Articles Tagged with Pay To Play

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On February 21, 2013, the Staff of the Securities and Exchange Commission (the “Staff” and the “SEC,” respectively) published its 2013 priorities for the National Examination Program (“NEP”) in order to provide registrants with the opportunity to bring their organizations into compliance with the areas that are perceived by the Staff to have heightened risk.  The NEP examines all regulated entities, such as investment advisers and investment companies, broker dealers, transfer agents and self-regulatory organizations, and exchanges.  This article will focus only on the NEP priorities pertaining to the investment advisers and investment companies program (“IA-ICs”)

As a general matter, the Staff is concerned with fraud detection and prevention, corporate governance and enterprise risk management, conflicts of interest, and the use and implications of technology.  The 2013 NEP priorities, viewed in tandem with the “Presence Exam” initiative that was announced by the SEC in October 2012, makes it abundantly clear that the Staff will focus on the approximately 2000 investment advisers that are newly registered as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank”).

The Staff intends to focus its attention on the areas set forth below.   

New and Emerging Issues.

The Staff believes that new and emerging risks related to IA-ICs include the following:

  • New Registrants.  The vast majority of the approximately 2,000 new investment adviser registrants are advisers to hedge funds or private equity funds that have never been registered, regulated, or examined by the SEC.  The Presence Exam initiative, which is a coordinated national examination initiative, is designed to establish a meaningful “presence” with these newly registered advisers.  The Presence Exam initiative is expected to operate for approximately two years and consists of four phases: (i) engagement with the new registrants; (ii) examination of a substantial percentage of the new registrants; (iii) analysis of the examination findings; and (iv) preparation of a report to the industry on the findings.  The Presence Exam initiative will not preclude the SEC from bringing enforcement actions against newly registered advisers.  The Staff will give a higher priority to private fund advisers that it believes present a greater risk to investors relative to the rest of the registrant population or where there are indicia of fraud or other serious wrongdoing.  We expect to see the SEC bring enforcement actions against private equity and hedge fund managers for issues related to valuations, calculation of performance-related compensation and communications to investors that describe valuations and performance-related compensation.
  • Dually Registered IA/BD.  Due to the continued convergence in the investment adviser and broker-dealer industry, the Staff will continue to expand coordinated and joint examinations with the broker dealer examination program of dually registered firms and distinct broker-dealer and investment advisory businesses that share common financial professionals.  It is not uncommon for a financial professional to conduct a brokerage business through a registered broker-dealer that the financial professional does not own or control and to conduct investment advisory business through a registered investment adviser that the financial professional owns and controls, but that is not overseen by the broker-dealer.  This business model presents many potential conflicts of interest.  Among other things, the Staff will review how financial professionals and firms satisfy their suitability obligations when determining whether to recommend brokerage or advisory accounts, the financial incentives for making such recommendations, and whether all conflicts of interest are fully and accurately disclosed.
  • “Alternative” Investment Companies.    The NEP will also focus on the growing use of alternative and hedge fund investment strategies in registered open-end funds, exchange-traded funds (“ETFs”), and variable annuity structures.  The Staff intends to assess whether: (i) leverage, liquidity and valuation policies and practices comply with regulations; (ii) boards, compliance personnel, and back-offices are staffed, funded, and empowered to handle the new strategies; and (iii) the funds are being marketed to investors in compliance with regulations.
  • Payments for Distribution In Disguise.    The Staff will also examine the wide variety of payments made by advisers and funds to distributors and intermediaries, the adequacy of disclosure made to fund boards about these payments, and boards’ oversight of the same.  With respect to private funds, the Staff will examine payments to finders or other unregistered intermediaries that may be conducting a broker dealer business without being registered as such.  Payments made pursuant to the Cash Solicitation Rule will also be a focus of private fund payment arrangements.

Ongoing Risks.

