considerable flexibility in designing their brochures and 
supplements so as best to communicate the required information to 
clients. In preparing brochure supplements, advisers would also have 
the flexibility of adapting the format of the supplements to best suit 
their firm: an adviser may: (i) Prepare a separate supplement for each 
supervised person; (ii) prepare a single supplement containing the 
required information for all of its supervised persons; (iii) prepare 
multiple supplements for groups of supervised persons (e.g., all 
supervised persons in a particular office or work group); or (iv) 
include all information about supervised persons in the firm brochure 
and prepare no separate supplements.\296\ The proposed amendments 
clarify that advisers may, with client consent, deliver their brochures 
and supplements, along with any updates, to clients electronically.
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    \296\ See Section II.B of this Release.
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    Regarding the fourth alternative, it would be inconsistent with the 
purposes of the Advisers Act to exempt small advisers from the proposed 
rule and form amendments. The information in an adviser's brochure is 
necessary for the client to evaluate the adviser's services, fees, and 
business practices, and to apprise the client of potential conflicts of 
interest and, when necessary, of the adviser's financial condition. 
Since we view the protections of the Advisers Act to apply equally to 
clients of both large and small advisers, it would be inconsistent with 
the purposes of the Act to specify different requirements for small 
entities.

G. Solicitation of Comment

    The Commission encourages the submission of comments on matters 
discussed in the IRFA. Comment is requested particularly on the number 
of small advisers that would be affected by the proposals, the burdens 
the proposals would impose on small advisers, and whether the effects 
of the proposed rule and form amendments on small advisers would be 
economically significant. Commenters are asked to describe the nature 
of any effect and provide empirical data supporting the extent of the 
effect. These comments will be placed in the same public comment file 
as comments on the proposals.
    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, the Commission is also requesting information regarding 
the potential impact of the proposals on the economy on an annual 
basis. Commenters should provide empirical data to support their views.

IX. Efficiency, Competition, and Capital Formation

    Section 202(c) of the Advisers Act requires the Commission, when 
engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital 
formation.\297\ Today the Commission is proposing amendments to Part 2 
of Form ADV and related Advisers Act rules that would require 
investment advisers registered with us to deliver to clients and 
prospective clients, brochures and brochure supplements written in 
plain English.
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    \297\ 15 U.S.C. 80b-2(c).
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    The brochure rule and form amendments that we are proposing today 
would promote efficiency and competition in the marketplace by 
improving the disclosure that advisers must provide to clients.\298\ 
These amendments are designed to require advisers to provide clients 
and prospective clients with clear, current, and more meaningful 
disclosure of the business practices, conflicts of interest, and 
background of investment advisers and their advisory personnel. 
Advisers would file their brochures with us electronically, and we 
would make them available to the public through our Web site. With the 
public availability of more thorough and current disclosure of 
advisers' services, fees, business practices and conflicts of 
interests, investors will be able to make more informed decisions about 
whether to hire or retain a particular adviser. A more informed 
investing public will create a more efficient marketplace and 
strengthen competition among advisers. Moreover, the electronic filing 
requirements are expected to expedite and simplify the process of 
filing firm brochures and amendments for the advisory firms, thus 
further improving efficiency. We believe, however, that the proposed 
brochure amendments are unrelated to and will have little or no effect 
on capital formation.
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    \298\ Along with the proposed brochure amendments, the 
Commission also is proposing conforming amendments to the General 
Instructions and Glossary of Form ADV to include instructions 
regarding brochure filing requirements and to add glossary terms and 
definitions that are used in Part 2. Additionally, the Commission 
also is proposing conforming amendments to the Advisers Act books 
and records rule. These proposed amendments would require advisers 
to maintain copies of their brochures, supplements, and amendments, 
and are intended to update the books and records rule in light of 
our proposed changes to Part 2. None of these proposed conforming 
amendments are expected to have an independent impact on efficiency, 
competition, or capital formation. To the extent that they 
facilitate the purposes of the proposed brochure amendments, the 
conforming amendments may, however, contribute to the expected 
effects on efficiency, competition and capital formation that would 
stem from the proposed brochure amendments and which are discussed 
below.
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    The Commission requests comment whether the above proposals, if 
adopted, would promote efficiency, competition, and capital formation. 
Commenters are requested to provide empirical data to support their 
views.

