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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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Written by Michael Wu

On November 11, 2010, the European Parliament adopted the EU Directive on Alternative Investment Fund Managers (the “Directive”).  The Directive will affect a significant number of alternative investment fund managers (“AIFMs”) that manage and/or market alternative investment funds (“Funds”), including hedge funds, commodity funds, private equity funds and real estate funds, within the European Union (“EU”).  The text of the Directive is expected to be published in the Official Journal sometime in the first or second quarter of 2011.  The Directive will be effective 20 days after publication and the EU Member States will have two years from such date to implement the Directive.

Scope: The Directive regulates AIFMs, rather than the Funds that they manage.  Specifically, the Directive regulates (a) EU AIFMs and (b) non-EU AIFMs that either (i) manage a Fund that is domiciled in the EU or (ii) market a Fund to investors in the EU.  A “small fund manager” that is regulated by its home EU Member State will be exempt from the majority of the Directive’s provisions if the AIFM manages less than €100 million in assets (or €500 million in assets, if its Funds do not use leverage and have at least a 5-year lock-up).

Marketing of Funds: The Directive defines “marketing” to mean “any direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM of units or shares in a [Fund] it manages to or with investors domiciled in the [EU].”  Under this definition, passive marketing (i.e., responding to inquiries from investors) would not be considered “marketing” under the Directive.  However, an AIFM’s use of a marketing or placement agent to conduct marketing activity in the EU would be considered “marketing” under the Directive.  The Directive implements a dual regime for marketing Funds in the EU.  An AIFM may market its Funds either (a) into an EU Member State if the EU Member State’s securities regulator expressly allows it, or (b) into all EU Member States under the EU “passport” regime.  However, the availability, applicable starting date and possible ending date will depend on whether the AIFM and/or the Fund is based in the EU or based outside of the EU.

Capital Requirements: If an AIFM only manages its own Funds, it must have initial capital of at least €300,000.  If an AIFM manages third party Funds, it must have initial capital of the higher of (a) ¼ of its annual expenditures and (b) €125,000.  In addition, if the Fund(s) managed by the AIFM have over €250 million in assets, the AIFM must have additional capital equal to 0.02% of the Fund(s) assets over €250 million.  However, in no event is the AIFM required to hold initial capital of more than €10 million.

Conduct of Business: The Directive will require AIFMs to meet certain conduct of business requirements, including the following:

  • No investor may obtain preferential treatment unless such treatment is disclosed in the Fund’s documentation.  Thus, side letter provisions would need to be disclosed to all investors in the Fund.
  • Conflicts of interest between the AIFM and the Fund or its investors must be disclosed and managed by the AIFM.
  • Risk management and portfolio management must be kept separate.
  • AIFMs must conduct stress tests and monitor the liquidity risk of open-ended Funds regularly.  The investment strategy, liquidity profile and redemption policy of each Fund managed by the AIFM must be consistent with each other.
  • In order to invest the Fund’s assets in any securitization positions, the originator of the securitization must retain at least a 5% net economic interest in the securitization.

Remuneration: AIFMs must have remuneration policies and practices that are consistent with and promote sound and effective risk management and do not encourage excessive risk taking.  For example, AIFMs may not guarantee multi-year bonuses, 50% of bonuses must be paid in the form of interests/shares of the Fund and 40-60% of bonuses must be deferred at least 3 to 5 years.  The remuneration policies and practices must apply to senior managers, but also to “control staff.”

Valuation: If an AIFM performs valuations internally, it must ensure that the valuation process is independent of the portfolio management and remuneration policies of the Fund and that measures are in place to identify and resolve conflicts of interest.  However, EU Member States have the authority to require an AIFM to subject its valuations to verification by external valuation agents or auditors.

Depositary: An AIFM must appoint a single depositary, such as an EU regulated bank or an EU securities firm, for each of its Funds.  If an AIFM manages a private equity fund, the depositary may be an “entity” that carries out depositary functions as part of its business activities.  For a non-EU Fund, generally, the depositary must be established in the jurisdiction where the non-EU Fund was formed or the jurisdiction of the AIFM’s principal place of business.

