Articles Tagged with Form ADV

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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 of.

See upcoming deadlines below and in red throughout this document.

The following is a summary of the primary annual or periodic compliance-related obligations that may apply to Investment Advisers.  The summary is not intended to be a comprehensive review of an Investment Adviser’s securities, tax, partnership, corporate or other annual 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.

u  List of annual compliance deadlines in chronological order:

State registered advisers pay IARD fee November-December (of 2012)
Form 13F (for 12/31/12 quarter-end) February 14, 2013
Form 13H annual filing February 14, 2013
Schedule 13G annual amendment February 14, 2013
Registered CTA Form PR (for December 31, 2012 year-end) February 14, 2013
TIC Form SLT Every 23rd calendar day of the month following the report as-of date
TIC Form SHCA March 1, 2013
Affirm CPO exemption March 1, 2013
Registered Large CPO Form CPO-PQR December 31 quarter-end report March 1, 2013
Registered Small CPO Form CPO-PQR year-end report March 31, 2013
Registered Mid-size CPO Form CPO-PQR year-end report March 31, 2013
Registered CPOs filing Form PF in lieu of Form CPO-PQR December 31 quarter-end report March 31, 2013
SEC registered advisers and ERAs pay IARD fee Before submission of Form ADV annual amendment by March 31, 2013
Annual ADV update March 31, 2013
Delivery of Brochure April 30, 2013
Form PF Filers pay IARD fee Before submission of Form PF
Form PF (for advisers required to file within 120 days after December 31, 2012 fiscal year-end) April 30, 2013
FBAR Form TD F 90-22.1 (for persons meeting the filing threshold in 2012) June 30, 2013
Form D annual amendment One year anniversary from last amendment filing

 

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Written by:  Jay Gould and Peter Chess

While you were touring the Champagne region or sipping umbrella drinks at the beach this summer, the California Department of Corporations (the “DOC”) was busy overhauling the rules applicable to investment advisers.  On August 27, 2012, the DOC adopted final rules, available here, that provide for an exemption from registration for certain private fund managers pursuant to specific conditions.  This exemption, along with the rules previously adopted by the Securities and Exchange Commission (the “SEC”), now permits certain investment advisers that provide advice only to private funds to operate without being fully registered with either the SEC or the State of California. 

Unlike the SEC rules, this exemption does not prohibit a fund manager from registering with the DOC—it simply allows the fund manager to decide whether it would like to register or rely on the exemption.  To rely upon this exemption, a California based adviser must complete and file the Form ADV (required under Rule 204-4 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”)) with the DOC that is required of an adviser that files for “exempt reporting adviser” status with the SEC.  But why would any adviser that is eligible to take advantage of the exemption decide to register? 

If a fund manager intends only to seek capital from “friends and family,” subjecting itself to the full registration requirements and the more complete compliance rules that are expected soon from the DOC could represent a significant expense to the manager.  Or, if a manager is leaving another organization and must quickly get to market, the three to four month process associated with the DOC review of an investment adviser application may be viewed as too long to wait.  But if a fund manager expects to target more institutional capital, or other investors that would have a reasonable expectation that the manager is subject to some regulatory oversight, the manager may very well decide that a California investment adviser registration is not so burdensome.  After all, a manager that seeks to rely on the exemption must still file the Form ADV, prepare a private placement memorandum, and have the fund audited, among other requirements discussed below.  The analysis that each fund manager must undertake in order to make this decision is multi-faceted and is ultimately one that is unique to each adviser and its own circumstance.

To briefly summarize the results of the DOC rulemaking, an investment adviser located in California may conduct its business without being a fully registered and regulated investment adviser under the DOC regulations so long as:

  • the adviser only advises private funds that rely on either Section 3(c)(1) or Section 3(c)(5) of the Investment Company Act of 1940, as amended, (which the DOC defines as “Retail Buyer Funds”) the investors of which are all “accredited investors”;
  • the adviser is not subject to any statutory disqualifications;
  • the adviser files certain periodic reports and notices; and
  • the adviser pays the annual registration fee of $125.  

