pursuant to the Instructions for Part 2, as well as the Web site
address for obtaining information about the adviser through IAPD. We
also are adopting an amendment to our recordkeeping rule that will
require the adviser choosing this approach to preserve a copy of the
summary of material changes, so that our examination staff has
access to such separately provided summaries. See rule 204-
2(a)(14)(i). See Section IV below.
    If an adviser includes the summary of material changes in its
brochure, and amends its brochure on an interim basis between annual
updating amendments, the adviser should consider whether it should
update its summary of material changes to avoid confusing or
misleading clients reading the updated brochure.
    \195\ See Rule 204-3(b) and Instruction 2 for Part 2A of Form
ADV. 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 120-day period is
designed to provide sufficient flexibility to allow advisers to
include the updated brochure or summary in a routine quarterly
mailing to clients. We expect that permitting an adviser to send
this document together with these routine mailings could
substantially reduce delivery costs. See Section VII below.
    \196\ 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)] (``Electronic Media Release'').
    \197\ See Instruction 6 for Part 2A of Form ADV. The adviser
must upload its brochure and the summary (as an exhibit) together in
a single, text-searchable file in Adobe Portable Document Format
(PDF) on IARD. See Instruction 6 for Part 2A of Form ADV.
---------------------------------------------------------------------------

    We proposed that each adviser annually deliver an updated brochure
to its clients because we were concerned that clients may be relying on
``stale'' brochures. Many commenters representing advisers objected,
arguing that this requirement would cause advisers to incur significant
costs,\198\ and that clients are not interested in receiving an annual
brochure.\199\ We believe our revised approach--permitting advisers to
deliver annually the summary of material changes, which was suggested
by several commenters \200\--addresses our concern that clients may
today be relying on ``stale'' brochures, while alleviating commenters'
concerns regarding the costs and burdens of annual delivery of the
brochure.\201\
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    \198\ See AICPA Letter; Eddy Letter; FPA Letter; IAA Letter; ICI
Letter; Mercer Letter; Merrill Lynch Letter; Morgan Stanley Letter;
MMI Letter; NAPFA Letter; NRS Letter; Pickard Letter; ProEquities
Letter; Roundtable Letter; Schwab Letter; SIFMA Letter; Sutherland
Letter; USAA Letter; comment letter of Wachovia Securities LLC (May
16, 2008) (``Wachovia Letter''); Wellington Letter, comment letter
of Wall Street Financial Group (May 16, 2008) (``WSFG Letter'').
    \199\ See, e.g., ASG Letter; comment letter of Clifford Swan
Investment Counsel (May 5, 2008) (``Clifford Letter''); First Allied
Letter; FPA Letter; FSI Letter; comment letter of Moody Aldrich
Partners (May 15, 2008) (``Moody Aldrich Letter''); NRS Letter;
Roundtable Letter; WSFG Letter.
    \200\ See ASG Letter; Clifford Letter; Federated Letter; First
Allied Letter; FPA Letter; FSI Letter; comment letter of the
Investment Adviser Association (Aug. 26, 2008); Merrill Lynch
Letter; Moody Aldrich Letter; NRS Letter; Roundtable Letter; Schnase
Letter; WSFG Letter.
    \201\ One commenter representing consumers agreed that such an
approach could minimize the costs of delivery without significantly
sacrificing investor protection. See Consumer Federation Letter.
---------------------------------------------------------------------------

    Some commenters urged that we revise our electronic delivery
guidance \202\ so that disclosure placed on the adviser's web page or
on IARD would be deemed to be delivered to its clients, regardless of
whether the clients have provided consent to electronic delivery.\203\
We note that an adviser's fiduciary duties may require it to obtain
client consent to many of the disclosures required by Part 2 and that
electronic access, without evidence that the adviser's delivery
obligation has been met (such as by obtaining the client's consent to
electronic delivery along with appropriate notice and access) would
not, in our judgment, serve to adequately protect client
interests.\204\
---------------------------------------------------------------------------

    \202\ See Electronic Media Release, see supra note 196.
    \203\ See, e.g., ABA Committees Letter; IAA Letter; Mercer
Letter; Roundtable Letter; Sutherland Letter; Wachovia Letter.
    \204\ See Electronic Media Release, supra note 196 at Section
II.A.3.
---------------------------------------------------------------------------

    Some commenters recommended that advisers be required to send
clients a notice providing a Web site link to where the brochure is
posted on the Internet, rather than having to deliver the actual
brochure to clients initially.\205\ Another commenter objected, arguing
that many investors are not yet willing to use the Internet to receive
disclosure documents and that an approach that would rely on electronic
delivery would be premature for retail investors.\206\ We are not
making such changes at this time, but will continue to consider
different approaches to delivering financial information to investors.
---------------------------------------------------------------------------

    \205\ See, e.g., ASG Letter; Borek Letter; FSI Letter; ICI
Letter; Lininger Letter; Merrill Lynch Letter; MMI Letter; Morgan
Stanley Letter; NAPFA Letter; Pickard Letter; SIFMA Letter;
Wellington Letter.
    \206\ See Consumer Federation Letter.
---------------------------------------------------------------------------

    Interim Delivery. As proposed, rule 204-3 requires advisers to
deliver an updated brochure (or a document describing the material
facts relating to the amended disciplinary event) promptly whenever the
adviser amends its brochure to add a disciplinary event or to change
material information already disclosed in response to Item 9 of Part
2A.\207\ One commenter opposed the interim updating requirement,
expressing concern that it would result in ``frequent interim
disclosure of information of minimal relevance to clients.'' \208\ We
disagree. We believe that disclosure of disciplinary information is
highly relevant to clients because it reflects on the integrity of the
investment adviser, may affect a client's trust and confidence in the
adviser, and may be of even greater interest if the adviser is adding
disciplinary information frequently. Therefore, we are adopting this
requirement as proposed.
---------------------------------------------------------------------------

    \207\ See rule 204-3(b)(4).
    \208\ See FSI Letter.
---------------------------------------------------------------------------

b. Updating Part 2A of Form ADV
    Similar to the existing requirements, the amended rules 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 (except the summary of material changes and the amount
of assets under management, which only has to be updated annually)
becomes materially inaccurate.\209\ In the case of both annual and
interim updates, advisers will make changes to their brochures using
their own computer systems and then simply file the revised versions of
their brochures through IARD.\210\
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    \209\ If an adviser is amending its brochure for a separate
reason between annual amendments, and the amount of assets under
management is materially inaccurate, the adviser should amend this
disclosure. See Instruction 4 for Part 2A of Form ADV.
    \210\ See rule 204-1(b).
---------------------------------------------------------------------------

    In some cases, an adviser filing its annual updating amendment may
not have any material changes to make to its brochure. If the adviser
has not filed any interim amendments to its brochure since the last
annual amendment and the brochure continues to be accurate in all
material respects, the adviser would not have to prepare or deliver a
summary of material changes to clients. The adviser also would not have
to prepare and file an updated firm brochure as part of its annual
updating amendment. If there was an interim amendment or the brochure
contained a material inaccuracy, however, the adviser would have to
file a summary of material changes describing any interim amendment(s)
along with an updated firm brochure as part of its annual

amendment filing. Although previously filed versions of an adviser's
brochures will remain in the IARD system, only the most recent version
of an adviser's brochure will be available to the public through the
Commission's Web site.\211\ The purpose of the public disclosure Web
site is to provide the public with current information about advisers,
rather than historic information.\212\
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    \211\ 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 will be available via the public disclosure Web site.
    \212\ Instructions for obtaining historic brochure filings may
be found at http://www.sec.gov/answers/publicdocs.htm.
---------------------------------------------------------------------------

B. Part 2B: The Brochure Supplement

    Rule 204-3 also requires that each firm brochure be accompanied by
brochure supplements providing information about the advisory personnel
on whom the particular client receiving the brochure relies for
investment advice.\213\ Among other things, the brochure supplements
will contain information about the educational background, business
experience, and disciplinary history (if any) of the supervised persons
who provide advisory services to the client. The brochure supplement
thus includes information that would not necessarily be included in the
firm brochure about supervised persons of the adviser who actually
provide the investment advice and interact with the client.
---------------------------------------------------------------------------

    \213\ See rule 204-3(b)(3). We believe that brochure supplements
will be important to advisory clients in selecting an adviser
because clients place great weight on the supervised person's
qualifications and events that may reflect on the integrity of
advisory personnel. See Proposing Release, supra note 8, at Section
II.B.1.
---------------------------------------------------------------------------

    Several commenters supported the brochure supplement
requirement.\214\ One stated that the brochure supplement's ``greater
personal relevance to investors will make [it] among the most widely
read of the disclosure documents they receive, particularly if they
receive it in a timely fashion.'' \215\ Another stated that the
brochure items addressed areas of interest to clients and stated that
``information on the qualifications and background of those who
influence clients in connection with their investments are as relevant,
if not more relevant, than the information currently required by Part 2
on senior executives of the firm that may have little or no direct
contact with the client.'' \216\
---------------------------------------------------------------------------

    \214\ See ASG Letter; Consumer Federation Letter; CFA Institute
Letter; FPA Letter; IAA Letter; Lininger Letter; NASAA Letter.
    \215\ Consumer Federation Letter.
    \216\ CFA Institute Letter.
---------------------------------------------------------------------------

    Several advisers that also are registered as broker-dealers,
however, urged that we not require a brochure supplement, arguing that
the brochure supplement would prove excessively costly, that at least
some of the information is available on the Financial Industry
Regulatory Authority's (FINRA) web-based BrokerCheck system,\217\ and
that information not available through BrokerCheck (such as the
``Educational Background,'' ``Other Business Activities,'' ``Additional
Compensation,'' and ``Supervision'' sections) is either not important
to clients or could be covered by general disclosure in the firm
brochure about the firm's policies and procedures.\218\ We disagree. We
believe that the additional information required by the supplement will
be important to many clients and, particularly for large advisers,
cannot be sufficiently described by firm policies and procedures. For
large advisers, such policies will by necessity tend to be general
because they must cover a large number of supervised persons with a
range of ancillary activities and conflicts. For example, we do not
believe that a prospective client would find it particularly helpful to
read in the firm brochure that all of the adviser's associated persons
had earned a college degree. Or that some of their associated persons
had additional business activities that may involve conflicts of
interest. Disclosure of such generalized information about the firm's
associated persons is unlikely to be meaningful to clients seeking to
understand the background, particular conflicts and outside business
activities of the individual providing investment advice to them.
---------------------------------------------------------------------------

