Articles Tagged with Qualified Client

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The following are some of the important annual compliance obligations investment advisers either registered with the Securities and Exchange Commission (the “SEC”) or with a particular state (“Investment Adviser”) and commodity pool operators (“CPOs”) or commodity trading advisors (“CTAs”) registered with the Commodity Futures Trading Commission (the “CFTC”) should be aware of.

This summary consists of the following segments: (i) List of Annual Compliance Deadlines; (ii) 2017 Enforcement Priorities In The Alternative Space; (iii) New Developments; and (iv) Continuing Compliance Areas.

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Table of Annual Compliance Deadlines……………………………………………………………. 3

2017 Enforcement Priorities In The Alternative Space………………………………………. 5

New Developments………………………………………………………………………………………. 7

 

CONTINUE READING…

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  • 3(c)(1) funds should update their offering documents to reflect $2.1 million net worth requirement.
  • Assets under management threshold remains unchanged at $1 million.
  • Only new client relationships entered and new investors admitted in private funds after August 15, 2016 are affected; new contributions by pre-August 15 investors are grandfathered.

The Securities and Exchange Commission (the “SEC”) issued an order on June 14, 2016 raising the net worth threshold for “qualified clients” in Rule 205-3 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”).  Effective August 15, 2016, the dollar amount of the net worth test increased from $2 million to $2.1 million. The dollar threshold of the assets-under-management test has not changed and remains at $1 million.  Adjustments to the dollar thresholds for the assets-under-management and net worth tests under Rule 205-3 are made pursuant to section 418 of the Dodd-Frank Act and section 205(e) of the Advisers Act and are intended to reflect inflation.  The adjusted amounts would reflect inflation from 2011 until the end of 2015.

Under the Advisers Act, an investment adviser is generally prohibited from receiving performance fees or other performance-based compensation.  Section 205(e) of the Advisers Act provides for an exemption to this prohibition and Rule 205-3 under the Advisers Act permits an investment adviser to receive performance fees only from “qualified clients.”  The increased threshold affects private funds that rely on the exception to the definition of investment company provided in section 3(c)(1) of the Investment Company Act (“3(c)(1) Funds”) which, under the rule, are allowed to pay performance-based fees if their investors are qualified clients.  Accordingly, 3(c)(1) Funds must amend their offering documents to conform to the new qualified client net worth threshold.

Grandfathering:  Subject to the transition rules of Rule 205-3, the June 2016 SEC order generally does not apply retroactively to clients that entered into advisory contracts (including investors that invested in a private fund) prior to the August 15, 2016 effective date.

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The relentless attention being paid to cyber-attacks is driving companies to increase cyber security budgets and purchases. In turn, this has led institutional investors and asset managers to see potentially massive returns associated with companies in the cyber security market. Indeed a number of companies that have gone public have had phenomenal success, and the constantly morphing nature of cyber-attacks means that purchasing trends are not likely to slow down any time soon.

However, it is critical to keep in mind that just as cyber security capabilities can be a very attractive component in evaluating a potential investment; it also could lead to potentially negative consequences. Ignorance of some key legal and policy considerations could lead to an improper assessment of the value/future earnings potential of technology investments. These considerations are true regardless of whether or not the technology or service has a core “security” component.

Below are some key issues to consider when making cyber security investment decisions:

  • Cyber security matters in every investment
    • It is a simple fact that every company faces cyber threats. Multiple studies have  demonstrated that essentially every company has been or is currently subject to cyber-attack and that most if not all have already been successfully penetrated at least once. This leads to a key consideration: every company’s cyber security posture should be considered when making investment decisions. For example, a company selling information technology that is less prone to cyber-attacks should be viewed as a better investment than competitors who pay little to no attention to how their products can be breached.
  • Cybercrime is cheap
    • The cost of conducting cyber-attacks is depressingly cheap: $2/hour to overload and shutdown websites, $30 to test whether malware will penetrate standard anti-virus systems, and $5,000 for an attack using newly designed methods to exploit previously undiscovered flaws. Indeed it is now so cheap to create malware that the majority of malicious programs are only used once – thereby defeating many existing cyber security systems which are designed to recognize existing threats. This all adds up to a cost/benefit analysis that is irresistible for cyber-attackers, and essentially guarantees that the pace and sophistication of attacks will not let up any time soon.
  • Cyber security should be in the company’s DNA
    • Whether a company is offering a service or a technology, a critical factor to consider is its approach to security. Companies that consider security a key functionality that needs to be integrated from the start of the design process are far more likely to go to market with an offering that has higher degree of security. Security as an afterthought is just that – an afterthought. Weaving security into the DNA of a service or technology will be extremely helpful in decreasing security risks. Just remember though that no security program or process is flawless, and no one should expect perfection.
  • Is there a nation-state problem?
    • An R&D or manufacturing connection to countries known for conducting large-scale cyber espionage causes heartburn for companies and governments alike. Too many instances have occurred where buying items from companies owned by or operated in problem nation states have resulted in cyber-attacks. In some cases, Federal agencies are prohibited from buying IT systems from companies with connections to specific governments. Investors and managers need to stay abreast of problem countries, and also examine whether the product or service has a connection to such countries. Failure to do so can lead to investments in companies that have limited market potential.
  • Do your homework and forensic analyses
    • There’s nothing like buying a trade secret only to find out it really isn’t a secret. Before investing in any company, conduct due diligence to determine how good the security of the company is and whether IP or trade secret information has been compromised.
  • If the government cares, so should you
    • The Federal government is stepping up its requirements regarding cyber security in procurements. That means that all federal contractors (not just defense contractors) are going to have to increase their internal cyber security programs if they want to win government contracts. Failure to have a good cyber security program could lead to lost contracts, and thus decreased growth. 
  • Words matter
    • Companies have been too lax in negotiating terms that explicitly set forth security expectations for IT products as well as who will be liable should there be a breach/attack. Judicious reviews of terms and conditions can help avoid liability following a cyber-attack. For example, companies should not accept boilerplate language regarding the following of “industry standards” or “best practices” with respect to cyber security. Instead, specific obligations and benchmarks need to be agreed upon before signing any agreement. Further agreements should be drafted to that make clear that security measures are the obligation of the other party. That way the investor has set up a stronger argument for recovering losses as well as shifting liability away from itself.
  • Insurance isn’t everything
    • Companies may be tempted to think that if a company has a cyber-insurance policy, they are protected in the event of a cyber-attack. The reality is that there is an enormous chasm between buying coverage and having claims paid. Cyber policies are increasingly being written and interpreted to cover fewer types of attacks, and so do not be tempted to think that cyber insurance can fully protect an investment.
  • SAFETY Act
    • Under the Support Anti-Terrorism by Fostering Effective Technologies Act (SAFETY Act), cyber security services, policies, and technology providers are all eligible to receive either a damages cap or immunity from liability claims. The SAFETY Act also protects cyber security buyers, as they cannot be sued for using SAFETY Act approved items. Possessing SAFETY Act protections should be considered a positive sign and indicative of potential earnings growth.