The Staff anticipates that the ongoing risks selected as focus areas for IA-ICs in 2013 will include:

  • Safety of Assets.  The Staff has indicated that recent examinations of investment advisers have found a high frequency of issues regarding the custody and safety of client assets under the Investment Advisers Act of 1940 (“Advisers Act”) Rule 206(4)-2 (the “Custody Rule”).   The staff will focus on issues such as whether advisers are: (i) appropriately recognizing situations in which they have custody as defined in the Custody Rule; (ii) complying with the Custody Rule’s “surprise exam” requirement; (iii) satisfying the Custody Rule’s “qualified custodian” provision; and (iv) following the terms of the exception to the independent verification requirements for pooled investment vehicles.  Many private equity funds and fund of funds have been slow to adopt policies and procedures that comply with the Custody Rule.
  • Conflicts of Interest Related to Compensation Arrangements.  The Staff expects to review financial and other records to identify undisclosed compensation arrangements and the conflicts of interest that they present.  These activities may include undisclosed fee or solicitation arrangements, referral arrangements (particularly to affiliated entities), and receipt of payment for services allegedly provided to third parties. For example, some advisers that place client assets with particular funds or fund platforms are, in return, paid “client servicing fees” by such funds and fund platforms. Such arrangements present a material conflict of interest that must be fully and clearly disclosed to clients.  These types of compensation arrangements are commonplace among private equity fund advisers, many of which have just recently registered.  In fact, many private equity funds have compensation arrangements that the Staff believes requires broker dealer registration.  We believe that the Staff will make this point quite clearly by bringing enforcement actions against certain private equity fund general partners for engaging in unregistered broker dealer activity.  Enforcement actions are viewed as an effective way to get the message across to an industry that has long ignored this particular issue.
  • Marketing/Performance.  Marketing and performance advertising is viewed by the Staff as an inherently high-risk area, particularly among private funds that are not necessarily subject to an industry standard for the calculation of investment returns.  Aberrational performance of certain registrants and funds can be an indicator of fraudulent or weak valuation procedures or practices.  The Staff will also focus on the accuracy of advertised performance, including hypothetical and back-tested performance, the assumptions or methodology utilized, and related disclosures and compliance with record keeping requirements.   The Staff is starting to think about how the anticipated changes in advertising practices related to the JOBS Act will affect their reviews regarding registrants’ use of general solicitations to promote private funds.  Whether private funds will be permitted to advertise performance under the JOBS Act rules remains to be seen.  Certainly, there have been loud and influential voices that advocated for the position that the SEC should continue to study performance advertising by private funds before allowing it in the adoption of the highly anticipated rules.
  • Conflicts of Interest Related to Allocation of Investment Opportunities.  Advisers managing accounts that do not pay performance fees (e.g., most mutual funds), side-by-side with accounts that pay performance-based fees (e.g., most hedge funds) face potential conflicts of interest.  The Staff will attempt to verify that the registrant has controls in place to monitor the side-by-side management of its performance-based fee accounts and non-performance-based fee accounts with similar investment objectives, especially if the same portfolio manager is responsible for making investment decisions for both kinds of client accounts or funds.  For certain types of strategies, such as credit strategies, where one fund may be permitted to invest in all securities in the capital structure, whereas other funds may be limited in what they can purchase by credit quality or otherwise, these potential conflicts of interest are particularly acute.  Fund managers must have policies in place that account for these potential conflicts, manage the conflicts and document the investment resolution.
  • Fund Governance.  The Staff will continue to focus on the “tone at the top” when assessing compliance programs.  The Staff will seek to confirm that advisers are making full and accurate disclosures to fund boards and that fund directors are conducting reasonable reviews of such information in connection with contract approvals, oversight of service providers, valuation of fund assets, and assessment of expenses or viability.  Chief Compliance Officers will want to make sure that those items that are required to be undertaken in the compliance manual actually occur as stated and scheduled.

Policy Topics.