    \217\ Another commenter argued against reliance on BrokerCheck.
See Consumer Federation Letter.
    \218\ See, e.g., CGMI Letter; Merrill Lynch Letter; Morgan
Stanley Letter; Schwab Letter; SIFMA Letter. BrokerCheck, which is
designed to help investors check the professional background of
current and former FINRA-registered securities firms and brokers, is
available at http://www.finra.org/Investors/ToolsCalculators/
BrokerCheck/index.htm. The following commenters argued that we
should not require the brochure supplement because it would provide
little new or useful information but would create significant costs
and burdens. See, e.g., NAPFA Letter; Pickard Letter; Roundtable
Letter; USAA Letter; comment letter of John H. Vineyard (Mar. 18,
2008) (``Vineyard Letter''). For the reasons discussed in the text,
we disagree.
---------------------------------------------------------------------------

    Commenters have, however, persuaded us to permit advisers to make
use of BrokerCheck as well as the IAPD system to disclose disciplinary
information available on those systems when the client has received a
brochure supplement electronically.\219\ The instructions for Part 2B
of Form ADV provide that the adviser may disclose in a supplement
delivered electronically that the supervised person has a disciplinary
event and provide a hyperlink to either the BrokerCheck or the IAPD
systems.\220\ We believe that this accommodation addresses commenters'
concerns regarding duplication of disclosure requirements, while
meeting our objective of providing advisory clients with convenient
access to information necessary to assess the individuals they are
relying on for investment advice.\221\ In addition to this
accommodation, we have made several other changes to the proposed
brochure supplement requirements in response to comments, which we
discuss below.
---------------------------------------------------------------------------

    \219\ IAPD was recently enhanced to allow investors to obtain
disciplinary history of supervised persons. See http://
www.nasaa.org/NASAA_Newsroom/Current_NASAA_Headlines/12811.cfm
for a press release announcing the launch of an enhancement to IAPD
to allow users to search for individuals.
    \220\ See Instruction 3 for Part 2B of Form ADV.
    \221\ We also believe that this approach addresses the concern
expressed by one commenter that reliance on BrokerCheck would hurt
those investors who are least sophisticated and therefore are most
likely to need this information, but who are the very ones that are
least likely to seek it out. See Consumer Federation Letter.
---------------------------------------------------------------------------

1. Format
    As proposed, the amendments require advisers to write their
supplements in plain English, but offer an adviser flexibility in
presenting information in a format that is best suited to the advisory
firm. This flexibility is designed to reduce the cost of preparing and
delivering supplements. Advisers may include supplement information
within the firm's brochure, an approach that may be attractive to
smaller firms with few persons for whom they will be required to
prepare supplements.\222\ Advisers may elect to prepare a supplement
for each supervised person. Alternatively, they can prepare separate
supplements for different groups of supervised persons (e.g., all
supervised persons in a particular office or work group). To promote
comparability of brochure supplements, we are requiring that a brochure
supplement must be organized in the same order, and contain the same
headings, as the items appear in the form, whether provided in a
brochure or separately.\223\
---------------------------------------------------------------------------

    \222\ IARD data as of May 3, 2010 indicate that 81% of advisers
registered with us have 10 or fewer employees performing investment
advisory functions on their behalf. Over 65% have five or fewer
employees performing advisory functions.
    \223\ If provided in a brochure, supplements must be included at
the end of the brochure and be sequenced for each supervised person.
See Instruction 1 of General Instructions for Part 2 of Form ADV and
Instruction 6 for Part 2B of Form ADV.

---------------------------------------------------------------------------

2. Supplement Items
    Part 2B, as we proposed and as we are adopting it today, consists
of six items. Many commenters who addressed the specific proposed items
supported the content of the brochure supplements generally.\224\
Others offered specific comments on certain items; we address these
comments below.
---------------------------------------------------------------------------

    \224\ See, e.g., CFA Institute Letter, CFP Board Letter; FPA
Letter.
---------------------------------------------------------------------------

    Item 1. Cover Page. Each supplement's cover page must include
information identifying the supervised person (or persons) covered by
the supplement as well as the advisory firm. One commenter stated that
the brochure supplement should not require a separate cover page.\225\
We intended Item 1 of the brochure supplement to require that the
information specified in the item be included on the front page of the
supplement, not that this be the only information on a cover page. We
have modified Item 1 accordingly to clarify that the information
required by the item may be presented either on a separate cover page
or at the top of the first page of the brochure supplement.
---------------------------------------------------------------------------

    \225\ See ASG Letter.
---------------------------------------------------------------------------

    Item 2. Educational Background and Business Experience. Item 2
requires the supplement to describe the supervised person's formal
education and his or her business background for the past five
years.\226\ If the supervised person either has no high school
education, no formal education after high school, or no business
background, the adviser must disclose this fact in the supplement. The
business background section must identify the supervised person's
positions at prior employers and not merely list the names of prior
employers.\227\
---------------------------------------------------------------------------

    \226\ Previously, Item 6 of Part 2 of Form ADV required this
information about the adviser's principal executive officers and
about individuals who determine general investment advice on behalf
of the adviser.
    \227\ For example, clients may be interested in knowing that a
supervised person was previously employed as an analyst at a hedge
fund as opposed to being employed as a computer support specialist
at a hedge fund.
---------------------------------------------------------------------------

    Advisers may include information about professional designations in
the supplement if they so choose. One commenter urged the Commission to
require the listing of any professional designations held as long as
the designations conform to the North American Securities
Administrators Association (NASAA) model rules and state regulations
that prohibit the misleading use of designations or
certifications.\228\ A few other commenters encouraged the Commission
to require disclosure about the minimum qualifications required for any
disclosed professional designation.\229\ We are not electing to require
a listing of professional designations as we do not require, nor do we
endorse, any designations. We are concerned that the Commission
requiring such disclosure could cause clients to mistakenly believe
that we do endorse designations. We do believe, however, that some
clients may be interested in learning of professional designations held
by the individuals providing them with investment advice. However, we
do not believe that such disclosure is meaningful without an
explanation of the minimum qualifications required to obtain the
designation. Accordingly, we are adding a requirement that if
professional designations are disclosed in the supplement, the
supplement must also provide a sufficient explanation of the minimum
qualifications required for the designation to allow clients and
potential clients to understand the value of the designation. The
disclosure, of course, also cannot be materially false or misleading by
suggesting, for example, that the designation implies more
qualifications or experience than the actual designation standards
require.\230\
---------------------------------------------------------------------------

    \228\ See CFP Board Letter.
    \229\ See ASG Letter; First Allied Letter; NASAA Letter. But see
Vineyard Letter (stating that the supplement should not allow
descriptions of professional designations since such disclosure
could imply that the Commission advocated obtaining the particular
designation).
    \230\ We note that 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. 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:[sol][sol]www.sec.gov/spotlight/seniors/freelunchreport.pdf);
Staff Update, ``Senior'' Specialists and Advisors: What You Should
Know About Professional Designations (available at
http:[sol][sol]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 vary
widely. FINRA has established and maintains a database of
designations used across the financial services industry that
contains basic information about the designation, such as the
issuing organization, prerequisites, and educational requirements.
http:[sol][sol]apps.finra.org/DataDirectory/1/prodesignations.aspx.
---------------------------------------------------------------------------

    Item 3. Disciplinary Information. Item 3 requires disclosure of any
legal or disciplinary event that is material to a client's evaluation
of the supervised person's integrity. It includes certain disciplinary
events that the Commission presumes are material to such an evaluation
if they occurred during the last 10 years.\231\ Several commenters
supported this requirement, and stated that such information would be
of great interest to clients.\232\
---------------------------------------------------------------------------

    \231\ This list parallels the 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 prior disclosure
requirements set out in rule 206(4)-4. The list also is
substantially similar to the list of disciplinary events advisers
and their advisory affiliates are already required to disclose in
response to Item 11 of Form ADV, Part 1A.
    As under Item 9 of Part 2A, Item 3 of Part 2B permits an adviser
to rebut the presumption with respect to a particular event, in
which case no disclosure to clients about the event will be
required. We 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. As under Item
9 of Part 2A, a note in Item 3 explains four factors the adviser
should consider when assessing whether the presumption can be
rebutted.
    \232\ See CFA Institute Letter; CFP Board Letter; Consumer
Federation Letter; FPA Letter; NASAA Letter.
---------------------------------------------------------------------------

    As proposed, Item 3 of the supplement would have required
disclosure of any event for which the supervised person had 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). Two commenters recommended that we not require this
particular disclosure, stating that an adviser would not know a
supervised person's reason for relinquishing a designation or
license.\233\ We recognize that an adviser may not always know why a
supervised person is relinquishing a designation or license. We are
modifying this requirement to clarify that this disclosure need only be
made if the adviser knew or should have known that the supervised
person relinquished his or her designation or license.
---------------------------------------------------------------------------

    \233\ See First Allied Letter; IAA Letter.
---------------------------------------------------------------------------

    As discussed above, we are modifying Item 3 to permit advisers that
send supplements electronically to clients to include hyperlinks to
disciplinary information available through the FINRA BrokerCheck system
as well as the IAPD system. A number of supervised persons of
investment advisers also are registered representatives of a broker-
dealer firm or are subject to state investment adviser reporting
requirements and thus may have disciplinary disclosure available
through BrokerCheck or IAPD. Permitting advisers to hyperlink to these
systems may minimize the costs of brochure supplements by leveraging

existing infrastructure established by broker-dealer and adviser
regulation. To take advantage of this provision, the brochure
supplement must be delivered electronically and must include: (i) A
statement that the supervised person has a disciplinary history, the
details of which can be found on BrokerCheck or the IAPD (as the case
may be); and (ii) a hyperlink to the relevant system with a brief
explanation of how the client can access the disciplinary history.
    Two commenters recommended that the Commission reconcile the
disclosure requirements in Item 3 of the brochure supplement with Item
14 of Form U4, the uniform form used by broker-dealer and state
investment advisory representatives to register (which includes certain
disciplinary disclosure and is the source of such information that is
available on BrokerCheck), stating that a lack of uniformity would
complicate compliance.\234\ We may consider in the future whether the
disclosure requirements in Item 3 and in Form U4 should be conformed,
as we recognize the substantial overlap between these disclosure items.
We note, however, that although the disclosure requirements are not
phrased identically, any disclosure required by the brochure supplement
would also have to be disclosed on Form U4.
---------------------------------------------------------------------------

    \234\ See ICI Letter; NASAA Letter.
---------------------------------------------------------------------------

    Item 4. Other Business Activities. Item 4 requires an adviser to
describe other business activities of its supervised persons. The item
specifically requires disclosure with respect to other capacities in
which the supervised person participates in any investment-related
business and any material conflicts of interest such participation may
create.\235\ In addition, the item requires the supplement to include
information about any compensation, including bonuses and non-cash
compensation, the supervised person receives based on the sales of
securities or other investment products, as well as an explanation of
the incentives this type of compensation creates.\236\ We are adopting
this item substantially as proposed. We believe that disclosure of any
such compensation is important because it creates an incentive for the
supervised person to base investment recommendations on his or her own
compensation rather than on clients' best interests.
---------------------------------------------------------------------------