There is no doubt about it; cyber risks are here to stay. Addressing those risks should be a core component of any business or investment strategy, because even if “today’s problem” is solved the introduction of new technologies will just mean a new threat vector for adversaries to exploit.

It is not all doom and gloom, however. Paying attention to cyber security trends and doing some simple due diligence will go far in minimizing digital risks. Make no mistake: defenses will always be incomplete and successful attacks will happen. However, with the right processes and approach, the bad outcomes can be minimized and investments will be protected.

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Written by Jay Gould, Ildiko Duckor and Michael Wu

Effective on September 19, 2011, investors that pay performance fees to an adviser must either have at least $1 million managed by the adviser or a net worth of at least $2 million.

As mandated by the Dodd-Frank Act, the SEC today issued an order that raises two of the thresholds that determine whether an investment adviser can charge its clients performance fees.  As discussed in the article we posted here on May 11, under the current Rule 205-3 of the Investment Advisers Act of 1940, 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 (“asset-under-management test”), or (ii) the investment adviser reasonably believes that the investor has a net worth of more than $1.5 million (“net worth test”).  Today’s SEC order adjusted the amounts for the asset-under-management test to $1 million and the net worth test to $2 million.  The SEC order is effective on September 19, 2011.

Accordingly, it is important for investment fund managers to amend their offering materials to comply with the new requirements of Rule 205-3 under the Advisers Act.

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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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The Securities and Exchange Commission has published its schedule for adopting rules to implement the Dodd-Frank Act. The proposed timetable for adopting rules related to the oversight of investment advisers and exempt offerings is as follows:

October – December 2010

  • §§404 and 406: Propose (jointly with the CFTC for dual-registered investment advisers) rules to implement reporting obligations on investment advisers related to the assessment of systemic risk
  • §§407 and 408: Propose rules implementing the exemptions from registration for advisers to venture capital firms and for certain advisers to private funds
  • §409: Propose rules defining “family office”
  • §410: Propose rules and changes to forms to implement the transition of mid-sized investment advisers (between $25 and $100 million in assets under management) from SEC to State regulation, as provided in the Act
  • §418: Propose rules to adjust the threshold for “qualified client”
  • §413: Propose rules to revise the “accredited investor” standard
  • §926: Propose rules disqualifying the offer or sale of securities in certain exempt offerings by certain felons and others similarly situated

January – March 2011

  • §913: Report to Congress regarding the study of the obligations of brokers, dealers and investment advisers
  • §914: Report to Congress regarding the need for enhanced resources for investment adviser examinations and enforcement
  • §919B: Complete study of ways to improve investor access to information about investment advisers and broker-dealers

April – July 2011

  • §§404 and 406: Adopt rules (jointly with the CFTC for dual-registered investment advisers) to implement reporting obligations on investment advisers related to the assessment of systemic risk
  • §§407 and 408: Adopt rules implementing the exemption from registration for advisers to venture capital firms and to certain advisers to private funds
  • §409: Adopt rules defining “family office”
  • §410: Adopt rules and form changes to implement the transition of mid-sized investment advisers (between $25 and $100 million in assets under management) from SEC to State regulation, as provided in the Act
  • §418: Adopt rules to adjust the threshold for “qualified client”
  • §413: Adopt rules to revise the “accredited investor” standard
  • §926: Adopt rules disqualifying the offer or sale of securities in certain exempt offerings by certain felons and others similarly situated
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The Dodd-Frank Wall Street Reform and Consumer Protection Act will significantly change the regulatory regime governing investment advisers, particularly investment advisers to private funds, such as hedge funds and private equity funds.  The primary purpose of the new rules and requirements is to “fill the regulatory gap,” by requiring advisers to private funds to register as investment advisers with the Securities and Exchange Commission or state securities regulators, unless an exemption applies, and provide information about their activities to the SEC. For a detailed discussion of the provisions of the Dodd-Frank Act applicable to advisers to private funds, please see our related Client Alert.