Articles Tagged with Sec

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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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On July 14, 2016, the Securities and Exchange Commission (SEC) announced an enforcement action against RiverFront Investment Group, LLC, a registered investment adviser serving as sub-adviser to clients in wrap fee programs established by various sponsors. The enforcement action resulted from RiverFront’s materially inadequate disclosure about changes in its trading practices and attendant transaction costs which exceeded wrap fees and caused millions of dollars in extra transaction costs for its clients.

In its role as sub-adviser, RiverFront had discretion to determine whether to send trades to sponsor-designated broker-dealers (whose costs were covered under the wrap fee program) or to other brokers in which case the clients would pay additional transaction costs. Wrap fee programs enable clients to pay one fee to cover a bundle of services, including, for example, trading, investment management and custody. From 2008 to 2011, RiverFront disclosed on its Form ADV that trades were “generally” executed through designated broker-dealers. It also disclosed that it may trade away in an effort to obtain best execution on behalf of its clients. A “trade away” is the practice of sending trades to a broker-dealer that has not previously been designated. In 2009, RiverFront started trading away significantly more transactions and charging clients fees that were not included in the annual wrap fee. However, in its annual Form ADV amendment filings from 2009 to 2011, RiverFront did not change its disclosures to reflect the frequency of its trade aways.

It was RiverFront’s failure to accurately and timely disclose on its Form ADV its trading practices and the potential for additional transaction costs that resulted in the SEC sanctions. The SEC held that RiverFront willfully violated Sections 207 and 204(a) of the Investment Advisers Act of 1940 and Rule 204-1(a) thereunder.

The SEC imposed sanctions against RiverFront, namely:

  • censorship; and
  • a $300,000 fine.

RiverFront also undertook to disclose quarterly on its website the volume of trades executed with non-designated brokers and the costs to be passed onto clients.

The RiverFront enforcement action serves as a reminder to investment advisers to review their Forms ADV to ensure that trading practices, costs and other material information regarding their advisory businesses are adequately and accurately disclosed.  Please contact an Investment Funds and Investment Management Group attorney for assistance with issues pertaining to Form ADV disclosure and related matters.

The SEC Press Release can be found here.

The full text of the SEC order can be found here.

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In line with the Securities and Exchange Commission’s (SEC) goal to enhance regulatory safeguards in the asset management industry, the SEC yesterday released a proposed new rule and rule amendments under the Investment Advisers Act of 1940. The proposed new rule 206(4)-4 would require SEC-registered investment advisers to adopt and implement written business continuity and transition plan (BCP) and review the plan’s adequacy and effectiveness at least annually.  The proposed amendment to rule 204-2 would require such advisers to keep copies of all BCPs that are in effect or were in effect during the last five years, and any records documenting the adviser’s annual review of its BCP.

The proposed rule is designed to address operational and other risks (internal or external) related to a significant disruption (temporary or permanent) in the investment adviser’s operations. Operational risks and disruptions generally include natural disasters or calamities, cyber-attacks, system failures, key personnel departure, business sale, merger, bankruptcy and similar events.

Under the proposed rule, an SEC-registered adviser should develop its BCP based upon risks associated with the adviser’s business operations and must include policies and procedures that minimize material service disruptions and address the following critical elements:

  • System maintenance and data protection
  • Pre-arranged alternate physical locations
  • Communication plans
  • Review of third-party service providers
  • Transition plan in the event of dissolution or inability to continue providing advisory services

The comment period will be 60 days after the proposed rule is published in the Federal Register.

A full copy of the proposed rule is available HERE.

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Earlier this month, the SEC announced the creation of its Office of Risk and Strategy  to operate within its Office of Compliance Inspections and Examinations (OCIE).  The new office will consolidate and streamline OCIE’s risk assessment, market surveillance, and quantitative analysis teams and provide operational risk management and organizational strategy for OCIE.

Headed by Peter B. Driscoll, a former E&Y auditor with law and CPA degrees, the Office of Risk and Strategy will lead the OCIE’s risk-based and data-driven National Examination Program.  Mr. Driscoll emphasized at the Investment Adviser Association’s annual compliance conference in Washington that private equity funds and private fund advisors would “continue to be a big focus” for the exam unit as well this year.  While this is no surprise, Driscoll also added that the focus on hedge funds will zero in on such areas as portfolio management, trading and back-office operations.  This may suggest a broader, deeper and more focused scrutiny on hedge funds than just the trading offenses we are familiar with from national headlines.

The SEC has been busy: it has visited at least 25% of ‘never-before-examined’ advisers, numbering over 700, which surpasses the SEC’s own goal.  There is no reason to expect the SEC’s enthusiasm to decline in this area in 2016.  If you are a hedge fund manager that has never been examined before, you may get a knock on your door this year.

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At the end of this month, the annual updating amendments for investment advisers’ Form ADV will be due. 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) 2016 Enforcement Priorities In The Alternative Space; (iii) New Developments; and (iv) Continuing Compliance Areas.

See the deadlines below and in red

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In commemorating the 75th anniversary of the Investment Company Act and Investment Advisers Act, David Grim discussed his views about the past, present and future of the investment management industry.  He selected four topics which in his opinion best illustrate the adaptability which the authors gave the 1940 laws governing the asset management industry.

Those topics are: (1) the role of exchange-traded funds (ETFs), (2) the role of private fund advisers, (3) the role of disclosure and reporting in our regulatory framework, and (4) the role of the board in fund oversight.

