Articles Tagged with Investment Advisers

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The U.S. Treasury Department’s Financial Crimes Enforcement Network will soon propose new rules that may require investment advisers to establish and implement written anti-money laundering programs designed to prevent advisory clients from using advisers to launder funds or perpetrate other criminal activities. The rules also may require advisers to report suspicious client activity.

The new rules may be similar in certain respects to rules proposed by Treasury in 2003, when the Department attempted to subject investment advisers to the AML provisions of the Bank Secrecy Act. The 2003 rules would have required advisers to (1) establish and implement policies, procedures and controls reasonably designed to prevent advisers from being used to launder money or finance terrorist activities, (2) provide independent testing of compliance by the advisory firms’ personnel, affiliates or third parties, (3) designate persons responsible for implementing and monitoring the operations and internal controls of the program and (4) provide ongoing training for appropriate persons who are involved with the program.

The new rules are likely to reflect comments received in response to the 2003 proposal and may be informed, in part, by certain practices followed by advisers in offshore jurisdictions. It is unclear whether the rules will require investment advisers to apply their anti-money laundering programs to their clients’ beneficial owners.

If the new rules are adopted, investment advisers will need to review and update their compliance manuals, as necessary, to incorporate anti-money laundering policies and procedures that are tailored to their business, clients and risks. In addition, private offering memoranda, fund governance documents, advisory agreements and other client communications should be updated to include information about the anti-money laundering program and suspicious activity reporting requirements.

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In the Federal Register for July 23, 2015, the Treasury Department published proposed regulations regarding the circumstances under which partnership allocations and distributions will be treated as disguised payments for services. These proposed regulations are aimed at attempts by investment fund managers to convert ordinary, management fee income into tax-favored long-term capital gains through the use of management fee waivers.

The proposed regulations draw heavily on the legislative history to Internal Revenue Code section 707(a)(2)(A), enacted as part of the Deficit Reduction Act of 1984 (P.L. 98-369), which provides that allocations and distributions to a partner by a partnership will be disregarded and instead treated as disguised payments for services if the performance of such services and the related direct or indirect allocation and distribution, taken together, are properly characterized as a transaction between the partnership and a partner acting other than in his capacity as a member of the partnership.

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Read this article and additional publications at pillsburylaw.com/publications-and-presentations.  You can also download a copy of the Client Alert.

Related post: Proposed Treasury Regulations May End Private…

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Pillsbury hosted a panel event for 100 Women in Hedge Funds on July 28 discussing conflicts of interests hedge fund managers face in managing multiple account types, such as funds, institutional separate accounts and sub-advised mutual funds.  Kristin Snyder, Associate Regional Director for Examinations, San Francisco Regional Office of the Securities and Exchange Commission, emphasized that while the SEC does not expect advisers to have conflict-free business models, clear disclosure and effective mitigation of material conflicts are essential fiduciary duties of an adviser.  Other panelists and representatives of hedge fund managers (Frank Martin, President, Standard Pacific Capital, LLC) and institutional investors (Michelle Young, Managing Director, Ohana Advisors), provided insights into identifying, assessing, mitigating, and managing those conflicts. Ildiko Duckor, Partner and co-head of Pillsbury’s Investment Funds and Investment Management group, moderated the panel and offered tips and comments on practical solutions to account conflicts.

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The Bureau of Economic Analysis (BEA) has extended the deadline to file Form BE-10, Benchmark Survey of U.S. Direct Investment Abroad, to June 30, 2015, for all new filers.

For information on Form BE-10 filing, please read our recent article HERE.

Further information on BE-10 is available at the BEA website.

 

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The Securities and Exchange Commission (SEC) today proposed rules, forms and amendments to modernize and enhance the reporting and disclosure of information by investment advisers and investment companies.

Investment advisers. The investment adviser proposed rules would amend the investment adviser registration and reporting form (Form ADV), and Investment Advisers Act Rule 204-2. On Form ADV, the proposed rules would require investment advisers to provide additional information for the SEC and investors to better understand the risk profile of individual advisers and the industry. Investment advisers would be required to report, among other things, detailed information about their separately managed accounts, including assets under management and types of assets held in the accounts. The proposed amendments to Investment Advisers Act Rule 204-2 would require advisers to maintain records of performance calculations and communications related to performance.

Investment companies. The investment company proposed rules would enhance data reporting for mutual funds, ETFs and other registered investment companies.  The proposals would require a new monthly portfolio reporting form (Form N-PORT) and a new annual reporting form (Form N-CEN) that would require census-type information.  The information would be reported in a structured data format, which would allow the SEC and the public to better analyze the information.  The proposals would also require enhanced and standardized disclosures in financial statements, and would permit mutual funds and other investment companies to provide shareholder reports by making them accessible on a website.

