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Written by:  Jay B. Gould and Jessica Brown

In response to the devastating effect of Hurricane Sandy which temporarily crippled U.S. equity and options markets in October 2012, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert on business continuity and disaster recovery planning for investment advisers. In the aftermath of Hurricane Sandy, the SEC reviewed the business continuity and disaster recovery plans of approximately 40 advisers who were affected by the storm “to assess their preparedness for and reaction to the storm.”

On August 16, 2013, a joint advisory was issued by OCIE, the CFTC’s Division of Swap Dealer and Intermediary Oversight, and the Financial Industry Regulatory Authority on business continuity and disaster recovery planning for a wide array of firms. The Risk Alert focuses exclusively on investment advisers and encourages advisers to review their business continuity plans in light of OCIE’s findings.  

The Risk Alert highlights the notable practices and weakness identified in the business continuity and disaster recovery plans and suggests improvements advisers could make to their plans in the following areas:

  • Preparation for widespread disruption
  • Planning for alternative locations
  • Preparedness of key vendors
  • Telecommunications services and technology
  • Communication plans
  • Reviewing and testing
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Written by: Jay B. Gould

On September 23, 2013, the JOBS Act rules that roll back the 80 year old ban on the use of general advertising and public solicitation by issuers of unregistered securities will be a reality. At least it will be a reality for fund managers that do not rely on an exemption from the Commodity Futures Trading Commission. Private funds managers will decide over time whether they would like to avail themselves of the new rules, which will allow them to post performance numbers on their websites, talk openly about their funds on CNBC and Bloomberg, sponsor NASCAR events, and just generally be more open and transparent about their businesses. The responsibilities associated with these new rights are the requirements that the fund manager verify the accredited status of each investor, refrain from committing financial fraud, and file a revised Form D to indicate that the fund is following the new rules. Whether to use these new rules will be a tough call for many fund managers as they consider whether greater transparency provides a benefit for their specific business model. Hedge funds have often avoided the glare of public scrutiny, but the trade-off of building a more recognizable brand and more easily reaching potential investors could provide motivation for some fund managers to give these new rules a try.

But what happens if a fund manager is initially enamored of the new rules and decides to advertise generally, but later changes his mind? Can a fund manager go back to the old “pre-existing, substantial relationship” days, and how do you do that once the fund has been “generally offered” to the public? This could happen for any number of reasons. Perhaps the most prevalent would be that the manager reaches capacity in the fund in either assets, such as a quant fund, or investor slots, which would more likely be the case for a fund that relies on Section 3(c)(1) for its exemption from investment company registration. A fund manager in one of these situations may have originally liked the idea of generally advertising, but subsequently finds public solicitation of limited utility and not worth the potential added scrutiny from regulators and market participants.

If a fund commences an offering pursuant to Rule 506(c) using general solicitation, and later wants to go back and use the old rules, (i.e., rule 506(b)), the issue is one of integration. Rule 506(b) prohibits general solicitation; accordingly, the only way to stop using the public offering rules once a fund manager has done so, would be to wait a period of time so the rule 506(c) offering is not integrated with the rule 506(b) offering. Rule 502(a) of Regulation D provides for a safe harbor from integration so long as the selling effort of the earlier offering ceases for six months, and the fund does not commence a subsequent offering for 6 months after completion of the earlier offering. Therefore, a fund manager would need to cease the offering, file the Form D to indicate that the offering is over, and wait six months before commencing the “private” offering. A new Form D would need to be filed for the private offering under Rule 506(b) once that offering commences.

There is another way whereby fund managers could go straight from the public offering to the private offering without the six month cooling off period. It is possible that a fund manager could use the five factor test safe harbor of Rule 502(a) to avoid integration and commence a new private offering immediately. For most hedge fund managers, this would be fairly tough test to meet. The five factors that a fund would need to consider are as follows:

(a) Whether the sales are part of a single plan of financing;
(b) Whether the sales involve issuance of the same class of securities;
(c) Whether the sales have been made at or about the same time;
(d) Whether the same type of consideration is being received; and
(e) Whether the sales are made for the same general purpose.

In order to meet the requirements of the five factor test, the fund seeking to avoid integration would need to offer a different class of shares/interests, for a different investment purposes, with different terms and conditions. For many hedge fund managers, this will be a difficult standard to meet. So the bottom line here appears to be that you can put Humpty Dumpty back together again, he will just need six months in intensive care.

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Written by:  Jessica Brown

On July 25, 2013, the Securities and Exchange Commission’s (“SEC”) Division of Investment Management released its first annual report to Congress, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), regarding how it used private fund data collected from investment advisers on Form PF. Dodd-Frank gave the SEC authority to require registered investment advisers to file reports and maintain records regarding the funds they advise. The SEC adopted Form PF in 2011 as the mechanism through which registered advisers must provide this information to the SEC.

Although it acknowledges that the intent of the Dodd-Frank provision was to provide data for the Financial Stability Oversight Council (“FSOC”) to assess systemic risk, the SEC is using the data to support its own regulatory programs as well.  

In this first report to Congress, the SEC indicated that is has been focused on the Form PF electronic filing system, resolving technical issues with security and data collection, guiding Form PF filers through the new form and system, establishing protocols for internal access and protection of data, and providing the FSOC with access to the data. Various divisions of the SEC have begun to use the Form PF data to assist with monitoring, identifying and examining investment advisers and private funds. The SEC also plans to provide non-proprietary Form PF data about large hedge funds to the International Organization of Securities Commission for its report on the global hedge fund market.