X. Statutory Authority

    We are proposing amendments to rule 203-1 under sections 203(c)(1), 
204, and 211(a) of the Investment Advisers Act of

[[Page 13987]]

1940 (15 U.S.C. 80b-3(c)(1), 80b-4, and 80b-11(a)).
    We are proposing amendments to rule 204-1 under sections 203(c)(1) 
and 204 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3(c)(1) 
and 80b-4).
    We are proposing amendments to rule 204-2 under section 204 and 
206(4) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-4 and 80b-
6(4)).
    We are proposing amendments to rule 204-3 under section 204, 
206(4), and 211(a) of the Investment Advisers Act of 1940 (15 U.S.C. 
80b-4, 80b-6(4), and 80b-11(a)).
    We are proposing amendments to rule 279.1, Form ADV, under section 
19(a) of the Securities Act of 1933 (15 U.S.C. 77s(a)), sections 23(a) 
and 28(e)(2) of the Securities Exchange Act of 1934 (15 U.S.C. 78w(a) 
and 78bb(e)(2)), section 319(a) of the Trust Indenture Act of 1939 (15 
U.S.C. 77sss(a)), section 38(a) of the Investment Company Act of 1940 
(15 U.S.C. 78a-37(a)), and sections 203(c)(1), 204, and 211(a) of the 
Investment Advisers Act of 1940 (15 U.S.C. 80b-3(c)(1), 80b-4, and 80b-
11(a)).
    We are proposing to remove and reserve rule 206(4)-4 under section 
206(4) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-6(4)).

List of Subjects in 17 CFR Parts 275 and 279

    Reporting and recordkeeping requirements, Securities.

Text of Rule and Form Amendments

    For the reasons set out in the preamble, Title 17, Chapter II of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

    1. The general authority citation for Part 275 continues to read as 
follows:

    Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.

    2. Section 275.203-1 is amended by revising paragraphs (a) and (b) 
to read as follows:


Sec.  275.203-1  Application for investment adviser registration.

    (a) Electronic Filing of Form ADV. (1) To apply for registration 
with the Commission as an investment adviser, you must complete Form 
ADV (17 CFR 279.1) by following the instructions in the form and you 
must file Part 1A of Form ADV and the firm brochure(s) required by Part 
2A of Form ADV electronically with the Investment Adviser Registration 
Depository (IARD) unless you have received a hardship exemption under 
Sec.  275.203-3.

    Note to paragraph (a)(1): Information on how to file with the 
IARD is available on the Commission's Web site at http://
www.sec.gov/iard.

    (2) After [INSERT DATE SIX MONTHS AFTER EFFECTIVE DATE OF RULES/
FORM] the Commission will not accept any initial application for 
registration as an investment adviser that does not include a brochure 
that satisfies the requirements of Part 2A of Form ADV.
    (b) Special rule for Part 2B. You are not required to file with the 
Commission the brochure supplements required by Part 2B of Form ADV.
* * * * *
    3. Section 275.204-1 is amended by revising the note to paragraph 
(a), and paragraphs (b) and (c) to read as follows:


Sec.  275.204-1  Amendments to application for registration.

* * * * *

    Note to paragraph (a): Information on how to file with the IARD 
is available on our Web site at http://www.sec.gov/iard.

    (b) Electronic filing of amendments. (1) Subject to paragraph 
(b)(2) of this rule, you must file all amendments to Part 1A of your 
Form ADV and all your amended firm brochure(s) required by Part 2A of 
Form ADV electronically with the Investment Adviser Registration 
Depository (IARD), unless you have received a continuing hardship 
exemption under Sec.  275.203-3.
    (2) Transition to electronic filing. You must amend your Form ADV 
by electronically filing with the IARD one or more brochures that 
satisfy the requirements of Part 2A of Form ADV (as amended effective 
[INSERT EFFECTIVE DATE OF RULES/FORM]) as part of the next annual 
updating amendment you are required to file after [INSERT DATE SIX 
MONTHS AFTER EFFECTIVE DATE OF RULES/FORM].