Highlights of the investment adviser and investment company proposals are available HERE.

The SEC is requesting for comments which should be submitted to be received within 60 days from publication of the proposed rules in the Federal Register.

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  • Mandatory reporting required by the Bureau of Economic Analysis on Form BE-10 – 2014 Benchmark Survey of U.S. Direct Investment Abroad
  • Investment managers, general partners, hedge funds and private equity funds are among those that may have to file

What is BE-10?

BE-10 is a benchmark survey of U.S. direct investment abroad, conducted once every five years by the Bureau of Economic Analysis (“BEA”) of the U.S. Department of Commerce. The purpose of the survey is to obtain economic data on the operations of U.S. parent companies and their foreign affiliates. The BE-10 survey is conducted pursuant to the International Investment and Trade in Services Survey Act, and the filing of reports is mandatory pursuant to Section 5(b)(2) of that Act. BE-10 reports are kept confidential and used for statistical analysis.

What is the filing deadline?

May 29, 2015 – if you are a U.S. Reporter (defined below) filing to report fewer than 50 Foreign Affiliates (defined below).

June 30, 2015 – if you are a U.S. Reporter filing to report 50 or more Foreign Affiliates.

Extensions. The BEA will consider reasonable requests for extensions if received before the applicable due date of the report. Extension requests should “enumerate the substantive reasons necessitating the extension” on the form provided by the BEA.

Who must file?

All U.S. persons that had direct or indirect ownership or control (each, a “U.S. Reporter”) of at least 10%[i] of the voting stock of a foreign business enterprise (a “Foreign Affiliate”) at any time during the entity’s 2014 fiscal year must file.

Any U.S. general partner or investment manager of a private fund could be a U.S. Reporter, and any hedge fund, private equity fund, or other private fund could be either a U.S. Reporter or a Foreign Affiliate, if they meet the above criteria.

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[i] A U.S. Reporter’s ownership interest in a Foreign Affiliate may be held indirectly through a directly held Foreign Affiliate that owned the given foreign enterprise. You must “look through” all intervening foreign enterprises in the chain to determine whether you hold a foreign business enterprise to the extent of 10% or more. To calculate your ultimate ownership percentage, multiply the direct ownership percentage in the first Foreign Affiliate by that first Foreign Affiliate’s direct ownership percentage in the second enterprise in the chain, multiplied by the direct ownership percentage for all other intervening enterprises in the ownership chain, until you reach the ownership percentage in the final foreign business enterprise. To illustrate, if a U.S. Reporter owned 50% of Foreign Affiliate A directly, and A owned 75% of foreign business enterprise B which, in turn, owned 80% of foreign business enterprise C, the U.S. Reporter’s percentage of indirect ownership of B would be 37.5% (the product of the first two percentages), its indirect ownership of C would be 30% (the product of all three percentages), and B and C (as well as A) would be considered Foreign Affiliates of the U.S. Reporter.

Read this article and additional publications at pillsburylaw.com/publications-and-presentations.

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The expense provisions of many private fund governing documents are becoming longer and more detailed for good reason – increased Securities and Exchange Commission (SEC) scrutiny and prosecution relating to expense allocation and disclosure.

On April 29th, the SEC announced charges against Alpha Titans LLC, a hedge fund advisory firm, its principal, Timothy P. McCormack and its general counsel, Kelly D. Kaeser, for improper use of fund assets to pay expenses that were not previously disclosed to fund investors. According to the SEC, office rent, employee salaries and benefits and other expenses totaling more than $450,000 were paid by two affiliated private funds without adequate disclosure or authorization. The SEC further alleged that Alpha Titans, McCormack and Kaeser sent investors audited financials that did not disclose that approximately $3 million of expenses pertained to transactions involving affiliates of McCormack.

According to the SEC, the funds’ outside auditor, Simon Lesser, was aware of the manner in which expenses and assets were allocated, yet approved audit reports containing unqualified opinions that the financial statements were presented fairly. He was charged with engaging in improper professional conduct in connection with an audit of the funds’ financial statements. The advisory firm also was charged with custody rule violations relating to its distribution on non-GAAP-compliant financial statements.

All of the charges were settled without admission or denial of responsibility; however, not without significant cost. McCormack and Kaeser will be barred from the securities industry for one year and Kaeser will be unable to represent an SEC-regulated entity for one year. Lesser will be suspended from providing accounting services on behalf of an entity regulated by the SEC for at least three years. Substantial monetary penalties also were assessed and the advisory firm and its principal agreed to pay disgorgement and prejudgment interest.

