Articles Tagged with SEC

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Written by Jay Gould and Michael Wu

On June 22, 2011, the Securities and Exchange Commission (SEC) adopted final rules that implement provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amending the Investment Advisers Act of 1940 (the “Advisers Act”).   The amendments include:

  • Statutory Threshold for SEC Registration.   The Dodd-Frank Act increases the threshold for SEC registration by creating a new category of advisers called “mid-sized advisers.”  A mid-sized adviser has assets under management between $25 million and $100 million.  If the mid-sized adviser’s principal office and place of business is located in a state that requires it to register as an investment adviser, the adviser must register with the state.  A mid-sized adviser must register with the SEC if it is not required to register in the state where it maintains its principal office and place of business, or if registered with that state, the adviser would not be subject to examination by that state’s securities commissioner.
  • Transition to State Registration, Registration Deadline.

    Existing SEC-registered adviser as of January 1, 2012 – must amend its Form ADV no later than March 30, 2012.Mid-sized adviser no longer eligible for SEC registration – must amend its Form ADV no later than March 30, 2012 to switch to state registration and withdraw its SEC registration by filing Form ADV-W no later than June 28, 2012.

    New Applicants.  Until July 21, 2011 (effective date of the final rules), advisers applying for registration that qualify as mid-sized advisers may register with either the SEC or the appropriate state securities authority.  Thereafter, mid-sized advisers must register with the appropriate state securities authority.

  • Exempt Reporting Advisers.  These are advisers that rely on either the venture capital exemption or the private fund advisers exemption.  The final rules require these exempt reporting advisers to submit an annual report with the SEC by filing an abbreviated Form ADV Part 1 completing only Items 1 (Identifying Information), 2.B (SEC Reporting by Exempt Reporting Advisers), 3 (Form of Organization), 6 (Other Business Activities), 7 (Financial Industry Affiliations), 10 (Control Persons), 11 (Disclosure Information), and any corresponding section of Schedules A, B, C and D.  There will be fees associated with the filing which will be the same as those for registered advisers.
  • Form ADV.  The SEC is amending Part 1 of Form ADV to require advisers to provide additional information: 1) about private funds they advise, 2) about their advisory business and business practices that may present conflicts of interest, and 3) about their non-advisory activities and financial industry affiliations.
  • Family Office exemption.  By defining “family office,” the SEC is allowing family offices to continue to be exempt from regulation of the Advisers Act.  The final rules expanded the exemption by including additional categories of family members and key employees as family clients.
  • Pay-to-Play Rule.  The final rules permit an adviser to pay a registered municipal advisor, or an SEC registered investment adviser or broker-dealer, to act as placement agent to solicit government entities on its behalf, so long as the municipal advisor is subject to the MSRB-adopted pay-to-play rule, or the SEC registered adviser or broker-dealer is subject to a FINRA-adopted pay-to-play rule, that is at least as stringent as the investment adviser pay-to-play rule.

The SEC also adopted final rules that eliminated the private adviser exemption under the Advisers Act and created three new exemptions from SEC registration for:

  • Advisers solely to venture capital funds (venture capital fund exemption).  The final rules define “venture capital fund” as a private fund that: 1) holds no more than 20% of the fund’s capital commitments in non-qualifying investments (other than short-term holdings); 2) does not borrow or is not leveraged except for a limited short-term borrowing; 3) does not offer redemption or liquidity rights to its investors; 4) represents itself to investors as pursuing a venture capital strategy; and 5) is not registered under the Investment Company Act of 1940 and is not a business development company.The SEC also adopted the grandfathering provision for this exemption provided the following three requirements are met by the fund: (i) represented to investors that it pursues a venture capital strategy; (ii) has sold securities prior to December 31, 2010; and (iii) does not sell securities to, or accept any capital commitments from, any person after July 21, 2011.
  • Advisers solely to private funds with less than $150 million in assets under management in the U.S. (private fund adviser exemption).  The instructions to Form ADV will be revised to provide a uniform method of calculating assets under management for regulatory purposes.
  • Certain foreign advisers without a place of business in the U.S.  A non-U.S. adviser that has no place of business in the U.S. is not required to register with the SEC if it has fewer than total 15 U.S. clients and private fund investors, has less than $25 million in aggregate assets under management from U.S. clients and private fund investors, and does not hold itself out to the public as an investment adviser.
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Written by Michael Wu

The Securities and Exchange Commission (“SEC”) has adopted rules implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act’s (“Dodd-Frank Act”) Whistleblower Program.  The Whistleblower Program requires the SEC to pay awards, under regulations prescribed by the SEC and subject to certain limitations, to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of the federal securities laws, or a rule or regulation promulgated by the SEC, that leads to the successful enforcement of a covered judicial or administrative action, or a related action that results in monetary sanctions of more than $1,000,000.  Dodd-Frank Act also prohibits retaliation by employers against individuals who provide the SEC with information about possible securities violations.

