Beginning in 2020, registered investment adviser ("RIA") firms registered with the Securities and Exchange Commission ("SEC") that serve retail investors are required to file and share the new Form ADV Part 3 (commonly referred to as the Form CRS) with their current and prospective retail investors. During regulatory examinations, regulators commonly cite mismatches and inaccuracies between the Form ADV Parts 1 and 2 as one of the most common regulatory compliance deficiencies. With the new Form ADV Part 3 requirement, the potential for deficiencies related to Form ADV inconsistency among the Form ADV Parts 1, 2, and 3 will grow significantly.
Historically, a common compliance mistake is that a firm’s Form ADV Part 1 does not match its Form ADV Part 2. During regulatory exams, both state and Securities and Exchange Commission ("SEC") examiners often find inconsistencies in the Form ADV including different fees charged than fees listed, services provided, incorrect assets under management, and more. For example, the 2019 Investment Adviser Coordinated Examinations Report published by the North American Securities Administrators Association listed inconsistencies between the Form ADV Part 1 and Part 2 as the most commonly cited registration-related investment adviser regulatory compliance deficiency.
Generally, new RIA firms will file an initial Form ADV that accurately reflects its business at the time of the firm's initial registration. However, as time passes, many RIA firms failed to update their Form ADV as the business evolves to reflect its current fee structure, services offered, assets under management, new conflicts of interest, etc. Now, when making filing document amendments, investment advisory firms not only must make sure the firm's Form ADV Part 1 and Part 2 are up to date and consistent with each other, but also that its Form ADV Part 3 reflects the same information.
The new two-page Form ADV Part 3, more commonly referred to as the Form CRS has five mandated sections:
- Relationship and Services
- Fees, Costs, Conflicts, and Standard of Conduct
- Disciplinary History
- Additional Information
As your firm begins to construct its Form CRS, it is great time to review the accuracy your firm’s current Form ADV Part 1 and Part 2, and make the required changes to ensure the information listed is consistent across both parts of the Form ADV. This is a crucial prerequisite before constructing the new Form CRS which is required to makes reference to a number of items on the Form ADV Parts 1 and 2. These references on the Form CRS include:
- Item 2.C: Form ADV Part 2A (Items 4 and 7 of Part 2A or Items 4.A and 5 of the Part 2A Appendix 1)
- Item 3.A(i): Form ADV Part 1A, Item 5.E.
- Item 3.A(iii): Form ADV Part 2A (Items 5.A., B., C., and D.)
- Item 3.B(iv): Form ADV Part 2A
- Item 4.B(i): Form ADV Part 1A, Item 11 or Form ADV Part 2A, Item 9
While a mismatching Form ADV Part 1 and Part 2 is a frequent compliance misstep for firms, it is one that can easily be avoided. As a best practice, it is recommended that investment advisers regularly review the Form ADV and record all changes within the business on an ongoing basis to facilitate easy updates when necessary. A well-constructed Form ADV is not only essential in helping to properly educate and inform prospective clients, but also an excellent opportunity to make a positive impression on examiners as it is the first document that they review before performing a regulatory audit.