Articles Posted in Private Funds

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The Form PF (PF is short for “private funds”) is a new Securities and Exchange Commission reporting form for investment advisers to private funds that have at least $150 million in private fund assets under management.  Comprising 42 pages and divided into 4 sections with corresponding subsections, Form PF may appear daunting at first.  The task of completing and filing the Form also entails categorizations, specific and nuanced reporting requirements and Form-specific calculations, not to mention the fact that improperly completed Forms may be delayed or even rejected.  However, with the proper tools and plan of attack, an adviser will be able to fulfill its reporting requirements and improve its data platform for a host of other reporting and filing requirements.  Form PF necessitates working with large amounts of data.  So, early planning, coordination and organization are essential for success.  In a guest article, Jay Gould, a Partner at Pillsbury Winthrop Shaw Pittman LLP and leader of Pillsbury’s Investment Funds & Investment Management practice team, and Kelli Brown, Director of Private Funds at Data Agent, LLC, describe ten steps that a hedge fund manager should take for successful Form PF completion and filing.  The article can be accessed on the Hedge Fund Law Report’s website (www.hflawreport.com – subscription required). 

Please contact Jay Gould if you have any further questions or seek further information about Form PF.

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Written by: Jay B. Gould and Peter Chess

On April 18, 2012, the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) voted to adopt rules defining “swap dealer,” “security-based swap dealer,” “major swap participant,” and “major security-based swap participant,” among other terms, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).  The Dodd-Frank Act assigns to the SEC the regulatory authority for security-based swaps[1] and assigns to the CFTC the regulatory authority for swaps. 

Under the adopted rules, the definitions are as follows:

A swap dealer is defined as any person who:

  • Holds itself out as a dealer in swaps;
  • Makes a market in swaps;
  • Regularly enters into swaps with counterparties as an ordinary course of business for its own account; or
  • Engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps.

The definition of security-based swap dealer tracks the definition of swap dealer, with “security-based swap” inserted where “swap” appears.

A major swap participant is a person that satisfies any one of the three parts of the definition:

  • A person that maintains a “substantial position” in any of the major swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan.
  • A person whose outstanding swaps create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets.”
  • Any “financial entity” that is “highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal banking agency” and that maintains a “substantial position” in any of the major swap categories.

The definition of major security-based swap participant tracks the definition of major swap participant with “security based-swap” inserted where “swap” appears.

The newly adopted rules contain further definitions for the terms “substantial position,” “hedging or mitigating commercial risk,” “substantial counterparty exposure,” “financial entity,” “highly leveraged,” and “eligible contract participant.”  In addition, the adopting release provides interpretative guidance on the definitions of swap dealer and security-based swap dealer, and the CFTC provides further details on the exclusion for swaps in connection with originating a loan, the exclusion of certain hedging swaps and the exclusion of swaps between affiliates.  Finally, the new rules call for a de minimis exemption from the definition of swap dealer and security-based swap dealer wherein a person who engages in a de minimis amount of swap or security-based swap dealing will be exempt from the respective definition.  

The SEC and the CFTC adopted the new rules under joint rulemaking, and the SEC rules become effective 60 days after the date of publication in the Federal Register, although dealers and major participants will not have to register with the SEC until the dates that will be provided in the SEC’s final rules for the registration of dealers and major participants.  The CFTC must adopt further rules defining the term “swap,” and swap dealers and major swap participants will need to register by the later of July 16, 2012, or 60 days after the publication of CFTC rules defining “swap.”

The full text of the SEC press release and fact sheet is available here.  The full text of the CFTC release is available here.

[1]               Security-based swaps are broadly defined as swaps based on (i) a single security, (ii) a loan, (iii) a narrow-based group or index of securities, or (iv) events relating to a single issuer or issuers of securities in a narrow-based security index. 

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Written by: Jay B. Gould and Peter Chess

On April 5, 2012, the Jumpstart Our Business Startups Act (the “JOBS Act” or the “Act”) was signed into law, creating a new regulatory on-ramp for emerging growth companies going public.  The JOBS Act also includes provisions that require the Securities and Exchange Commission (the “SEC”) to undertake various initiatives, including rulemaking and studies touching on capital formation, disclosure and registration requirements.  Title II of the Act affects offerings by issuers pursuant to Regulation D under the Securities Act of 1933, as amended (the “Securities Act”), as well as resales under Rule 144A of the Securities Act.  In particular, the Act directs the SEC to amend its rules to:

  • Repeal the ban on general solicitation and general advertising for offerings under Rule 506 of Regulation D when sales are only to accredited investors;
  • Revise Rule 144A to provide that securities sold under Rule 144A may be offered to persons other than qualified institutional buyers (“QIBs”), including by use of general solicitation or general advertising, provided that securities are only sold to persons reasonably believed to be QIBs; and
  • Amend Section 4 of the Securities Act such that offers and sales exempt under Rule 506 shall not be deemed public offerings under the federal securities laws as a result of general advertising or general solicitation.

For Private Funds, Regulation D as we know it is still in effect for the next 90 days as the JOBS Act directs the SEC to make the relevant rule changes to Rule 506 and Rule 144A within 90 days, but it does not modify the current text of those rules.  In addition, Funds should continue to follow applicable terms of SEC interpretative guidance.  Senior members of the SEC staff participated in discussion of the JOBS Act yesterday that provided further guidance on this subject, and the SEC is still currently seeking public comments on SEC regulatory initiatives under the JOBS Act.