To view a full text of the Final Rule, please click here.

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Written by Michael Wu

The Securities and Exchange Commission (the “SEC”) recently published a notice of its intent to raise the dollar thresholds that would need to be satisfied in order for an investment adviser to charge its investors a performance fee.  Currently, under Rule 205-3 of the Investment Advisers Act of 1940, as amended, an investment adviser may charge its investors a performance fee if (i) the investor has at least $750,000 under management with the investment adviser, or (ii) the investment adviser reasonably believes that the investor has a net worth of more than $1.5 million.  To comply with the Dodd-Frank Act, the SEC must adjust these dollar amounts for inflation by July 21, 2011 and every five years thereafter.

Thus, the SEC intends to issue an order that would revise the dollar amount tests to $1 million for assets under management and $2 million for net worth.  The SEC is also proposing to amend Rule 205-3 to: (i) provide the method for calculating future inflation adjustments of the dollar amount tests, (ii) exclude the value of a person’s primary residence from the net worth test, and (iii) modify the transition provisions of the rule.  The SEC is seeking public comment on the proposed rule.

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Written by Jay Gould, Ildi Duckor and Michael Wu

On March 22, 2011, U.S. House Oversight Committee Chairman Darrell Issa (R., Calif.), sent a sharply worded letter to Chairman Mary Schapiro of the Securities and Exchange Commission (the “SEC”), in which he demanded that the SEC justify several of its rules regarding raising capital, including the “quiet period” that restricts a company’s communications ahead of an initial public offering (“IPO”) and the rules that limit the number of investors in private companies to 499. The immediate impetus of this letter (the “Issa Letter”) appeared to be the recent decision by Facebook to issue shares exclusively to non-U.S. investors due to the requirement for a private company to file financial statements with the SEC once it has more than 499 U.S. equity holders, as well as the general decline of the overall IPO market in the U.S.

The Issa Letter accuses the SEC of stifling capital creation and causing the decline of the IPO market in the U.S. by clinging to obsolete and inflexible laws and regulations. Chairman Issa asks whether the decline in public equity listings and issuances have been driven by the expansion and complexity of SEC regulations, the expansion of personal liability under the Sarbanes-Oxley Act of 2002, the new uncertainty surrounding regulations to be issued pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), securities class action lawsuits and the expansion of other regulatory, legal or compliance burdens. Chairman Issa railed against the prohibition on promotional statements made between the time that a registration statement has been filed and the time it becomes effective as a violation of an issuer’s rights under the First Amendment. Chairman Issa further finds fault in the inability of the SEC to fashion rules to permit effective early stage capital formation, accuses the SEC of certain conflicts of interest and ineptitude in its staff, and suggests that “sophisticated” investors, regardless of whether they satisfy the “accredited” investor standard, should be permitted to invest in private placements.

On April 6, 2011, Chairman Schapiro responded to Chairman Issa in a detailed and heavily footnoted tome (the “Shapiro Letter”) that sought to correct some of the basic misunderstandings in the Issa Letter. The Schapiro Letter provides an interesting and brief history of the development of private offerings, the development of the private markets, the IPO process, the rationale behind public reporting, and the SEC’s views towards capital raising strategies. Much of this discussion is either relevant to investment fund managers or directly on point with their businesses, and certainly worth a read.

Chairman Issa raises some interesting points and the combative tone of his letter should not be a reason to simply dismiss his concerns. There are, however, two interesting questions that Chairman Issa could have raised with the SEC, but did not, the answers to which may have been even more productive to the discussion.

First, does the SEC believe that if it was self-funded, it would be more responsive to the needs of the capital markets and be able to better balance its dual mandates of creating efficient capital markets and protecting shareholders? It should be noted that early drafts of the Dodd-Frank Act stated that the SEC was to be self-funded, but that language was later removed when our two political parties agreed on specific budget numbers for the SEC, which they believed would permit the SEC to meet its significant new and continuing obligations. Once the Dodd-Frank Act became law, a bi-partisan Congress promptly ignored these funding mandates and has continued to impede the effectiveness of the SEC through the budget process.