    \235\ See Item 4.A of Part 2B.
    \236\ See Item 4.A.2 of Part 2B.
---------------------------------------------------------------------------

    We also are adopting a requirement to disclose other business
activities or occupations that the supervised person engages in if they
involve a substantial amount of time or pay.\237\ 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. Several commenters supported
inclusion of this item.\238\ A few commenters urged that we not require
disclosure of this information,\239\ with one commenter arguing that
such information is irrelevant to the adviser's competence in providing
investment advice,\240\ and another stating that such a requirement
would be burdensome.\241\ We are retaining this requirement because we
believe that investors will find this information helpful in assessing
the conflicts created by those activities.
---------------------------------------------------------------------------

    \237\ See Item 4.B of Part 2B.
    \238\ See, e.g., Berlin Letter; CFA Institute Letter; CFP Board
Letter; NASAA Letter. The NASAA Letter urged disclosure of all
outside business activities regardless of whether they occupied a
substantial amount of that person's time or income.
    \239\ See IAA Letter; ProEquities Letter; Vineyard Letter.
    \240\ See IAA Letter.
    \241\ See ProEquities Letter.
---------------------------------------------------------------------------

    Finally, some commenters stated that the Commission should define
``substantial sources of income'' and ``substantial amount of time'' by
reference to specific percentages or in some other manner.\242\ We
believe that what amounts to ``substantial'' in many cases depends on
particular facts and circumstances, and thus we are not establishing
any specific definition of what is and is not substantial. However, we
do understand the concern that there is likely some level at which a
source of income or amount of time would rarely interfere or conflict
with an adviser's business of providing investment advice. Accordingly,
we are allowing advisers to make a presumption that if the other
business activities represent less than 10 percent of the supervised
person's time and income, they are not substantial.\243\
---------------------------------------------------------------------------

    \242\ See Case Letter; FSI Letter; ProEquities Letter; TAG
Letter.
    \243\ See Item 4.B of Part 2B.
---------------------------------------------------------------------------

    Item 5. Additional Compensation. This item requires 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.\244\
---------------------------------------------------------------------------

    \244\ Bonuses based (in part or whole) on sales, client
referrals or new accounts trigger required disclosure, but other
bonuses do not. Regular salaries need not be disclosed.
---------------------------------------------------------------------------

    Two commenters suggested that we not require this disclosure, with
one of these commenters stating that disclosure of any conflicts
arising out of such compensation arrangements is already required by an
adviser's fiduciary duty and that firms should be free to make such
disclosure in the firm's brochure or investment advisory contract,
rather than in the brochure supplement.\245\ We are adopting Item 5 as
proposed. We believe clients need to know if their individual adviser
has these arrangements in order to assess the advisory services of that
particular supervised person and that general disclosure of this
conflict in a firm-wide brochure or advisory contract is not an
adequate substitute. As we stated above, general disclosure of this
type of conflict in many firm-wide brochures or advisory contracts will
by necessity tend to be general because it must cover a variety of
supervised persons with a range of compensation arrangements. Such
general disclosure is unlikely to be meaningful to clients seeking to
understand the particular compensation arrangements and associated
conflicts of the individual providing investment advice to them.
---------------------------------------------------------------------------

    \245\ See Morgan Stanley Letter; Schwab Letter. Morgan Stanley
made the comment regarding fiduciary duties.
---------------------------------------------------------------------------

    Item 6. Supervision. This item requires an adviser to explain how
the firm monitors the advice provided by the supervised person
addressed in the brochure supplement. It also requires 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.
    We are adopting Item 6 as proposed. One commenter supported this
requirement, stating that it is important for clients to have the
ability to locate a person within a firm to whom they can direct
questions or voice concerns about their accounts.\246\ Some commenters
recommended that the Commission not require this item, asserting that
investors would not be interested in this information and that this
requirement would not make sense for smaller advisory firms.\247\ We
believe that it is important for clients to be able to contact an
appropriate person at an advisory firm, regardless of the firm's size,
if they have any questions or complaints about the handling of their
account. This will allow clients to determine appropriate redress for
their complaints without having to go through the particular supervised
person that is the focus of the complaint. Therefore, we are requiring
this disclosure.
---------------------------------------------------------------------------

    \246\ See CFA Institute Letter.
    \247\ See FPA Letter; FSI Letter; IAA Letter; Sutherland Letter.
---------------------------------------------------------------------------

    Several commenters requested that the Commission permit advisers to

furnish clients with a general contact number and email address instead
of the name and contact information for the supervisor because
supervisory personnel may change frequently, triggering the need for
updated supplements, and because some supervised persons have multiple
supervisors.\248\ We do not agree with commenters' suggestion and are
adopting this requirement as proposed. We believe that providing the
name and telephone number of a specific individual responsible for
supervising the representative's advisory activities will ensure that
the client has ready access to the supervisor if the client has any
complaints or concerns. In the unlikely event that a supervised person
has more than one direct supervisor of his or her advisory services,
the adviser may identify any one of those supervisors as long as that
supervisor has the authority to respond to the client's question or
complaint (or can raise the issue to a higher-level supervisor, if
appropriate).
---------------------------------------------------------------------------

    \248\ See FPA Letter; FSI Letter; Roundtable Letter; USAA
Letter; Wachovia Letter.
---------------------------------------------------------------------------

3. Delivery and Updating
a. Delivery
    We are requiring as proposed 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; or (ii) makes
discretionary investment decisions for that client's assets, even if
the supervised person has no direct client contact. We believe that
clients are most interested in learning about the background and
experience of these individuals from whom they receive investment
advice.
    In the Proposing Release, we stated that 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.\249\ We explained our view that, when investment advice
is formulated by a team, specific information about each individual
team member takes on less importance. A few commenters stated that all
representatives providing advice as part of a team will likely have
direct client contact from time to time, and thus that the Commission's
proposed exemption from the brochure supplement delivery requirement
for supervised persons that provide advice as part of a team and that
have no direct client contact, in fact, would not exempt any team
members from this requirement as a practical matter, despite the
limited utility of disclosure about each supervised person comprising a
large advisory team.\250\ We agree with commenters that volumes of
disclosure about a large group of supervised persons likely would not
be meaningful to investors. Accordingly, we are modifying this
requirement, as suggested by one commenter,\251\ based on the approach
to disclosure under the Company Act where a team of individuals is
jointly and primarily responsible for the day-to-day management of a
mutual fund's portfolio.\252\ If investment advice is provided by a
team comprised of more than five supervised persons, brochure
supplements need only be provided for the five supervised persons with
the most significant responsibility for the day-to-day advice provided
to the client.\253\
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    \249\ See Proposing Release, supra note 8, at n.164.
    \250\ See, e.g., Federated Letter; ICI Letter; NAPFA Letter.
    \251\ See ICI Letter.
    \252\ See Instruction 2 for Item 5(b) of Form N-1A.
    \253\ See rule 204-3(b)(3).
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    Another commenter urged the Commission to exempt from the brochure
supplement requirement any supervised persons providing non-
discretionary advice (even if not part of a team).\254\ A commenter
representing investors strongly opposed this recommendation, arguing
that investors do not differentiate the advice they receive on this
basis.\255\ We believe that, where a supervised person is providing
investment advice directly to a client, disclosure relating to the
background and integrity of that person would be important to a client.
It assists the client in evaluating the value of that investment
advice, an evaluation we believe clients make regardless of whether the
advice is non-discretionary.\256\
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    \254\ See SIFMA Letter.
    \255\ See Consumer Federation Letter.
    \256\ We note that an adviser's fiduciary duties to its clients
under the Advisers Act do not turn on whether its advice is provided
on a discretionary or non-discretionary basis.
---------------------------------------------------------------------------

    An adviser generally must provide its clients with a brochure
supplement for each supervised person who provides the advisory
services as described above. However, advisers are not required to
deliver supplements to three 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; \257\ and (iii) certain
``qualified clients'' who also are officers, directors, employees and
other persons related to the adviser.\258\ An adviser that does not
have any clients to whom a supplement will have to be delivered will
not have to prepare any supplements.\259\ Similarly, an adviser will
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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    \257\ 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 will
result in an unnecessary expense with little appreciable benefit. We
believe, however, that delivery of a firm brochure will be useful
where the cost of the impersonal advisory services is significant,
that is $500 or above.
    \258\ Rule 205-3(d)(1)(iii) also 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; or (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.
    \259\ See note to rule 203-1(a) and (b); Instruction 1 for Part
2B of Form ADV.
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    We proposed exempting advisers from delivering the brochure
supplement to certain sophisticated clients,\260\ and received several
comments from those representing advisers supporting the exemption or
urging its expansion.\261\ The brochure supplement is intended to
contain fundamental information about the qualifications of persons
providing investment advice. Sophisticated clients are likely to
request this type of information, even if not affirmatively provided by
an investment adviser. Given that advisers will be preparing and
delivering brochure supplements anyway, we believe the incremental
burden of meeting the rule's obligations with respect to these
sophisticated clients will be minimal and would not justify an
exemption. We are therefore requiring that advisers deliver brochure
supplements to all clients other than, as described above: (i) Those
clients to whom the adviser is not required to deliver a firm brochure;
(ii) clients who receive only impersonal investment advice; and (iii)
certain ``qualified clients'' who also are officers, directors,
employees and other persons related to the adviser.
---------------------------------------------------------------------------

    \260\ See Proposing Release at Section II.B.1.
    \261\ See, e.g., IAA Letter; ICI Letter; Pickard Letter; T. Rowe
Letter.
---------------------------------------------------------------------------

    The supervised person's supplement initially must be given to each
client at or before the time when that specific supervised person
begins to provide advisory services to that specific

client.\262\ A few commenters argued that a large adviser with
thousands of supervised persons may have staff changes on any given day
and suggested that delivery be permitted promptly after the time the
supervised person begins providing advisory services to the
client.\263\ But the brochure supplement is intended to assist
investors in determining whether to retain the services of a particular
adviser and in evaluating the individual advice they are receiving.
This function could not be fully served if a client did not receive the
supplement until after the supervised person already had begun
providing advice to the client. As a result, we are adopting this
delivery requirement as proposed.
---------------------------------------------------------------------------

    \262\ See rule 204-3(b)(3) and Instruction 3 for Part 2B of Form
ADV.
    \263\ See IAA Letter; ICI Letter.
---------------------------------------------------------------------------

b. Updating
    We are adopting as proposed, the requirement that advisers deliver
an updated supplement to clients only when there is new disclosure of a
disciplinary event, or a material change to disciplinary information
already disclosed, in response to Item 3 of Part 2B.\264\ Because the
final rule allows advisers to reference BrokerCheck or IAPD for
disclosure of a supervised person's disciplinary information when the
supplement is delivered electronically, if the supplement refers to
BrokerCheck or IAPD a change in disclosure required by Part 2B would
require the adviser to electronically deliver an updated supplement (or
sticker) to clients when BrokerCheck or IAPD has been updated with new
disclosure of a disciplinary event, or a material change to
disciplinary information already disclosed, with the updated supplement
(or sticker) indicating that the disciplinary information for the
supervised person has changed and providing a hyperlink to BrokerCheck
or IAPD. We believe this information is critical for clients because it
reflects upon the supervised person's integrity and may affect a
client's trust and confidence in that person and the adviser that
employs the supervised person.
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    \264\ See rule 204-3(b)(4). We note that an adviser's fiduciary
duty may require it to inform a client of material changes to
disclosures in the supplement even if rule 204-3 does not require
delivery of an updated supplement to clients.
---------------------------------------------------------------------------