Additionally, with respect to Retail Buyer Funds:

  • the adviser may only charge performance fees to investors that meet the Advisers Act definition of a “qualified client”;
  • the Retail Buyer Fund must be audited annually by a Public Company Accounting Oversight Board (“PCAOB”) registered accounting firm and deliver a copy of the audited financial statements to each beneficial owner; and
  • the adviser must provide “material disclosures” to fund investors that adequately and accurately describe the investment program of the fund and the relationship of the adviser to the fund (e.g., the type of disclosures that competent counsel drafts on behalf of fund managers now).

When an adviser that is eligible for the California exemption reaches $100 million in assets, it would become an exempt reporting adviser with the SEC and would need to switch its status over to the SEC.  And when it reaches $150 million it must become a fully registered investment adviser with the SEC; accordingly, investment advisers can operate without being fully registered with the SEC or the State of California so long as they have less than $150 million in assets and satisfy the conditions discussed above.

The California exemption contains a “grandfathering” provision for Retail Buyer Funds formed prior to the release of the exemption, as the additional requirements listed above are deemed satisfied if the Retail Buyer Fund: (i) distributes annual audited financial statements; (ii) pre-existing investors receive the “material disclosures” discussed above; (iii) from August 27, 2012 on, the Fund only sells interests to “accredited investors”; and (iv) the adviser receives performance-based compensation only from pre-existing investors or “qualified clients.”

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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

On January 18, 2012, the Office of Investment Adviser Regulation, part of the Division of Investment Management, issued a no-action letter (the “2012 Letter”) in response to a request for guidance from the American Bar Association’s Subcommittee on Hedge Funds on issues regarding the registration of certain investment advisers that are related to investment advisers registered with the Securities and Exchange Commission (the “SEC”).  The 2012 Letter both reaffirms previous positions of the SEC and provides additional guidance, as discussed below.

Special Purpose Vehicles (“SPVs”).  In a December 8, 2005 letter, the SEC stated that it would not recommend enforcement action against a registered adviser and an SPV if the SPV did not separately register as an investment adviser, subject to conditions.  The 2012 Letter reaffirms this position.  The conditions in such a situation require that:

  • the investment adviser to a private fund establishes the SPV to act as the private fund’s general partner or managing member;
  • the SPV’s formation documents designate the investment adviser to manage the private fund’s assets;
  • all of the investment advisory activities of the SPV are subject to the U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act”); and
  • the registered adviser subjects the SPV, its employees and persons acting on its behalf to the registered adviser’s supervision and control and, therefore, the SPV, all of its employees and the persons acting on its behalf are “persons associated with” the registered adviser.

SPVs with Independent Directors.  The 2012 Letter states that an SPV that relies on the above conditions may also have “independent directors” and therefore would not be required to meet the uniformity of personnel requirement.

Groups of Related Advisers.  The 2012 Letter notes that for a variety of reasons, advisers to private funds may be part of a group of related advisers.  In some situations these advisers, although organized as separate legal entities, conduct a single advisory business because they, among other things, are subject to a unified compliance program and use the same or similar names.  The 2012 Letter states that a filing adviser and one or more relying advisers would be conducting a single advisory business and thus a single registration would be appropriate under the following circumstances:

  • The filing adviser and each relying adviser advise only private funds and separate account clients that are qualified clients and are otherwise eligible to invest in the private funds advised by the filing adviser or a relying adviser and whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to those private funds. 
  • Each relying adviser, its employees and the persons acting on its behalf are subject to the filing adviser’s supervision and control and, therefore, each relying adviser, its employees and the persons acting on its behalf are “persons associated with” the filing adviser. 
  • The filing adviser has its principal office and place of business in the United States and, therefore, all of the substantive provisions of the Advisers Act and the rules thereunder apply to the filing adviser’s and each relying adviser’s dealings with each of its clients, regardless of whether any client or the filing adviser or relying adviser providing the advice is a United States person. 
  • The advisory activities of each relying adviser are subject to the Advisers Act and the rules thereunder, and each relying adviser is subject to examination by the SEC.
  • The filing adviser and each relying adviser operate under a single code of ethics and a single set of written policies and procedures, administered by a single chief compliance officer.
  • The filing adviser discloses in its Form ADV (Miscellaneous Section of Schedule D) that it and its relying advisers are together filing a single Form ADV in reliance on the 2012 Letter and identifies each relying adviser by completing a separate Section 1.B., Schedule D, of Form ADV for each relying adviser and identifying it as such by including the notation “(relying adviser).”
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Written by Michael Wu

