Ep.1: The ADV Trap: Common Mistakes That Could Cost You—And How to Avoid Them

Intro (00:00):

This is Adviser Intelligence, the podcast for investment advisers and financial institutions. In each episode, attorneys from your investment management and securities team break down compliance, regulation, and risk into practical insights that help you stay exam ready and ahead of what’s next. This podcast is brought to you by Stark & Stark.

Joseph Antonakakis, Esq. (00:29):

Welcome to the Adviser Intelligence Podcast by Stark & Stark. My name’s Joseph Antonakakis.

Stephen Galletto, Esq. (00:36):

I’m Steven Galletto.

Jeffrey Lang, Esq. (00:37):

And I’m Jeffrey Lang.

Joseph Antonakakis, Esq. (00:39):

And today we’re going to talk about common pitfalls that we see on Form ADV, the ADV part one, part 2A, and Form CRS. Why don’t we kick things off with ADV part one? And we’ll preface all this by saying we work with advisers across the country, hundreds of them.

Stephen Galletto, Esq. (00:58):

State and SEC registered to everybody.

Joseph Antonakakis, Esq. (01:00):

All of whom have to file these ADV filings.

Stephen Galletto, Esq. (01:04):

Right. If they want to stay registered, they do.

Joseph Antonakakis, Esq. (01:06):

If they want to stay registered.

Jeffrey Lang, Esq. (01:08):

So Joe, I know we’re going to talk today about all the different parts of the Form ADV. Why is this a timely conversation right now?

Joseph Antonakakis, Esq. (01:14):

Well, that’s a great question for two reasons, because as of the time of this recording, the SEC just put out their 2026 exam priorities and they’ve listed ADV and policies and procedures and other regulatory documents as priorities during examinations as they do every year. And the second reason is hopefully this podcast at the time the guests are listening is going to be ADV filing season.

Jeffrey Lang, Esq. (01:43):

Right.

Joseph Antonakakis, Esq. (01:43):

And so that’s the other reason why we’re talking about it today.

Jeffrey Lang, Esq. (01:45):

So for most people, once January 1st rolls around and I’m through March 31st, it’s all on with the ADV. Got to get it done and got to get it offered or delivered out after that. But this time of year, it’s all about the ADV.

Stephen Galletto, Esq. (02:02):

Within 90 days of your fiscal year end, you have to make sure your ADV annual amendment’s submitted and filed. And then within 120 days of your fiscal year end, you have to make sure you’re actually delivering that or offering to deliver that to all your clients. So it’s important to make sure you know one, what you’re doing so you can get it done quickly, promptly, and accurately.

Joseph Antonakakis, Esq. (02:21):

And if you don’t know what you’re doing, hiring attorneys who do.

Stephen Galletto, Esq. (02:23):

Right. That’s where we come in.

Joseph Antonakakis, Esq. (02:25):

That’s right.

Stephen Galletto, Esq. (02:27):

So Joe, when you’re helping someone draft an ADV, what is probably the biggest hurdle for the people you’re working with? For me, and again, I’ve been doing this for a lot of years, 17 years. The biggest hurdle usually ends up being, is this an asset under management? How do I classify this under 5D? What type of client relationship is this? Is this discretionary or non-discretionary?

Joseph Antonakakis, Esq. (02:55):

And just for the record, you’re talking about ADV part one right now.

Stephen Galletto, Esq. (02:59):

Correct. Well, the assets under management also show up on the ADV part two as well. But trying to get the assets broken out in a particular way where, again, you can justify it when the SEC steps into your office and says, “Show me where all of these assets are coming from. Show me what these relationships actually are. ” Again, there are some gray areas where you can move the assets from one type of client relationship to another. Maybe you count the assets, maybe you don’t, but having a narrative and being able to actually explain how you get to the numbers that you display on your ADV part 1 is essential.