    As with the brochure, advisers must amend a brochure supplement
promptly if information in it becomes materially inaccurate.\265\ Any
new clients to whom the adviser is obligated to deliver a supplement
under our amended rule must be given an amended supplement (or the
``old'' supplement and a sticker). Supplements, like brochures, may be
delivered on paper or electronically.\266\ Because we believe most
information in the supplement is unlikely to become materially
inaccurate over time, advisers are not required to deliver supplements
to existing clients annually. These requirements have not been modified
from the proposal.
---------------------------------------------------------------------------

    \265\ See Instruction 4 for Part 2B of Form ADV.
    \266\ See Instruction 5 for Part 2B of Form ADV.
---------------------------------------------------------------------------

C. Filing Requirements, Public Availability

    The Commission is amending rule 204-1 to require advisers to file
their new brochures with us electronically through the IARD
system.\267\ Advisers are not required to file brochure supplements or
supplement amendments with the Commission, and they will not be
available on the Commission's public website.\268\Advisers are required
to maintain copies of all supplements and amendments in their
files.\269\
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    \267\ Rule 204-1 had required advisers to file only ``Part 1A of
Form ADV'' electronically. We are amending it to require Part 1A and
Part 2A of Form ADV to be filed electronically.
    \268\ See rules 203-1(a) and 204-1(b) and Instruction 9 for Part
2B of Form ADV. Because brochure supplements would not be filed with
us, they would not be deemed filed and 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).
    \269\ See rule 204-2(a)(14)(i) and Instruction 9 for Part 2B of
Form ADV.
---------------------------------------------------------------------------

    The IARD will accept brochure filings using the text-searchable
Adobe Portable Document Format (``PDF'').\270\ The IARD provides
advisers with online access to the Part 2A Items and instructions.
Instead of completing Part 2A online, advisers will create their
brochure on their own computers, convert it to a PDF, 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 to the source file on their own computers and then
attach the revised versions to their IARD filing. The IARD will not
accept an annual updating amendment without an updated brochure, a
representation by that adviser that the brochure on file does not
contain any materially inaccurate information, or a representation that
the adviser does not have to prepare a brochure because it does not
have to deliver it to any clients (e.g., the adviser's clients are
limited to registered investment companies). The IARD also will not
accept an annual updating amendment without a representation that the
summary of material changes is attached as an exhibit to or included in
the updated brochure or a representation that no summary of material
changes is required because there have been no material changes to the
adviser's brochure since its last annual updating amendment.\271\ If an
adviser using multiple brochures discontinues using a particular
brochure, the IARD system will permit the adviser to eliminate that
brochure from its current filing.\272\
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    \270\ FINRA will assist investment advisers with converting
brochures into a text-searchable PDF format using software available
to the adviser or, if necessary, providing the adviser with PDF
conversion software.
    \271\ If the adviser's summary of material changes is a separate
document, the adviser must attach the summary as an exhibit to its
brochure and upload the brochure and the summary in one single,
text-searchable, PDF file on IARD.
    \272\ Similarly, if an adviser is no longer required to prepare
a brochure for delivery, the IARD system will permit the adviser to
eliminate that brochure from its current filing.
---------------------------------------------------------------------------

    Most commenters addressing electronic filing supported the new
filing requirement and public availability of the brochures.\273\ Some,
however, expressed concern that public disclosure of advisers'
brochures through IAPD could reveal proprietary and confidential
business information to competitors.\274\ We have reviewed our
requirements and do not believe that they would require disclosure of
proprietary or confidential business information. Indeed, the
information that would be disclosed is very similar to that which we
have long required to be disclosed by advisers in their brochures and
which until 2000 was filed in paper with the Commission and publicly
available.\275\ We believe that there is a substantial public interest
in having this information readily available to prospective clients,
which may assist them in their search for an investment adviser. In
addition, we believe that public disclosure will have a beneficial
effect on business practices by, for example, discouraging advisers

from engaging in certain practices because those practices would have
to be publicly disclosed.
---------------------------------------------------------------------------

    \273\ See CGMI Letter; Fried Frank Letter; CFA Institute Letter;
Katten Letter; NAPFA Letter; NASAA Letter; NRS Letter; NSCP Letter;
Sidley Letter.
    \274\ See comment letter of Brown & Brown Financial Services,
Inc. (Mar. 27, 2008) (``Brown Letter''), comment letter of Executive
Advisers, Inc. (May 14, 2008); comment letter of Larry Laws and
Associates, Inc. (May 14, 2008); comment letter of James E. Wernli
(May 20, 2008) (``Wernli Letter'').
    \275\ Until 2000, our rules required advisers to file both Part
I and Part 2 of Form ADV with us and it was available in our public
reference room. See Section I.C.2 of Electronic Filing by Investment
Advisers; Amendments to Form ADV, Investment Advisers Act Release
No. 1897 (Sept. 12, 2000) [65 FR 57438 (Sept. 22, 2000)].
---------------------------------------------------------------------------

    Other commenters expressed concern that a fund adviser's required
public disclosure of Part 2 through IAPD could jeopardize the reliance
of any private funds that it advised on the private offering exemption
in the Securities Act of 1933 and the safe harbor for offshore
transactions from the registration provisions in Section 5 of that
statute.\276\ We believe registrants can provide information required
by Part 2 without jeopardizing reliance on those exemptions. The
inclusion of private fund information beyond that required in Part 2,
however, such as subscription instructions, performance information,
and financial statements, may jeopardize such reliance by constituting
a public offering or conditioning the market for the securities issued
by those funds.
---------------------------------------------------------------------------

    \276\ 15 U.S.C. 77e. Some expressed specific concern that the
public disclosure may be deemed to violate the prohibition on
``general solicitation'' and ``general advertising'' that applies to
private offerings conducted in accordance with Rule 506 of
Regulation D. See AICA Letter; AIMA Letter; Fried Frank Letter;
Janus Letter; NSCP Letter. One mentioned that the public disclosure
could raise questions as to whether there are ``directed selling
efforts'' in the United States, which would be inconsistent with the
rules applicable to offshore offerings under Regulation S under the
Securities Act. See Sidley Letter.
---------------------------------------------------------------------------

D. Transition to New Requirements

    As discussed below in the discussion of compliance and effective
dates,\277\ we are adopting transition requirements that, as proposed,
provide advisers with at least six months to comply with the amended
rules and forms.\278\ While a few commenters asked for more time to
prepare the brochures and brochure supplements,\279\ we believe the
proposed transition period is sufficient. Advisers that are currently
registered with us will have at least 8 months (from the end of July
2010 through the end of March 2011) to prepare and file narrative
brochures as a result of the compliance dates discussed below. We also
note that we have changed the period by which firms must deliver the
new brochure and brochure supplements to their existing clients after
this electronic filing compliance date from 30 days to 60 days to make
sure that advisers have enough time to comply with the
requirement.\280\
---------------------------------------------------------------------------

    \277\ See Section V of this Release.
    \278\ Rule 204-1(c). We proposed 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
six months after the date the revised form becomes effective.
    \279\ See AICPA Letter; First Allied Letter; NAPFA Letter; T.
Rowe Letter.
    \280\ Two commenters suggested a rolling transition over several
months to avoid an inordinate demand on outside consulting and legal
services by many advisers at the same time. See Fried Frank Letter;
NAPFA Letter. We believe that the transition period we have provided
to comply with the new Part 2 requirement permits advisers to work
with their service providers in advance of the date their filings
are required.
---------------------------------------------------------------------------

III. Amendments to Form ADV Instructions and Glossary

    Together with the Part 2 amendments, we also are making conforming
amendments to the General Instructions and the Glossary of Terms for
Form ADV. We are amending the General Instructions to Form ADV to
include instructions regarding brochure filing requirements. Similarly,
we are amending the Glossary of Terms to add the following five terms
that are used in Part 2: (i) ``brochure;'' \281\ (ii) ``brochure
supplement;'' \282\ (iii) ``custody;'' \283\ (iv) ``investment adviser
representative;'' \284\ (v) ``supervised person;'' \285\ and (vi)
``wrap brochure or wrap fee program brochure.'' \286\ We also are
updating 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.
---------------------------------------------------------------------------

    \281\ ``Brochure'' means: ``A written disclosure statement that
you must provide to clients and prospective clients.'' See Form ADV:
Glossary.
    \282\ ``Brochure supplement'' means: ``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.
    \283\ ``Custody'' means ``holding, directly or indirectly,
client funds or securities, or having any authority to obtain
possession of them. You have custody if a related person holds,
directly or indirectly, client funds or securities, or has any
authority to obtain possession of them, in connection with advisory
services you provide to clients. Custody includes: (i) Possession of
client funds or securities (but not of checks drawn by clients and
made payable to third parties) unless you receive them inadvertently
and you return them to the sender promptly but in any case within
three business days of receiving them; (ii) Any arrangement
(including a general power of attorney) under which you are
authorized or permitted to withdraw client funds or securities
maintained with a custodian upon your instruction to the custodian;
and (iii) Any capacity (such as general partner of a limited
partnership, managing member of a limited liability company or a
comparable position for another type of pooled investment vehicle,
or trustee of a trust) that gives you or your supervised person
legal ownership of or access to client funds or securities.'' See
rule 206(4)-2(d)(2).
    \284\ ``Investment adviser representative'' means: ``Any of your
firm's supervised persons (except those that provide only impersonal
investment advice) is an investment adviser representative, if--(i)
the supervised person regularly solicits, meets with, or otherwise
communicates with your firm's clients, (ii) the supervised person
has more than five clients who are natural persons and not high net
worth individuals, and (iii) more than ten percent of the supervised
person's clients are natural persons and not high net worth
individuals.'' See Form ADV: Glossary. Cf. rule 203A-3(a).
    \285\ ``Supervised person'' means: ``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.
    \286\ ``Wrap brochure or wrap fee program brochure'' means:
``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 updating 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 revision properly reflects 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.\287\ 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
registered advisers. Certain entities will need to file Form ADV-NR
with the Commission to appoint agents for service of process because
they relied on the glossary definition and therefore were not required
to file the form. We received no comments on these changes and are
adopting them as proposed.
---------------------------------------------------------------------------

    \287\ This amendment will 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 275.0-2(b)(2)].
---------------------------------------------------------------------------

IV. Amendments to Rule 204-2

    We also are adopting 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 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.\288\ Additionally, the
amendments require registered advisers to prepare and preserve
documentation of the method they use to calculate 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.\289\ The amendments also
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 for the period the event is presumed material, if the event is
not disclosed in the adviser's brochure or the relevant brochure
supplement.\290\ These records will 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 received no
comments on these changes and are adopting them as proposed.
---------------------------------------------------------------------------

    \288\ See rule 204-2(a)(14)(i). The rule also will require
advisers to keep and maintain a copy of the summary of material
changes that is not included in the brochure, as well as a record of
the dates that each brochure, amendment, and summary of material
change was given to any client.
    \289\ See discussion at supra note 40 and accompanying text.
    \290\ See discussion at supra notes 86--89 and accompanying
text.
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V. Effective and Compliance Dates

    The amended rules and forms will be effective on October 12, 2010.