On July 28, 2010, the Securities and Exchange Commission (“SEC”) adopted amendments to Part 2 of Form ADV, and related rules under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), to require registered investment advisers to provide clients with a “brochure” under Part 2A of Form ADV and a “brochure supplement” under Part 2B of Form ADV written in plain English.  The brochure contains information about the advisory firm and the brochure supplement contains information about the personnel who provide investment advice.

On December 28, 2010, the SEC extended the compliance dates for the brochure supplement.  Specifically, the new compliance dates are as follows:

  • New Investment Advisers: investment advisers filing their applications for registration between January 1, 2011 and April 30, 2011, have until May 1, 2011 to begin delivering brochure supplements to new and prospective clients and until July 1, 2011 to deliver brochure supplements to existing clients.  The compliance dates for investment advisers filing their applications for registration after April 30, 2011 remain unchanged.
  • Existing Investment Advisers: existing investment advisers with a fiscal year ending on December 31, 2010 through April 30, 2011, have until July 31, 2011 to begin delivering brochure supplements to new and prospective clients and until September 30, 2011 to deliver brochure supplements to existing clients.  The compliance dates for existing investment advisers with fiscal years ending after April 30, 2011 remain unchanged.

Please note that the SEC is not extending the compliance date for filing and delivery of the brochure required by Part 2A of Form ADV and the related rules under the Advisers Act.  The full text of the adopting rule is available here.

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As we have previously discussed here, the Securities and Exchange Commission adopted significant changes to Part 2 of Form ADV. Among other things, the new Part 2 requires greatly expanded disclosure presented in a narrative, plain English format. The California Department of Corporations has now also adopted the new Part 2, effective October 12, 2010, thereby subjecting California-registered investment advisers to these same disclosure requirements. Compliance dates for California investment advisers are as follows:

  • As of January 1, 2011 all new investment adviser applicants will have to file the new Part 2 of Form ADV as part of their application.
  • As of January 1, 2011 all licensed investment advisers will need to incorporate the new Part 2 of Form ADV with their next filing of an amendment to Form ADV, or their annual updating amendment to Form ADV.
  • Between October 12, 2010 and January 1, 2011 applicants and currently licensed investment advisers filing amendments to their Part II of Form ADV may use either the current Part II or the new Part 2.
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On July 21, 2010, the Securities and Exchange Commission voted to adopt changes to Part 2 of Form ADV (commonly referred to as the “brochure”), which is the principal disclosure document provided by SEC-registered investment advisers to their clients. SEC Chairman Mary Shapiro described the changes as being necessary to ensure that the information most relevant to clients is included in the brochure and that such information is presented in a way that is accessible to investors.

The amendments drastically alter both the form and content of Part 2. The principal changes are to require:

  • Narrative, plain English disclosure. Part 2 previously required advisers to respond to a series of multiple-choice and fill-in-the-blank questions organized in a “check-the-box” format.  The revised Part 2 directs advisers to provide a narrative brochure written in plain English. Advisers are to tailor the presentation of their disclosure to their clients’ level of financial sophistication, employ clear, concise language, use examples and otherwise seek to ensure that material information is effectively communicated to clients.
  • Expanded disclosure. The amended Part 2 requires advisers to discuss more topics and provide more detailed disclosure regarding their business and employees, particularly in regards to any arrangements that may give rise to conflicts of interest. In addition to the information explicitly required to be disclosed in Part 2, advisers have a fiduciary duty to provide clients with all material information regarding the advisory relationship. Such disclosure may be included in Part 2 or disclosed to clients by some other means.
  • Public accessibility. Part 2A of Form ADV must be filed electronically and will be publicly available on the SEC’s website.

