Rule 204-3 Supporting statement - (Jan, 2016 Extension)

SUPPORTING STATEMENT
For the Paperwork Reduction Act Information Collection Submission for
Rule 204-3
A.

JUSTIFICATION
1.

Necessity for the Information Collection

Rule 204-3, the “brochure rule,” requires an investment adviser to deliver its
brochure and brochure supplements to its new clients or prospective clients before or at
the start of the advisory relationship and to deliver annually thereafter the full updated
brochure or a summary of material changes to its brochure. The rule also requires 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.

The brochure assists the client in

determining whether to retain, or continue employing, the adviser. Advisers registered with
the Commission are required to prepare and electronically file firm brochures through the
Investment Adviser Registration Depository (“IARD”).
Rule 204-3 contains a collection of information titled “Rule 204-3 under the
Investment Advisers Act of 1940,” found at 17 CFR 275.204-3, which is mandatory. Its
currently approved OMB control number is 3235-0047. An agency may not sponsor, and a
person is not required to respond to, a collection of information unless it displays a currently
valid OMB control number. The likely respondents to this information collection are
investment advisers registered with the Commission.
The collection of information the brochure rule requires is necessary for several
reasons. It enables the client or prospective client to evaluate the adviser’s background
and qualifications, and to determine whether the adviser’s services and practices are

appropriate for that client. It informs the client of the nature of the adviser’s business,
which may inform or limit the client’s rights under the advisory contract. It apprises the
client of situations in which the interests of the adviser may potentially be adverse to or in
conflict with those of the client. Under some circumstances, it enables the client to
consider the financial condition of the adviser in deciding whether to entrust funds or
securities to the custody of the adviser or whether to pay large advisory fees in advance.
The information that Rule 204-3 requires to be contained in the brochure is also used by
the Commission and staff in its enforcement, regulatory, and examination programs.
Responses are not kept confidential.
2.

Purposes of the Information Collection

Investors need accurate information about an investment adviser and its practices
in order to determine whether to retain, or to continue to employ, that adviser. The
Commission and staff need the information in its enforcement, regulatory, and
examination programs.
3.

Consideration Given to Information Technology

The Commission’s use of computer technology in connection with this
information collection, which has been previously approved by OMB, has not changed.
The Commission currently permits advisers to satisfy their obligations under this
collection of information by delivering Part 2 of Form ADV electronically with client
consent. 1
4.
1

Duplication

See 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)) (publishing Commission interpretive guidance
with respect to use of electronic media to fulfill investment advisers’ disclosure delivery
obligations).

2

The collection of information requirements of rule 204-3 are not duplicated
elsewhere.
5.

Effect on Small Entities

The requirements of rule 204-3 are the same for all investment advisers registered
with the Commission, including those that are small entities.2 To some extent small
advisers may have lesser burdens under rule 204-3. This is because small advisers
usually have less complicated business practices, fewer employees, and fewer clients, and
therefore their brochures and brochure supplements would be shorter, and would be
delivered to fewer clients.
6.

Consequences of Less Frequent Collection

The collection of information required by the rule is necessary to protect investors
by providing clients and potential clients with information about the adviser, its business,
and its conflicts of interest. The consequences of not collecting this information would be
that clients and prospective clients may not have the information they need in order to
evaluate the adviser’s business practices and to determine whether to select or retain that
adviser.
7.

Inconsistencies with Guidelines in 5 CFR 1320.5(d)(2)

The collection of information imposes no additional requirements regarding record
retention.
2

Under Advisers Act rule 0-7, for purposes of the Regulatory Flexibility Act an
investment adviser generally is a small entity if it: (i) Has assets under management of
less than $25 million; (ii) did not have total assets of $5 million or more on the last day of
its most recent fiscal year; and (iii) does not control, is not controlled by, and is not under
common control with another investment adviser that has assets under management of
$25 million or more, or any person (other than a natural person) that had total assets of $5
million or more on the last day of its most recent fiscal year.

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8.

Consultations Outside Agency

The Commission and the staff of the Division of Investment Management
participate in an ongoing dialogue with representatives of the investment adviser profession
through public conferences, meetings, and informal exchanges. These various forums
provide the Commission and the staff with a means of ascertaining and acting upon
paperwork burdens facing the industry.
The Commission requested public comment on the collection of information
requirements in rule 204-3 before it submitted this request for extension and approval to the
Office of Management and Budget. The Commission received no comments in response to
its request.
9.

Payment or Gift

None.
10.

Confidentiality

The information collected pursuant to rule 204-3 is by delivery of brochures and
brochure supplements to advisory clients and prospective clients. These disclosures are
not kept confidential.
11.

Sensitive Questions

No PII collected/Not applicable.
12.

