Rules Comments: S7-10-00

June 14, 2000

Mr. Jonathan G. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re: Request for Comments on Proposed Rules Concerning Electronic Filing by Investment Advisers and Proposed Amendments to Form ADV -- File No. S7-10-00

Dear Mr. Katz:

The Investment Management Practice Group of Dechert Price & Rhoads is pleased to have this opportunity to comment on the Commission's proposed rules concerning electronic filing by investment advisers and proposed amendments to Form ADV, as set forth in Release No. IA-1862 dated April 5, 2000 (the "Release").

Dechert Price & Rhoads is an international law firm with a wide-ranging investment management practice that serves clients in the United States and worldwide. Among these clients are many investment advisers registered with the Commission under the Investment Advisers Act of 1940 (the "Advisers Act"). In developing these comments, we have drawn on our own experience with investment adviser matters, and have been mindful of the interests of advisory clients. In response to the Commission's request for comments, we have discussed the Commission's proposals extensively with our clients. Although the comments that follow have been very usefully informed by the perspectives shared in this process, they reflect our own views and not necessarily those of any client of the firm.

In general, we applaud the Commission's efforts, through its proposed rulemaking, to establish an electronic filing system for investment advisers and to improve the quality of information that advisers provide to clients and prospective clients. We strongly share the Commission's view that the proposed revisions to Form ADV to require investment advisers to provide a narrative brochure written in plain English represent a better approach to client disclosure. We are concerned, however, that certain of the proposals would impose significant new compliance burdens on investment advisers, while not substantially improving the quality of information available to investors. Our specific comments on the proposed rules are discussed below.

I. Delivery

A. In General

The proposed delivery requirements would be similar to current requirements (i.e., an adviser would deliver its brochure at the start of the advisory relationship and offer to deliver the brochure annually), with one important difference. Advisers would be required to provide clients with written brochure updates whenever information in the brochure becomes materially incorrect, and include these updates with brochures delivered to prospective clients.¹

We agree that it is incumbent upon an adviser, as a fiduciary, to keep its clients apprised of material changes to certain key information affecting its relationship with its clients, such as changes in fees, changes in key advisory personnel, conflicts of interest, disciplinary actions involving the adviser, and developments affecting the financial viability of the adviser. We also agree that an adviser should make available to existing clients, and deliver to prospective clients, an updated brochure reflecting all material changes to the information contained therein. We do not believe, however, that every piece of information required in the brochure is of such significance to the investor that delivery of a notification of change to all existing clients of the adviser is warranted. In our experience, advisers frequently make minor, albeit material, changes to information contained in the brochure that likely is of little interest to clients. The adoption of the proposed amendment to Rule 204-3 under the Advisers Act would, in our view, impose substantial burdens on advisers, and would not enhance the quality of information available to investors.

Rather than imposing a broad requirement to notify clients of material changes with respect to all information required in the brochure, we suggest that the Commission identify certain information deemed critical to the advisory relationship, for which a material change would require notification to clients. Examples of such critical information include the areas cited above. Such a targeted approach would, in our view, assure that investors receive meaningful information about their adviser, while minimizing advisers' compliance burdens.

B. Delivery to Limited Partners

Another aspect of the proposal relating to delivery would require an adviser acting as the general partner of a limited partnership, the manager of a limited liability company, or the trustee of a trust to provide a brochure to each investor in such investment vehicle.² In the Release, the Commission notes that some advisers treat the limited partnership, rather than the limited partners, as their client, and therefore do not deliver the brochure to the limited partners. The Commission states that the proposal is necessary to serve the remedial purposes of Rule 204-3.

As an initial matter, we take issue with the Commission's suggestion that its proposal "clarifies" that advisers have an existing obligation to deliver brochures to limited partners.³ The Commission states that the position taken by many advisers that limited partnerships, rather than limited partners, be treated as clients for purposes of Rule 204-3 is based on Rule 203(b)(3)-1(a)(2), which the Commission notes is "limited by its terms to counting clients for determining eligibility for the `small adviser exception.'"⁴ In fact, the issue of whether limited partners should be treated as clients for purposes of the rules under the Advisers Act is a long-standing one, for which the Commission and the staff have not provided clear guidance. Prior to the adoption of the safe harbor provided by Rule 203(b)(3)-1, the term "client" was not defined in either the Advisers Act or the rules thereunder. Moreover, the staff has declined to treat limited partners as clients for certain purposes under the Advisers Act. In Valuemark Capital Mgmt., Inc., the staff took the position that if a limited partnership satisfies the requirements of Rule 203(b)(3)-1, then the adviser may treat the limited partnership as the client under all provisions of Rule 205-3 (addressing the use of performance fee arrangements).⁵

In light of this background, and the fact that neither the Commission nor the staff has published guidance stating that limited partners should be treated as clients for purposes of Rule 204-3, we believe that the Commission should characterize its proposal as a new requirement, rather than a clarification of an existing one.

