No matter what form of investment advisory firm you have, completing Form ADV is a necessity. As a reminder, Form ADV is the form used by investment advisers to register with both the SEC and state securities regulators (see our June 12, 2019 post for more detail). Today’s post deals with the particularities of one component of Form ADV, Part 2B or the brochure supplement, and its unique application to robo-advisers.

First, we’ll briefly discuss the requirements of the brochure supplement and how it is handled in a traditional investment firm. Then, we’ll discuss how the brochure supplement applies to robo-adviser firms, given the unique nature by which a robo-adviser firm provides investment advice.

As we discussed in our previous post, Form ADV includes two parts, Parts 1 and 2. Part 2 of Form ADV is further sub-divided into two separate parts:  Part 2A, known as the brochure, and as noted, Part 2B, or the brochure supplement. Unlike Part 2A, which must be filed with the relevant regulator (e.g., the SEC) and is publicly available, the brochure supplement is not required to be filed by SEC registrants. A brochure supplement must be provided to each client of an investment adviser, except for (i) clients not required to receive a brochure (or wrap fee program brochure), like investment company clients; (ii) clients who only receive impersonal investment advice, even if they receive a brochure; and (iii) clients who are executive officers of the firm and employees who have been performing duties for the firm for at least 12 months.

In a brochure supplement, an investment adviser must provide information for each individual that it supervises who; (i) formulates investment advice for the client and has direct client contact; or (ii) makes discretionary investment decisions for the client’s assets, even if the supervised individual has no direct client contact. A brochure supplement requires that an individual disclose information related to educational and business background, any disciplinary history, other business activities, any basis for additional compensation, and information disclosing how the individual is supervised at the firm. In a traditional investment adviser/client relationship, where investment advice is being communicated directly from investment adviser personnel to the client, the decision as to who to include in a brochure supplement is typically straightforward. However, in the case of your robo-advisory firm, that decision is murkier.

Unfortunately the SEC has yet to provide guidance in this context. This places the onus on robo-advisory firms to determine which of its employees should be included on a brochure supplement. Given that robo-advisers utilize automated algorithms (not people) to formulate investment advice for clients and select investments their portfolios, neither prong of the brochure supplement requirement seems to apply. However, robo-adviser firms do employ or contract with individuals who design, test, and maintain algorithms that create the advice provided to clients. At present, industry best practice is for firms to create brochure supplements for such individuals.  For a small robo-advisory firm, this is likely a manageable task because the number of individuals is limited. For larger firms, with teams devoted to algorithm maintenance, the task of brochure supplement compliance becomes much larger. While the brochure supplement stipulates that if investment advice is provided by a team comprised of more than five supervised individuals, brochure supplements need only be provided for the five supervised individuals with the most significant responsibility for the day-to-day advice provided to the client, the tasks of making that determination may still be a challenge. If you find yourself with questions regarding the brochure supplement, the best course of action is to consult with a legal or compliance professional.

We hope you’re enjoying the blog so far! Please check back soon to read my colleague, Craig Foster’s next piece covering investment adviser representative licensing.