Articles Tagged with Investment Advisers

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The Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a Risk Alert yesterday providing a list of the most frequently identified compliance issues relating to the Advertising Rule (Rule 206(4)-1) under the Investment Advisers Act of 1940.  These compliance issues were identified as part of the OCIE examination of investment advisers:  misleading performance results, misleading one-on-one presentations, misleading claim of compliance with voluntary performance standards, “cherry-picked” profitable stock selections, misleading selection of recommendations and insufficient/inaccurate compliance policies and procedures.

Compliance with the Advertising Rule has long been, and remains, a favorite focus of the SEC.  In an age of fundraising challenges, investment advisers must balance the pressing need of appealing to prospective clients with adherence to precise regulatory standards.  Each marketing piece should go through rigorous internal review and sign-off procedures and, as necessary, outside counsel evaluation.  Investment advisers are urged to pay special attention to any form of performance or track record marketing.

Click here for the full Risk Alert. Contact your Pillsbury attorney for additional assistance.

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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.

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Table of Annual Compliance Deadlines……………………………………………………………. 3

2017 Enforcement Priorities In The Alternative Space………………………………………. 5

New Developments………………………………………………………………………………………. 7

 

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  • 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.

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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.

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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.

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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.

State Implications

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.

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Earlier this month, the SEC announced the creation of its Office of Risk and Strategy  to operate within its Office of Compliance Inspections and Examinations (OCIE).  The new office will consolidate and streamline OCIE’s risk assessment, market surveillance, and quantitative analysis teams and provide operational risk management and organizational strategy for OCIE.

Headed by Peter B. Driscoll, a former E&Y auditor with law and CPA degrees, the Office of Risk and Strategy will lead the OCIE’s risk-based and data-driven National Examination Program.  Mr. Driscoll emphasized at the Investment Adviser Association’s annual compliance conference in Washington that private equity funds and private fund advisors would “continue to be a big focus” for the exam unit as well this year.  While this is no surprise, Driscoll also added that the focus on hedge funds will zero in on such areas as portfolio management, trading and back-office operations.  This may suggest a broader, deeper and more focused scrutiny on hedge funds than just the trading offenses we are familiar with from national headlines.

The SEC has been busy: it has visited at least 25% of ‘never-before-examined’ advisers, numbering over 700, which surpasses the SEC’s own goal.  There is no reason to expect the SEC’s enthusiasm to decline in this area in 2016.  If you are a hedge fund manager that has never been examined before, you may get a knock on your door this year.

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At the end of this month, the annual updating amendments for investment advisers’ Form ADV will be due. 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) 2016 Enforcement Priorities In The Alternative Space; (iii) New Developments; and (iv) Continuing Compliance Areas.

See the deadlines below and in red

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In commemorating the 75th anniversary of the Investment Company Act and Investment Advisers Act, David Grim discussed his views about the past, present and future of the investment management industry.  He selected four topics which in his opinion best illustrate the adaptability which the authors gave the 1940 laws governing the asset management industry.

Those topics are: (1) the role of exchange-traded funds (ETFs), (2) the role of private fund advisers, (3) the role of disclosure and reporting in our regulatory framework, and (4) the role of the board in fund oversight.

He called disclosure one of the critical pieces of the 40 Acts, and noted that the amount of information available to investors about funds and advisers through publicly available forms, prospectuses and offering documents has increased exponentially since 1940.  Specifically regarding private funds, he noted that the vast number of newly registered advisers after the passage of Dodd-Frank have resulted in a new era of transparency that has been beneficial to both investors and private fund advisers, in addition to the SEC.  The public availability of aggregated information has shed light on persistent questions and some misconceptions about the private fund industry. Investors have also benefitted by being able to make more informed choices when investing.

The full remarks are available here.

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(This article was published in the first February 2016 issue of “The Review of Securities and Commodities Regulation” and is reprinted here with permission.)

The last half of 2015 has been characterized by a lot of debate and press attention on the role of the Chief Compliance Officer (“CCO”) at investment advisers. It has attracted attention within the highest levels at the SEC as reflected in a series of public statements and speeches, including the public disagreement of two Commissioners on whether or not there is a new trend targeting CCOs. While this debate has been unusual, it has led to a healthy and productive discussion about the CCO’s role. Below, we will discuss in turn: (a) recent statements over the past six months by SEC leaders about CCOs and whether or not there is a new trend targeting them, (b) what qualities are essential to an effective CCO and whether or not the job should be outsourced, and (c) how an effective compliance leader can prevent and detect any problems and be truly effective in preparing the firm for SEC examinations.

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