We also disagree with the Commission's conclusion that limited partners should be deemed to be clients of investment advisers for purposes of Rule 204-3. To the extent that a limited partnership is managed based on its investment objectives, rather than the individual investment objectives of its limited partners, the relationship between the adviser and the limited partners is akin to the relationship between the adviser to a mutual fund and the fund's shareholders. The Commission does not take the position that fund shareholders should receive the fund adviser's brochure, presumably because shareholders receive all material information about their investment in the fund's prospectus. While the Commission has not mandated the types of information that must be set forth in the offering documents provided to investors in unregistered vehicles, such vehicles typically provide an offering document that contains information about the vehicle's adviser that is at least as extensive as the adviser information contained in a mutual fund prospectus.

Moreover, limited partners are protected from fraud without regard to their status as advisory clients. Rule 10b-5 under the Securities Exchange Act of 1934, as amended, effectively requires that all material relevant information about an adviser be provided to private fund investors. And, as the Commission notes in the Release, the antifraud provisions of the Advisers Act have been deemed to apply to limited partners.⁶ Thus, the treatment of limited partners as "clients" to whom brochures must be delivered is, in our view, unnecessary because other provisions of the federal securities laws assure that limited partners receive material information about limited partnership investments.

Finally, we believe that the proposed amendment to Rule 204-3 is overbroad, and could lead in certain cases to the imposition of significant burdens on advisers. To the extent that the Commission determines to adopt the proposal, we suggest the following modifications:

A clause indicating that Rule 204-3(d) is applicable only to private funds not registered under the Investment Company Act of 1940 should be included to avoid having the delivery requirements apply to entities that are not securities investment funds. For example, the provision could be amended to read as follows:

If as an adviser, you are the general partner of a limited partnership, the manager of a limited liability company, or the trustee of a trust, which limited partnership, limited liability company or trust would be an "investment company" but for Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940, then for purposes of this section . . . .
The requirements of 204-3(d) should exempt non-U.S. investment vehicles ("offshore funds"). Many offshore funds are similar to U.S. registered investment companies, in that they are regulated by a foreign regulatory authority, are offered to the public, and have a large number of shareholders. Thus, a requirement to deliver the brochure to all investors would be both expensive and burdensome. It would seem that in the case of offshore funds, delivery of a copy of the brochure to the fund itself should be sufficient, particularly if interests in the funds are not sold to U.S. persons.
As noted above, most limited partnerships provide prospective investors with an offering document that includes much of the same information required to be included in the brochure. The proposal should be amended to clarify that the brochure need not be a separate document in addition to the offering document, so long as the offering document provides all the information required in a brochure.
The proposed rule should clarify, with respect to brochures incorporated into or delivered along with offering documents for limited partnerships, that any person authorized to deliver those offering documents, such as placement agents, should be allowed to effect satisfactory delivery under Rule 204-3. As proposed, the rule appears to allow only investment advisers or supervised persons to effect delivery. Such stringent delivery requirements are unnecessary to effect the goal of distributing information to investors.
As drafted, Rule 204-3(d) simply states that limited partners should be treated as clients. We believe that the Commission should amend the rule expressly to state that the treatment of limited partners as clients is limited solely to brochure delivery.

II. Disclosure

A. Part 2A -- The Firm Brochure

The disclosure required by proposed Part 2A generally is similar to that currently required by Part II of Form ADV. One noteworthy difference, however, is the proposal's enhanced focus on potential conflicts of interest. In several areas that may give rise to potential conflicts of interest with clients, the proposal would require disclosure of the adviser's practice, a discussion of the conflict raised by the practice, and a description of the adviser's control procedures for addressing the conflict. These areas include:

the receipt of transaction-based compensation;
participation or interest in client transactions;
personal trading; and
brokerage practices, including the use of soft dollars, and the allocation of brokerage in exchange for client referrals.

We agree that advisers should disclose information regarding potential conflicts of interest in the firm brochure. We are concerned, however, that the inclusion of policies and procedures adopted by advisers to address such conflicts could add substantially to the length and bulk of the firm brochure, and render it a less readable, user-friendly document. In our experience, advisers frequently adopt detailed and lengthy procedures designed to address potential conflicts of interest. Moreover, most clients are unlikely, in our view, to review such policies and procedures.