Second, does the SEC believe that significantly increasing the number of investors to which a private company can sell shares, without providing full and fair disclosure, would shrink the public markets, make fewer investment opportunities available to ordinary investors, and accelerate the wealth divide that is threatening to destabilize the U.S.? The securities laws were meant to level the playing field among investors, and the SEC over the years has attempted to enforce this mandate through the registration process and its enforcement actions. Larry Ribstein provides a thoughtful view of this dilemma here.

The balance between effective regulation for investor protection and efficient capital markets to encourage responsible investment is a delicate one that we can expect to be treated quite indelicately in the current political climate.

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Written by Jay Gould, Ildi Duckor and Michael Wu

On March 18, 2011, the Securities and Exchange Commission released new guidance regarding Form ADV.  The SEC’s Q&As can be found here.  The most significant development pertains to a registered adviser’s obligation to deliver Part 2.  Specifically, Question III.2 reads as follows:

Q: Rule 204-3 requires an adviser to deliver a brochure and one or more brochure supplements to each client or prospective client. Does rule 204-3 require an adviser to a hedge or other private fund to deliver a brochure and supplement(s) to investors in the private fund?

A: Rule 204-3 requires only that brochures be delivered to “clients.” A federal court has stated that a “client” of an investment adviser managing a hedge fund is the hedge fund itself, not an investor in the hedge fund. (Goldstein v. Securities and Exchange Commission, 451 F.3d 873 (D.C. Cir. 2006)). 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, manager or person serving in a similar capacity. (Posted March 18, 2011)

Although the SEC’s response focuses on “hedge funds,” because the term “client” is defined the same way for all “private funds,” we can reasonably conclude that advisers to private equity funds and other private funds can satisfy the delivery obligations by delivering the new Part 2 to the general partners of the private equity funds or private funds that they manage – as opposed to the investors in such funds.  This is a significant change because previously most registered advisers provided Part 2 to all of the investors in the funds that they managed.

Please note that registered advisers are still required to file Part 2 of Form ADV with the SEC.

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Written by Michael Wu

On January 26, 2011, the SEC proposed a rule that would require SEC-registered advisers to hedge funds, private equity funds and other private funds to report information to the Financial Stability Oversight Council (“FSOC”) that would enable it to monitor risk to the U.S. financial system.  The information would be reported to the FSOC on Form PF and the information reported on Form PF would be confidential.

The proposed rule would subject large advisers to hedge funds, “liquidity funds” (i.e., unregistered money market funds) and private equity funds to heightened reporting requirements.  Under the proposed rule, a large adviser is an adviser with $1 billion or more in hedge fund, liquidity fund or private equity fund assets under management.  All other advisers would be regarded as smaller advisers.  The SEC anticipates that most advisers will be smaller advisers, but that the large advisers represent a significant portion of private fund assets.

Smaller advisers would be required to file Form PF once a year and would report only basic information about their hedge funds, private equity funds and/or other private funds, such as information regarding leverage, credit providers, investor concentration, fund performance, fund strategy, counterparty credit risk and the use of trading and clearing mechanisms.

Large advisers would be required to file Form PF quarterly and would provide more detailed information than smaller advisers.  The information reported would depend on the type of private fund that the large adviser manages.

  • Large advisers to hedge funds would report, on an aggregated basis, information regarding exposures by asset class, geographical concentration and turnover.  If a hedge fund has a net asset value of at least $500 million, the adviser would report information regarding the fund’s investments, leverage, risk profile and liquidity.
  • Large advisers to liquidity funds would report the types of assets in their liquidity funds, information relevant to the risks of the funds, and the extent to which the liquidity funds comply with Rule 2a-7 of the Investment Company Act of 1940, as amended.
  • Large advisers to private equity funds would respond to questions regarding the extent of leverage incurred by their funds’ portfolio companies, the use of bridge financing and their funds’ investments in financial institutions.

The SEC’s public comment period on the proposed rule will last 60 days.

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Written by Michael Wu

On January 21, 2011, the SEC released its study on the effectiveness of the standard of care required of broker-dealers and investment advisers that provide personalized investment advice regarding securities to retail customers (“Covered Broker-Dealers and Investment Advisers”).  The study also considered the existence of regulatory gaps, shortcomings or overlaps that should be addressed by rulemaking.  The study was prepared pursuant to Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The study recommends that the SEC establish a uniform fiduciary standard for Covered Broker-Dealers and Investment Advisers that is at least as stringent as the fiduciary standard under Sections 206(1) and (2) of the Investment Advisers Act of 1940, as amended.  The SEC staff stated that under this standard, Covered Broker-Dealers and Investment Advisers must “act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.”

