The Commission is amending the recordkeeping obligations set forth in Commission regulations along with corresponding technical changes to certain provisions regarding retention of oral communications and record retention requirements applicable to swap dealers and major swap participants, respectively. The amendments modernize and make technology neutral the form and manner in which regulatory records must be kept, as well as rationalize the rule text for ease of understanding for those persons required to keep records pursuant to the Commodity Exchange Act and regulations promulgated by the Commission thereunder. The amendments do not alter any existing requirements regarding the types of regulatory records to be inspected, produced, and maintained set forth in other Commission regulations.
The global compliance deadline for implementation of variation margin requirements for uncleared swap transactions is March 1, 2017. Unless an exception is available, the rules generally require swap dealers to collect and post variation margin with no credit threshold. The rules require the parties to enter into new or amended credit support documentation, limit the types of collateral that may be posted, prescribe minimum transfer amounts and effectively require new operational processes to be put in place. Moreover, different rules can apply depending on who the swap dealer’s regulator is and/or the jurisdiction of the counterparty. Not surprisingly, many market participants, particularly smaller financial firms, buy-side firms, asset managers, pension funds and insurance companies are unlikely to be compliant by the March 1 deadline. This has caused immense consternation among buy-side market participants who feared that they would be unable to trade until they came into compliance.
On February 23, 2017, following requests from numerous trade associations, U.S. banking regulators and IOSCO, the umbrella body for global securities regulators, issued statements encouraging leniency in enforcement of the documentation requirements. More specifically, the Federal Reserve provided guidance to examiners of CFTC-registered swap dealers that, except for transactions with financial end users that present “significant exposures” (which must still comply with the March 1 deadline), examiners should focus on swap dealer’s good faith efforts to comply as soon as possible but no later than September 1, 2017. Similarly, though less explicitly, IOSCO issued a statement that, while it expects all parties to make every effort to meet the March 1 deadline, it believes that the global regulators should take “appropriate measures … to ensure fair and orderly markets during the introduction and application of such variation margin requirements.” These statements follow the release by the CFTC on February 13, 2017 of a time-limited no-action letter delaying compliance by swap dealers under their jurisdiction until September 1, 2017.
There are a number of paths to compliance for buy-side firms, including negotiating bilateral agreements or amendments directly with swap dealers or using an industry-wide questionnaire-style protocol developed by ISDA and available through their ISDA Amend automated service run jointly with Markit.
If you have questions regarding the current deadlines or need assistance with compliance, please contact our derivatives partner, Daniel Budofsky (email@example.com), or your regular Pillsbury contact.
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) 2017 Enforcement Priorities In The Alternative Space; (iii) New Developments; and (iv) Continuing Compliance Areas.
Table of Contents
On December 5, 2016, a Notice of reporting requirements was filed in the Federal Register by the U.S. Department of Treasury informing the public of the Treasury’s mandatory survey, due every 5 years, of ownership of foreign securities by U.S. residents as of December 31, 2016. All U.S. persons who meet the reporting requirements must respond to, and comply with, this survey on Form TIC-SHC by March 3, 2017.
Who Must Report?
i. Fund Managers and Investors. U.S. persons who own foreign securities for their own portfolios and/or who invest in foreign securities on behalf of others (referred to as ‘‘end-investors’’), including investment managers and fund sponsors such as:
- Managers of private and public pension funds
- Hedge fund managers
- Managers and sponsors of private equity funds, venture capital companies and similar private investment vehicles
- Managers and sponsors of commingled funds such as money market mutual funds, country funds, unit-investment funds, exchange-traded funds, collective-investment trusts, and similar funds
- Foundations and endowments
- Trusts and estates
- Insurance companies
- U.S. affiliates of foreign entities that fall into the above categories.
These U.S. Persons must report on Form SHC if the total fair value of foreign securities—aggregated over all accounts and for all U.S. branches and affiliates of their firm—is $200 million or more as of the close of business on December 31, 2016.
ii. Custodians. U.S. persons who manage, as custodians, the safekeeping of foreign securities for themselves and other U.S. persons (including affiliates in the U.S. of foreign entities). These U.S. persons must report on Form SHC if the total fair value of the foreign securities whose safekeeping they manage on behalf of U.S. persons—aggregated over all accounts and for all U.S. branches and affiliates of their firm—is $200 million or more as of the close of business on December 31, 2016.
iii. Those Notified. U.S. persons who are notified by letter from the Federal Reserve Bank of New York. These U.S. persons must file Schedule 1, even if the recipient of the letter is under the reporting threshold of $200 million and need only report ‘‘exempt’’ on Schedule 1. U.S. persons who meet the reporting threshold must also file Schedule 2 and/or Schedule 3.
What To Report?
Information on holdings by U.S. residents of foreign securities, including equities, long-term debt securities, and short-term debt securities (including selected money market instruments).
How To Report?
Completed reports on Form TIC-SHC can be submitted electronically or mailed to the Federal Reserve Bank of New York, Statistics Function, 4th Floor, 33 Liberty Street, New York, NY 10045–0001. Inquiries can be made to the survey staff of the Federal Reserve Bank of New York at (212) 720–6300 or email: SHC.firstname.lastname@example.org. Inquiries can also be made to Dwight Wolkow at (202) 622–1276, email: comments2TIC@do.treas.gov
When To Report?