Pillsbury and KPMG, along with the California Hedge Fund Association, will be sponsoring a program on the JOBS Act and the new world of “general solicitation” for Funds in June.

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By: Louis A. Bevilacqua, Joseph R. Tiano, Jr., David S. Baxter, Ali Panjwani and K. Brian Joe

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act), a bill with widespread bipartisan support and assembled from a combination of legislative initiatives introduced throughout 2011 targeting smaller companies and focusing on cheaper capital raising and job creation. We discuss the key provisions of the JOBS Act and their impact on these companies and securities offerings.

The Jumpstart Our Business Startups Act (JOBS Act) is a consolidation of several bills introduced throughout 20111 with the goal of making it easier for smaller companies to raise money and lessen their regulatory burden while doing so. The House of Representatives passed the JOBS Act on March 8 by a vote of 390-23, and the Senate passed the same bill, with one amendment, on March 22 by a vote of 73-26. The Senate amendment offered a more restrictive take on the House bill’s provisions dealing with the increasingly popular grass-roots financing method known as crowdfunding. On reconsideration of the bill with the Senate amendment, the JOBS Act passed the House by a vote of 380-41 on March 27, and President Obama signed it into law on April 5. The JOBS Act is one of the most comprehensive pieces of legislation in recent years to be specifically targeted at developing companies. This Alert summarizes the most important provisions of the JOBS Act and the implications of those provisions.

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Written by Jay Gould, Michael Wu and Peter Chess

The Commodity Futures Trading Commission (the “CFTC”) recently amended its registration rules regarding Commodity Pool Operators (“CPOs”) and Commodity Trading Advisors (“CTAs”), which will require many general partners and managers of private investment funds that previously relied on an exemption from registration to now register with the CFTC.  After a public comment period in which the industry overwhelmingly supported the continuation of these exemptions, the CFTC decided to rescind the CPO exemption under CFTC Rule 4.13(a)(4) and amend the CPO exemption under CFTC Rule 4.13(a)(3).  Rule 4.13(a)(4) previously exempted private pools from registering as a CPO with the CFTC for funds offered only to institutional qualified eligible purchasers (“QEPs”) and natural persons who meet QEP requirements that hold more than a de minimis amount of commodity interests.

The CFTC’s amendment did not change the application of CFTC Rule 4.13(a)(3) to a fund of a hedge fund (“Fund of Funds”).  However, due to the repeal of these exemptions, many of the general partners or managers of a Fund of Funds’ underlying funds may be required to register as CPOs, thereby requiring registration of the Fund of Funds manager.  The CFTC has provided guidance with respect to when a Fund of Funds manager may continue to rely upon an exemption from registration as a CPO.  We have summarized these circumstances below:     

  • If a fund (i) allocates a Fund of Fund’s assets to one or more underlying funds, which do not satisfy the trading limits of CFTC Rule 4.13(a)(3)[1] (“Trading Limits”) and each of which is operated by a registered CPO, and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may only rely on Section 4.13(a)(3) if the Fund of Funds itself satisfies the Trading Limits.
  • If a fund (i) allocates a Fund of Fund’s assets to one or more underlying funds, each having a CPO who is either (a) exempt under CFTC Rule 4.13(a)(3) or (b) a registered CPO that complies with the Trading Limits, and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may rely on Section 4.13(a)(3).
  • If a fund (i) allocates a Fund of Fund’s assets to one or more underlying funds, each of which satisfies the Trading Limits, and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may multiply the percentage restriction applicable to each underlying fund by the percentage of the Fund of Fund’s allocation of assets to such underlying fund, to determine whether that fund may rely on Section 4.13(a)(3).
  • If a fund (i) allocates the Fund of Fund’s assets to one or more underlying funds, and it has actual knowledge of the Trading Limits of the underlying funds (e.g., where the underlying funds or their CPOs are affiliated with a fund), and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may aggregate the commodity interest positions across the underlying funds to determine compliance with the Trading Limits and whether or not that fund may rely on CFTC Rule 4.13(a)(3). 
  • If a fund (i) allocates no more than 50% of the Fund of Fund’s assets to underlying funds that trade commodity interests (regardless of the level of trading engaged by such underlying funds), and (ii) does not allocate the Fund of Fund’s assets directly to commodity interest trading, that fund may rely on CFTC Rule 4.13(a)(3).

The CFTC amended Section 4.13(a)(3) to address how to calculate the notional value of swaps and how to net swaps.  In addition, the CFTC will now require a CPO relying on Section 4.13(a)(3) to submit an annual notice to the National Futures Association affirming its ability to continue relying on the exemption.  If a CPO cannot affirm its ability to do so, the CPO will be required to withdraw the exemption and, if necessary, apply for registration as such.

For additional information on whether these rule amendments will require you to register as a CPO or CTA, or whether the CFTC guidance or another exemption might provide a further exemption from registration, please contact your Pillsbury Investment Funds Attorney.

[1]   CFTC Rule 4.13(a)(3) requires that at all times either: (a) the aggregate initial margin and premiums required to establish commodity interest positions does not exceed five percent of the liquidation value of the Fund’s investment portfolio; or (b) the aggregate net notional value of the Fund’s commodity interest positions does not exceed one-hundred percent of the liquidation value of the Fund’s investment portfolio.

