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Written by: Jeffrey Stern and Anthony H. Schouten

The Commodity Futures Trading Commission has issued new “know your customer” and external business conduct rules to give effect to certain provisions of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under these rules, major dealers in swaps and derivatives (“Swap Dealers”) will be required to, among other things, conduct diligence on counterparties, verify their status as “eligible contract participants” and ensure that swap recommendations are suitable for them. In addition, these rules impose heightened duties on Swap Dealers that trade with employee benefit plans subject to Title I of the Employee Retirement Income Security Act of 1974, governmental plans as defined in ERISA Section 3, endowments, state and federal agencies, and other protected counterparties (“Special Entities”).


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The NFA recently issued a notice entitled “Guidance on the Annual Affirmation Requirement for those Entities that are currently operating under an exemption or exclusion from CPO or CTA registration.”  As of February 2012, each person claiming an exemption or exclusion from CPO registration under CFTC Regulation 4.5, 4.13(a)(1), 4.13(a)(2), 4.13(a)(3), 4.13(a)(5) or an exemption from CTA registration under 4.14(a)(8) is required to annually affirm the exemption or exclusion upon which it relies.  The annual notice affirming the exemption or exclusion is due within 60 days of the calendar year end.  The first notice is due for the calendar year ending December 31, 2012.  The required affirmation must be filed electronically on the NFA’s Exemption System.  A full version of the NFA notice along with FAQs regarding the annual affirmation requirement is available here.

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Written by:  Jay Gould

The Securities and Exchange Commission (the “SEC”) recently charged and entered into consent decrees with four India-based brokerage firms for providing brokerage services to U.S. investors without being registered as broker dealers under the U.S. securities laws.  This otherwise mildly interesting enforcement action by the SEC should serve as a cautionary tale to hedge fund managers based outside the U.S. that seek to raise capital from U.S. investors, as well as U.S. fund managers that seek to sell their fund shares in foreign countries.

Many non-U.S.-based fund managers seek to raise money from U.S. investors due to the large amounts of available capital in this country and the relative willingness of U.S. investors to consider managers from foreign jurisdictions.  However, visiting potential U.S. investors or sending fund marketing materials into the U.S. without complying with the U.S. broker dealer rules could result in a fate similar to that suffered by the four Indian brokerage firms that were sanctioned and fined by the SEC. In order to avoid an enforcement proceeding, non-U.S. fund managers should retain a properly registered U.S. brokerage firm to sell the fund’s securities, enter into a “chaperoning” arrangement with a U.S. broker or register a subsidiary as a broker-dealer in the U.S.  

Whether prudent or not, most U.S.-based fund managers rely on Rule 3a4-1, the so-called “issuers exemption,” under the Securities Exchange Act of 1934 (the “1934 Act”) in order to avoid either registering the general partner or an affiliate of the fund as a broker, or retaining an unrelated broker to sell the fund’s interests.  But when U.S. fund managers travel outside the U.S. to gauge interest or solicit potential investors, the U.S. rules are not applicable.  Each country has its own regulatory scheme, and fund managers are well advised to understand what is permitted and prohibited in each country before visiting each country at the risk of being the subject of a new episode of “Locked Up Abroad.”  Indeed, certain countries impose criminal sanctions for offering securities if the offeror is not properly authorized to do so.

The Investment Fund Law Blog boldly predicts that the SEC will one day soon re-visit the industry’s expansive interpretation of the “issuer’s exemption” and the result will not be pleasant for the private funds industry.

So what did these Indian brokerage firms do to incur the wrath of the SEC?  The activities that these firms engaged in included:

  • Buying and selling Indian securities on Indian stock exchanges on behalf of U.S. investors;
  • Managing public offerings for Indian issuers in which shares were sold to U.S. investors;
  • Soliciting U.S. investors by email, phone calls, and in-person meetings between Indian issuers and U.S. investors;
  • Engaging in commission sharing agreements with U.S. registered broker-dealers, in which the firms provided research to U.S. investors in exchange for commission income;
  • Organizing and sponsoring conferences in the U.S. bringing together representatives of Indian issuers and U.S. investors; and
  • Sending firm employees to the U.S. to meet with U.S. investors and attend corporate road shows.

Many of these activities no doubt sound hauntingly familiar to U.S.-based fund managers that travel abroad for the purpose of raising capital.  All four firms were censured and ordered to pay a combined total of more than $1.8 million in disgorgements and prejudgment interest, but no civil penalties were imposed due to the firms’ cooperation with the SEC.  The firms have all submitted settlement offers, without admitting or denying any wrongdoing.

The SEC’s press release on the matter can be found here