Welcome to the March 1, 2024 edition of On The Docket, which includes the following content:
- Annual ADV Amendment Webinar Recording
- Proxy Voting Authority
- Switching Between State & SEC Registration
- Multiple Brochures; One Form CRS
- Separately Managed Accounts ≠ Separately Managed Accounts
- The Importance of Advisory Agreement Assignment Clauses in RIA M&A
- “High Net Worth Individuals” Definitional Hell
- FinCEN Proposal to Impose AML Rules on RIAs
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Happy reading.
– Chris
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Annual ADV Amendment Webinar Recording
In December, I presented a CE webinar on behalf of XYPN entitled “Gearing Up For Your Annual ADV Amendment”.
If you’re an XYPN member and want to watch a recording of the webinar, click this link (though you may want to log in to your Academy portal first).
During the webinar, I covered:
- The filing, delivery, and timing logistics of ‘other-than-annual’ v. annual ADV amendments.
- Recommended steps and tactics specific to various sections of Form ADV.
Proxy Voting Authority
We generally counsel our adviser clients not to assume voting authority with respect to client securities (i.e., proxy voting).
Why?
- Nothing in the Advisers Act or its rules requires advisers to vote client proxies; it is completely optional.
- Exercising proxy voting authority on behalf of a client is a fiduciary act that must be undertaken with a duty of care and loyalty. Why voluntarily add yet another responsibility that will be scrutinized by the SEC through the fiduciary duty lens?
- Advisers that assume client proxy voting authority are required to create and maintain additional policies/procedures, make additional disclosures in Form ADV, and retain additional records under the SEC’s recordkeeping rule. Why self-impose more documentation and disclosure obligations?
- Exercising voting authority can impose a significant expenditure of time/resources to do it right. Third-party proxy voting services can help offload this burden, but this adds additional expense.
- If an adviser screws up its proxy voting responsibility bad enough, it may be deemed by the SEC to be a “fraudulent, deceptive, or manipulative act, practice or course of business” within the anti-fraud provisions of the Advisers Act.
There are certainly valid reasons to assume client proxy voting authority (to meet client expectations, e.g.), but advisers on the fence should carefully consider whether they want to assume the added burden.
For advisers that do not intend to assume client proxy voting responsibility, periodically review clients’ custodial account-opening forms to confirm that such responsibility has not been unintentionally delegated to you.
Switching Between State & SEC Registration
Given most advisers are in the throes of preparing their annual ADV amendments and some may be facing state-to-SEC or SEC-to-state registration conversions, I’m resharing my article from last year about the options, requirements, and logistics of such conversions.
Multiple Brochures; One Form CRS
A single adviser can have multiple Form ADV Part 2A brochures, but only one Form CRS relationship summary.
Abbreviated FAQs below:
Q: We offer several advisory services. May we prepare multiple firm brochures?
A: Yes.
Q: My firm offers three types of services to our retail investors. Can my firm prepare and deliver three different relationship summaries, one for each type of service that it offers?
A: No.
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For example, an adviser that acts as a subadviser to other independent advisers and separately provides direct-to-investor financial planning services can utilize two separate brochures – one for each respective service offering.
However, this same adviser must utilize a single, consolidated relationship summary that accounts for both its subadvisory business and its financial planning business.
Separately Managed Accounts ≠ Separately Managed Accounts
What constitutes a ‘separately managed account’ in the industry’s lexicon is very different from what the SEC and Form ADV instructions consider to be a separately managed account.
Historically, it’s fair to say that a separately managed account was understood by the industry to mean just that – an investor’s account that was not managed directly by the advisory firm itself but was managed instead by a third-party advisory firm that managed the investor’s account pursuant to a specific investment directive that was distinct from the advisory firm’s other accounts. When the SEC adopted various revisions to Form ADV Part 1 in late 2016, however, it took the opportunity to turn this understanding on its head:
“For purposes of reporting on Form ADV, we consider advisory accounts other than those that are pooled investment vehicles (i.e., registered investment companies, business development companies and pooled investment vehicles that are not registered (including, but not limited to, private funds)) to be separately managed accounts.”
In other words, unless an advisory firm is an adviser or manager to an investment company (a mutual fund or [typically] an exchange traded fund), a Business Development Company (BDC), or an unregistered pooled investment vehicle (e.g., a hedge fund), the accounts advised or managed by the advisory firm are considered to be separately managed accounts.