Joseph Antonakakis, Esq. (03:39):

Yeah. And I’ve actually seen that come up in exams over the past several years where the SEC will come in and say, “Okay, how do you justify having three billion in assets under management? Break it down for me. Show me, in some cases, show me those accounts and prove it.

Stephen Galletto, Esq. (03:52):

So Jeff, what’s the difference between discretionary assets under management and non-discretionary?

Jeffrey Lang, Esq. (03:58):

Okay. The difference between discretionary assets under management and non-discretionary assets under management is if I have discretionary assets under management, that means I can manage and trade on those assets without first getting the client’s consent. I can just basically place the trades. If I have a non-discretionary arrangement, that means that I can still manage the assets, but I have to get the client’s consent before I place the trades.

Stephen Galletto, Esq. (04:28):

Great. So either way, you need to be able to transact on these assets for them to be assets under management in the first place, right?

Jeffrey Lang, Esq. (04:34):

That’s right.

Stephen Galletto, Esq. (04:34):

Right. And if you can do it without talking to the client first, you have discretionary authority, right, Joe?

Joseph Antonakakis, Esq. (04:39):

That’s correct.

Stephen Galletto, Esq. (04:39):

Great. So what do we do in a situation where we have a discretionary agreement with a client? It’s the only agreement we have detailing what the relationship is with that client. And we have some accounts where the client wants to have the adviser reach back out to them before they actually trade. There’s a side arrangement on those separate accounts or other instances where the adviser has brought the client to a private fund or something like that. The adviser’s not signing off on subscription documents. No one’s going to do that. You shouldn’t do that. See, break the fourth wall when it makes sense. But in that instance where you don’t actually have the authority to sign the actual subscription docs on behalf of clients, do you really have transactional authority? Are those really discretionary assets under management, right? And if you’re going to count those as discretionary assets under management, even though we have no authority to do anything on a discretionary basis with those relationships, how do we justify that?

(05:41):

Now, what I’ve done, again, I’ve looked at the totality of the relationship with the underlying client. What is the client expecting of you as the adviser? Would the client answer a question, posed to them?

(05:59):

Is your adviser acting with discretion? Would the client say yes? If so, I think we’re in a safer space counting all those assets as discretionary assets under management, even when we’re dealing with private fund assets. Jeff, what do you think?

Jeffrey Lang, Esq. (06:13):

I agree. I think that the way to approach it is say, “What is my ultimate arrangement with the client?” Gee, there might be circumstances where I may reach out to them and double check on certain items before I take action. But to your point, looking at the totality of the arrangement, what does my agreement with that client set forth that I’m going to do? So how is it documented? And that’s largely how it’s going to play out for me on the ADV.

Joseph Antonakakis, Esq. (06:43):

May I shift gears for a moment? Staying on the ADV part one. Can we talk about another pitfall, which is item nine? Custody. The custody section.

Stephen Galletto, Esq. (06:52):

Yes. Ooh, the dreaded custody.

Joseph Antonakakis, Esq. (06:54):

Yes. Dreaded custody. Jeff, would you mind giving us the lowdown on the different types of custody?

Stephen Galletto, Esq. (07:02):

Low down or down low?

Joseph Antonakakis, Esq. (07:04):

I think it’s the lowdown.

Stephen Galletto, Esq. (07:05):

The lowdown.

Joseph Antonakakis, Esq. (07:06):

We can look that up afterwards.

Stephen Galletto, Esq. (07:07):

Fair enough. Jeff.

Jeffrey Lang, Esq. (07:08):

So you have item 9A and item 9B. Custody by the firm and custody by related persons of the firm. And what’s custody? Custody is going to be when I’m a trustee over accounts. I’m a power of attorney over accounts. I have username and password ID. Maybe I do some bill pay.

Joseph Antonakakis, Esq. (07:29):

You receive checks. Receive checks.

Stephen Galletto, Esq. (07:31):

Third party checks made payable.

Jeffrey Lang, Esq. (07:33):

Third party checks made payable, but not where I send them out to the custodian right away.