To implement the uniform fiduciary standard, the study recommends that the SEC adopt rules to address the following:

  • Disclosure Requirements.  Rules should be adopted to address both the existing “umbrella” disclosures (e.g., ADV Part II) and specific disclosures provided by Covered Broker-Dealers and Investment Advisers when a transaction is executed.
  • Principal Trading.  Rules should be adopted to address how Covered Broker-Dealers can satisfy the uniform fiduciary standard when engaging in principal trading activities.
  • Customer Recommendations.  Rules should be adopted to address the duty of care obligations that Covered Broker-Dealers and Investment Advisers have in making recommendations to retail customers.

The study further recommends that the SEC harmonize other areas of broker-dealer and investment adviser regulation, such as regulations pertaining to advertising and communication, the use of finders and solicitors, supervision and regulatory reviews, licensing and registration of firms, licensing and registration of associated persons, and maintenance of books and records.

Based on the study, it appears likely that the SEC will adopt a uniform fiduciary standard in the near future.  However, at this time, it is not clear how the standard would affect the manner in which Covered Broker-Dealers and Investment Advisers conduct their businesses.

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By: Michael Wu

As the new year is upon us, we wanted to take a moment to remind you of some of the annual compliance obligations that you may have as an investment adviser that is registered with the Securities and Exchange Commission (the “SEC”) or with a particular state (“Investment Adviser”).  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.

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 tax, partnership, corporate or other 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.

  • 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.  Effective on January 1, 2011, Investment Advisers must file both Part 1 and Part 2A of the Form ADV with the SEC through the electronic IARD system.  Accordingly, if you are SEC-registered adviser whose fiscal year ends on or after December 31, 2010, you must file Part 1A and Part 2A as part of your annual updating amendment by March 31, 2011.  If you are a state-registered adviser whose fiscal year ends on or after December 31, 2010, you must also file Part 1A, Part 1B and Part 2A as part of your annual updating amendment by March 31, 2011.
  • New FINRA Entitlement Program.  FINRA is implementing 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.  Beginning November 15, 2010, Preliminary Renewal Statements (“PRS”), which list advisers’ renewal fees, are available for printing through the IARD system.  By December 10, 2010, an investment adviser should have submitted to FINRA through the IARD system, its preliminary renewal fee.  Any additional fees that were not included in the PRS will show in the Final Renewal Statements which are available for printing beginning January 3, 2011.  All final renewal fees should be submitted to FINRA through the IARD system by February 3, 2011.
  • 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 private fund investors 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. The 2011 deadline for providing investors with Form ADV Part 2B depends on whether an Investment Adviser is a new or existing SEC-registered adviser and whether the Investment Adviser is providing it to prospective, new or existing investors.
  • Annual Assessment.  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; and

3)      the business continuity/disaster recovery plan, which should be “stress tested” and adjusted as necessary.

  • Annual/Surprise Audit.  Because Investment Advisers are generally deemed to have custody of client assets, they must 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 provide audited financial statements to fund investors should remind their auditors that an annual surprise audit is necessary.
  • 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.  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” 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.  The reconfirmation may be obtained through “negative consent” letters.
  • Anti-money Laundering.  Although FinCEN withdrew its 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.
  • 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”).
  • 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.
  • 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 as of 2009, all Form D filings for continuous offerings will need to be amended 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.

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Written by Michael Wu

On Friday, November 19, 2010, the Securities and Exchange Commission (the “SEC”) issued a Proposed Rule amending the Investment Advisers Act of 1940, as amended, and a Proposed Rule implementing provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The purpose of the proposed rules is to strengthen the SEC’s oversight of investment advisers and fill key gaps in the regulatory landscape. The following is a summary of the key provisions of the proposed rules.

Increased Disclosure for Registered Advisers:  Under the proposed rules, advisers to private funds would have to provide the following information about the private funds they manage:

  • Basic organizational and operational information about the funds they manage, such as information about the amount of assets held by the fund, the types of investors in the fund, and the adviser’s services to the fund.
  • Identification of five categories of “gatekeepers” that perform critical roles for advisers and the private funds they manage (i.e., auditors, prime brokers, custodians, administrators and marketers).

In addition, the proposed rules would require registered advisers to provide more information about their advisory businesses, including information about:

  • The types of clients they advise, their employees, and their advisory activities.
  • Their business practices that may present significant conflicts of interest (such as the use of affiliated brokers, soft dollar arrangements and compensation for client referrals).

The proposed rules also would require advisers to provide additional information about their non-advisory activities and their financial industry affiliations.