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Written by: Ildiko Duckor and Peter Chess

In light of the current regulatory environment, now more than ever, it is critical for you to comply with all of the legal requirements and best practices applicable to Investment Advisers.  The beginning of the year is a good time to review, consider and, if applicable, satisfy these requirements and best practices. 

As the new year is upon us, there are some important annual compliance obligations Investment Advisers either registered with the Securities and Exchange Commission (the “SEC”) or with a particular state (“Investment Adviser”) should be aware. 

First, we wanted to address three situations where Investment Advisers may need to make changes with regard to their registration.  These are:

(1) SEC-registered Investment Adviser switching to State registration.  SEC-registered Investment Advisers are required to withdraw registration if they have less than $90 million in Assets under Management (“AUM”).  Those Investment Advisers have a June 28, 2012 deadline for state approval.  These advisers should submit a state Form ADV to the relevant state by March 20, 2012 to allow at least 90 days for state approval (California in particular).

(2) State-registered Investment Adviser switching to SEC registration.  A state-registered Investment Adviser whose AUM as of December 31, 2011 was $110 million or more must register with the SEC by March 30, 2012.  Going forward, state-registered Investment Advisers must apply for registration with the SEC within 90 days of becoming eligible for SEC registration and not relying on an exemption from registration.  The threshold for registration with the SEC is $100 million or more in AUM, but you may stay registered with the state up to $110 million in AUM.

(3) Currently exempt Investment Adviser registering with the SEC.  An Investment Adviser previously exempt from registration that is now registering with the SEC must do so by the March 30, 2012 deadline.  The Form ADV should have been filed with the SEC by February 14, 2012.

The following is a summary of the primary annual or periodic compliance-related obligations that may apply to Investment Advisers.  The summary section begins with what we feel are “hot” areas of compliance for 2012, and then addresses continuing compliance and other regulatory issues.  The summary is not intended to be a comprehensive review of an Investment Adviser’s tax, partnership, corporate or other year-end requirements, nor an exhaustive list of all of the obligations of an Investment Adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) or applicable state law.  Although many of the obligations set forth below apply only to SEC-registered Investment Advisers, state-registered Investment Advisers may be subject to similar and/or additional obligations depending on the state in which they are registered.  State-registered Investment Advisers should contact us for additional information regarding their specific obligations under state law.

“Hot” Compliance Areas

Qualified Client Threshold Updated.  In a Final Rule amendment recently released, the SEC clarified the calculation of the dollar amount thresholds applicable to the new qualified client standard which became effective on September 19, 2011.  The changes that became effective September 19, 2011 for the “qualified client” definition under the Advisers Act involved changing the previous $750,000 AUM test to $1 million and the current net worth test to $2 million.  The value of a person’s primary residence and certain debt secured by the property may not be included in the net worth test.  Either of these tests must be met at the time of entering into the advisory contract.  Investment Advisers that impose performance fees should prepare to amend form advisory agreements to account for the new thresholds for contracts entered into after September 19, 2011.  Investment Advisers that manage hedge funds, private equity funds, or other private funds that impose performance fees or incentive/carried interest allocations should have revised subscription agreements as follow:

  • Investors first investing between September 19, 2011 and May 22, 2012 are subject to the $1 million AUM and $2 million net worth thresholds, but these are calculated by including the value of the person’s primary residence.
  • Investors first investing as of or after May 22, 2012 are subject to the $1 million AUM and $2 million net worth thresholds, but the calculation excludes the value of the person’s primary residence.
  • There are two grandfather provisions. (1) Registered Investment Advisers are permitted to continue to charge clients performance fees if the clients were considered qualified clients before the rule changes. (2) Newly registering Investment Advisers will be permitted to continue charging performance fees to those clients they were already charging performance fees.

Accredited Investor Definition Changes.  The “accredited investor” definition has been amended to include any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1 million except that the person’s primary residence may not be included as an asset for purposes of the calculation.  Other final amendments to the relevant rules added provisions for the treatment of debt secured by the primary residence and a grandfathering provision that permits the application of the former net worth test in certain limited circumstances.  Investment Advisers should revise subscription agreements for the clarified threshold calculation as follows:

  • Any investor making a first investment or making an additional contribution on or after July 21, 2010 must exclude the value of the primary residence from the net worth calculation.
  • Any investor making a first investment or making an additional contribution on or after February 27, 2012 must exclude the value of the primary residence from the net worth calculation in addition to observing the provisions added by the other final amendments described above.
  • Investors must qualify under the standard in effect at the time of each new investment contribution.

Form PF.  The SEC and the Commodity Futures Trading Commission (“CFTC”) adopted new reporting rules on October 31, 2011.  The new SEC rule under the Advisers Act requires Investment Advisers that advise one or more private funds and have at least $150 million in private fund AUM to file the Form PF with the SEC.  The new CFTC rule requires commodity pool operators (“CPOs”) and commodity trading advisors registered with the CFTC to satisfy specific filing requirements with respect to private funds by filing the Form PF with the SEC in certain circumstances.  The Form PF has quarterly and annual filing requirements based on a number of factors, including amounts and types of assets.

  • Large hedge fund advisers[1] must file the Form PF within 60 days of each fiscal quarter end, with the first filing after the end of the first fiscal quarter ending on or after June 15, 2012.
  • Large liquidity fund advisers[2] must file the Form PF within 15 days of each fiscal quarter end, with the first filing after the end of the first fiscal quarter ending on or after June 15, 2012.
  • All other filers[3] must file the Form PF within 120 days of each fiscal year end, as applicable, on or after December 15, 2012.
  • Under initial compliance, many advisers will not need to file their first Form PF until 2013.