He called disclosure one of the critical pieces of the 40 Acts, and noted that the amount of information available to investors about funds and advisers through publicly available forms, prospectuses and offering documents has increased exponentially since 1940.  Specifically regarding private funds, he noted that the vast number of newly registered advisers after the passage of Dodd-Frank have resulted in a new era of transparency that has been beneficial to both investors and private fund advisers, in addition to the SEC.  The public availability of aggregated information has shed light on persistent questions and some misconceptions about the private fund industry. Investors have also benefitted by being able to make more informed choices when investing.

The full remarks are available here.

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(This article was published in the first February 2016 issue of “The Review of Securities and Commodities Regulation” and is reprinted here with permission.)

The last half of 2015 has been characterized by a lot of debate and press attention on the role of the Chief Compliance Officer (“CCO”) at investment advisers. It has attracted attention within the highest levels at the SEC as reflected in a series of public statements and speeches, including the public disagreement of two Commissioners on whether or not there is a new trend targeting CCOs. While this debate has been unusual, it has led to a healthy and productive discussion about the CCO’s role. Below, we will discuss in turn: (a) recent statements over the past six months by SEC leaders about CCOs and whether or not there is a new trend targeting them, (b) what qualities are essential to an effective CCO and whether or not the job should be outsourced, and (c) how an effective compliance leader can prevent and detect any problems and be truly effective in preparing the firm for SEC examinations.

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On January 11, the Office of Compliance Inspections and Examinations (OCIE) of the SEC announced its 2016 Examination Priorities (“Priorities”). To promote compliance, prevent fraud and identify market risk, OCIE examines investment advisers, investment companies, broker-dealers, municipal advisors, transfer agents, clearing agencies, and other regulated entities. In 2016, OCIE will continue to rely on the SEC’s sophisticated data analytics tools to identify potential illegal activity.

This year, private fund advisers should pay attention to the following OCIE Priorities:

  • Side-by-side management of performance-based and asset-based fee accounts: controls and disclosure related to fees and expenses
  • Cybersecurity: testing and assessments of firms’ implementation of procedures and controls
  • High frequency trading: excessive or inappropriate trading
  • Liquidity controls: potentially illiquid fixed income securities – focus on controls over market risk management, valuation, liquidity management, trading activities
  • Marketing / Advertisements: new, complex, and high risk products, including potential breaches of fiduciary obligations
  • Compliance controls: focus on repeat offenders and those with disciplined employees

Highlights for other market participants:

  • Never-Before-Examined Investment Advisers and Investment Companies: focused, risk-based examinations will continue
  • Broker-Dealers:
    • Marketing / Advertisements: new, complex, and high risk products and related sales practices, including potential suitability issues
    • Fee selection / Reverse Churning: multiple fee arrangements – recommendations of account types, including suitability, fees charged, services provided, and disclosures
    • Market Manipulation: pump and dump; OTC quotes; excessive trading
    • Cybersecurity: testing and assessments of firms’ implementation of procedures and controls
    • Anti-Money Laundering: missed SARs filings; adequacy of independent testing; terrorist financing risks
    • Registered representatives in branch offices – focus on inappropriate trading
    • Retirement Accounts: suitability, conflicts of interest, supervision and compliance controls, and marketing and disclosure practices
  • Public Pension Advisers: pay to play, gifts and entertainment
  • Mutual Funds and ETFs: liquidity controls – potentially illiquid fixed income securities
  • Immigrant Investor Program: Regulation D and other private placement compliance

For additional details, visit the SEC’s Examination Priorities for 2016. Please call an Investment Funds and Investment Management Attorney to discuss your firm’s risk areas.

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On November 3, 2015, an Illinois federal jury convicted Michael Coscia, a high-frequency commodities trader, of six counts of commodities fraud and six counts of spoofing—entering a buy or sell order with the intent to cancel before the order’s execution.1 Coscia’s conviction was the first under the criminal anti-spoofing provisions added to the Commodity Exchange Act (CEA) by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. In the press release touting its victory, the prosecution announced: “The jury’s verdict exemplifies the reason we created the Securities and Commodities Fraud Section in Chicago, which will continue to criminally prosecute these types of violations.” High-frequency traders should take note that the conviction on all six counts of spoofing charged in Coscia’s case may embolden prosecutors across the nation to pursue other spoofing cases with vigor. Given the real possibility of a felony indictment and conviction for spoofing—the latter of which exposes a defendant to imprisonment for up to ten years and significant monetary fines—high-frequency traders should carefully evaluate their strategies and conduct.2

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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.

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On November 18, 2015, the staff from the U.S. Commodity Futures Trading Commission’s (“CFTC”) Division of Swap Dealer and Intermediary Oversight issued a swap dealer de minimis exception preliminary report (“Preliminary Report”).

The Preliminary Report was issued pursuant to the SEC and CFTC joint regulation defining the term “swap dealer” and providing for a de minimis exception to the swap dealer definition. Under the regulation, a person shall not be deemed to be a swap dealer unless its swap dealing activity exceeds an aggregate gross notional amount threshold of $3 billion (measured over the prior 12-month period), subject to a phase-in period during which the gross notional amount threshold is set at $8 billion. Under the terms of the regulation, the phase-in period will terminate on December 31, 2017, and the de minimis threshold will fall to $3 billion, unless the CFTC sets a different termination date for the phase-in period or modifies the de minimis exception.

The Preliminary Report discusses:

  • Relevant statutory and regulatory provisions defining the term “swap dealer” and implementing the de minimis exception.
  • Data considered in preparing the Preliminary Report.
  • Policies underlying swap dealer registration and regulation and the de minimis exception that form the basis for evaluating the swap market data.
  • Data in light of alternative approaches to a de minimis exception.

Comments on the Preliminary Report must be submitted on or before January 19, 2016 and may be submitted electronically via the CFTC’s Comment Online Process. The staff will complete and publish for public comment a final report after considering the comments it receives on the Preliminary Report.