A. New Investment Advisers

    Each adviser applying for registration with the Commission after
January 1, 2011 must file a brochure or brochures that meet the
requirements of amended Part 2A as part of the application for
registration on Form ADV.\291\ Such advisers must, upon registering,
begin to deliver to their clients and prospective clients a brochure
and brochure supplements that meet the requirements of the amended form
in accordance with the amended rules discussed above.\292\
---------------------------------------------------------------------------

    \291\ Rule 203-1(b). This requirement applies only if the
adviser is required to deliver a brochure. See note to Rule 203-1.
    \292\ Rule 204-3(b).
---------------------------------------------------------------------------

B. Registered Advisers

    Each adviser registered with the Commission whose fiscal year ends
on or after December 31, 2010, must include in its next annual updating
amendment to its Form ADV a brochure or brochures that meet the
requirements of the amended form.\293\ Accordingly, each adviser with a
fiscal year end of December 31, 2010 must file an annual updating
amendment with the new brochures no later than March 31, 2011. Within
60 days of filing such amendment, the adviser must deliver to its
existing clients a brochure and brochure supplement that meet the
requirements of amended Form ADV.\294\ Each adviser must, after the
initial filing of the brochures, begin to deliver to new clients and
prospective clients a new brochure and brochure supplements in order to
satisfy its obligations under the brochure rule.\295\
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    \293\ Rule 204-1(c). This filing requirement applies only if the
adviser is required to deliver a brochure. See note to Rule 203-1.
    \294\ Rule 204-3(g)(1).
    \295\ Rule 204-3(g)(2).
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VI. Paperwork Reduction Act

    As explained in the Proposing Release, certain provisions of the
rule and form amendments that we are adopting today contain
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (``PRA'').\296\ In the Proposing
Release, the Commission published notice soliciting comment on the
collection of information requirements. The Commission submitted the
collection of information requirements to the Office of Management and
Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5
CFR 1320.11, and OMB approved these collections of information under
control numbers 3235-0049 (expiring 2/28/2011), 3235-0278 (expiring 3/
31/2011), 3235-0047 (expiring 2/28/2011), and 3235-0345 (expiring 3/31/
2011). The titles for these collections of information are ``Form
ADV,'' ``Rule 204-2,'' ``Rule 204-3,'' and ``Rule 206(4)-4,''
respectively, all under the Advisers Act. An agency may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid control number.
---------------------------------------------------------------------------

    \296\ 44 U.S.C. 3501.
---------------------------------------------------------------------------

    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 rule and form amendments that we are adopting 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 amendments to Part 2 of Form
ADV. The second collection of information involved is that under the
amendment to rule 204-2, which requires advisers to maintain and
preserve specified books and records. The third collection involved is
that related to an amendment to rule 204-3, which requires advisers to
deliver certain information required under Form ADV to their clients.
    In addition, we are withdrawing rule 206(4)-4, the rule requiring
advisers to disclose certain disciplinary and financial information,
because the disclosure required by that rule is incorporated into the
amendments to Part 2 of Form ADV that we are adopting.

A. Summary of Comment Letters

    We requested comment on the Paperwork Reduction Act analysis
contained in the Proposing Release. A number of commenters expressed
concerns that the paperwork burdens associated with our proposed
amendments to Part 2 of Form ADV were understated.\297\ Several
commenters stated that our estimates of the burdens of preparing and
delivering brochure supplements were too low and that the requirement
would impose heavy burdens on advisers, in particular, large advisory
firms with thousands of employees and clients.\298\ Several commenters
noted that these costs would increase particularly in the context of
wrap fee programs.\299\ In response to comments on the requirements of
Form ADV Part 2, we have made several substantive modifications to the
proposed amendments that we believe in general will reduce the
paperwork burdens associated with the rule and form amendments. For
example, we have modified the annual brochure delivery requirement to
allow it to be satisfied by delivering just a summary of material
changes in the brochure. We have revised Item 5 so that advisers do not
need to include a fee schedule in brochures provided only to clients
that are ``qualified purchasers.'' We have not adopted proposed
disclosure of cash balance practices and proxy voting services from
Items 8 and 17, respectively. We are permitting supervised persons with
certain disciplinary information disclosed through FINRA's BrokerCheck
system or the IAPD system to refer clients to that information in their
brochure supplements (if they are provided electronically and contain a
hyperlink to the BrokerCheck or the IAPD system, as relevant) rather
than reproducing that information. When investment advice is provided
to a client by a team, we are requiring that brochure supplements need
only be provided for the five supervised persons with the most
significant responsibility for the day-to-day advice provided to the
client.
---------------------------------------------------------------------------

    \297\ See ASG Letter; Berlin Letter; Federated Letter; First
Allied Letter; Fried Frank Letter; FSI Letter; IAA Letter; Jackson
Letter; NAPFA Letter; NRS Letter; Pickard Letter; Sutherland Letter;
Vineyard Letter.
    \298\ See Merrill Lynch Letter; Morgan Stanley Letter; Schwab
Letter; SIFMA Letter; Sutherland Letter.
    \299\ See Federated Letter; MMI Letter; Morgan Stanley Letter.

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B. Revisions to Paperwork Reduction Act Burden Estimates

    After considering commenters' concerns that the Commission's
estimated paperwork burdens for firms complying with the amended Form
ADV Part 2 were too low, and in light of revisions we have made to our
proposed amendments to Part 2, we are revising our estimates for
purposes of the Paperwork Reduction Act.
1. Amendments to Form ADV
a. Part 2 of Form ADV
    The information required by the amendments to Form ADV is
mandatory. Advisers are required to disclose this information to their
clients and, therefore, it is not kept confidential. The currently
approved total annual burden for all advisers completing, amending, and
filing revised Form ADV with us is 132,599 hours. As stated in the
Proposing Release, we continue to believe that most of the paperwork
burden will be incurred in advisers' initial preparation of a revised
brochure and brochure supplements, as most advisers will have to draft
a narrative brochure and all advisers will have to prepare new brochure
supplements, and that over time this burden will decrease substantially
because the paperwork burden will be limited to updating information.
The paperwork burdens of preparing a narrative firm brochure and
brochure supplements are likely to vary substantially among advisers,
because Part 2 gives an adviser considerable flexibility in structuring
its disclosure, the amount of disclosure required will vary among
advisers, and the number of supplements that will need to be prepared
depends on the number of supervised persons at a firm that provide
investment advice. We believe that the revisions to Part 2 will impose
a small burden on advisers in collecting information because there is a
significant overlap between the information required by the previous
Part 2 and the new Part 2A requirements and because advisers already
collect information on the business background and disciplinary
histories of their supervised persons to comply with state investment
adviser representative registration requirements.\300\ Accordingly, we
expect that most of the paperwork burden from amended Part 2 will arise
from an adviser drafting the narrative disclosure for its brochure and
brochure supplements based on disclosures it and its supervised persons
already made in Schedule F of Part 2 and in Form U4, and in expanding
its discussion of how the adviser addresses certain conflicts of
interest.
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    \300\ There are three entirely new items in the Part 2A we are
adopting today--Item 2's summary of material changes, Item 6's
performance fee disclosure requirement, and Item 15's custody
disclosure requirement. The remainder of the items in Part 2A either
were generally covered by the previous Part 2 or were required
disclosure under other Advisers Act rules, such as rule 206(4)-6
regarding proxy voting and rule 206(4)-4 regarding financial and
disciplinary information. In addition, most states require that
supervised persons of SEC-registered investment advisers that are
investment adviser representatives file Form U4, which requires
similar business background and disciplinary information as the
brochure supplement.
---------------------------------------------------------------------------

    As noted above, we have revised our estimated burdens for purposes
of the Paperwork Reduction Act to take into account comments received
as well as substantive modifications to Part 2 from the form that was
proposed.
    In the Proposing Release, we estimated the average initial annual
burden associated with Form ADV to be 5 hours for smaller
advisers.\301\ We received several comments that provided estimates of
the paperwork burden associated with the proposed rule and form
amendments for small advisers. One commenter estimated that preparing
the initial Form ADV Part 2 would require 16 to 40 hours, depending on
the nature of the firm's business, and that each subsequent amendment
to that form would take 10 to 32 hours, depending on the nature of the
amendments.\302\ Another said that a small firm would take 60 hours to
draft the initial brochure.\303\ A small firm commenter estimated that
it would take 40 to 60 hours to prepare the initial brochure and
another 20 to 40 hours per year thereafter to update it.\304\ A
compliance consulting firm estimated that it would take on average 15
hours for a small firm to prepare the initial brochure.\305\ One law
firm estimated that smaller advisers would spend at least 44.5 hours
preparing the new brochure.\306\ We do not believe that small advisers
will require as many as 60 hours for their initial revision of Part 2A
because, as discussed above, firms already have collected much of the
information for Part 2A, many of the disclosures were already required
under previous Part 2 requirements or other Advisers Act rules or as a
result of the adviser's fiduciary obligations, and small advisers are
unlikely to have extensive conflicts of interest that would necessitate
lengthy brochure disclosures. We have reviewed several brochures of
small investment advisers drafted in a narrative format that would
appear to be generally responsive to the requirements we are adopting
today, and these brochures are short, likely because of the relative
simplicity of most small advisers' business models.\307\ We also do not
believe that small advisers will spend significant amounts of time
preparing brochure supplements because they have a small number of
supervised persons. Based on these considerations, we estimate that the
average initial annual burden associated with Form ADV to be at the low
end of the 15 to 60 hour range provided by commenters, or 15 hours for
each small adviser.
---------------------------------------------------------------------------

    \301\ For purposes of the estimates in this section, we have
categorized small advisers as those with 10 or fewer employees,
medium-sized advisers as those with between 11 and 1,000 employees,
and large advisers as those with over 1,000 employees. Unless
otherwise noted, the IARD data cited below is based on advisers'
responses to questions on Part 1A of Form ADV as of May 3, 2010.
    \302\ ASG Letter.
    \303\ NAPFA Letter.
    \304\ Jackson Letter.
    \305\ NCS Letter.
    \306\ Fried Frank Letter.
    \307\ We note that advisers that choose to disclose more than is
required by Part 2A (or their fiduciary obligations) will create
lengthier brochures than those that take a more focused approach.
---------------------------------------------------------------------------

