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The brochure rule states that investment advisers and brokers registered under the federal or state authority must provide a written disclosure statement to their client before transacting with them. This statement contains the basic information about the services offered by investment advisors, their terms and conditions.
The brochure rule is one of the regulations of the Securities and Exchange Commission (SEC) for investment advisers. This rule is contained in the Investment Advisers Act of 1940, it is otherwise carried the rule 204-3.
A Little More on What is the Brochure Rule
The rule 204-3 or the brochure rule is legally binding to all investment advisers registered by the state or federal authorities. This rule stipulates that an easy to understand material such as a brochure containing the services, terms, and conditions of an investment adviser must be provided to all clients. It is a full disclosure statement in the written form offered to prospective clients. The rule 204-3 also stipulates the time investment advisers must provide the material.
There are two ways to provide a full disclosure statement under the brochure rule, they are through;
- Giving the client Form ADV Part 2A (brochure) and Part 2B (brochure supplement), or by
- Giving an actual brochure that contains the same information as Form ADV Part 2A and 2B.
The basic information that a brochure must contain include the following;
- Background information about the investment adviser or broker.
- Service terms, fees charged, and available discounts.
- Referral fees that clients can enjoy if there is any.
- The types of services the adviser provides.
- The type of clients the services are offered to and the minimum dollar amount that can be managed.
- The discretionary power that the adviser holds over the client’s funds or custody over the client’s securities.
- Factors that could cause a change in investment policies during the lifetime of an investment.
- Other brokers or advisers the adviser is affiliated with.
Generally, the brochure must contain all the needed information about an investment or advisory service needed by clients.
Who Should Receive a Brochure
All the prospective clients of a registered investment adviser is entitled to a brochure. The existing clients must also receive a new brochure annually which contains updates or possible changes that have occurred during the space of one year.
According to the brochure rule, all new clients must receive the brochure of an investment adviser at least 48 hours before they enter into a contractual agreement with the adviser. Any adviser that fails to provide the brochure is deemed fraudulent and this act is punishable by the SEC.
Exceptions to the Brochure Rule
Although the brochure rule mandates investment advisers to issue a brochure containing basic information about the services they offer and other terms and conditions to prospective, there are exceptions to this rule. Registered advisers do not need to give the following clients a brochure;
- A client in form of a SEC-registered investment company.
- A client who will pay the SEC-registered adviser less than $500 in a year.
- A client that receives only impersonal advisory services from the registered adviser.
- Certain officers and employees.
Reference for “Brochure Rule”
Academic research on “Brochure Rule”
Regulatory challenges for the EU asset management industry, Lannoo, K. (2010). Regulatory challenges for the EU asset management industry. ECMI Policy Brief, (15). The European asset management industry is feeling squeezed from all sides, as a result of growing prudential, product and conduct regulation. A new Directive, UCITS IV, has only just been enacted, and already new challenges are emerging in the regulation of hedge and venture capital funds, the review of the regulatory regime for depositaries (or financial custodians) and amendments to the MiFID Directive. In addition, a new European supervisory framework is in the making, which implies much stricter controls on enforcement. These changes are taking place in the context of one of the largest declines suffered by the industry in the last two decades, from which many fund managers have not yet recovered. This paper first briefly reviews recent developments in the EU asset management industry, followed by a discussion of the regulatory framework for asset management and the challenges ahead. Its focuses primarily on the UCITS and emerging non-UCITS investment fund regime, and its interaction with the MiFID regime covering investment services.
The’Many Faces’ of Mutual Fund Revenue Sharing, Haslem, J. A. (2014). The’Many Faces’ of Mutual Fund Revenue Sharing. Journal of Index Investing, 5(3), 59-72. The objective of this article is to take some of the mystery out of mutual fund revenue sharing, but without being able to say investors have transparent disclosure. It appears that most in the world of regulation and practice of revenue sharing lacks clarity, consistency, proper redress, and investor transparency, such as the so-called direct distribution of revenue-sharing payments from mutual fund adviser profits.
Liquid Alternative Mutual Funds: An Asset Class that Expands Opportunities for Diversification, Lewis, C. M. (2016). Liquid Alternative Mutual Funds: An Asset Class that Expands Opportunities for Diversification. Available at SSRN 2755368. Contrary to the widely held misconception that alternative mutual funds use derivatives to take on significant risk in the search for outsized returns, the empirical evidence suggests that these funds do not subject investors to undue risk, and have important diversification benefits that can make them a highly beneficial tool for the average investor. These funds enable investors to construct diversified portfolios that either reduce the level of risk for a given level of return, or increase returns at the same level of risk, or both, and they have enabled ordinary investors to access an important, diversified asset class that had previously available only to high net worth individuals and institutional investors. To the extent that investors are heavily concentrated in equities, LAMFs can preserve expected returns at meaningfully lower risk levels.
Timing is everything: an evaluation and comparison of market timing strategies,Brooks, C., Katsaris, A., & Persand, G. (1970). Timing is everything: an evaluation and comparison of market timing strategies. Following early failures, more recent empirical evidence has suggested that timing entries to and exits from equity markets may be feasible. A number of approaches to this most basic form of dynamic asset allocation are available, but which works best? This study investigates the relative profitability of several different methodologies using a very long dataset on the S&P 500. In order to overcome the accusations of data snooping and arbitrary parameter choice that beset much previous work in this area, we carefully consider whether the rule performance is sensitive to the specified user-adjustable parameters. We find that all but one of the approaches are able to beat a buy-and-hold equities strategy in risk-adjusted terms, although a strategy based on the difference between the earnings-price ratio and short term Treasury yields works best
Robo-advisors: A closer look, Fein, M. L. (2015). Robo-advisors: A closer look. Available at SSRN 2658701. Robo-advisors have been touted by the Department of Labor as a source of investment advice that can benefit retirement investors by minimizing costs and avoiding conflicts of interest. On the other hand, they have been labelled as gimmicky and overly simplistic by some critics who have used them. The Securities and Exchange Commission has cautioned that robo-advisors may result in investment recommendations that are based on incorrect assumptions, incomplete information, or circumstances not relevant to an individual investor. This paper examines whether robo-advisors in fact provide personal investment advice, minimize costs, and are free from conflicts of interest. It also evaluates whether robo-advisors meet a high fiduciary standard of care and act in the client’s best interest. Based on a detailed review of user agreements for three leading robo-advisors, this paper concludes that robo-advisors do not live up to the DOL’s acclaim. They are not designed for retirement accounts subject to ERISA and should be approached with caution by retail and retirement investors looking for personal investment advice.