We are going to talk a little bit about Form ADV today. What is an ADV? If you don’t know the answer, don’t feel bad. Most investors, even many financial professionals, are not familiar with it. Form ADV is the uniform form used by investment advisers to register with both the Securities and Exchange Commission (SEC) and state securities authorities. It tells you about all aspects of a firm’s practice, including the types of the advisory services offered, the adviser’s fee schedule, conflicts of interest, disciplinary information, and more.  

SEC states on their website, “before you hire someone to be your investment adviser, always ask for, and read carefully, both parts of the adviser’s Form ADV. “

Why is it important for investors to read this form? In the financial service industry, a firm can have as many arrangements as it likes that result in conflicts of interests, as long as they’re legal and compliance with applicable rules.  And if the firm does not adhere to the fiduciary standard, it will not feel obligated to put investors’ interest first. Luckily, however, Registered Investment Advisers are required to disclose all arrangements that result in conflicts of interests in their ADV. 

Let me give you another example, say you are considering two advisors: Advisor A and Advisor B. Advisor A quotes you 1% to manage your assets, while Advisor B quotes you 0.5%. Does Advisor B charge you less? NOT necessarily. Some financial advisory firms’ main source of revenues comes not from fees earned from their advisory services, but from proprietary product sales, commissions and kick-backs from product companies. In other words, they can charge you 0% for advisory services but still, potentially, make a lot of money from you at the cost of your investment return. One big Wall Street Firm reported in their ADV in 2016 that on annual basis, less than 1% of their revenue was actually from their consulting services. It’s principal sources of income, which includes commissions and other compensation for the sale of investment products, are derived from its business as a broker-dealer.  

In the financial service industry, talk is cheap. That’s why it’s important to read the writing on the wall. And the only writing you can trust is what’s required to be on the Form ADV.             

The form consists of two parts: Part 1 is the check-the-box section, used mainly by the SEC for regulatory purpose. Part 2 is the narrative brochure that you, as the investor, should read carefully.

The SEC requires investment advisers to prepare Part 2 using plain English, and the layout is quite standard. Here are some highlights of Part 2: Item 4 describes a firm’s Advisory Business and Item 10 lists the company’s other financial industry activities and affiliations.  If a company produces proprietary products as part of the financial advisory business, they generally will disclose it in item 4, or a company can have one subsidiary to produce proprietary products and another subsidiary, the investment advisor, as the sales force to sell the products, then they will disclose it in Item 10. In either cases,  it is important that you watch out for potential conflicts of interest as firms often have incentives to push their proprietary products vs. the alternatives.  

Another important item is Item 15, Custody. Personally, I cannot emphasis enough the importance of having an independent third-party custodian to custody your assets. A custodian is a financial institution that holds customers’ securities for safekeeping to minimize the risk of theft or loss. Custodians are also required to send you official account or portfolio statements. One article on US News stated that “ Bernie Madoff’s failure to use an independent custodian enabled him to defraud investors for so many years. If an adviser tells you that you don’t need (a third party custodian) ,end the meeting and leave immediately. This is a deal-killer and should raise many red flags.”  There are many other benefits to segregating asset management from asset custody—safe guarding is just one of them. 

As a public document, the ADV can also be obtained by visiting the following link. 

http://www.adviserinfo.sec.gov/