Stephen Galletto, Esq. (07:38):

Right.

Jeffrey Lang, Esq. (07:38):

But so-

Stephen Galletto, Esq. (07:39):

Hold on. Third party checks made payable where you send the checks to the custodian, you’re not candling his custody?

Jeffrey Lang, Esq. (07:45):

If the check is made payable to the custodian and I get that check out right away-

Stephen Galletto, Esq. (07:51):

Mr. Smith writes a check payable to the custodian or Mr. Smith writes a check payable to Mr. Smith’s custodial account for deposit only. That wouldn’t be custody.

Jeffrey Lang, Esq. (08:01):

Not custody.

Stephen Galletto, Esq. (08:01):

But the IRS sends a check back on behalf of Mr. Smith, paying Mr. Smith. Mr. Smith signs the back of the check endorsing it for deposit only. That would be custody.

Jeffrey Lang, Esq. (08:11):

Custody.

Stephen Galletto, Esq. (08:11):

Custody.

Jeffrey Lang, Esq. (08:12):

Custody.

Stephen Galletto, Esq. (08:13):

Cutody.

Jeffrey Lang, Esq. (08:13):

So if we have custody. So if we have custody, we’re counting the number of clients and the amount of assets over which we have custody. Now there’s a nuance. The nuance is standing letters of instructions, standing letters of authorization to third parties. And if we follow the Schwab no action guidance with respect to these standing letters of authorization, then these would be reportable as custody at item nine, but they will not trigger the need for a surprise exam, an annual surprise custody exam.

Stephen Galletto, Esq. (08:50):

Right. So that no action letter is from 2017. Everyone listening to the podcast should know full well about that, that no action letter, unless you’re new to the business, in which case it’s totally fine. If you’re new to the business, by the way, all of this is going to be brand new to you. You’re not going to have seen this before. This is after years and years and sometimes decades of experience feeling out how the SEC views these questions. It takes time to develop this feel, which is why it’s important to listen to stuff like this, to ask questions, honestly. If anyone listening to this has any questions about any of this, please feel free to reach out to any of us or anyone else that’s part of our team. We see a lot of these questions. We navigate this all the time.

Jeffrey Lang, Esq. (09:32):

Right. And a lot of questions we get is, “Well, hey, what’s the difference between 9A and 9B?” So we’re talking about the same custody qualifications, but 9A is when the firm has custody. 9B is when related parties of the firm have custody. What’s related party? Related party could be your related accounting firm, related entity, or it could be the individuals of the firm. So it could

Joseph Antonakakis, Esq. (09:59):

So if somebody’s like a power of attorney or executor.

Jeffrey Lang, Esq. (10:03):

Right. Individually. And not on behalf of the firm, individually playing that role is going to go in 9B.

Stephen Galletto, Esq. (10:10):

Which creates custody for the firm either way.

Jeffrey Lang, Esq. (10:11):

Either way.

Stephen Galletto, Esq. (10:12):

And you have to undergo the surprise CPA exam, which will set you back between eight and 15 grand.

Jeffrey Lang, Esq. (10:17):

Right.

Stephen Galletto, Esq. (10:18):

And also- It gets reported in- Hours of your life you will never get back. Right. Yes.

Joseph Antonakakis, Esq. (10:23):

So custody, you get an SEC, surprise custody exam by a CPA.

Jeffrey Lang, Esq. (10:28):

Right.

Joseph Antonakakis, Esq. (10:30):

Standing letters of authorization like you were talking about, Jeff, no custody exam required.

Jeffrey Lang, Esq. (10:35):

As long as you follow that no action guidance.

Joseph Antonakakis, Esq. (10:38):

Precisely.

