New Form ADV Rules for Registered Investment Advisers

On July 28, 2010, the Securities and Exchange Commission (“SEC”) amended Part 2 of Form ADV and certain rules under the Investment Advisers Act of 1940 to require registered investment advisers (“RIAs”) to provide clients with a brochure and brochure supplements written in plain English. See Final Release http://www.sec.gov/rules/final/2010/ia-3060.pdf.


Starting in in the summer of 2011, RIA’s clients will receive new and more extensive disclosure. According to the SEC, currently in the United States there are more than 11,000 RIAs that manage more than $38 trillion for more than 14 million clients. 81% of RIAs have 10 or fewer advisors. Over 65% have five or fewer advisors. The new rules are warranted. RIAs owe fiduciary duties to their clients and clients have to receive sufficient information about the RIAs (their affiliates, compensation, disciplinary actions, etc.) to be able to make informed decisions when choosing an adviser.

Form ADV has two parts. Part 1(A and B) is used to register RIAs with state and federal authorities. Part 2A contains the requirements for the disclosure “brochure” that advisers must provide to prospective clients initially and to existing clients annually, and Part 2B contains information about the advisory personnel providing clients with investment advice.

Part 2A contains 18 disclosure items about the advisory firm itself. It is now required to be provided in narrative form in a specified format rather than “check the box” format. There need to be headings and narrative answers with respect to each of the 18 items. Much of the disclosure required in Part 2A addresses RIA’s conflicts of interest with its clients. Importantly, new Item 8 requires that advisers describe their investment strategies and how strategies involving frequent trading can affect portfolio performance, as well as the material risks involved with each significant investment strategy. There are concerns that such disclosure requirement may cause some RIAs to lose their competitive advantage.

Part 2B contains six items and focuses on disclosure regarding supervisory personnel of the RIAs, including their educational and professional background, disciplinary actions, and other substantial business activities. The disclosure is made more meaningful given that the clients will receive information about specifically those supervisors who formulate their investment advice, have direct client contact with them or make discretionary investment decisions for such client’s assets. Unlike Part 2A, Part 2B will not be made publicly available.

Complying with the new rules will not be easy or cheap. The SEC estimates that, on average, a small RIA will spend about 15 hours putting together the initial revised Form ADV, a medium-sized adviser – 97.5 hours, and a large adviser - 1,989 hours. Given that there are more small advisers than large ones, this would average to 36.24 hours per adviser. A small adviser will also have to spend about $3,200 for legal services on Part 2, medium-sized adviser - $4,400 and large adviser - $10,400. It remains to be seen whether these estimates accurately reflect the reality.

On December 28, 2010, the SEC extended the compliance dates for delivering brochure supplements. In particular, all existing RIAs that are registered with the SEC as of year-end 2010 have until July 31, 2011 to begin delivering brochure supplements to new and prospective clients and until September 30, 2011 to deliver brochure supplements to existing clients. New RIAs (that file applications for registration in January-April 2011) have until May 1, 2011 to begin delivering brochure supplements to new and prospective clients and until July 1, 2011 to deliver brochure supplements to existing clients.

As with any new rule, this one strives to preserve a balance between the necessity for additional and more accurate disclosure while not placing undue financial burden on the RIAs. After all, the burden of complying with the new ADV rules will be mostly felt during the first year of compliance, when the brochure and its supplement have to be written from scratch. The following years, advisers will be able to update and supplement the information without having to re-write it (that is, of course, if the disclosure requirements do not change again).

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Personal Liability of New York Shareholders

In this blog post I would like to highlight one important but not widely known fact about New York privately held corporations: top ten shareholders of such corporation may be held personally liable for any unpaid compensation to the corporation’s employees.


This law may come as a surprise to those who incorporated their business in order to limit their personal liability. Well, incorporation does not offer absolute protection to the business owners. There are exceptions, and one of them is that ten largest shareholders may be personally liable for unpaid compensation.

This law is found in Section 630(a) of the New York Business Corporation Law. Several things to note here:

• The law applies only to privately held corporations (not to LLCs or investment companies).
• It covers not just wages, but other types of monetary compensation as well, including overtime, vacation, severance pay, contributions to insurance or welfare benefits, pension or annuity funds.
• It excludes contractors.
• The shareholders are liable jointly and severally. This means that the employees can choose to go after one wealthiest shareholder for the whole amount instead of all ten. The law allows that shareholder to seek pro rata contributions from the other largest shareholders.
• The employee needs to first try to recover the unpaid amounts from the corporation. Only if the judgment remains unsatisfied, can the shareholder pursue the claim against the shareholders.
• The law establishes a procedure that employees have to follow. It consists of a written notice to be given within a specified period of time to the target shareholders that the employee intends to hold such shareholders personally liable under section 630(a).

One additional note: the law extends only to New York corporations and does not include corporations formed in other states that do business in New York. This question was tested as recently as October 2010 in New York courts. See Stuto v Kerber, 2010 NY Slip Op. 7646 (NY Appellate Div, 3rd Dept. 2010). So, all a business owner needs to do to escape from the reach of this law is to incorporate elsewhere and then register in New York as a foreign corporation. For example, Delaware does not have a similar provision.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

SEC inquires into secondary trading activities by large private companies

Last week the New York Times published an article (http://dealbook.nytimes.com/2010/12/27/stock-trading-in-private-companies-draws-scrutiny/?hp) regarding the SEC investigation of trading in shares of some of the largest domestic private companies, such as Facebook and Twitter. Since these are privately held companies, any secondary trading in their shares is restricted. Such shares can only be resold in private placements compliant with the SEC rules, which, according to Rule 506 of Regulation D, means that such shares can only be sold:


• to accredited investors;
• without general solicitation or advertising;
• to a maximum of 35 nonaccredited investors (in which case specified disclosure has to be made); and
• with resale restrictions.

Such rules place limitations on the secondary trading in private companies’ stock, and for good reason. There is little publicly available financial information about the privately held companies, so investment in such companies presents greater risks. Of course, if one thinks of Facebook with its millions of subscribers and astronomical advertising revenues, the risks seem to be minor. After all, if this company is not stable financially, then which one is?

Another question then comes to mind: why is Facebook not public? A company becomes a public company when it sells its stock to the general public, usually through a national exchange (such as NYSE or Nasdaq). Then the company becomes subject to reporting obligations under the Securities and Exchange Act of 1934, which means that the company has to file its annual, quarterly and current reports with the SEC, revealing its financial information and information about its business operations. The same disclosure obligations apply once a private company has 500 or more equity holders.

Periodic reporting has become an expansive undertaking for many companies that are struggling with high legal and accounting costs associated with being “public”: preparation of reports, attestation requirements, internal controls over financial reporting, etc. The main advantage of being a public company is the ability to quickly raise large amounts of capital (there is no need to write extensive disclosures since such information is already available to the market through periodic reporting and offerings can be made to all investors, not just the accredited ones). On the other hand, as the economy is still in the “recovery” stage, raising capital from the public may not be as advantageous (public companies may have lower stock price than if they were private companies issuing shares through private placements).

For example, Facebook does not seem to have difficulty raising capital while being a private company. It has just announced raising $500 million from Goldman Sachs and an unnamed Russian investor. Even though Goldman Sachs would count as one investor for the purposes of a “500 shareholders threshold”, it is likely that there may be hundreds of smaller investors behind Goldman Sachs. However, the rule does not provide for “look through” to the beneficial shareholder level.

It is suspected that the SEC is focusing on the fact that there may already be 500 or more equity holders in any of these private companies but the real question, at least to me, is when these companies are going to become “public”.