    In the Proposing Release, we estimated that the average initial
annual burden associated with Form ADV for medium-sized advisers would
be approximately 50 hours. We received a comment from a medium-sized
adviser stating that it currently spends approximately 45 hours per
year to update its Part 2 brochure.\308\ This commenter did not
estimate how long it took to prepare its initial Part 2 brochure under
the prior format and did not estimate how long it would take to prepare
or update the new Part 2A brochure and brochure supplements. We
received a comment from another medium-sized adviser estimating that it
would take a minimum of 163 hours for the initial preparation and
internal handling of the brochure supplement.\309\ Most of our medium-
sized advisers are closer to the size of small advisers than large
advisers, with 77% of medium-sized advisers having between 11 and 50
employees.\310\ Accordingly, we expect that while these advisers will
have a higher burden than smaller advisers due to the greater size and
complexity of their business model, the majority will not have burdens
dramatically greater than small advisers. We also estimated that each
medium adviser, on average, will require 30 minutes to prepare each
brochure supplement, based on an estimate of

brochure supplement preparation time provided by one medium adviser
commenter.\311\ Based on these considerations and the comments on small
firm burdens, we have revised our estimate of the average initial
annual burden associated with Form ADV for each medium-sized adviser to
be 97.5 hours.\312\
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    \308\ See Federated Letter.
    \309\ See First Allied Letter. The First Allied Letter stated
that it had approximately 325 investment advisory representatives
and assumed that each supplement would take 30 minutes to prepare.
    \310\ Based on IARD data as of May 3, 2010.
    \311\ First Allied Letter.
    \312\ We assume that preparing Part 1 and Part 2A of Form ADV
would take each medium adviser on average 60 hours per year based on
our estimate for smaller advisers, the fact that the average medium
adviser is closer in size to a small adviser than a large adviser,
the discussion above that advisers already have much of the
information required by the new Part 2A and it is largely a matter
of converting it to a narrative format, and the one comment we did
receive from a medium sized adviser on the time it took to amend its
brochure annually. We estimate that each medium adviser, on average,
has 75 supervised persons based on the average number of employees
performing investment advisory functions at medium sized advisers
according to IARD data. We thus estimated that each medium adviser
on average would spend 37.5 hours preparing the initial brochure
supplements (75 supervised persons x 30 minutes per supervised
person = 37.5 hours per year), for a total of 97.5 hours for the
initial preparation of all of Form ADV.
---------------------------------------------------------------------------

    Finally, in the Proposing Release we estimated that the average
initial annual burden associated with Form ADV for large advisers would
be approximately 3,300 hours. We received no estimates from commenters
of the burden on large advisers from preparing the new brochure. We
received estimates from two of the largest advisers that the brochure
supplement would require between 30,000 to 45,000 hours initially.\313\
Unlike with respect to small and medium advisers, the brochure
supplement dramatically increases the estimated burden associated with
preparing Form ADV for large advisers because of their significantly
larger number of employees that provide investment advice (some with
over 1,000 per firm according to IARD data). The primary difference
between the burden associated with preparing the brochure for large and
smaller firms is the likelihood that there will be additional items to
which large firms will have to respond and the likelihood that large
firms will have additional conflicts of interest to address. We
estimate that these additional brochure disclosures will add a
relatively small amount compared to the burden estimate for medium
advisers, but that the brochure supplement requirement will add a
significant burden compared to medium advisers. We do not expect the
burden for most large firms to be as substantial, on average, as
estimated in the Merrill Lynch and Morgan Stanley comment letters,
however, because these firms based their estimate on substantially more
supervised persons providing investment advisory services than an
average large adviser.\314\ We estimate that preparing Part 1 and Part
2A of Form ADV would take each large adviser on average 100 hours per
year.\315\ Based on commenters' estimates, we now estimate that the
brochure supplement will take each large adviser on average 30 minutes
per supervised person to collect and prepare a supplement.\316\ As a
result, we now estimate the initial average burden associated with
preparing Form ADV for each large adviser to be 1,989 hours.\317\
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    \313\ The Merrill Lynch Letter estimated that the brochure
supplement requirement would require 45,000 hours per year. The
Morgan Stanley Letter estimated that it would take in the range of
30,000 to 35,000 hours for it to comply with the brochure supplement
requirement initially and 8,000 to 10,000 hours annually to comply
going forward. In their comment letters, Merrill Lynch and Morgan
Stanley stated that approximately 8,000 and 14,000 employees,
respectively, performed investment advisory functions at their
firms. These employee numbers place these two commenters at the
highest end of the range of the 36 advisers in our large category
with only four other firms reporting as of May 3, 2010 that they had
8,000 or more employees performing such functions.
    \314\ See supra note 114.
    \315\ This estimate is based on our estimate for medium
advisers, the discussion above that advisers already have much of
the information required by the new Part 2A and it is largely a
matter of converting it to a narrative format, and our view that the
additional disclosure required by large advisers' business models is
not so substantial as to require dramatically more brochure
preparation time than medium advisers.
    \316\ We estimate that each large adviser, on average, has 3,777
supervised persons based on the average number of employees
performing investment advisory functions at large advisers according
to IARD data. The Merrill Lynch Letter estimated that each
supplement would require 3 hours to prepare. We believe that this
estimate includes the burden to track and update brochure
supplements which we discuss and account for separately, and which
are not part of this burden estimate. We do not expect that brochure
supplements for supervised persons at large advisers are likely to
require more preparation time than supplements at medium advisers,
particularly when more supervised persons at large advisers than
medium advisers are likely to have information available through
BrokerCheck or the IAPD that can be referenced in those supervised
persons' supplements, reducing supplement preparation time. Brochure
supplements consist of only 6 disclosure items, several of which
(i.e., cover page, supervision, education) are simple to collect and
draft in a few minutes). Accordingly, we estimate that an adviser
would spend 30 minutes per supervised person to collect and prepare
a supplement.
    \317\ We estimate that each large adviser on average would spend
1,889 hours preparing the initial brochure supplements (3,777
supervised persons x 30 minutes per supervised person = 1,889 hours
per year), for a total of 1,989 hours per year on average per large
adviser for the initial preparation of all of Form ADV.
---------------------------------------------------------------------------

    In the Proposing Release, we estimated that an average investment
adviser's collection of information burden associated with initial
preparation of Form ADV would be 22.25 hours per year. According to
IARD data, there are 9,482 small advisers, 2,140 medium-sized advisers,
and 36 large advisers. Based on the revised hourly burden estimates
discussed above, we now believe that 36.24 hours is an accurate
reflection of the time that it will take the average adviser to
initially complete revised Form ADV (including both Parts 1 and
2).\318\ This is an increase of 13.99 hours over our initial estimate.
---------------------------------------------------------------------------

    \318\ 9,482 small advisers x an estimated 15 hours/adviser +
2,140 medium-sized advisers x an estimated 97.5 hours/adviser + 36
large advisers x an estimated 1,989 hours/adviser = 422,484 hours
total. 422,484 hours/11,658 total advisers = 36.24 hours/adviser.
---------------------------------------------------------------------------

    Respondents under this collection of information will be advisers
registered with the Commission as well as new applicants for investment
adviser registration with the Commission. We estimate that
approximately 1000 new investment advisers will register with us each
year.\319\ Thus, in combination with the approximately 11,658 existing
investment advisers registered with the Commission, we estimate that
the total number of respondents under this collection of information
will be 12,658 advisers. Based on the estimated average collection of
information burden of 36.24 hours per adviser, the total initial
collection of information would amount to 458,726 hours for new
registrants and for currently registered advisers that re-file Form ADV
(including Part 2) through the IARD system.\320\ Amortizing this total
burden imposed by Form ADV over a three-year period to reflect the
anticipated period of time that advisers would use the revised Form
would result in an average burden of an estimated 152,909 hours per
year,\321\ or 12.08 hours per year for each new applicant and for each
adviser currently registered with the Commission that would re-file
through the IARD.\322\
---------------------------------------------------------------------------

    \319\ Based on IARD data over the last five years.
    \320\ (12,658 advisers x 36.24 hours) = 458,726 hours.
    \321\ 458,726 hours/3 years = 152,909 hours/year.
    \322\ 152,909 hours/12,658 advisers = 12.08 hours/adviser.
---------------------------------------------------------------------------

    We estimate that some advisers may incur a one-time initial cost
for outside legal and compliance consulting fees in connection with
preparation of Part 2 of Form ADV. While we received no specific
comments on our estimate regarding outside legal costs in the Proposing
Release, one commenter did state that compliance consultants assist a
significant percentage of advisers in preparing their Form ADV.\323\ As
a result, we are changing our estimate to reflect a quarter of small
advisers using compliance consulting services and a

quarter of small advisers using outside legal services and to reflect
half of medium advisers using compliance consulting services in lieu of
outside legal services and a quarter of medium advisers still using
outside legal services. We estimate that the initial per adviser cost
for legal services related to preparation of Part 2 of Form ADV would
be $3,200 for small advisers, $4,400 for medium-sized advisers, and
$10,400 for larger advisers.\324\ We estimate that the initial per
adviser cost for compliance consulting services related to initial
preparation of the amended Form ADV will range from $3,000 for smaller
advisers to $5,000 for medium-sized advisers.\325\ We estimate that a
quarter of small and half of medium advisers, or 2,371 and 1,070
advisers, respectively, are likely to seek outside compliance
consulting services in their preparation of Form ADV.\326\ We estimate
that a quarter of small advisers, or 2,370 advisers, and a quarter of
medium advisers, or 535 advisers, are likely to engage outside legal
services.\327\ We estimate that all of the 36 large advisers will
engage outside legal services in preparation of Form ADV. Thus, we
estimate that approximately 2,941 advisers will elect to obtain outside
legal assistance and approximately 3,441 advisers will elect to obtain
outside consulting services, for a total cost among all respondents of
$22,775,400.\328\
---------------------------------------------------------------------------

    \323\ See NCS Letter.
    \324\ Outside legal fees are in addition to the projected hourly
per adviser burden discussed above. $400 per hour for legal services
x 8 hours per small adviser = $3,200. $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 on average is based on our consultation
with advisers and law firms who regularly assist them in compliance
matters.
    \325\ Outside compliance consulting fees are in addition to the
projected hourly per adviser burden discussed above. Based on
consultation with compliance consulting firms who regularly assist
investment advisers in Form ADV preparation, we estimate that small
advisers will incur expenses of $3000 per year for the initial
preparation of the new Form ADV and medium advisers will incur
expenses of $5000 per year for the initial preparation of the new
Form ADV.
    \326\ 9,482 small advisers x 0.25 = 2,371. 2,140 medium-sized
advisers x 0.5 = 1,070.
    \327\ 2,140 medium-sized advisers x 0.25 = 535.
    \328\ For outside legal services, ($4,400 x 535 medium advisers)
+ ($3,200 x 2,370 small advisers)) + ($10,400 x 36 large advisers) =
$ 10,312,400. For compliance consulting services, ($3,000 x 2,371
small advisers) + ($5,000 x 1,070 medium advisers) = $12,463,000.
$10,312,400+$12,463,000 = $22,775,400
---------------------------------------------------------------------------