    Note to paragraph (b): Information on how to file with the IARD 
is available on our Web site at http://www.sec.gov/iard.

    (c) Special rule for Part 2B. You are not required to file with the 
Commission amendments to brochure supplements required by Part 2B of 
Form ADV.
* * * * *
    4. Section 275.204-2(a)(14) is revised to read as follows:


Sec.  275.204-2  Books and records to be maintained by investment 
advisers.

    (a) * * *
    (14)(i) A copy of each brochure and brochure supplement, and each 
amendment or revision to the brochure and brochure supplements, 
required by Part 2 of Form ADV (17 CFR 279.1); any summary of material 
changes that is required by Part 2 of Form ADV but is not contained in 
the brochure or brochure supplements; and a record of the dates that 
each brochure and brochure supplement, each amendment or revision 
thereto, and each summary of material changes was given to any client 
or to any prospective client who subsequently becomes a client.
    (ii) Documentation describing the method used to compute managed 
assets for purposes of Item 4.E of Part 2A of Form ADV, if the method 
differs from the method used to compute assets under management in Item 
5.F of Part 1A of Form ADV.
    (iii) A memorandum describing any legal or disciplinary event 
listed in Item 9 of Part 2A or Item 3 of Part 2B of Form ADV 
(Disciplinary Information) and presumed to be material, if the event 
involved the investment adviser or any of its supervised persons and is 
not disclosed in the brochure or brochure supplements described in 
paragraph (a)(14)(i) of this section. The memorandum must explain the 
investment adviser's determination that the presumption of materiality 
is overcome, and must discuss the factors described in Item 9 of Part 
2A or Item 3 of Part 2B of Form ADV.
* * * * *
    5. Section 275.204-3 is revised to read as follows:


Sec.  275.204-3  Delivery of firm brochures and brochure supplements.

    (a) General requirements. If you are registered under the Act as an 
investment adviser, you must deliver a firm brochure and one or more 
supplements to each client or prospective client as required by this 
section. The brochure and supplement(s) must contain all information 
required by Part 2 of Form ADV (17 CFR 279.1).
    (b) Delivery requirements. You (or a supervised person acting on 
your behalf) must deliver to a client or prospective client:
    (1) Your current brochure before or at the time you enter into an 
investment advisory contract with the client and, after that, an 
updated brochure annually within 120 days after the end of your fiscal 
year;
    (2) A current brochure supplement for a supervised person before or 
at the time that supervised person begins to provide advisory services 
to the client. For purposes of this section, a supervised person will 
provide advisory services to a client if that supervised person will:

[[Page 13988]]

    (i) Formulate investment advice for the client and have direct 
client contact; or
    (ii) Make discretionary investment decisions for the client, even 
if the supervised person will have no direct client contact.
    (c) Exceptions to delivery requirements.
    (1) You are not required to deliver a brochure to a client:
    (i) That is an investment company registered under the Investment 
Company Act of 1940 (15 U.S.C. 80a-1 to 80a-64) or a business 
development company as defined in that Act, provided that the advisory 
contract with that client meets the requirements of section 15(c) of 
that Act (15 U.S.C. 80a-15(c)); or
    (ii) Who receives only impersonal investment advice for which you 
charge less than $500 per year.
    (2) You are not required to deliver a brochure supplement to a 
client:
    (i) To whom you are not required to deliver a brochure under 
paragraph (c)(1) of this section;
    (ii) Who receives only impersonal investment advice;
    (iii) Who would be a ``qualified purchaser'' under section 
2(a)(51)(A) of the Investment Company Act of 1940 (15 U.S.C. 80a-
2(a)(51)(A)); or
    (iv) Who would be a ``qualified client'' of your firm under Sec.  
275.205-3(d)(1)(iii).
    (d) Wrap fee program brochures. (1) If you are a sponsor of a wrap 
fee program, then the brochure that paragraph (b)(1) of this section 
requires you to deliver to a client or prospective client of the wrap 
fee program must be a wrap fee brochure containing all information 
required by Part 2A Appendix 1 of Form ADV. Any additional information 
in a wrap fee brochure must be limited to information applicable to 
wrap fee programs that you sponsor.
    (2) You do not have to deliver a wrap fee brochure if another 
sponsor of the wrap fee program delivers, to the client or prospective 
client of the wrap fee program, a wrap fee program brochure containing 
all the information your wrap fee program brochure must contain.