The report must be submitted by March 3, 2017.
Additional information including technical information for electronic submission can be obtained from the Form SHC Instructions available here.
- 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.
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.
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.
The CFTC’s recent enforcement against Bitfinex’s financed trading activities demonstrates the Commission’s increasing interest in virtual currency and digital assets.
The U.S. Commodity Futures Trading Commission (CFTC) is further expanding its oversight of virtual currency exchanges and digital assets in general. On June 2, 2016, Bitfinex (a Hong Kong-based bitcoin and cryptocurrency exchange) settled with the CFTC following an investigation into its trading activities. The CFTC charged that the exchange offered illegal off-exchange financed retail commodity transactions, and that Bitfinex had failed to register as a Futures Commission Merchant (FCM) as required by law. As a result, Bitfinex will pay $75,000 in civil penalties.
This action is more evidence of the CFTC’s interest in not only bitcoins, but any digital asset that can be considered a commodity. Transactions in decentralized digital tokens (such as Ether, DAO Tokens, Safecoins, Factoids, and Bitcrystals) are becoming more common, and so is regulatory interest.
International investors have frequently used Mauritius holding companies for their Indian investments, seeking to take advantage of the exemption under the India-Mauritius income tax treaty (the “Mauritius Treaty”) from Indian capital gains tax generally applicable on the disposition of shares of Indian companies. On May 10, 2016, the Governments of Mauritius and the Republic of India announced the signing of a protocol (the “Protocol”) to the Mauritius Treaty, Article 4 of which revises Article 13 of the Mauritius Treaty, dealing with capital gains.
President Obama signed into law the SBIC Advisers Relief Act (as part of the Fixing America’s Surface Transportation Act of 2015—the FAST Act) on December 4, 2015. (See also our Annual Compliance Alert) After the enactment of the Dodd-Frank Act, advisers to Small Business Investment Companies (SBICs) were limited in their choice to one of the available exemptions from registration under the Investment Advisers Act of 1940. The SBIC Advisers Relief Act provides certain additional relief for investment advisers that advise private funds and SBICs, and for those that advise venture funds and SBICs. The SEC’s Investment Management Guidance update interprets the SBIC Advisers Relief Act and its implications.
What is an SBIC?
An SBIC is a privately owned and operated investment company making long term investments specifically in U.S. businesses and is licensed by the Small Business Administration (SBA). The primary reason firms choose to become licensed with the SBA is to secure SBA financing.
What is the SBIC Adviser Exemption?
As originally implemented by the Dodd-Frank Act, the SBIC adviser exemption provided relief from SEC registration to those advisers whose only clients consisted of one or more SBICs, irrespective of assets under management. However, the SBIC adviser exemption did not allow advisers to combine multiple exemptions such as the private fund or venture capital fund adviser exemptions in order to avoid SEC registration.
For example, an Adviser to both a venture fund and an SBIC (that does not qualify as a venture fund) would not be able to rely on either the venture capital fund adviser exemption or the SBIC adviser exemption. Instead, the adviser would have had to rely on the private fund adviser exemption which would only be available to it if it had less than $150 million in regulatory assets under management.
Impact of the SBIC Advisers Relief Act on the use of the Venture Capital Fund and Private Fund Adviser Exemptions
The SBIC Advisers Relief Act amends Investment Advisers Act by:
- including in the definition of a venture capital fund SBIC funds (other than business development companies).
- excluding from the private fund adviser exemption the $150 million asset limitation with respect to a private fund that is a SBIC fund (other than a business development company).
As a result, an adviser:
- may rely on the venture capital fund adviser exemption and advise both SBICs and venture capital funds; or
- may rely on the private fund adviser exemption and advise both SBICs and non-SBIC private funds as long as the non-SBIC private funds account for less than $150 million in assets under management.
- that is registered and advises SBICs may be eligible to withdraw its registration and begin reporting to the SEC as an exempt reporting adviser under either the venture capital fund adviser exemption or the private fund adviser exemption.
In contrast to an adviser relying solely on the SBIC Adviser Exemption, the SEC staff believes that when an SBIC adviser choses to rely on the private fund or venture capital fund exemption, the adviser is required to submit reports to the SEC as an exempt reporting adviser.
Additionally, the SEC staff notes that (i) advisers currently relying on the private fund or venture capital adviser exemption may advise SBIC clients following the revised exemptions and (ii) certain registered advisers of SBICs may be eligible to withdraw their current registration and rely upon the private fund adviser or the venture capital fund exemption as exempt reporting advisers.
It is important to note that the Investment Advisers Act, as amended by the SBIC Advisers Relief Act, now preempts states from requiring advisers that rely on the SBIC fund exemption to register, be licensed or qualify as an investment adviser in the state. As a result of the federal preemption, advisers that manage only SBIC funds will be relieved from having to register (or may withdraw if registered) in states that have not adopted exemptions to investment adviser registration analogous to the Investment Advisers Act.
Please contact an Investment Funds and Investment Management group attorney for further detail and with your questions.