Delegation of AIFM Responsibilities: An AIFM must notify its regulator prior to delegating any of its responsibilities.  AIFMs may only delegate portfolio and/or risk management functions to regulated entities or with prior authorization from the AIFM’s regulator.  However, regardless of any delegation of functions, the AIFM will remain liable to the Fund and its investors as though no delegation was made.

Disclosure: Among other things an AIFM must satisfy the following disclosure requirements:

  • If the AIFM’s publicly available annual financial report does not satisfy the disclosure requirements of the Directive, each of its Funds must be audited annually.  The annually audited report must be made available to investors and the relevant regulatory agencies.  The report must provide details of remuneration.
  • An AIFM must provide its investors with information about the Fund, including its strategy (which may not work for “black box” hedge funds), what assets it may invest in, its valuation procedures, any descriptions of preferential treatment, the percentage of assets that are illiquid and subject to side pockets, changes in managing liquidity and its risk profile.  The AIFM must also regulatory disclose the amount of leverage the Fund employs.
  • An AIFM must report to its home EU Member State regulator(s) matters relating to the Fund, including those disclosed to its investors.  In addition, if the Fund uses leverage on a “substantial basis,” the AIFM must report the specifics regarding the Fund’s use of leverage.
  • If a Fund acquires 50% or more of the voting rights of a private company, the AIFM would have to provide information of its holding (a) to the company, (b) to all other shareholders of the company and (c) to its home EU Member State regulator.  The AIFM would need to disclose, among other things, the future development of the private company either in the company’s annual report or in the AIFM’s annual report.

Leverage: An AIFM must set and comply with reasonable leverage limits for each Fund that it manages.  EU Member States will have the authority to impose restrictions on the use of leverage.

The Directive will become effective in January 2011.  The EU Member States will then have two years to transpose the Directive into their respective national laws.  Over the next four years, the European Commission will pass further legislation to ensure consistent interpretation and effective implementation of the rules by the EU Member States.  The European Commission will also review the application and scope of the Directive four years after the Directive’s effective date, including its impact on private equity and venture capital funds.

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Written by Jay Gould

On November 16, 2010, the U.S. Securities and Exchange Commission (“SEC”) instituted public administrative and cease-and-desist proceedings against Thrasher Capital Management, LLC (“Thrasher”) and its Chief Executive Officer and Managing Member, James Perkins, pursuant to Sections 203(e), 203(f) and 203(k) of the U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act”).  The proceedings were instituted because (i) Thrasher, a SEC-registered investment adviser, failed to make available to the SEC the books and records that Thrasher was required to make available under Section 204 of the Advisers Act and (ii) Thrasher’s Form ADV contained untrue statements of material facts regarding its client base and its ownership.  The SEC Order indicates that Thrasher did not respond to the SEC Examination Staff to contact them, which precipitated the SEC issuing a subpoena in order to compel cooperation.  The SEC also found material discrepancies in Thrasher’s Form ADV that could have been easily remedied with only a minimum of compliance oversight.  As a result of such conduct, the SEC found that Thrasher willfully violated Section 204(a) of the Advisers Act, which requires advisers that use the mails or interstate commerce to maintain and make available to the SEC certain books and records and Section 207 of the Advisers Act, which prohibits any “person” (defined to include advisers, such as Thrasher) to “make any untrue statement of a material fact in any registration application or report filed with the [SEC] under section 203 or 204, or willfully to omit to state in any such application or report any material fact which is required to be stated therein.”  Perkins was found to have willfully aided and abetted and to have caused Thrasher’s violations of Sections 204(a) and 207 of the Advisers Act.

In anticipation of the institution of the proceedings, Thrasher and Perkins submitted an Offer of Settlement (“Offer”), which the SEC accepted.  In connection with the Offer, the SEC ordered that (i) Thrasher and Perkins cease and desist from committing or causing any violations and any future violations of Sections 204(a) and 207 of the Advisers Act; (ii) Thrasher’s investment adviser registration be revoked; and (iii) Perkins be suspended from association with any investment adviser for nine months.  No monetary penalty was imposed on Perkins because he submitted a sworn Statement of Financial Condition along with other evidence and has asserted that he is unable to pay a civil penalty.

