Articles Posted in Client Alert

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Recent enforcement action could signal expanding the boundaries of misappropriation theory, with significant implications for SEC-regulated entities and other market participants.

TAKEAWAYS

  • With Chair Gensler at the helm, an emboldened SEC Enforcement Division will continue to take aggressive positions in insider trading enforcement actions and is willing to test the contours of insider trading law in litigation.
  • The Panuwat enforcement action advances the novel theory that possessing confidential information about one issuer may preclude trading in the securities of competitors and other companies in a business sector.
  • In light of the increased risk posed by the Panuwat matter, regulated entities and other market participants should review their policies and procedures to ensure that they are reasonably designed and tailored to
    prevent the misuse of material nonpublic information.

On August 17, 2021, the U.S. Securities and Exchange Commission (SEC) charged a former pharmaceutical company executive with insider trading for purchasing the securities of a rival company based on confidential information he learned about his own employer’s contemplated merger with another pharmaceutical company. The SEC’s enforcement action, which is being litigated in the United States District Court for the Northern District of California, appears to confirm early predictions that the SEC, with Chair Gary Gensler at the helm, would aggressively police the securities markets for insider trading.

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Most 3(c)(1) private equity and hedge funds are impacted; exempt venture capital funds are not impacted.

Effective August 16, 2021, the dollar thresholds specified in the definition of “qualified client” under Rule 205-3 of the Investment Advisers Act of 1940, as amended (“Advisers Act”) will increase (i) from $2.1 million to $2.2 million (net worth test) and (ii) from $1 million to $1.1 million (assets under management (AUM) test).  Clients that enter into investment advisory agreements (and existing fund investors that make additional fund investments) in reliance on the net worth test prior to the effective date will be “grandfathered” in under the prior net worth threshold.  The increases are made pursuant to a five-year inflation adjustment required by section 205(e) of the Advisers Act (section 419 of the Dodd-Frank Act).  (The most recent prior change was effective August 15, 2016.)

Section 205(a)(1) of the Advisers Act generally restricts an investment adviser from entering into, extending, renewing, or performing any investment advisory contract that provides for compensation to the adviser based on a share of capital gains on, or capital appreciation of, the funds of a client (“performance compensation prohibition”).  Rule 205-3 of the Advisers Act provides a limited exemption from the performance compensation prohibition and permits investment advisers to receive performance-based compensation (incentive allocations, carry, carried interest, performance fee etc.) from “qualified clients.”

After August 16, a “qualified client” is a person that:

(i) has at least $1.1 million in assets under management with the investment adviser immediately after entering into the advisory contract (AUM test); or

(ii) has a net worth (in the case of a natural person client, together with assets held jointly with a spouse) that the investment adviser reasonably believes is in excess of $2.2 million immediately prior to entering into the advisory contract (net worth test).

As a reminder, the value of a natural person’s primary residence must not be included in net worth; indebtedness secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time the investment advisory contract is entered into, need not be counted as a liability toward net worth (except that debt acquired or a loan amount increased within 60 days before investment or contract execution date must be counted); and indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the residence also must be counted as a liability.

A qualified client also includes both a “qualified purchaser” as defined in section 2(a)(51)(A) of the Investment Company Act of 1940, as amended (the “Investment Company Act”), and an investment adviser’s “knowledgeable employees.”  The newly revised definition will, therefore, affect certain private investment funds that rely on Section 3(c)(1) of the Investment Company Act (but not those funds relying on Section 3(c)(7)) and separately managed accounts that charge performance fees.

Advisory clients that established an advisory relationship (signed a contract) before the effective date of the new thresholds will be “grandfathered” in under the prior net worth threshold.  Investors in a private fund are considered, for these purposes, a client of the adviser (fund manager).  Therefore, future investments in a fund by the same investor who first invested in that fund before August 16 also will be grandfathered at the prior dollar thresholds. However, managers of section 3(c)(1) funds should update their subscription agreements and other offering documents to reflect the new qualified client threshold for new investors who first invest after August 16, 2021. In addition, notably, existing investors in a 3(c)(1) fund of funds (investor fund) that first invests in a 3(c)(1) fund (investee fund) after the effectiveness of a new threshold would nevertheless each have to be qualified client under the new thresholds because the investor fund’s investment in the investee fund would count as a new advisory relationship.

Private fund advisers (hedge fund, private equity and venture capital fund managers) that rely on the federal ‘private fund adviser” exemption from investment adviser registration will not be impacted, including with respect to their 3(c)(1) funds. The Adviser’s Act performance compensation prohibition applies only to registered investment advisers but does not apply to investment advisers relying on the federal private fund adviser exemption (so called “exempt reporting advisers”). Certain states (e.g., California, Texas), however, mandate under their state equivalent private fund adviser exemptions that even exempt reporting advisers, other than exempt venture capital fund advisers, only charge a performance fee to qualified clients with respect to their 3(c)(1) funds. Therefore, while private fund advisers that qualify as “venture capital fund advisers” will not be impacted by the new qualified client thresholds, exempt reporting advisers that are private equity or hedge fund managers will have to comply with the qualified client standard in their 3(c)(1) funds under certain state laws.