Stephen Galletto, Esq. (10:38):

Right. So just taking a step back, that no action letter from 2017 has seven bullet points. Five of which you have zero control over. Those are all going to fall squarely on the custodian, right? So Schwab, Fidelity, whoever you’re working with, you’re going to make sure that they are backing up each one of those five bullet points off of the no action letter. The two that you have to make sure that you are complying with are one, you are not the third party that is receiving the payment pursuant to that standing letter of authorization. And two, the check doesn’t come through your office. It goes directly to that third party. You don’t want to take possession of that check that’s going to be delivered to that third party.

Joseph Antonakakis, Esq. (11:18):

Why don’t we talk now about Form ADV part 2A and 2B? We’ve discussed all the pitfalls involved with part one. Part 2A and 2B, what are some things you’re seeing where people get it wrong? We talked about assets under management. That’s going to be item four.

Stephen Galletto, Esq. (11:32):

Right.

Joseph Antonakakis, Esq. (11:34):

I see folks struggle with item five where they post their fees. And the SEC hones in on this as well because they come in and one of their primary questions is, are you accurately disclosing your fee to your clients? And item five of ADV part 2A is where you do that.

Stephen Galletto, Esq. (11:52):

Right. So there’s a lot of different ways you can adjust the way in which you’re calculating a fee and you need to be cognizant of it. So a few years back, folks started leaning on third party systems and tools to start helping, to start help them calculate client fees, right? Adjusting for inflows and outflows, factoring in accrued interest and accrued dividends. Your investment advisory agreement in all likelihood is not going to say you do all of these things. It’s not going to have a specific inflow and outflow limit for when you’re going to make adjustments to the overall fee.

Joseph Antonakakis, Esq. (12:26):

That’s what goes into the part 2A.

Stephen Galletto, Esq. (12:27):

Correct. Well, I mean, that’s been our solution for it. Otherwise, you’re constantly putting out amendments to your investment advisory agreement to your client. And from my perspective, investment advisers want to have the least amount of paperwork in front of their clients as possible. We run out of that all the time. To the extent that we can minimize either communicating an amendment or requiring a re-execution of the investment advisory agreement, we want to do that. So we can put language in item five, clarifying how fees are being calculated. And for the most part, be able to lean on that and satisfactorily get through an SEC examination on those points.

Joseph Antonakakis, Esq. (13:08):

Yeah. If you don’t mind, I want to shift gears one more time. To talk about my favorite regulatory filing. Form CRS.

Stephen Galletto, Esq. (13:18):

That is my least favorite regulatory filing.

Joseph Antonakakis, Esq. (13:20):

Form CRS is my favorite. Because it’s short and sweet like me. And-

Stephen Galletto, Esq. (13:26):

I’m going to vomit. Can we get a bag over here? That’s terrible.

Joseph Antonakakis, Esq. (13:32):

God. All right. My favorite regulatory filing is Form CRS. And the reason why is because it’s an easy filing, but it’s easy to get wrong. Let me talk for just a second what’s required. Number one, it is strictly limited in the rule to two pages. If your form CRS is longer than two pages, you’re doing something wrong. Unless you have a third material changes page that

Stephen Galletto, Esq. (14:00):

Or you’re also a broker dealer. Filing a four page combined.

Joseph Antonakakis, Esq. (14:04):

Precisely.

Stephen Galletto, Esq. (14:05):

Right. But for the most part, many of our listeners probably won’t have that issue.

Joseph Antonakakis, Esq. (14:11):

You never know who’s listening.

Stephen Galletto, Esq. (14:12):

You’re right.

Joseph Antonakakis, Esq. (14:14):

But to your point, correct. There are some circumstances where it is longer than two pages, but in the majority of circumstances, you’re limited to two pages, plus a third material changes page to outline any material changes.

Stephen Galletto, Esq. (14:27):

Why I do not like the form CRS is because three quarters of the form CRS is dictated language. I have form CRSs in order to keep it to that two page maximum, the font needed to be adjusted down to like 8.75. The spacing gets augmented. And quite honestly, I always feel like I don’t have enough space to get everything in there. So I’m always reverting back or pointing back to specific sessions of the ADV part 2a.