A separately managed account has nothing to do with whether the account is managed by a third-party, but instead has everything to do with whether the account is pooled with or unpooled from (i.e., separate from) other accounts.
The Importance of Advisory Agreement Assignment Clauses in RIA M&A
In the context of an M&A transaction involving an investment adviser, one of the most impactful contractual nuances is the ‘assignment clause’ in the seller’s client advisory agreements.
This particular clause should be carefully scrutinized early in due diligence, as it will impact how the ultimate consummation of the transaction will unfold.
Here’s why:
- The sale of an adviser’s business generally triggers a ‘change of control’ of such business.
- A change of control triggers the ‘assignment’ of the seller’s client advisory agreements.
- The seller’s clients are legally required to ‘consent’ to an assignment of their advisory agreements to the buyer.
- Depending on the assignment clause of the seller’s client advisory agreements (and whether the seller is state or SEC registered), clients may be required to ‘affirmatively’ consent to such assignment or may be permitted to ‘passively’ consent to such assignment.
- Affirmative consent requires that the client sign a consent form (or a new client advisory agreement with the buyer). Passive consent permits the seller to simply send a notice of the assignment reasonably in advance of its effectiveness (if the client doesn’t object to such assignment, consent is inferred).
In the whirlwind of consummating a transaction, it is far easier for the seller to send a blanket notice to which clients need not respond rather than to track down tens, hundreds, or potentially thousands of signed client consent forms or advisory agreements in a short period of time.
If the seller’s client advisory agreements are woefully outdated or otherwise problematic, however, this could be reason enough for the buyer to desire newly-signed client advisory agreements during the closing period – even if the seller’s existing client advisory agreements contain a passive consent assignment clause.
One way or the other, future sellers would be wise to assess the assignment clause in their existing client advisory agreements well in advance of a potential sale and, if viable, consider adopting a passive consent assignment clause.
“High Net Worth Individuals” Definitional Hell
Form ADV Part 1 requires advisers to report the number of clients and AUM attributable to clients that are “high net worth individuals.”
Determining who qualifies as a HNW individual requires a traverse across multiple cross-referential definitions, two federal securities acts, and standalone SEC inflationary adjustment orders. It’s absurd:
🧐 First, one must review the definition of “high net worth individual” in the Form ADV Glossary. This is not helpful, as it redirects the reader to the Form ADV Glossary definition of “qualified client” and the definition of “qualified purchaser” in section 2(a)(51)(A) of the Investment Company Act of 1940.
🤨 Next, one must review the Form ADV Glossary definition of “qualified client.” This is also not helpful, as it again redirects the reader to the definition of “qualified client” in SEC Rule 205-3.
😑 Next, one must review the definition of “qualified client” in SEC Rule 205-3. This definition alone is 390 words and also cross-references various sections of the Investment Company Act of 1940. It also references dollar thresholds that are not specified in the rule itself, but instead are only specified in separate SEC orders that are periodically subject to inflationary adjustments.
😡 Next, one must find what the most recent SEC inflationary adjustment is with respect to the dollar thresholds referenced in the definition of “qualified client.”
🤬 Finally, one must review the definition of “qualified purchaser” in section 2(a)(51)(A) of the Investment Company Act of 1940. This definition alone is 430 words and cross references multiple other sections of the Investment Company Act of 1940.
If your head hasn’t imploded from the sheer weight of the regulatory madness, you can now answer the seemingly simple question of which clients are HNW individuals.
Bear in mind, all of this is to complete just two boxes in the Form ADV Part 1.
FinCEN Proposal to Impose AML Rules on RIAs
Here we go again: the Financial Crimes Enforcement Network (“FinCEN”) once again proposes to subject investment advisers to a variety of anti-money laundering requirements:
Brief initial takeaways:
- This is currently only a proposal, and it isn’t the first time FinCEN has tried to sweep advisers within scope of AML regulations (its last failed attempt dates back to 2015).
- As proposed, such requirements would only apply to SEC-registered advisers and exempt reporting advisers, but not state-registered advisers.
- FinCEN would delegate exam authority to the SEC.
- The comment period is open until April 15, 2024. If adopted, advisers would be required to comply within 12 months from the final rule’s effective date.
- The proposal does not include a customer identification program requirement for advisers, but FinCEN has signaled such additional requirements would be later proposed jointly with the SEC.