New CFTC Rules.  In a February 9, 2012 Final Rule, the CFTC rescinded Section 4.13(a)(4), which provided private pools with an exemption from registration as a CPO with the CFTC.  Investment Advisers operating 3(c)(7) private funds will no longer be able to claim exemption from CPO registration for funds offered only to institutional qualified eligible purchasers (“QEP”) and natural persons that meet QEP requirements that hold more than a de minimis amount of commodity interests.  The exemption under Section 4.13(a)(3) was retained, which provides exemption from CPO registration in cases where the pool trades minimal amounts of futures such that at all time either (a) the aggregate initial margin and premiums required to establish the fund’s commodity interest positions may not exceed 5% of the fund’s liquidation value or (b) the aggregate notional value of the fund’s commodity interest positions may not exceed 100% of the fund’s liquidation value.  Advisers that had relied on the Section 4.13(a)(4) exemption will either need to avail themselves of the Section 4.13(a)(3) exemption or register as a CPO, i.e., both 3(c)(1) or 3(c)(7) pools will have to comply with the 4.13(a)(3) exemption or register.

Continuing Compliance Areas

Update Form ADV.  An Investment Adviser must file an annual amendment to Form ADV Part 1 and Form ADV Part 2 within 90 days of the end of its fiscal year.  Part 1 and Part 2A of the Form ADV must be filed with the SEC through the electronic IARD system.  Accordingly, if you are SEC-registered adviser whose fiscal year ends on or after December 31, 2011, you must file Part 1A and Part 2A Brochure as part of your annual updating amendment by March 30, 2012.  If you are a state-registered adviser whose fiscal year ends on or after December 31, 2011, you must also file Part 1A, Part 1B, Part 2A Brochure and 2B Brochure Supplement as part of your annual updating amendment by March 30, 2012.

New Form ADV Part 1.  Part 1 of Form ADV has been amended, most importantly, with regard to the calculation of AUM and auditor information.  The Form now contains a uniform method of calculating AUM, and eliminates adviser discretion in including or excluding certain assets from the AUM calculation.

Form ADV Ongoing Updates.  Investment Advisers must amend Part 1 of their Form ADV promptly during the year if certain information becomes materially inaccurate.  The brochure and supplement must also be updated promptly during the year if any information becomes materially inaccurate unless the material inaccuracies result solely from changes in the amount of client assets managed or changes to the fee schedule.

FINRA Entitlement Program.  FINRA implemented changes to its Entitlement Program, which provides access to an Investment Adviser’s IARD account.  Every adviser firm (new and existing) is now required to designate an individual as its Super Account Administrator (SAA).  The SAA must be an authorized employee or officer of the adviser firm.

Fund IARD Account.  An Investment Adviser must ensure that its IARD account is adequately funded to cover payment of all applicable registration renewal fees and notice filing fees.

State Notice Filings/Investment Adviser Representatives.  An Investment Adviser should review its advisory activities in the various states in which it conducts business and confirm that all applicable notice filings are made on IARD.  In addition, an Investment Adviser should confirm whether any of its personnel need to be registered as “investment adviser representatives” in any state and, if so, register such persons or renew their registrations with the applicable states.

Brochure Rule.  On an annual basis, an Investment Adviser must provide its clients and separate account client(s) with a copy of its updated Form ADV Part 2A, or provide a summary of material changes and offer to provide an updated Form ADV Part 2A.  An adviser could meet its delivery obligation to a hedge fund client by delivering its brochure to a legal representative of the fund, such as the fund’s general partner.  Delivery is required within 120 days of the end of the adviser’s fiscal year.

Annual Assessment of Compliance Program.  At least annually, an Investment Adviser must review its compliance policies and procedures to assess their effectiveness.  The annual assessment process should be documented and such document(s) should be presented to the Investment Adviser’s chief executive officer or executive committee, as applicable, and maintained in the Investment Adviser’s files.  At a minimum, the annual assessment process should entail a detailed review of:

  • (1)  the compliance issues and any violations of the policies and procedures that arose during the year, changes in the Investment Adviser’s business activities and the effect that changes in applicable law, if any, have had on the Investment Adviser’s policies and procedures;
  • (2)  the Investment Adviser’s Code of Ethics, including an assessment of the effectiveness of its implementation and determination of whether they should be enhanced in light of the Investment Adviser’s current business practices;
  • (3)  the business continuity/disaster recovery plan, which should be “stress tested” and adjusted as necessary;
  • (4)  the Social Media policies and procedures, which the SEC recommends all Investment Advisers should adopt as part of their compliance policies and procedures; Investment Advisers should consider adding such policies and procedures if they have not already done so;
  • (5) review compliance with side letters and other special terms policies and procedures; and,
  • (6)  the Whistleblower policies and procedures, which Investment Advisers should consider adopting or reviewing in light of recent SEC rules that implemented the whistleblower program that became effective in August 2011.  Under the new rules, persons who provide information to the SEC about a violation of any securities law may be eligible in certain situations to receive 10 to 30 percent of amounts recovered by the SEC.  Advisers should consider internal policies that promote employee reporting of violations.