Joseph Antonakakis, Esq. (14:57):

Which you’re also supposed to do in Form CRS.

Stephen Galletto, Esq. (14:59):

Right. But at the same time, what’s the point then?

Joseph Antonakakis, Esq. (15:02):

The part of the form CRS that I see people get wrong the most is item four as it relates to disciplinary history.

Stephen Galletto, Esq. (15:09):

Why?

Joseph Antonakakis, Esq. (15:11):

The reason why is because whether a firm has some disciplinary history listed on their ADV or an individual has a disciplinary history listed on their form U4, people struggle and say, “I don’t see why this particular item should appear on my form CRS. I don’t know why I need to say yes that I have disciplinary history.”

Stephen Galletto, Esq. (15:33):

It’s just a yes or no. If you have 30 investment advisers, odds are someone did something stupid in college, right? I mean, this is what it boils down to, right? If there was ever a disclosure that needed to stick on someone’s Form U4, and there are forever disclosures on the Form U4, were you ever charged with a felony? Okay, that one time I was charged with a felony. That needs to be a yes on the Form CRS. I’m sorry. You can fight that all you want, but that’s not going to change.

Jeffrey Lang, Esq. (16:01):

Even if it’s from 1994.

Stephen Galletto, Esq. (16:03):

Felony is a felony is a felony.

Joseph Antonakakis, Esq. (16:05):

Well, depends on the question.

Stephen Galletto, Esq. (16:06):

Except for Florida. If a felony happens in Florida, sometimes it doesn’t actually happen. True story.

Joseph Antonakakis, Esq. (16:13):

No comment on felonies that may or may not have occurred in Florida. Yeah.

Jeffrey Lang, Esq. (16:17):

The other thing to keep in mind with Form CRS that pops up a lot in exams is looking at your Form CRS and the specific information, pricing, describing your programs and whatnot, and making sure that it’s consistent with what’s being said in Form ADV Part 2A. Very important to match that up.

Joseph Antonakakis, Esq. (16:35):

Yeah. Regulators look at that and they’ll say, “Okay, why does your ADV say that your fee range is 50 basis points to 100 basis points, but your CRS says it’s…”

Stephen Galletto, Esq. (16:45):

Up to?

Joseph Antonakakis, Esq. (16:47):

Well, that, or it could say, why does it say it’s 75 basis points to 100 basis

Stephen Galletto, Esq. (16:51):

Points? And that’s just wrong.

Joseph Antonakakis, Esq. (16:52):

That’s a material inaccuracy. You want to make sure to Jeff’s point that it’s accurate.

Stephen Galletto, Esq. (16:56):

Right. Again, I think as you could probably tell from the conversations we were having today that there is a lot of room for interpretation on the Form ADV. There’s always going to be more questions. There’s always going to be new interpretations of the questions in the Form ADV. Things are always changing. So pay attention to things that Stark & Stark puts out there. We do a compliance alert and a compliance update for those of you that are actually following us.

Joseph Antonakakis, Esq. (17:26):

And a compliance podcast.

Stephen Galletto, Esq. (17:27):

And a compliance podcast. Brand new episode one compliance podcast wrapping up and there will be many more coming in the upcoming months. If you have any suggestions, things that you guys want to hear us talk about, by all means, please feel free to shoot them on end. Happy to talk and cover those points for you. Gentlemen, it’s been a pleasure. Thank you very much. I think we all learned a lot. I learned a lot from you, Joe. I learned a lot from you, Jeff.

Jeffrey Lang, Esq. (17:57):

I learned a lot.

Stephen Galletto, Esq. (17:58):

If we weren’t sitting in these chairs, we’d hug it out right now. All right. Episode one, done.

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Intro (18:06):

The Adviser Intelligence Podcast provides general information and commentary only. The content is not legal advice, nor does it create an attorney-client relationship. For more information about Stark & Stark services, please visit our website at www.stark-stark.com.