Investment advisers, whether registered with the SEC or a state, should view this particular enforcement action as an example of how not to interact with their primary regulator.  When the SEC or a state Securities Commission asks for information, advisers should respond promptly and professionally.  Additionally, with the new disclosure requirements that will be required in 2011 under the new “Brochure Rule,” advisers must be vigilant to maintain the accuracy of their disclosures in both their filings with regulators and their communications to clients.  The settlement of this enforcement action by Thrasher is now a material proceeding that must be disclosed to all current and potential clients.  Investment advisers should make every effort to avoid a similar fate and can do so with an effective compliance program that is appropriate to the business of each adviser.

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Written by Michael Wu and Judy Deng

Although fund managers may form private equity funds of funds in China that have non-Chinese investors (hereinafter referred to as “foreign-invested fund of funds” or “FIE FoFs”), they need to be aware of certain currency conversion issues that may apply based on how the FIE FoF operates.  Foreign-invested funds of funds may be subject to currency conversion issues that do not affect other onshore, or China-based, foreign-invested investment funds because the Administration Regulations on Foreign-Invested Venture Capital Enterprises issued in 2003 (the “FIVCE Regulations”), which are the only comprehensive regulations pertaining to foreign-invested investment funds in China, did not explicitly contemplate the establishment of FIE FoFs.  For more information regarding the FIVCE Regulations, please see Introduction to RMB funds.

The FIVCE Regulations generally require that a foreign-invested investment fund’s portfolio companies be private companies in the high technology industry.  Thus, the regulatory authorities may determine that a FIE FoF that only invests in other onshore investment funds (i.e., a FIE FoF that does not make direct investments in private Chinese companies in the high technology industry), should not be a foreign-invested investment fund covered by the FIVCE Regulations (a “FIVCE”).  To the extent a FIE FoF is not a FIVCE, it may not be able to convert non-renminbi (“RMB”) currency of its foreign investors into RMB for purposes of investing in onshore investment funds.

In August of 2008, China’s State Administration of Foreign Exchange issued “Circular 142,” which provides that foreign invested enterprises (“FIEs”) may not convert their non-RMB currency into RMB for onshore investment, unless the FIEs are organized as “equity investment enterprises” and approved by the regulatory authorities.  Currently, there is no clear guidance regarding what qualifies as an “equity investment enterprise,” but most industry professionals believe that a foreign-invested holding company (“Holding Company”) or FIVCE may qualify.  Unfortunately, most FIE FoFs will not qualify as Holding Companies because Holding Companies are subject to substantial capitalization requirements and direct investment experience in China.  Thus, if a FIE FoF is not deemed a FIVCE, and is consequently treated as a FIE, it may need to qualify as a Holding Company in order to convert its non-RMB currency into RMB.

While the current landscape in China for FIE FoFs may deter some fund managers from forming FIE FoFs, being able to raise a fund of funds that can accept both RMB and non-RMB currencies may motivate other managers to form FIE FoFs.  Please feel free to contact us with any questions regarding foreign-invested funds of funds.

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Written by Jay Gould

On March 10, 2010, the Securities and Exchange Commission (“SEC”) adopted amendments to Rule 201 and Rule 200(g) of Regulation SHO (“Rules”).  In order to give certain exchanges additional time to modify current procedures for conducting single-priced transactions for covered securities that have triggered Rule 201’s circuit breaker and to give industry participants additional time for programming and testing for compliance with the requirements of the Rules, the SEC has extended the compliance date for both Rules from November 10, 2010 to February 28, 2011.  A full text of the adopting rule is available here.


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According to the Wall Street Journal, the Commodity Futures Trading Commission has sent subpoenas to hedge funds and other large natural gas traders seeking information regarding trading activity in natural gas derivatives. The subpoenas request information regarding trading activity in 2008 and 2009, a period during which natural gas prices fell by close to 80%. The full text of the article is available here.