The staff anticipates that the policy topics for IA-ICs will include:

  • Money Market Funds.  The SEC continues to delude itself regarding the regulation of money market funds.  This once sleepy and relatively benign product is now the pillar of the commercial paper market and functions like and deserves the regulation of a banking product.  But the SEC, and the mutual fund trade organization, are loathe to cede authority to banking regulators for this “dollar per share”  product.  Accordingly, the SEC will continue to try to find ways for thinly capitalized advisers to offer and manage  money market funds by requiring money market funds to periodically stress test their ability to maintain a stable share price based on hypothetical events, such as changes in short-term interest rates, increased redemptions, downgrades and defaults, and changes in spreads from selected benchmarks (i.e., basically, all of the market events that have proven fatal to money market funds in the past and which will be so again as long as these funds remain fundamentally flawed).
  • Compliance with Exemptive Orders.  The staff will focus on compliance with previously granted exemptive orders, such as those related to registered closed-end funds and managed distribution plans, employee securities companies, ETFs and the use of custom baskets, and those granted to fund advisers and their affiliates permitting them to engage in co-investment opportunities with the funds.  Exemptive orders are typically granted pursuant to a number of well-developed conditions with which the registrant promises to adhere.  The market timing and late trading scandals of 2003 illustrated that once a registrant has obtained an exemptive order, it may or may not abide by all of the conditions of that order.
  • Compliance with the Pay to Play Rule.  To prevent advisers from obtaining business from government entities in return for political “contributions” (i.e., engaging in pay to play practices), the SEC recently adopted and subsequently amended, a pay to play rule. The Staff will review for compliance in this area, as well as assess the practical application of the rule.  Advisers should be aware that most states have their own pay to play rules and many of them have penalties that are far more onerous than the SEC’s rule.

We will continue to monitor this and other new developments and provide our clients with up to date analysis of the rules and regulations that may affect their businesses.

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Written by: Jay Gould and Peter Chess

On July 1, 2010, the Securities and Exchange Commission (the “SEC”) adopted Rule 206(4)-5 under the Investment Advisers Act of 1940, as amended, which prohibited an investment adviser from providing advisory services for compensation to a government client for two years after the advisers or certain of its executives or employees make a contribution to certain elected officials or candidates.  Rule 206(4)-5, also known as the Pay to Play Rule, also included a third-party solicitor ban that prohibited an adviser or its covered associates from providing or agreeing to provide, directly or indirectly, payment to any third-party for a solicitation of advisory business from any government entity on behalf of such adviser, unless such third-party was an SEC-registered investment adviser or a registered broker or dealer subject to pay to play restrictions. 

As originally adopted, the third-party solicitor ban’s compliance date was September 13, 2011.  However, not long after the Pay to Play Rule was adopted, Congress created a new category of SEC registrants called “municipal advisors” in the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Municipal advisors include persons that undertake a solicitation of a municipal entity.  The SEC then amended the Pay to Play Rule on June 22, 2011 in order to add municipal advisors to the category of registered entities excepted from the third-party solicitor ban and extended the original compliance date of the third-party solicitor ban.

On June 8, 2012, the SEC released a final rule that extends (for a second time) the compliance date for the third-party solicitor ban.  The SEC explained that it was necessary to ensure an orderly transition for advisers and third-party solicitors as well as to provide additional time for them to adjust compliance policies and procedures after the transition.  The new compliance date for the third-party solicitor ban will now be nine months after the required registration date for municipal advisers with the SEC under the Securities Exchange Act of 1934, as amended.  This compliance date has yet to be finalized as the SEC has not yet adopted the applicable rule.

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Written by: Ildiko Duckor and Peter Chess

In light of the current regulatory environment, now more than ever, it is critical for you to comply with all of the legal requirements and best practices applicable to Investment Advisers.  The beginning of the year is a good time to review, consider and, if applicable, satisfy these requirements and best practices. 

As the new year is upon us, there are some important annual compliance obligations Investment Advisers either registered with the Securities and Exchange Commission (the “SEC”) or with a particular state (“Investment Adviser”) should be aware. 