Advisers with a fiscal year end of December 31, 2010 must file an annual updating amendment with the new brochures no later than March 31, 2011. Given the need to provide greatly expanded and more individually tailored disclosure, investment advisers should anticipate that their next annual update will be a much more time and resource intensive exercise and involve the creation of a new, comprehensive disclosure document. Accordingly, they should begin their preparations, including discussions with outside counsel, well in advance of their filing deadline.

The revised Part 2 consists of two sub-parts: Part 2A (the “brochure”), which contains 18 disclosure items about the advisory firm, and Part 2B (the “brochure supplement”), which provides information about certain advisory personnel.

Part 2A – The Brochure

Content

Part 2A requires advisers to create narrative brochures responding to the following 18 separate disclosure items.

Item 1. Cover Page. The adviser must disclose on the cover page of its brochure the name of the firm, its business address, contact information, website (if applicable) and the date of the brochure. The brochure must also include a statement that the brochure has not been approved by the SEC or any state regulator.

Item 2. Material Changes. An adviser amending its brochure must identify and discuss the material changes since the last annual update. This information must be provided on the cover page, the page immediately following the cover page, or in a separate document accompanying the brochure.

Item 3. Table of Contents. The brochure must include a table of contents detailed enough to permit clients and prospective clients to locate topics easily.  Advisers must present information in the same order and under same headings as listed in Part 2A of Form ADV.

Item 4. Advisory Business. Item 4 requires each adviser to describe its advisory business, including how long it has been in business and the types of advisory services it offers. If an adviser offers substantially different types of advisory services, it can choose to prepare separate brochures so long as each client receives all applicable information about services and fees.

An adviser must also disclose the amount of client assets under its management. For the purpose of calculating the amount of assets under management for this Item, the adviser may use a method that differs from the method used to report assets under management in Part 1A of Form ADV.  Advisers must update the amount of assets under management annually (as part of their annual updating amendment) and make interim amendments only for material changes in assets under management when they are filing an “other than annual amendment” for a separate reason.

Item 5. Fees and Compensation. An adviser must describe in its brochure how it is compensated for advisory services, provide a fee schedule, and disclose whether fees are negotiable.  Adviser may omit providing fee schedules to clients who are “qualified purchasers,” as defined under the Investment Company Act of 1940.

Item 5 also requires advisers to disclose any compensation they or their personnel receive that is attributable to the sale of a security or other investment product (e.g., brokerage commissions), discuss the conflicts of interest such compensation creates and describe how the adviser addresses these conflicts. Advisers must also disclose that the client may purchase the same security or investment product from a broker that is not affiliated with the adviser.

Item 6. Performance-Based Fees. An adviser that charges performance-based fees must disclose this fact.  If an adviser manages both accounts that are charged a performance-based fee and accounts that are charged another type of fee, the adviser must discuss the conflicts of interest that arise from its simultaneous management of these accounts, including its incentive to favor the accounts it charges a performance-based fee, and describe how it addresses these conflicts.

Item 7. Types of Clients. Item 7 requires advisers to describe the types of advisory clients they have and any requirements they impose on opening or maintaining an account, such as minimum account size.

Item 8. Methods of Analysis, Investment Strategies and Risk of Loss. Item 8 requires advisers to describe their methods of analysis and investment strategies and the material risks involved for each significant investment strategy or method of analysis. If an adviser’s primary strategy involves frequent trading of securities, the adviser must explain how frequent trading can affect investment performance.

Item 9. Disciplinary Information. An adviser must disclose any legal or disciplinary event that is material to a client’s or prospective client’s evaluation of the integrity of the adviser or its management personnel. The Instructions to Item 9 contain a non-exclusive list of disciplinary events presumed to be material if they incurred in the previous 10 years. The list includes convictions for theft, fraud, bribery, perjury, forgery, counterfeiting, extortion and violations of securities laws.

Item 10. Other Financial Industry Activities and Affiliations. Each adviser must describe material relationships or arrangements the adviser (or any of its management personnel) has with related financial industry participants, any material conflicts of interest these relationships or arrangement create, and how the adviser addresses these conflicts.