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Following the September 2008 run on money market funds, which began following the failure of Lehman Brothers Holdings, Inc., the Treasury Department requested that the President’s Working Group on Financial Markets (“PWG”) prepare a report on the regulatory changes needed to address systemic risk and to reduce the susceptibility of money market funds to runs. On October 21, 2010, the PWG responded with its report entitled “Money Market Fund Reform Options.” The policy options discussed in the report include:

  • requiring money market funds to have floating net asset values;
  • creating emergency liquidity facilities funded by the money market fund industry;
  • requiring large redemptions to be paid in kind, rather than in cash; and
  • mandating participation in an insurance system.

The report emphasized that new measures intended to mitigate money market fund risks would also likely reduce the appeal of money market funds to many investors and cause investors to shift assets to unregulated funds with stable NAVs, such as offshore money market funds, enhanced cash funds, and other stable value vehicles. As such funds are subject to little or no regulatory oversight, the growth of unregulated money market funds would likely increase systemic risks. Therefore, any policies intended to reduce the risks associated with money market funds would need to limit the potential for regulatory arbitrage by imposing enhanced constraints on unregulated money market fund substitutes (for example, by providing that the exemptions from registration under the Investment Company Act of 1940 provided by Sections 3(c)(1) and 3(c)(7) thereunder are not available to investment vehicles maintaining a stable net asset value).

The Financial Stability Oversight Council will further examine the reform options discussed in the report in order to identify those most likely to reduce money market funds’ susceptibility to runs.

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The Securities and Exchange Commission and Commodity Futures Trading Commission recently adopted interim final rules for the reporting of swaps that were entered into prior to the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act and had not expired as of July 21, 2010 (“pre-enactment swaps”). The adoption of these rules was mandated by the Dodd-Frank Act, which required the SEC and CFTC to adopt rules for the reporting of pre-enactment swaps within 90 days of the enactment of the Dodd-Frank Act.

Reporting Obligations

The requirements of the SEC and CFTC rules are substantially similar. They require specified counterparties to pre-enactment swaps to provide to a registered swap data repository or the relevant Commission:

  • a copy of the transaction confirmation, in electronic form, if available, or in written form, if there is no electronic copy; and
  • the time, if available, the transaction was executed.

In addition, a counterparty to a pre-enactment swap is required to report to the relevant Commission upon request any information relating to such swap during the time that the interim final temporary rule is in effect. Such information may include actual trade data as well as summary trade data. Summary data may include a description of the types of a swap dealer’s counterparties or types of reference entities, or the total number of pre-enactment swaps entered into by the dealer and some measure of the frequency and duration of those contracts.

Reporting Party

The new rules require the following parties to report swaps:

  • with respect to a swap in which only one counterparty is a swap dealer or major swap participant, the swap dealer or major swap participant must report the swap;
  • with respect to a swap in which one counterparty is a swap dealer and the other counterparty is a major swap participant, the swap dealer must report the swap;
  • with respect to any other swap, the parties to the swap must select a reporting party.

Record Retention

Each counterparty to a pre-enactment swap that may be required to report such swap must retain information and documents relating to the terms of the transaction. Specifically, such counterparties must retain all information and documents, if available, to the extent and in such form as they currently exist, relating to the terms of the swap, including but not limited to:

  • any information necessary to identify and value the transaction;
  • the date and time of execution of the transaction;
  • all information from which the price of the transaction was derived;
  • whether the transaction was accepted for clearing by any clearing agency or derivatives clearing organization, and, if so, the identity of such clearing agency or derivatives clearing organization;
  • any modification(s) to the terms of the transaction; and
  • the final confirmation of the transaction.

Effective Date

The record retention requirements are effective immediately. Reporting obligations will become effective on the earlier of (i) the compliance dates established by the SEC and CFTC in future rulemaking or (ii) 60 days after a registered swap data repository commences operations.