    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 two
times during the year.\329\ A few commenters believed that we had
underestimated the information burden associated with amending Form
ADV.\330\ As a result, we are revising our estimate of the collection
of information burden for preparing amendments. One of the two
amendments that firms on average make each year will be an interim
updating amendment, and we estimate that this amendment will require
0.5 hours per amendment because interim amendments typically only amend
one or two items \331\ in Form ADV and thus should not require much
time to prepare. The other amendment is the firm's annual updating
amendment of Form ADV. Part 2A requires only a few additional
requirements with the annual updating amendment than is required
throughout the year--the summary of material changes since the last
annual updating amendment, an updated fee schedule, and an updated
figure for assets under management. We also expect that advisers will
not have to spend a significant amount of time generally reviewing
their brochure before filing their annual updating amendment as the
instructions to the form and their fiduciary obligations require them
to keep information they provide to clients free of material
inaccuracies. Based on these considerations, we estimate that the
average adviser will spend 6 hours per year completing their annual
updating amendment to Form ADV. Finally, we believe that the
information required in the brochure supplements is unlikely to change
frequently for any particular supervised person, and, as a result, that
brochure supplements will be amended infrequently.\332\ We also
estimate that changes to most of the supplement information is already
tracked by advisers in order to allow them to keep Forms U4 for their
investment advisory representatives current, and that tracking changes
to this information for brochure supplement purposes as well will
impose negligible additional costs. Accordingly, we estimate that it
will require an average burden per adviser of one hour per year for
interim amendments to brochure supplements, for a total burden on all
advisers of 11,658 hours per year.\333\ Thus, we estimate that the
total paperwork burden on advisers of amendments to Form ADV will be
87,435 hours per year.\334\
---------------------------------------------------------------------------

    \329\ In the Proposing Release, we estimated that each adviser,
on average, filing Form ADV through the IARD system amended its form
1.5 times per year. We have updated this estimate based on IARD
system data regarding the number of filings of Form ADV amendments.
    \330\ In the Proposing Release, we estimated that each adviser,
on average, would spend 0.75 hours per year amending its Form ADV.
The ASG Letter estimated that amendments to Part 2 would take 10 to
32 hours, depending on the nature of the amendments. The Jackson
Letter estimated that it would take small firms 20 to 40 hours per
year to update Part 2. The Federated Letter stated that they
currently spend approximately 45 hours per year amending the
previous Part 2.
    \331\ Based on IARD system data.
    \332\ Largely for this reason, we have not broken down our
estimated burden for preparing the annual updating amendment to Form
ADV based on the size of the adviser since most of the difference in
the initial Form ADV preparation burden was driven by the brochure
supplement. We also do not believe that the burden for preparing an
annual updating amendment to Part 2A of Form ADV will vary
significantly based on the size of the adviser.
    \333\ 1 hour per year x 11,658 advisers = 11,658 hours per year.
    \334\ 11,658 advisers x 1 interim brochure amendment per year x
0.5 hours = 5,829 hours per year for interim amendments. 11,658
advisers x 1 annual brochure amendment per year x 6 hours = 69,948
hours per year for annual amendments. 11,658 advisers x 1 hour per
year for supplement amendments = 11,658 hours per year for
supplement amendments. 5,829 + 69,948 + 11,658 = 87,435 hours.
---------------------------------------------------------------------------

    Commenters also highlighted the fact that the particular supervised
persons for whom the adviser will have to deliver brochure supplements
to particular clients will change over time and that these changes will
generate costs.\335\ The adviser may hire new employees who may begin
providing investment advisory services that require preparation of a
brochure supplement. We estimate that advisers on average will hire two
new supervised persons each year for which a brochure supplement would
have to be prepared.\336\ We further estimate that, on average, an
adviser will spend 0.5 hours preparing each new brochure
supplement.\337\ Preparation of these new supplements thus would
require all advisers to spend 11,658 hours per year.\338\
---------------------------------------------------------------------------

    \335\ See, e.g., Schwab Letter; SIFMA Letter; Sutherland Letter.
    \336\ Estimate is weighted average based on analysis of changes
in aggregate responses to Item 5.B(1) of Part 1A of Form ADV over
the last 5 years and the number of investment advisers registered
with the Commission.
    \337\ See discussion at supra note 311 and accompanying text.
    \338\ Two new supervised persons per year x 0.5 hours per
supplement x 11,658 investment advisers = 11,658.
---------------------------------------------------------------------------

    The revised 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 as
well as creating new supplements for new employees, is estimated to be
approximately 252,002 hours per

year.\339\ This burden represents an increase of 151,026 hours over
that estimated in the Proposing Release.\340\ This increase is
attributable primarily to our increased estimates of the hourly
preparation burden associated with Part 2 in response to comments. As
discussed in the Proposing Release, in addition to these estimated
burdens, under this collection of information there is also a burden of
16,455 hours associated with advisers' obligations to deliver to
clients copies of their adviser codes of ethics upon request.\341\
Thus, the estimated revised total annual hourly burden under this
collection of information would be 268,457 hours.\342\ This represents
an increase of 135,858 hours per year from the currently approved
burden.\343\
---------------------------------------------------------------------------

    \339\ 152,909 hours per year attributable initial preparation of
Form ADV + 87,435 hours per year for amendments to Form ADV + 11,658
hours per year for supplements for new employees = 252,002 hours.
    \340\ Revised burden 252,002 hours - proposing release burden of
100,976 hours = 151,026 hours.
    \341\ See Code of Ethics Adopting Release, supra note 114. As we
estimated in the Proposing Release (and on which we received no
comment), we estimate that only one percent of an adviser's clients
actually request a copy the adviser's code of ethics. 0.01 x 1,300
(the estimated average number of clients per adviser) = 13 requests
per registrant. See infra note 357 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 1.3 hours for each adviser stemming from the obligation to
deliver copies of their codes of ethics to clients. 13 requests per
adviser x 0.10 hours = 1.3 hours/adviser. This obligation applies to
both currently-registered (11,658 respondents) and newly-registered
advisers (1000 respondents), for a total annual burden of 16,455
hours. 12,658 respondents x 1.3 hours = 16,455 hours.
    \342\ 16,455 hours + 252,002 hours = 268,457 hours.
    \343\ Revised burden 268,457 hours - currently approved burden
of 132,599 hours = 135,858 hours.
---------------------------------------------------------------------------

b. Rule 206(4)-4
    Rule 206(4)-4 currently requires advisers to disclose certain
disciplinary and financial information to clients. We are rescinding
rule 206(4)-4 and incorporating its substantive provisions into Part 2
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 Part 2.
2. 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.\344\ The likely respondents to this collection of
information requirement are all of the approximately 11,658 advisers
currently registered with the Commission.
---------------------------------------------------------------------------

    \344\ See section 210(b) of the Advisers Act (15 U.S.C. 80b-
10(b)).
---------------------------------------------------------------------------

    The amendments to rule 204-2 require advisers to prepare and
preserve a memorandum describing any legal or disciplinary event listed
in Item 9 in Part 2A of Form ADV 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. Additionally, the amendments require advisers to
prepare and preserve documentation of the method they use to calculate
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. These records are 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 we stated in the Proposing Release, we believe that the
amendments to rule 204-2 will result in an increased burden of four
hours for each adviser subject to the additional requirements. We
received no comments on the Commission's burden estimates relating to
rule 204-2 and are leaving these estimates unchanged, except to update
collection estimates based on IARD data.
    We estimate that 350 advisers will use a method for calculating
managed assets in Part 2A 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
2A.\345\ We also estimate that 156 advisers will conclude that the
materiality presumption in Part 2 has been 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.\346\
---------------------------------------------------------------------------

    \345\ Based on the Commission staff's conversations with
industry professionals, we anticipate that approximately three
percent of the 11,658 advisers registered with us as of May 3, 2010
will use a method for computing managed assets in Part 2A of Form
ADV that differs from the method used to compute assets under
management in Part 1A of Form ADV. 11,658 advisers x 0.03 = 350
advisers.
    \346\ Approximately 1,559 advisers registered with the
Commission report disciplinary information in Part 1A of their Form
ADV as of May 3, 2010. We anticipate that most of these advisers
will include all disciplinary information in their brochures and
supplements, but that approximately 10% of these advisers, or 156,
will need to prepare and preserve a memorandum explaining their
basis for not disclosing a legal or disciplinary event listed in
Part 2 in their brochures and supplements. 1,559 advisers x 0.10 =
156 advisers.
---------------------------------------------------------------------------

    We estimate that a total of 506 advisers will have to prepare and
preserve additional records in accordance with amendments to rule 204-
2.\347\ Only 487 of these are already accounted for in the currently
approved burden estimate. We estimate that adding 19 advisers to those
subject to the amended provisions of rule 204-2 will yield a 76 hour
increase in burden under the rule.\348\
---------------------------------------------------------------------------

    \347\ 350 advisers that we estimate would prepare memoranda
regarding an alternative method for calculating assets under
management + 156 advisers that we estimate would prepare memoranda
regarding unreported nonmaterial disciplinary events = 506 advisers.
    \348\ 506 advisers-487 advisers = 19 advisers. 19 advisers x 4.0
hours = 76 hours.
---------------------------------------------------------------------------

    The approved annual aggregate burden for rule 204-2 is currently
1,954,109 hours based on an estimate of 10,787 registered advisers, or
181.15 per registered adviser.\349\ Taking into account the estimated
increased burden of 76 hours as discussed above, as well as an increase
of 871 registered advisers,\350\ the revised annual aggregate burden
for all respondents to the recordkeeping requirements under rule 204-2
is therefore estimated to be 2,111,967 total hours.\351\
---------------------------------------------------------------------------

    \349\ 1,954,109 hours/10,787 registered advisers = 181.15 hours
per adviser.
    \350\ As stated above, our IARD data show that as of May 3, 2010
there were 11,658 advisers registered with the SEC. 11,658-10,787 =
871.
    \351\ (1,954,109 current burden hours + 76 hours due to an
increase in the estimated number of registered advisers subject to
additional recordkeeping under the amendments + (871 due to an
increase of total number of registered advisers x 181.15 hours per
adviser)) = 2,111,967. The annual average burden per registered
adviser is therefore 181.16 hours. 2,111,967 total hours/11,658
advisers = 181.16 hours per adviser.
---------------------------------------------------------------------------