Item 11. Code of Ethics, Participation in Client Transactions and Personal Trading. Item 11 requires advisers to describe their codes of ethics and state that a copy is available upon request. If the adviser or a related person recommends to clients, or buys or sells for client accounts, securities in which the adviser or a related person has a material financial interest, the adviser must describe this practice and the conflicts of interest presented. Items 11.C and 11.D require disclosure of personal trading by the adviser and its personnel in securities that the adviser or a related person recommends to clients.

Item 12. Brokerage Practices. Item 12 requires advisers to describe their practices regarding soft dollars, client referrals, directed brokerage and trade aggregation and discuss the conflicts of interest resulting from such practices.

Item 13. Review of Accounts. An adviser must disclose whether it reviews client accounts and, if so, the frequency of such reviews.

Item 14. Client Referrals and Other Compensation. Item 14 requires advisers to describe any arrangement under which they or a related person compensates another for client referrals, any conflicts of interest arising from such arrangement and how the adviser addresses these conflicts of interest. The brochure must also disclose any arrangement under which the adviser receives any economic benefit from a person who is not a client for providing advisory services to clients.

Item 15. Custody. Item 15 requires an adviser with custody of client funds or securities to explain in its brochure that clients will receive account statements directly from the qualified custodian. Advisers must also explain to clients that they should carefully review the account statements they receive from the qualified custodian. In addition, if an adviser also sends clients account statements, the adviser’s explanation must include a statement urging clients to compare the account statements they receive from the qualified custodian with those they receive from the adviser.

Item 16. Investment Discretion. An adviser must disclose if it has discretionary authority over client accounts and any limitations clients may place on this authority.

Item 17. Voting Client Securities. Advisers must disclose whether they have or will accept authority to vote client securities and, if so, describe the voting policies they have adopted. Each adviser must describe whether (and how) clients can direct it to vote in a particular solicitation, how the adviser addresses conflicts of interest when it votes securities, and how clients can obtain information from the adviser on how the adviser voted their securities. Advisers that do not accept authority to vote securities must disclose how clients receive their proxies and other solicitations.

Item 18. Financial Information. This item requires disclosure of any financial condition reasonably likely to impair the adviser’s ability to meet contractual commitments to clients. An adviser that requires prepayment of fees must give clients an audited balance sheet showing the adviser’s assets and liabilities at the end of its most recent fiscal year.

Appendix 1. The Wrap Fee Program Wrap. Advisers that sponsor wrap fee programs continue to be required to prepare a separate, specialized firm brochure for clients of the wrap fee program in lieu of the sponsor’s standard brochure.

Delivery

Initial Delivery. Advisers must deliver a current brochure before or at the time of entering into an advisory contract with a client. Advisers are not required to deliver brochures to clients who (i) receive only impersonal investment advice and are charged less than $500 in adviser fees per year; (ii) are investment companies registered under the Investment Company Act; or (iii) are business development companies subject to Section 15(c) of the Investment Company Act.

Annual Delivery. Advisers must annually provide to each client to whom they must deliver a brochure either: (i) a copy of the current (updated) brochure that includes or is accompanied by the summary of material changes; or (ii) a summary of material changes that includes an offer to provide a copy of the current brochure. Each adviser must make this annual delivery no later than 120 days after the end of its fiscal year.

Interim Delivery. Advisers must deliver an updated brochure (or a document describing the material facts relating to the amended disciplinary event) promptly whenever the adviser amends its brochure to add a disciplinary event or to change material information already disclosed in response to Item 9 of Part 2A.

Updating

Advisers are required to keep their brochures current by updating them at least annually, and updating them promptly when any information in the brochures (except the summary of material changes and the amount of assets under management, which only has to be updated annually) becomes materially inaccurate.

Filing

Brochures must be filed with the SEC electronically through the Investment Adviser Registration Depository system. Although previously filed versions of an adviser’s brochure will remain in the IARD system, only the most recent version will be publicly accessible through the SEC’s website.