    Note to paragraph (d): A wrap fee brochure does not take the 
place of any brochure supplements that you are required to deliver 
under paragraph (b)(2) of this section.

    (e) Amendments. Section 275.204-1 and instructions to Form ADV 
contain instructions that you must follow to amend your brochure and 
brochure supplements. You must provide a current brochure and current 
brochure supplements to any new clients or prospective clients. If an 
amendment adds disclosure of an event, or materially revises 
information already disclosed about an event, in response to Item 9 of 
Part 2A or Item 3 of Part 2B of Form ADV (Disciplinary Information), 
then you must provide the current brochure or current brochure 
supplements (or the amendment), as applicable, to all existing clients 
to whom you are required to deliver a brochure or brochure supplement 
under this section.
    (f) Multiple brochures. If you provide substantially different 
advisory services to different clients, you may provide them with 
different brochures, so long as each client receives all information 
about the services and fees that are applicable to that client. The 
brochure you deliver to a client may omit any information required by 
Part 2A of Form ADV if the information does not apply to the advisory 
services or fees that you will provide or charge, or that you propose 
to provide or charge, to that client.
    (g) Other disclosure obligations. Delivering a brochure or 
supplement in compliance with this section does not relieve you of any 
other disclosure obligations you have to your advisory clients or 
prospective clients under any federal or state laws or regulations.
    (h) Transition rule. (1) Within 30 days after the date by which you 
are first required by Sec.  275.204-1(b)(2) to electronically file your 
brochure with the Commission, you must deliver to each of your existing 
clients your current brochure and all current brochure supplements as 
required by Part 2 of Form ADV.
    (2) As of the date by which you are first required to 
electronically file your brochure with the Commission, you must begin 
using your current brochure and current brochure supplements as 
required by Part 2 of Form ADV to comply with the requirements of this 
section pertaining to initial delivery to new and prospective clients.
    (i) Definitions. For purposes of this section:
    (1) Impersonal investment advice means investment advisory services 
that do not purport to meet the objectives or needs of specific 
individuals or accounts.
    (2) Current brochure and current brochure supplement mean the most 
recent revision of the brochure or brochure supplement, including all 
amendments to date.
    (3) Sponsor of a wrap fee program means an investment adviser that 
is compensated under a wrap fee program for sponsoring, organizing, or 
administering the program, or for selecting, or providing advice to 
clients regarding the selection of, other investment advisers in the 
program.
    (4) Supervised person means any of your officers, partners or 
directors (or other persons occupying a similar status or performing 
similar functions) or employees, or any other person who provides 
investment advice on your behalf.
    (5) Wrap fee program means an advisory program under which a 
specified fee or fees not based directly upon transactions in a 
client's account is charged for investment advisory services (which may 
include portfolio management or advice concerning the selection of 
other investment advisers) and the execution of client transactions.


Sec.  275.206(4)-4  [Removed and reserved]

    6. Section 275.206(4)-4 is removed and reserved.

PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 
1940

    7. The authority citation for Part 279 continues to read as 
follows:

    Authority: 15 U.S.C. 80b-1, et seq.

    8. Form ADV (referenced in Sec.  279.1) is amended by:
    a. In the instructions to the form, revising the section entitled 
``Form ADV: General Instructions.'' The revised version of Form ADV: 
General Instructions is attached as Appendix A;
    b. In the instructions to the form, revising the section entitled 
``Glossary of Terms.'' The revised version of Form ADV: Glossary of 
Terms is attached as Appendix B; and
    c. Removing Form ADV, Part II, and adding Form ADV, Part 2. Form 
ADV, Part 2 is attached as Appendix C.

    Note: The text of Form ADV does not and the amendments will not 
appear in the Code of Federal Regulations.

* * * * *

    Dated: March 3, 2008.

    By the Commission.
Florence E. Harmon,
Deputy Secretary.
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 [FR Doc. E8-4611 Filed 3-13-08; 8:45 am]

BILLING CODE 8011-01-C