The lesson for private funds, their advisers and outside auditors is simple. First, fund documents should clearly, accurately and thoroughly disclose the types and amounts of expenses to be charged to the fund or its investors. Second, fund managers must allocate expenses and use fund assets strictly in accordance with the relevant provisions in the fund documents. Finally, outside auditors must be diligent in reviewing expense allocations and the use of fund assets to determine compliance with fund documents.

There should be no doubt that the risk of non-compliance is real.

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The Division of Investment Management (the “Division”) of the Securities and Exchange Commission issued a cybersecurity guidance identifying cybersecurity of registered investment companies (“funds”) and registered investment advisers (“advisers”) as an important issue. Recognizing the rapidly changing nature of cyber threats and consequently, the necessity for funds and advisers to protect sensitive information including information of fund investors and advisory clients, the Division is suggesting a number of measures that funds and advisers may wish to consider in addressing the issue. To mitigate cybersecurity risk, the Division suggests that funds and advisers: 1) conduct a periodic assessment of their technology system and security controls and processes to identify potential cybersecurity threats and vulnerabilities, 2) create a strategy that is designed to prevent, detect and respond to cybersecurity threats, and 3) implement the strategy through written policies and procedures, training of officers and employees, and investor and client education. In addition, the Division also suggests that funds and advisers may wish to consider reviewing their operations and compliance programs whether they have measures in place that mitigate their exposure to cybersecurity risk, as well as assessing whether protective cybersecurity measures are in place at service providers that they rely on in carrying out their business operations.

A full version of the cybersecurity guidance is available HERE.

Please call an Investment Funds and Investment Management attorney with your inquiries regarding your firm’s cybersecurity risks and compliance procedures that address them.

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On April 20, 2015, the Securities and Exchange Commission (“SEC”) issued an order against an investment advisory firm and its former chief compliance officer, for violating Sections 206(2) and 206(4) and rule 206(4)-7 of the Investment Advisers Act and rule 38a-1 of the Investment Company Act. The SEC charged BlackRock Advisors LLC with breaching its fiduciary duty by failing to disclose a conflict of interest involving the outside business activity of one of its top-performing portfolio managers, Daniel J. Rice III. BlackRock agreed to be censured and to settle the charges by paying a $12 million penalty and engaging an independent compliance consultant to conduct an internal review.

During his tenure as an energy sector portfolio manager at BlackRock, Rice founded an oil and gas exploration and production company, formed a joint venture with a public company held in his managed funds, and acquired a second public company also held in BlackRock portfolios. BlackRock learned of Rice’s outside business activity, but allowed him to continue his involvement. The SEC found that BlackRock failed to report the conflicts of interest to the board of directors of the affected registered funds or advisory clients and failed to monitor and reassess Rice’s outside business activity after discovering the conflicts of interest. The SEC also censured BlackRock for failing to maintain and implement internal policies regarding the outside activities of employees. While Blackrock’s policies required employees to report potential conflicts and to seek pre-approval before serving on a board of directors, the firm failed to outline how employees’ outside activities would be assessed for conflicts purposes or to identify the individuals responsible for assessing outside activities.

Additionally, the SEC found BlackRock’s former chief compliance officer personally liable for causing the failure by BlackRock funds to report material compliance matters—namely Rice’s violation of BlackRock’s private investment policy—to their board of directors. The ex-officer agreed to pay a $60,000 civil penalty to settle the charge.

If you have question concerning your firm’s internal policies on the outside business activities of employees, please reach out to your Pillsbury attorney contact.

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On April 14, 2015, the Department of Labor issued its much anticipated re-proposal of regulations defining and expanding the persons who are treated as ERISA fiduciaries.  Under the proposal, subject to certain exceptions, all persons who  provide investment advice or recommendations for a fee to an employer-sponsored  retirement plan, plan fiduciary, plan participant, IRA or IRA owner would be deemed “fiduciaries”.  Other than investment education and “order taking”, most other investment sales related activities will result in fiduciary status.  Some of these advisors are subject to federal securities laws, others are not.

Being a fiduciary means that the advisor must provide impartial advice and put the client’s best interest first and must not accept any compensation payments creating conflicts of interest unless the payments qualify for an exemption (newly proposed) intended to ensure that the customer is adequately protected.  If the regulations are finalized, compliance with the terms of the new exemption will be a necessary condition for continuing many of the compensation practices currently in use by the investment industry.

We expect to issue a Client Alert on the Proposal and new Rule.  If you have any questions, please feel free to contact our Funds or Employee Benefits attorneys.