Part 2B – The Brochure Supplement

Each brochure must be accompanied by brochure supplements providing information about the officers, partners, directors and employees of the adviser who provide investment advice (collectively, “supervised persons”). Specifically, advisers are required to provide a client with a brochure supplement for each supervised person who: (i) formulates investment advice for that client and has direct client contact; or (ii) makes discretionary investment decisions for that client’s assets. If investment advice is provided by a team comprised of more than five supervised persons, brochure supplements need only be provided for the five supervised persons with the most significant responsibility for the day-to-day advice provided to the client.

Content

Item 1. Cover Page. The cover page must include information identifying the supervised person covered by the supplement and the advisory firm.

Item 2. Educational Background and Business Experience. Item 2 requires the adviser to describe the supervised person’s formal education and his or her business background for the past five years. The business background section must identify the supervised person’s positions at prior employers and not merely list the names of prior employers.  If professional designations are disclosed in the supplement, the supplement must also provide a sufficient explanation of the minimum qualifications required for the designation to allow clients and potential clients to understand the value of the designation.

Item 3. Disciplinary Information. Item 3 requires disclosure of any legal or disciplinary event that is material to a client’s evaluation of the supervised person’s integrity. It includes certain disciplinary events that the SEC presumes are material to such an evaluation if they occurred during the last 10 years.

Item 4. Other Business Activities. Item 4 requires an adviser to describe other business activities of its supervised persons. The adviser must disclose other capacities in which the supervised person participates in any investment-related business, any compensation the supervised person receives based on the sales of securities or other investment products, and any material conflicts of interest such participation or compensation may create. The brochure supplement must also disclose other business activities or occupations that the supervised person engages in if they involve a substantial amount of time or pay. Business activities representing less than 10 percent of the supervised person’s time and income are presumed not to be substantial.

Item 5. Additional Compensation. This item describes arrangements in which someone other than a client gives the supervised person an economic benefit (such as a sales award or other prize) for providing advisory services.

Item 6. Supervision. This item requires an adviser to explain how the firm monitors the advice provided by the supervised person addressed in the brochure supplement. It also requires a firm to provide the client with the name, title, and telephone number of the person responsible for supervising the advisory activities of the supervised person.

Delivery

The supervised person’s supplement initially must be given to each client at or before the time when that specific supervised person begins to provide advisory services to that specific client.

Advisers are not required to deliver supplements to three types of clients: (i) clients to whom an adviser is not required to deliver a firm brochure (e.g., registered investment companies and business development companies); (ii) clients who receive only impersonal investment advice; and (iii) certain officers, directors, employees and other persons related to the adviser.

Updating

Advisers must deliver an updated supplement to clients only when there is new disclosure of a disciplinary event, or a material change to disciplinary information already disclosed, in response to Item 3 of Part 2B. As with the brochure, advisers must amend a brochure supplement promptly if information in it becomes materially inaccurate. Any new clients to whom the adviser is obligated to deliver a supplement must be given an amended supplement (or the “old” supplement and a sticker). Advisers are not required to deliver supplements to existing clients annually.

Filing

Advisers are not required to file brochure supplements or supplement amendments with the SEC, and they will not be available on the SEC’s public website. Advisers are required to maintain copies of all supplements and amendments in their files.

Compliance Dates

New Advisers

Advisers registering with the SEC after January 1, 2011 must file a brochure meeting the requirements of amended Part 2A and, upon registering, begin to deliver a brochure and brochure supplements to clients and prospective clients in accordance with the requirements discussed above.

Registered Advisers

Each adviser currently registered with the SEC whose fiscal year ends on or after December 31, 2010 must include in its next annual updating amendment to its Form ADV a brochure that meets the requirements of the amended form. Accordingly, each adviser with a fiscal year end of December 31, 2010 must file an annual updating amendment with the new brochures no later than March 31, 2011. Within 60 days of filing such amendment, the adviser must deliver to its existing clients a brochure and brochure supplement that meet the requirements of amended Form ADV. Each adviser must, after the initial filing of the brochures, begin to deliver to new clients and prospective clients a new brochure and brochure supplements satisfying the requirements discussed above.