Custody; Annual/Surprise Audit.  Private fund Investment Advisers should have their funds audited by a PCAOB registered independent account and provide audited financial statements of their fund(s), prepared in accordance with U.S. generally accepted accounting principles, to the fund(s)’ investors within 120 days of the end of the fund(s)’ fiscal year.  Investment Advisers that do not have their private funds audited should determine whether they are deemed to have custody of those funds’ assets and therefore are subject to an annual surprise audit and other requirements.

Annual Privacy Notice.  Under SEC Regulation S-P, an Investment Adviser must provide its fund investors or client(s) who are natural persons with a copy of the Investment Adviser’s privacy policy on an annual basis, even if there are no changes to the privacy policy.

New Issues.  Compliance should now address FINRA Rule 5131, which became effective in May 2011 and prohibits quid pro quo and “spinning” allocations of new issues of securities and addresses the book-builiding, new issue pricing, penalty bids, trading and waivers of lock-up agreements by member firms and associated persons.  This new rule must be observed in addition to Rule 5130, whereby an Investment Adviser that acquires “new issue” IPOs for a fund or separately managed client account must obtain written representations every 12 months from the fund or account’s beneficial owners confirming their continued eligibility to participate in new issues.  This annual representation may be obtained through “negative consent” letters.

ERISA.  An Investment Adviser may wish to reconfirm whether its fund(s)’ investors are “benefit plan investors” and whether investments by benefit plan investors result in fund assets being characterized as “plan assets” for purposes of reconfirming its fund(s)’ compliance with the 25% “significant participation” exemption under ERISA.  This is particularly important if a significant amount of a fund’s assets have been withdrawn or redeemed, and some Investment Advisers may need to check compliance procedures with each investment or withdrawal.  The reconfirmation may be obtained through “negative consent” letters.

Anti-Money Laundering.  FinCEN may consider a new round of proposed anti-money laundering regulations for unregistered investment companies, certain investment advisers and commodity trading advisors.  An Investment Adviser is still subject to the economic sanctions programs administered by OFAC and should have an anti-money laundering program in place.  An Investment Adviser should review its anti-money laundering program on an annual basis to determine whether the program is reasonably designed to ensure compliance with applicable law given the business, customer base and geographic footprint of the Investment Adviser.

FBAR Reporting.  A U.S. person is required to file a Report of Foreign Bank and Financial Accounts (“FBAR”) if they have a financial interest in or signature authority over a foreign bank, securities or other financial account (e.g., a prime brokerage account) in another country.  Failure to file this form when required can result in significant penalties.  Financial accounts that may be subject to FBAR reporting include accounts of a mutual fund or similar pooled fund which issues shares available to the general public that have a regular net asset value determination and regular redemptions.  Private offshore funds, such as hedge funds and private equity funds (e.g., a Cayman Island “mutual fund”) are not deemed to be a foreign financial account, and therefore investment advisers are not required to file an FBAR with respect to these funds.  However, if these private funds have either a foreign bank account, foreign prime brokerage account, or other foreign financial account, and the adviser has signature authority over those accounts, then the adviser may have to file an FBAR with respect to those accounts.

“Pay-to-Play”.  The SEC adopted two measures on June 30, 2010 to prevent “pay-to-play” practices by Investment Advisers seeking to manage funds for state and local governments.  The SEC adopted amendments to these rules in 2011.  The amendments cover a multitude of topics, including the prohibition of soliciting or coordinating campaign contributions from others for elected officials in a position to influence the selection of the adviser.  With regard to California, generally employees of “external managers” fall under the definition of “placement agent” requiring lobbyist registration. There are exceptions. Employees (i.e., partners, members, etc.) who spend at least 1/3 of their time during a calendar year managing assets (i.e., securities) will not fall under the “placement agent” definition and may solicit from California state public plans.  This would require a portfolio manager-type to be involved in marketing to covered entities.  The second exception, a 3-prong test requires that the manager be selected through a competitive bidding process, which is rare, so this exception may not be helpful.

Special Purpose Vehicles of Investment Advisers.  In January 2012, the SEC confirmed that, subject to certain conditions, it would not recommend enforcement action to the SEC under the Advisers Act against an Investment Adviser or a related Special Purpose Vehicle established to act as the general partner or managing member of a private fund managed by the Investment Adviser if the Special Purpose Vehicle does not separately register as an Investment Adviser.

Amend Schedule 13G or 13D.  An Investment Adviser whose client or proprietary accounts, separately or in the aggregate are beneficial owners of 5% or more of a registered voting equity security, and who have reported these positions on Schedule 13G, must update these filings annually within 45 days of the end of the calendar year, unless there is no change to any of the information reported in the previous filing (other than the holder’s percentage ownership due solely to a change in the number of outstanding shares).  An Investment Adviser reporting on Schedule 13D is required to amend its filings “promptly” upon the occurrence of any “material changes.”  In addition, an Investment Adviser whose client or proprietary accounts are beneficial owners of 10% or more of a registered voting equity security must determine whether it is subject to any reporting obligations, or potential “short-swing” profit liability or other restrictions, under Section 16 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Section 16 Filings.  Individuals or entities that hold a beneficial ownership of ten percent of any class of equity securities registered under Section 12 of the Exchange Act, if an officer or director of such issuer, may be required to file Form 3, 4, or 5 regarding crossing certain thresholds, reporting certain sales, and making certain annual reports.