    We further estimate that some advisers may incur a one-time cost
for outside legal fees in connection with preparing a memorandum
explaining their basis for not disclosing a legal event listed in Part
2 in their brochures and 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.\352\ We believe that approximately 80 percent of the advisers
preparing such memoranda would likely engage outside legal services to
assist in their preparation.\353\

Thus, we estimate that approximately 125 advisers will incur these
costs, for a total cost among all respondents of $150,000.\354\
---------------------------------------------------------------------------

    \352\ 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.
    \353\ We made the same estimate in the Proposing Release and
received no comment on this estimate.
    \354\ 156 advisers x 0.80 = 125. $1,200 x 125 = $150,000.
---------------------------------------------------------------------------

3. 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 11,658 investment
advisers registered with the Commission.
    Rule 204-3 previously required 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. The rule previously required no further brochure
delivery unless the client accepted 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 require advisers to deliver their
brochures and brochure supplements at the start of an advisory
relationship and to deliver annually thereafter the full updated
brochure or a summary of material changes to their brochure.\355\ The
amendments also require that advisers deliver an amended brochure or
brochure supplement (or just a statement describing the amendment) to
clients only when disciplinary information in the brochure or
supplement becomes materially inaccurate.\356\
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    \355\ See rule 204-3(b).
    \356\ See rule 204-3(b).
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    The total annual burden currently approved by OMB for rule 204-3 is
6,902,278 hours. This currently approved burden is based on each
adviser having, on average, an estimated 670 clients. Our records now
currently indicate that the 11,658 advisers registered with the
Commission have, on average, 1,300 clients.\357\ This change, along
with our amendments permitting annual delivery of a summary of material
changes to the brochure (instead of the entire brochure) alters the
collection of information burden from that currently approved.
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    \357\ This average is based on advisers' responses to Item 5.C
of Part 1A of Form ADV as of May 3, 2010, excluding the three
advisers that reported the largest number of clients. Those advisers
account for over 50% of all advisory clients of SEC registrants and
not excluding them would raise the average client count to 2,576
clients. These three 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.
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    We expect that advisers will send their brochure or summary of
material changes annually in a ``bulk mailing'' to clients that may
include clients' account statements, periodic reports, or other
important documents. We estimate that, with a bulk mailing, an adviser
will require no more than 0.02 hours to send the adviser's brochure or
summary of material changes to each client, or an annual burden of 26
hours per adviser.\358\ Thus, we estimate the total burden hours for
11,658 advisers to distribute their firm brochure to existing clients
initially and annually thereafter to be 303,108 hours per year.\359\ We
have revised our estimate of the amount of time it will take an adviser
to deliver its brochure or summary of material changes based on our
view that most advisers will make their annual delivery as part of the
mailing of an account statement or other periodic report that they
already make to clients, and thus the additional burden will be adding
a few pages to the mailing.
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    \358\ (0.02 hours per client x 1,300 clients per adviser based
on IARD data as of May 3, 2010) = 26 hours per adviser. We note that
the burden for preparing brochures is already incorporated into the
burden estimate for Form ADV discussed above. The Proposing Release
estimated that it would require 0.25 hours to send the adviser's
brochure to each client. Upon further consideration we determined
that it would not take an adviser 15 minutes to mail or e-mail an
adviser's brochure to a client.
    \359\ (0.02 hours per client x 1,300 clients per adviser) x
11,658 advisers based on IARD data as of May 3, 2010 = 303,108
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 583.\360\ We further estimate that an adviser will
require no more than 0.1 hours per client for delivery of each such
update.\361\ This represents about 130 hours per interim update.\362\
Thus, the aggregate annual hour burden for affected advisers to deliver
interim updates to their brochures or supplements will be approximately
75,790 hours per year.\363\
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    \360\ Of the advisers registered with the Commission, 13% report
disciplinary events on their Form ADVs (as of May 10, 2010, only
1,559 of all 11,658 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, 5% of advisers will be required to deliver a single
interim update to each of their clients, resulting in a total of
approximately 583 interim updates per year. 0.05 x 11,658 x 1 update
= 583 updates.
    \361\ 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. Since this mailing may not be included with a
mailing of a statement or other periodic report, we estimate that it
will take slightly more time than to deliver the annual brochure or
summary of material changes. We also revised this estimate based on
our belief that it would only take one or two minutes, not fifteen
minutes to mail a brochure or summary of material changes. See supra
note 358.
    \362\ 0.1 hours per client x 1,300 clients per adviser = 130
hours per update.
    \363\ 583 updates x 130 hours = 75,790 hours.
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    Several commenters noted that some advisers will incur costs in
creating systems to track which brochure supplements need to be
delivered to which clients as supervised persons providing investment
advice to particular clients change over time.\364\ Because most medium
advisers tend to resemble small advisers in terms of the number of
employees providing investment advisory services,\365\ we estimate that
only large advisers will need to design and implement systems to track
changes in supervised persons providing investment advice to particular
clients. We estimate that on average each of the 36 large advisers will
spend 200 hours per year designing and implementing such systems, for a
total of 7,200 hours per year.\366\
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    \364\ See, e.g., Schwab Letter; SIFMA Letter; Sutherland Letter.
    \365\ According to IARD data, only 4% of medium advisers report
in response to Item 5.B(1) of Part 1A of Form ADV that more than 250
employees perform investment advisory functions.
    \366\ 36 large advisers x 200 hours per year per large adviser =
7,200 hours per year.
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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 386,098 hours per
year, or 33.1 hours per adviser.\367\ This represents a decrease of
6,516,180 hours from the currently approved PRA burden.\368\ The
decreased burden results primarily from our revised estimate of the
time it will take firms to deliver their brochures, supplements and
amendments.
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    \367\ 303,108 hours (initial and annual delivery) + 75,790 hours
(interim delivery of updates to disciplinary information) + 7,200
(supplement tracking systems) = 386,098 hours. 386,098 hours/11,658
advisers = 33.1 hours per adviser.
    \368\ 6,902,278 hours - 386,098 hours = 6,516,180 hours.
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VII. Cost-Benefit Analysis

A. Background

    The Commission is sensitive to the costs and benefits of its rules.
This rulemaking will 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 also essentially move into the form itself existing rule
provisions that require advisers to disclose certain disciplinary and
financial information.\369\
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    \369\ Accordingly, the Commission is withdrawing rule 206(4)-4
as duplicative.
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    The amendments require that advisers deliver this narrative
brochure to clients at the outset of the advisory relationship and
deliver an updated brochure or a summary of material changes to that
brochure annually thereafter. Advisers generally will have to deliver
to each client an initial brochure supplement for each supervised
person who provides advisory services to that client. Advisers must
deliver to clients interim updates to their brochure and brochure
supplements that involve a change to disciplinary information required
by Part 2. The rules provide exceptions to the brochure and supplement
delivery requirements for certain types of clients, and excuse the
adviser from preparing a brochure and supplements if there is no client
to whom they must be delivered. The rule amendments 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 rule and form amendments. In the Proposing
Release,\370\ 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. Several commenters thought that the costs
of the proposed annual brochure delivery requirement would be
substantial and would not be offset by a significant corresponding
benefit since they believed that few clients would read the brochure on
an annual basis.\371\ We note that, in response to these concerns, we
have made several changes that are designed to reduce costs to
advisers, including eliminating the proposed requirement for advisers
to deliver an updated brochure annually to clients and instead allowing
advisers to deliver to clients a summary of the material changes made
to the brochure. Several commenters also argued that the Proposing
Release had underestimated the costs of the brochure supplement, and
urged that we not impose this disclosure requirement.\372\ For many of
the same reasons we discussed in the Paperwork Reduction Act section
above, we are revising certain estimates of costs as described below.
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    \370\ See supra note 8.
    \371\ See, e.g., Berlin Letter; CGMI Letter; FSI Letter; Jackson
Letter; Merrill Lynch Letter.
    \372\ See supra note 298 and accompanying text. These commenters
often asserted that the costs of the supplement outweighed any
benefits but did not discuss the benefits the supplement would
provide to clients and how these benefits may outweigh the costs. In
addition to the supplement cost estimates in the Merrill Lynch
Letter and the Morgan Stanley Letter discussed above, the Schwab
Letter estimated that it would cost it in excess of $5 million to
design, build, and implement systems associated with supplement
creation and compliance for its approximately 1,600 investment
advisory representatives. The SIFMA Letter estimated that the
supplement would impose industry-wide costs in excess of $100
million.
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B. Form ADV Part 2 and IARD Filing

    As discussed above, the revisions to Part 2 require substantially
all advisers to prepare plain English narrative brochures.\373\
Advisers file their brochures electronically through the IARD in a
process much like attaching a file to an e-mail.
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    \373\ Under the amendments, advisers that are not required to
deliver a brochure to clients are not 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 or business development companies, therefore, are not
required to prepare a brochure. We estimate, based on information
filed with us on Form ADV, that approximately 292 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 14 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 also would be excused from preparing any brochure
supplements.
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    The new narrative brochures and electronic filing provide
substantial benefits to advisory clients and prospective clients. The
brochures present clients with critically important information they
need to determine whether to hire or continue the services of a
particular adviser. This information will be presented in a uniform
format easy for most investors to understand. Investors searching for
an adviser will be able to access the firm's brochures through our
public disclosure Web site even before contacting the firm, and thus
will be in a better position to know whether they wish to inquire
further about the services the firm is offering or conflicts raised by
the adviser's business activities or practices. The narrative brochure
will enable prospective clients to determine more easily whether they
wish to engage an adviser that does not have certain conflicts, that
does not have a disciplinary history, or that does not engage in
certain business practices. The electronic availability of the
brochures will provide further benefits. Clients will be able to
compare business practices, strategies, and conflicts of a number of
advisers, which may help them to select the most appropriate adviser
for them. Third parties will be able to access adviser brochure
information, which would allow academics, businesses and others to
access additional information about registered investment advisers,
which they can use to study the industry.
    Brochure supplements will provide benefits to clients and
prospective clients by providing them, for the first time, with
information about the educational background, business experience,
disciplinary history (if any) and conflicts of the individuals
providing them with investment advice. This information will allow
clients and prospective clients to determine whether there are
safeguards or precautions that they would like to take before receiving
investment advice from that person or whether they would prefer to
receive investment advice from someone else. A prospective client could
be satisfied with its selection of an advisory firm based on the firm
brochure disclosures, but then determine that the firm is not the right
fit once he or she reviewed the supplements of the actual individuals
that would provide investment advice to him or her. Alternatively, the
prospective client could retain the firm but request that other
individuals provide advice in their place, potentially preventing
costly or disruptive replacement or termination at a later date. This
is a substantial improvement over the more limited information
available today to clients and prospective clients about individuals in
which clients place great trust.
    To the extent that clients and prospective clients feel more