Increased Disclosure for Exempted Advisers:  The proposed rules would require exempt reporting advisers (i.e., advisers that are exempt because they only advise venture capital funds or advise private funds with less than $150 million in assets under management (“AUM”)) to file, and periodically update, reports with the SEC, using the same registration form as registered advisers. Rather than completing all of items on the form, exempt reporting advisers would fill out a limited subset of items, including:

  • Basic identifying information for the adviser and the identity of its owners and affiliates.
  • Information about the private funds the adviser manages and about other business activities that the adviser and its affiliates are engaged in that present conflicts of interest that may suggest significant risk to clients.
  • The disciplinary history of the adviser and its employees that may reflect on their integrity.

As with registered advisers, exempt reporting advisers would file the reports on the SEC’s investment adviser electronic filing system (IARD), which means that such reports would be publicly available.

Pay-to-Play:  The proposed rules would amend the current investment adviser “pay-to-play” rule in response to changes made by the Dodd-Frank Act. The pay-to-play rule prohibits advisers from engaging in pay to play practices.  Under the proposed rules, an adviser could pay a registered municipal adviser, instead of a “regulated person,” to solicit government entities on its behalf if the municipal adviser is subject to a pay-to-play rule adopted by the MSRB that is at least as stringent as the investment adviser pay-to-play rule.

Dodd-Frank Act Exemptions:  Under the Dodd-Frank Act, the following advisers would not need to register with the SEC: (i) advisers solely to venture capital funds; (ii) advisers solely to private funds with less than $150 million in AUM in the U.S. or (iii) certain foreign advisers without a place of business in the U.S.  The proposed rules provide further guidance regarding these exemptions.

Definition of Venture Capital Fund:  Under the proposed rules, a venture capital fund is a private fund that:

  • Represents itself to investors as being a venture capital fund.
  • Only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash.
  • Is not leveraged and its portfolio companies may not borrow in connection with the fund’s investment.
  • Offers to provide a significant degree of managerial assistance, or controls its portfolio companies.
  • Does not offer redemption rights to its investors.

Under a grandfathering provision, private funds that currently make venture capital investments and represent themselves as venture capital funds would generally be deemed to meet the proposed definition.

Definition of Private Fund Advisers with less than $150 million AUM in the U.S.:  Under the proposed rules, in order to rely on this exemption, a U.S. adviser would have to meet the conditions of the exemption with respect to all of its private fund AUM. A foreign adviser would have to meet the conditions of the exemption only with respect to its AUM in the U.S., but generally not with respect to its assets managed from abroad.

Definition of Foreign Private Advisers:  The proposed rules would define certain terms included in the statutory definition of “foreign private adviser” in order to clarify the application of the foreign private adviser exemption. The proposed rules incorporate definitions set forth in other SEC rules, all of which are likely to be familiar to foreign advisers active in the U.S. capital markets.

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On September 22, 2010, the Managed Funds Association submitted initial comments to the Securities and Exchange Commission and the Commodity Futures Trading Commission on regulatory topics under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The MFA’s comments reflected concerns that the broad wording of the Dodd-Frank Act would result in certain provisions being inappropriately applied to private investment funds. To address these concerns, the MFA proposed that:

  • the SEC not create a self-regulatory organization to oversee investment advisers;
  • the SEC and the CFTC adopt guidance clarifying the criteria relevant to determining whether an investment adviser or a CTA that is registered with one of the agencies can rely on the relevant exemption from registration with the other agency;
  • strong confidentiality safeguards be put in place to protect proprietary information of private fund advisers provided to the SEC or CFTC;
  • appropriate implementation periods be provided to allow market participants time to adjust to any change in the definitions of “accredited investor” or “qualified client;”
  • the SEC define “accredited investor” to include “knowledgeable employees” of a private investment fund and amend Rule 3c-5 under the Investment Company Act of 1940 to expand the types of employees who can qualify as “knowledgeable employees” under that Rule;
  • the SEC and CFTC define “Security-Based Swap Dealer” (“SSD”) to exclude those market participants who are not in the business of buying and selling securities as well as those who buy and sell for their own account;
  • the SEC and CFTC exclude swap customers from SSD registration and regulation with respect to their cleared security-based swaps;
  • in setting capital requirements for non-bank Major Security-Based Swap Participants (“MSSPs”), the SEC and CFTC count collateral posted by such non-bank MSSPs towards any capital requirements;
  • position limits not be imposed on swaps;
  • the SEC not apply rules prohibiting incentive-based compensation to advisers of private investment funds;
  • the SEC retain the existing reporting periods under Section 13(d) and Section 16(a) of the Securities Exchange Act of 1934; and
  • the SEC not impose a new standard of conduct for investment advisers with retail customers.