Form 13F.  An “institutional investment manager,” whether or not an Investment Adviser, must file a Form 13F with the SEC if it exercises investment discretion with respect to $100 million or more in securities subject to Section 13(f) of the Exchange Act (e.g., exchange-traded securities, shares of closed-end investment companies and certain convertible debt securities), which discloses certain information about such its holdings.  The first filing must occur within 45 days after the end of the calendar year in which the Investment Adviser reaches the $100 million filing threshold and within 45 days of the end of each calendar quarter thereafter, as long as the Investment Adviser meets the $100 million filing threshold.

Form 13H.  The SEC adopted Rule 13h-1 under the Exchange Act which requires “Large Traders” meeting certain definitional thresholds in transactions in NMS securities to identify themselves to the SEC and make certain disclosures to the SEC on Form 13H, effective October 3, 2011.  “Large Traders” are defined as any person that exercises investment discretion over one or more accounts and effects transactions of NMS securities for or on behalf of such accounts, in an aggregate amount of at least $20 million in a day or $200 million in a month.  In addition to an initial filing, all large traders must submit an annual filing on Form 13H within 45 days after the end of the calendar year and submit any amendments promptly after the end of any calendar quarter where information in the form becomes materially inaccurate.

Treasury International Capital System (“TIC”) Forms:

  • TIC Form SLT.  Adopted in 2011, the Form SLT is required to be submitted by entities with consolidated reportable holdings and issuances with a fair market value of at least $1 billion as of the last day of any month.  The first filing was required to be submitted by January 23, 2012 for consolidated data as of December 31, 2011.
  • TIC Form SHC.  The Form SHC is a mandatory survey of the ownership of foreign securities, including selected money market instruments, by U.S. residents as of December 31, 2011.  The form must be submitted by fund managers and other entities required to do so no later than March 2, 2012.

Offering Materials.  As a general securities law disclosure matter, and for purposes of U.S. federal and state anti-fraud laws, including Rule 206(4)-8 of the Advisers Act, an Investment Adviser must continually ensure that each of its fund offering documents is kept up to date, consistent with its other fund offering documents and contains all material disclosures that may be required in order for the fund investor to be able to make an informed investment decision.

Full and accurate disclosure is particularly important in light of Sergeants Benevolent Assn. Annuity Fund v. Renck, 2005 NY Slip op. 04460, a recent New York Appellate Court decision, where the court held that officers of an investment adviser could be personally liable for the losses suffered by a fund that they advised if they breached their implied fiduciary duties to the fund.  The fiduciary nature of an investment advisory relationship and the standard for fiduciaries under the Advisers Act includes an affirmative duty of utmost good faith, and full and fair disclosure of all material facts, and an affirmative obligation to use reasonable care to avoid misleading clients.

Accordingly, it may be an appropriate time for an Investment Adviser to review its offering materials and confirm whether or not any updates or amendments are necessary.  In particular, an Investment Adviser should take into account the impact of the recent turbulent market conditions on its fund(s) and review its fund(s)’ current investment objectives and strategies, valuation practices, performance statistics, redemption or withdrawal policies and risk factors (including disclosures regarding market volatility and counterparty risk), its current personnel, service providers and any relevant legal or regulatory developments.

Blue Sky Filings/Form D.  Many state securities “blue sky” filings expire on a periodic basis and must be renewed.  Accordingly, now may be a good time for an Investment Adviser to review the blue-sky filings for its fund(s) to determine whether any updated filings or additional filings are necessary.  We note that all Form D filings for continuous offerings will need to be amended with the SEC on an annual basis.

Liability Insurance.  Due to an environment of increasing investor lawsuits and regulatory scrutiny of fund managers, an Investment Adviser may want to consider obtaining management liability insurance or review the adequacy of any existing coverage, as applicable.

If you have any questions regarding the summary above, please feel free to contact us.

 

[1]   Large hedge fund advisers are advisers with at least $1.5 billion under management attributable to hedge funds.

[2]   Large liquidity fund advisers are advisers with at least $1 billion in combined AUM attributable to liquidity funds and registered money market funds.

[3]   This group includes smaller private fund advisers and large private equity fund advisers, which are advisers with at least $2 billion in AUM attributable to private equity funds.  All advisers with at least $150 million in AUM that are not considered large hedge fund advisers, large liquidity fund advisers, or large private equity fund advisers are considered smaller private fund advisers.

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Last week’s article on HFMWeek entitled “Disclosure Gets Closer” discussed registration requirements of investment advisers to hedge funds under the Dodd-Frank Act.  The article, which was written by Will Wainewright, quoted Jay Gould, a partner and member of our Investment Fund and Investment Management team, who said “[T]he most difficult part of SEC registration – not an onerous process in itself – is implementing, testing, internally enforcing and updating the compliance procedures that the SEC will be checking on once you are registered.” 

A full text of the article is available here.

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Written by: Jay Gould and Peter Chess

1.  What is the Form PF?

The Form PF (PF is short for “private funds”) is a new form that focuses mainly on private fund reporting with regard to information such as counterparty dealings, leverage, and investment exposure.  A “private fund” under the Form PF refers to any issuer that would be an investment company under the Investment Company Act of 1940, as amended, if not for the exemptions provided by Sections 3(c)1 or 3(c)7 of that Act.  Under some circumstances, non-“private funds” such as money market funds registered with the SEC may be required to report on the Form, in addition to “private funds.”

2.  Do investment advisers need to file the Form PF?

Yes, in certain circumstances.  Only investment advisers registered with the SEC that meet a $150 million threshold must report on the Form PF.  The $150 million threshold refers to a specific and somewhat complicated calculation with regard to regulatory assets under management. 