Burden of Information Collection

Rule 204-3, the “brochure rule,” requires an investment adviser to deliver its
brochure and brochure supplements to its new clients or prospective clients before or at
the start of the advisory relationship and to deliver annually thereafter the full updated
brochure or a summary of material changes to the brochure. The rule also requires that

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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.
The total annual burden currently approved by OMB for rule 204-3 is 331,456
hours. This currently approved burden is based on 10,754 advisers registered with the
Commission having, on average, an estimated 1,200 clients each. Our records now
indicate that the 11,956 advisers registered with the Commission have, on average, an
estimated 1,494 clients. 3 We are updating and revising the total collection of information
burden based upon new data. 4
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 continue to 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 30 hours per adviser. 5

3

This average is based on advisers’ responses to Item 5.C.(1) of Part 1A of Form ADV as
of January 4, 2016, excluding the three advisers that reported the largest number of
clients. Those advisers 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.

4

The data are collected from the Form ADVs filed through the IARD system January 4,
2016.

5

(0.02 hours per client x 1,494 per adviser based on IARD data as of January 4, 2015) =
approximately 30 hours per adviser. We note that the burden for preparing brochures is
already incorporated into a separate burden estimate for Form ADV. Since we expect
that most advisers will make their annual delivery as part of a mailing of an account
statement or other periodic report they already make to clients, we estimate that the
additional burden will be adding a few pages to the mailing.

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Thus, we estimate the total burden hours for 11,956 advisers to distribute their firm
brochure to clients annually to be approximately 357,245 hours per year. 6
Advisers are also 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 598. 7 We further estimate that an adviser will require no more than 0.1
hours per client for delivery of each such update. 8 This represents about 150 hours per
interim update. 9 Thus, the aggregate annual hour burden for affected advisers to deliver
interim updates to their brochures or supplements will be approximately 89,700 hours per
year. 10 We estimate that large advisers will need to design and implement systems to
track changes in supervised persons providing investment advice to particular clients.
We do not expect that such systems will be necessary for small advisers or medium

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(0.02 hours per client x 1,494 clients per adviser) x 11,956 advisers based on IARD data
as of January 4, 2016 = approximately 357,245 hours.

7

Of the advisers registered with the Commission, 13% report disciplinary events on their
Form ADVs (as of January 4, 2016, only 1,594 of all 11,956 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 598 interim
updates per year. 0.05 x 11,956 x 1 update = 598 updates.

8

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 a separate burden estimate for Form ADV.
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.

9

0.1 hours per client x 1,494 clients per adviser = approximately 150 hours per update.

10

598 updates x 150 hours = 89,700 hours.

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advisers. 11 We estimate that on average each of the 96 large advisers will spend 200
hours per year designing and implementing such systems, for a total of 19,200 hours per
year. 12 Thus, rule 204-3 now results in a total collection of information burden of
466,145 hours per year, or approximately 39 hours per adviser. 13 This includes estimated
time for large advisers to design and implement systems to track that the right
supplements are delivered to the right clients as personnel providing investment advice to
those clients change. This represents an increase of 134,689 hours from the currently
approved PRA burden. 14

The increase burden results primarily from an increase in the

number of advisers that are required to deliver their brochures, supplements and
amendments. We estimate the burden associated with annual and interim delivery of
brochures, supplements and the summary of material changes would represent an annual
cost of $26,570,265. 15

11

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. According to IARD
data, only 1.56% 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.

12

96 large advisers x 200 hours per year per large adviser = 19,200 hours per year.

13

357,245 hours (initial and annual delivery) + 89,700 hours (interim delivery of updates to
disciplinary information) + 19,200 (supplement tracking systems) = 466,145 hours.
466,145 hours / 11,956 advisers = approximately 39 hours per adviser.

14

466,145 hours – 331,456 hours = 134,689 hours.

15

Based on data from the Securities Industry and Financial Markets Association’s Office
Salaries in the Securities Industry 2013, modified to account for an 1,800-hour work-year
and multiplied by 2.93 to account for bonuses, firm size, employee benefits and
overhead, we expect that delivery requirements of rule 204-3 will most likely be
performed by a clerk at an estimated cost for a general clerk of $57 per hour. 466,145
hours x $57 = $ 26,570,265. We estimate that advisers will not incur any incremental
postage costs in these mailings because we assume that advisers will mail annual
summary of material changes with another mailing the adviser was already delivering to
clients and that advisers were already delivering to clients disclosure of new material
disciplinary events on an interim basis under rule 204-3.

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13.

Costs to Respondents

$0.
14.

Costs to Federal Government

There are no costs to the government directly attributable to rule 204-3.
15.

Changes in Burden

The estimated total burden hours has increased to 466,145 hours per year from the
currently approved burden based on new information on the number of SEC-registered
investment advisers that we obtained from Form ADVs filed through the IARD as of
January 4, 2016.
16.

Information Collection Planned for Statistical Purposes

Not applicable.
17.

Approval to Omit OMB Expiration Date

The Commission is not seeking approval to omit the expiration date.
18.

Exception to Certification

Not applicable.
B.

COLLECTIONS OF INFORMATION EMPLOYING STATISTICAL
METHODS
Not applicable.

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