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Please contact your attorney at Pillsbury’s Investment Funds Group for additional information.

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Today, the Securities and Exchange Commission announced it had finalized reforms under the Investment Advisers Act to modernize rules that govern investment adviser advertisements and payments to solicitors. The amendments create a single rule that replaces the current advertising and cash solicitation rules. The final rule is designed to comprehensively and efficiently regulate investment advisers’ marketing communications.

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The Commodity Futures Trading Commission at its open meeting on Tuesday, October 6, unanimously approved a final rule adopting amendments to Form CPO-PQR for commodity pool operators (CPOs).

The amendments to Form CPO-PQR (1) eliminate existing Schedules B and C of the form, except for the Pool Schedule of Investments; (2) amend the information requirements and instructions to request Legal Entity Identifiers (LEIs) for commodity pool operators and their operated pools that have them, and to delete questions regarding pool auditors and marketers; and (3) make certain other changes due to the rescission of Schedules B and C, including the elimination of all existing reporting thresholds. Click here for the full press release.

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An expanded universe of individuals and entities will be able to participate as “accredited investors” in securities offerings as a result of recent SEC rulemaking.

TAKEAWAYS

  • The SEC has expanded its definition of “Accredited Investor” to additional individuals and entities, including individuals with certain professional certifications and knowledgeable employees of private funds.
  • The amendments may provide additional regulatory certainty for issuers, investors and counsel.

On August 26, 2020, the Securities and Exchange Commission (the SEC) adopted amendments to the definition of “accredited investor” in Rule 501(a) of Regulation D under the Securities Act of 1933 (the Amendments). The Amendments, which will become effective 60 days after they are published in the Federal Register, expand the pool of individuals and entities that qualify as accredited investors. The definition of accredited investor is relevant, among other things, to the operation of Rule 506 of Regulation D, which is a safe harbor under Section 4(a)(2) of the Securities Act. Rule 506 is the most commonly-used exemption for private offerings, accounting for the vast majority of the trillions of dollars raised through unregistered offerings every year. Unregistered, private offerings of securities have supplanted public offerings as the dominant form of capital-raising in the United States. Since regulatory requirements are much greater for offerings that include non-accredited investors, an overwhelming majority of Rule 506 offerings are offered only to accredited investors.

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Read this article and additional Pillsbury publications at Pillsbury Insights.

More of this will be covered at an ALI CLE webinar, sponsored by Pillsbury, later this month that focuses on Regulation D Offerings and Private Placements.  To find out more about this webinar and to register, please visit https://www.ali-cle.org/course/Regulation-D-Offerings-Private-Placements-2020-VCCP0922

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On May 22, 2020, the Small Business Administration (SBA) issued its interim final rule on loan forgiveness. The rule describes, in a question-and-answer format, the mechanics of applying for and receiving loan forgiveness under the Paycheck Protection Program. In “SBA Issues Long-Awaited Paycheck Protection Program Forgiveness Regulations,” colleagues Alexander B. GinsbergJenny Y. LiuDavid B. Dixon and Matthew Oresman discuss how the May 22, 2020 interim final rule is consistent with, and expands on, the loan forgiveness calculation that was evident from SBA’s loan forgiveness application template, which SBA published on May 15, 2020.

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Both the House and Senate have passed a bipartisan bill to modify elements of the PPP established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The legislation, intended to provide a “quick fix” to obstacles faced by small businesses seeking relief under the forgivable loan program, was signed into law by President Trump on June 5, 2020. In “Key Changes to Paycheck Protection Program,” colleagues Matthew OresmanAlexander B. GinsbergLori Panosyan and Jenny Y. Liu discuss how the Flexibility Act proposes to amend the controversial 75/25 rule imposed by the SBA that currently requires PPP borrowers to use at least 75 percent of their loan proceeds on payroll costs, amid other changes.

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We urge our clients to consult Pillsbury’s comprehensive COVID-19 Resource Center for information regarding Responding to a Global Crisis, Business Interruption, Cybersecurity, Employer Concerns and other general matters related to the COVID-19 pandemic. We also recommend the following specific measures to mitigate risks of business interruption and regulatory noncompliance resulting from the COVID-19 pandemic.

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Registered and Exempt Reporting Firms:

The deadline for the annual update of Form ADV is approaching.  We have previously notified you regarding filing obligations that were due between January 1 and March 1.  Below is a recommended compliance and filing deadline table addressing registered firms’ obligations for the remainder of the calendar year.  Let us know if you need any assistance.

Annual Compliance Deadlines

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In response to the coronavirus pandemic, see the Pillsbury articles and webinar regarding our recommendations. If you have not already, at this point you should:

  • Review and/or activate your business continuity plan
  • Review your vendor relationships and assess any stressors
  • Shore up cybersecurity protections and be vigilant regarding heightened risks
  • Assemble a response team for immediate, intermediate and long-term plans

Please contact us with any of your needs.

Read this article and additional Pillsbury publications at Pillsbury Insights.