3.  What are the categories of filers? 

Advisers required to file the Form PF need to determine which category of filer corresponds to them.  Large private fund advisers are categorized as either large hedge fund advisers, large liquidity fund advisers, or large private equity fund advisers.  Large hedge fund advisers are those having at least $1.5 billion in regulatory assets under management attributable to hedge funds, subject to other conditions.  Large liquidity fund advisers are those having at least $1 billion in regulatory assets under management attributable to “liquidity funds” and money market funds registered with the SEC, subject to other conditions.  Large private equity fund advisers are those having at least $2 billion in regulatory assets under management attributable to private equity funds, subject to other conditions.  All other filers are categorized as smaller private fund advisers.

4. What are the reporting deadlines?

Initial compliance under the Form PF will be in phases.  The first required filers will be large private fund advisers with at least $5 billion attributable to hedge funds, to liquidity funds, or to private equity funds.  These large hedge fund advisers will have 60 days, and large liquidity fund advisers will have 15 days, after the end of the first fiscal quarter ending on or after June 15, 2012, to file their first Form PF.

Other filers will have to make their first filing by the deadline following the end of the first fiscal quarter for each adviser, as applicable, on or after December 15, 2012.  Under the initial compliance, many advisers will not need to file their first Form PF until 2013.

Going forward, the Form PF must be filed:

  • For large hedge fund advisers, within 60 days of its fiscal quarter end;
  • For large liquidity fund advisers, within 15 days of each fiscal quarter end; and
  • For other filers, within 120 days of each fiscal year end.

5.  What constitutes the Form PF? 

The Form PF, in its entirety, contains sixty pages, and is divided into four sections with corresponding subsections.  Most advisers will not have to complete all four sections.  The four sections feature reporting on, among other things: identifying information about the adviser; fund-by-fund reporting by all advisers about items such as fund identification, performance and valuation; fund-by-fund reporting by hedge fund advisers about items such as strategies, counterparties, and trading practices; aggregated private fund reporting for large hedge fund advisers; fund-by-fund reporting by large hedge fund advisers about items such as asset classes, portfolio liquidity, and risk metrics; fund-by-fund reporting for large liquidity fund advisers; and, fund-by-fund reporting for large private equity fund advisers. 

6.  What about the confidentiality of information reported?

Because of the nature of governmental sharing of the data provided on the Form PF, advisers should consider the options available to them with regard to preserving confidentiality.  Consequently, advisers should consider changing their overall recordkeeping practices so that they routinely identify funds solely by numerical or alphabetical designations.  

7.  How is the Form PF filed? 

The Form PF will be filed using the same IARD system on which advisers make the Form ADV filing.

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Written by guest contributor, Bruce Frumerman, Frumerman & Nemeth Inc.

This article first appeared in FINAlternatives on January 30, 2012 and is re-printed with permission below.

It’s one thing when people who are not part of the hedge fund investor universe say hedge funds are money management firms that reveal too little about themselves. It’s another thing entirely when those folks investing in hedge funds are complaining about this.

In January SEI released part one of its results from its fifth annual survey of institutional hedge fund investors, conducted in collaboration with Greenwich Associates, The Shifting Hedge Fund Landscape. Three of the recommendations the report offers hedge fund firm owners give a glimpse into where surveyed investors are asking hedge funds to “provide more windows into investment processes and decision-making,” as SEI put it.

SEI says hedge funds need to:

  • Go The Extra Mile To Make Strategies Understandable.

Thoroughly explain the strategies and processes [you] are using to generate returns.

  • Keep Articulating And Reinforcing The Value Proposition.

Demonstrate exactly how [your] strategy and methods are enhancing [your] clients’ risk-adjusted portfolio returns.

  • Clarify Performance Expectations.

Work to help clients understand the tradeoffs between risk and reward, and how [your strategy] can be expected to perform under varying market conditions.

All of this points to a specific failing: most hedge funds are not communicating enough detail about how they think and how they invest. It’s not enough for a hedge fund manager to know this in his head. Further, it’s not enough for a hedge fund sales person to believe she is able to recite all this required information in a verbal presentation at a pitch meeting with a prospect. Institutional investors need to have this in writing. After all, they’ll be referring to a hedge fund’s marketing collateral when, months after a hedge fund has made its in-person presentation, the institution’s investment committee finally gets around to discussing the hedge fund firm and its strategy.

As SEI’s survey makes clear, hedge funds are not building out their storyline content enough to fully explain how they invest, differentiate themselves from competitors and communicate appropriate performance expectations. I’ve identified a reason why this is too often so: taking the wrong starting point. Many hedge fund firm owners go about their internal process of creating their storylines about how they invest by trying to think in bullet points, because that’s what goes into a flip chart pitchbook. That is the wrong starting point and the wrong point of reference. Think this way and you will end up leaving out too much detail about what you do that prospective investors want you to be communicating. Market this way and you may leave some prospects thinking your firm lacks transparency and others that your firm lacks the competence to pull of what you claim you aim to do.

Savvy hedge fund firms recognize that a flip chart pitchbook is a marketing tool, not the only marketing tool. They know that they have to deliver marketing collateral into the hands of institutional investor prospects who may take months before to looking at those documents again when discussing the hedge fund and its strategy in an investment committee meeting.