We suggest that advisers be required to state in the firm brochure that they have adopted policies designed to address a particular conflict of interest, and offer to provide the policies to clients upon request. This approach would serve the interests of clients who may be interested in the details of such policies, while limiting the information contained in the firm brochure to that which is likely to be of interest and utility to most clients.

B. Part 2B -- The Brochure Supplement

Under the proposal, firm brochures would be accompanied by a brochure supplement that provides information about the adviser's advisory personnel. Advisers would provide each client with a supplement describing the educational, business and disciplinary background of the "supervised person(s)" who will provide advisory services to that client. The requirements for updating a brochure supplement and delivering the corrected information to clients would be essentially the same as for the firm brochure.

The contents of brochure supplement would include:

a description of the supervised person's formal education and business background for the past five years, including an identification of the supervised person's professional designations or attainments;
disclosure regarding the disciplinary history of the supervised person, including any proceeding revoking or suspending a professional attainment, designation, or license of the supervised person;
a description of any other business activities of the supervised person, including, if applicable, a description of any related conflict of interest and any procedures the adviser uses to address the conflict;
disclosure as to whether the supervised person receives transaction-based compensation, including bonuses and non-cash compensation;⁷
a discussion of who formulates the advice given to clients and, if the supervised person formulates the advice, an explanation of how the firm monitors the advice provided;
the name, title and telephone number of the person responsible for supervising the advisory activities of the supervised person; and
disclosure as to whether the supervised person was the subject of a bankruptcy petition during the past ten years.

Form ADV currently requires brochures to include background information only on firm executives and members of a firm's investment committee. We recognize that background information regarding all advisory personnel likely would be of interest to certain clients. We believe, however, that the utility of this information is outweighed by the costs that would be imposed under the proposal. In large organizations and multinational organizations with staff in several different jurisdictions, the burdens of compiling and keeping current the information required in the brochure supplement are likely to be significant.

We suggest that the brochure supplement be limited to information about disciplinary actions. Such information arguably is of the greatest significance to clients, and is likely to be both readily available to a supervised person's employer, and relatively static from year to year. Modifying the brochure supplement in this manner would, in our view, serve to provide clients with critical information about their advisory personnel, while limiting the compliance costs to advisers.

* * * * * *

We appreciate the opportunity to comment on the Commission's proposed rules. If we can be of any further assistance in this regard, please contact John V. O'Hanlon at (617) 728-7111, David A. Vaughan at (202) 261-3355, or another member of the firm's Investment Management Practice Group.

Sincerely yours,

DECHERT PRICE & RHOADS

cc: Honorable Arthur Levitt, Chairman
Honorable Norman S. Johnson
Honorable Isaac C. Hunt, Jr.
Honorable Paul R. Carey
Honorable Laura S. Unger

Footnotes

¹	This requirement could be satisfied by delivering a reprinted brochure or, in most circumstances, a "sticker," a notice identifying the stale information and providing the current information. Advisers that deliver their brochure to clients electronically could also deliver stickers electronically.
²	For ease of reference, we refer to "limited partner" and "limited partnership" as representative of the entities set forth in the proposed rule.
³	See Release at n.117 and accompanying text.
⁴	Id. We note that the definition of "client" in Rule 203(b)(3)-1(a)(2) also applies to the national de minimis standard in Rule 222-2.
⁵	Valuemark Capital Mgmt., Inc., SEC No-Action Letter, 1997 WL 310069 (June 4, 1997). See, also, Release No. IA-1633 at n.139 and accompanying text (the Commission declined to address whether or not a relationship involving multiple persons should be treated as a single client in a rulemaking given the "inherently factual nature of such determinations"); Selzer v. Bank of Bermuda Ltd., 385 F. Supp. 415, 420 (S.D.N.Y. 1974) (finding the Advisers Act inapplicable because the "trustee does not advise the trust corpus, which then takes action pursuant to his advice, rather the trustee acts himself as principal"). But see Joseph J. Nameth, SEC No-Action Letter, 1983 WL 30256 (Jan. 31, 1983) (staff states that it does not agree with the holding of the court in Selzer).
⁶	See Abrahamson v. Fleschner, 568 F.2d 862 (22 Cir. 1976) cert. denied 436 U.S. 913 (1978).
⁷	The supplement would also have to 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.