A flip chart pitchbook is not a leave-behind piece whose copy retells on paper the detail of what a fund manager presents verbally at a pitch meeting regarding the full story of his fund and its investment process. The people you pitch have learned from experience that bullet points in the typical flip chart pitch book rarely tell the full story. In a meeting, the portfolio manager or salesperson usually “fills in the blanks”, adding more information as they elaborate about their firm and its investment process. If you assume all of your prospects are attentive enough to absorb and recall this non-documented content months later, when investment allocation decisions might be made, you are mistaken.

So, how can you do a more effective job of thoroughly explaining your fund’s strategy and process in writing?

Here’s a recommendation for giving your firm a fresh start in this new year: begin by putting onto paper a clean, rethought long version storyline that explains your investment beliefs and details the process you follow to implement your strategy. Once you’ve written this out in sentence and paragraph format reread what you wrote, and try to do so with the critical eye of a skeptical prospect, because you need to construct a storyline to sell with that is buyer-focused, not seller-focused.

Your words need to be cogent and compelling. Keep in mind that people will not be able to follow you if your explanation about how you invests jumps around, so see to it that you build and tell a linear story.

With your new, long version storyline copy in hand you’ll have the baseline content that can be applied to a range of marketing tools. This content can serve as the meat of an in-person verbal presentation. Highlights of the long version storyline can be excised to be added to the data presented in a flip chart pitchbook, and to a fact sheet/backgrounder piece. Importantly, the full content belongs in a document of its own: an “evergreen” brochure that just addresses investment process. This evergreen document should retell in print what you communicate verbally at a pitch meeting for educating and persuading people to understand and buy into how you invest.

How useful is adding a brochure format marketing piece as a selling tool to provide, as SEI puts it, “more windows into investment processes and decision-making”?

Here’s a recent case example from a hedge fund client of my communications and sales marketing consulting firm. Having presented his pitch to a university endowment officer, the fund manager was complimented on his evergreen brochure leave-behind because, as the prospect noted, it fully retold the fund’s investment process that was given in the verbal pitch. That endowment officer added that nine out of ten times he only gets a flip chart pitchbook from those who pitch him, so he often lacks the investment process detail he needs, in an easily accessible marketing piece, for his due diligence. Another endowment team the hedge fund manager met with echoed that feedback. After telling the hedge fund manager they liked how his investment process was clearly spelled out in his 12-page, brochure-format leave-behind, they complained to him about getting too many 50-page pitchbooks from other money management firms.

So, if you want to be in a better position to attract new investors this year, look into how you could do a better job of articulating and reinforcing your value proposition; both with the story you tell and the range of marketing collateral in which you deliver it. Make it easier for your institutional prospects to remember and recount to fellow investment committee members how your firm invests and you will have created a competitive edge in your marketing.

 

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© 2012 Frumerman & Nemeth Inc.

Bruce Frumerman is CEO of Frumerman & Nemeth Inc., a communications and sales marketing consultancy that helps financial services firms create brand identities for their organizations and develop and implement effective new marketing strategies and programs. His firm’s work has helped money management clients attract over $7 billion in new assets, yet Frumerman & Nemeth is not a Third Party Marketing firm. Bruce has over 30 years of experience in helping money managers to develop buyer-focused positioning strategies to differentiate them from their competitors; create more cogent and compelling sales presentations and marketing materials to better tell their story; and use media relations marketing and industry conference speaking opportunities to help establish a branded identity for their organization by generating third-party endorsement for the expertise of their people, the value of their services and the quality of their products. He has authored many articles on the topic of marketing money management services and is a frequent speaker on the subject at industry conferences. He can be reached at info@frumerman.com, or by visiting www.frumerman.com.

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Written by Jay Gould and Peter Chess

In re-proposed custody rules, the California Department of Corporations (“DOC”) has reflected the most important aspects of the comment letter that Pillsbury provided on July 27, 2011, such that all transactions and short positions need not be disclosed in the quarterly account statements.  In general, the re-proposed custody rules define “custody,” and subject to certain limited exceptions, require that advisers with custody maintain the assets with a qualified custodian.  The re-proposed custody rules also specify details with regard to audits and require compliance by advisers with specific safeguards.   

The DOC also released proposed regulations that contain a successor to the private fund exemption, which are currently in the comment period.  Under the DOC’s proposed private adviser exemption, advisers would be eligible provided they: (i) have not violated securities laws; (ii) file periodic reports with the DOC; (iii) pay the existing investment adviser registration and renewal fees; and (iv) comply with additional safeguards when advising 3(c)(1) funds.  Additionally, under the proposed regulations, the exemption defines a private fund adviser as an investment adviser that provides advice only to qualifying private funds, which include 3(c)(1) and 3(c)(7) funds.  A grandfathering provision for private advisers is also included. 

The Massachusetts Securities Division released amendments similar to the DOC’s on January 18, 2012.  These amendments contain regulations that relate to the private fund exemption and custody requirements, among others.  The amendments, released after consideration of industry comments, make substantive changes to the definition of “institutional buyer,” re-propose a broadened private fund exemption that includes the introduction of a grandfathering provision, and propose requirements for advisers with discretion over, or custody of, client funds. 

The purpose of the Massachusetts amendments is to coordinate with the new rule adopted by the Securities and Exchange Commission under the Dodd-Frank Act.  Also included in the amendments is an exemption from state registration for advisers that provide advice solely to private funds that qualify as 3(c)(1) or 3(c)(7) funds.