First, we wanted to address three situations where Investment Advisers may need to make changes with regard to their registration.  These are:

(1) SEC-registered Investment Adviser switching to State registration.  SEC-registered Investment Advisers are required to withdraw registration if they have less than $90 million in Assets under Management (“AUM”).  Those Investment Advisers have a June 28, 2012 deadline for state approval.  These advisers should submit a state Form ADV to the relevant state by March 20, 2012 to allow at least 90 days for state approval (California in particular).

(2) State-registered Investment Adviser switching to SEC registration.  A state-registered Investment Adviser whose AUM as of December 31, 2011 was $110 million or more must register with the SEC by March 30, 2012.  Going forward, state-registered Investment Advisers must apply for registration with the SEC within 90 days of becoming eligible for SEC registration and not relying on an exemption from registration.  The threshold for registration with the SEC is $100 million or more in AUM, but you may stay registered with the state up to $110 million in AUM.

(3) Currently exempt Investment Adviser registering with the SEC.  An Investment Adviser previously exempt from registration that is now registering with the SEC must do so by the March 30, 2012 deadline.  The Form ADV should have been filed with the SEC by February 14, 2012.

The following is a summary of the primary annual or periodic compliance-related obligations that may apply to Investment Advisers.  The summary section begins with what we feel are “hot” areas of compliance for 2012, and then addresses continuing compliance and other regulatory issues.  The summary is not intended to be a comprehensive review of an Investment Adviser’s tax, partnership, corporate or other year-end requirements, nor an exhaustive list of all of the obligations of an Investment Adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) or applicable state law.  Although many of the obligations set forth below apply only to SEC-registered Investment Advisers, state-registered Investment Advisers may be subject to similar and/or additional obligations depending on the state in which they are registered.  State-registered Investment Advisers should contact us for additional information regarding their specific obligations under state law.

“Hot” Compliance Areas

Qualified Client Threshold Updated.  In a Final Rule amendment recently released, the SEC clarified the calculation of the dollar amount thresholds applicable to the new qualified client standard which became effective on September 19, 2011.  The changes that became effective September 19, 2011 for the “qualified client” definition under the Advisers Act involved changing the previous $750,000 AUM test to $1 million and the current net worth test to $2 million.  The value of a person’s primary residence and certain debt secured by the property may not be included in the net worth test.  Either of these tests must be met at the time of entering into the advisory contract.  Investment Advisers that impose performance fees should prepare to amend form advisory agreements to account for the new thresholds for contracts entered into after September 19, 2011.  Investment Advisers that manage hedge funds, private equity funds, or other private funds that impose performance fees or incentive/carried interest allocations should have revised subscription agreements as follow:

  • Investors first investing between September 19, 2011 and May 22, 2012 are subject to the $1 million AUM and $2 million net worth thresholds, but these are calculated by including the value of the person’s primary residence.
  • Investors first investing as of or after May 22, 2012 are subject to the $1 million AUM and $2 million net worth thresholds, but the calculation excludes the value of the person’s primary residence.
  • There are two grandfather provisions. (1) Registered Investment Advisers are permitted to continue to charge clients performance fees if the clients were considered qualified clients before the rule changes. (2) Newly registering Investment Advisers will be permitted to continue charging performance fees to those clients they were already charging performance fees.

Accredited Investor Definition Changes.  The “accredited investor” definition has been amended to include any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1 million except that the person’s primary residence may not be included as an asset for purposes of the calculation.  Other final amendments to the relevant rules added provisions for the treatment of debt secured by the primary residence and a grandfathering provision that permits the application of the former net worth test in certain limited circumstances.  Investment Advisers should revise subscription agreements for the clarified threshold calculation as follows:

  • Any investor making a first investment or making an additional contribution on or after July 21, 2010 must exclude the value of the primary residence from the net worth calculation.
  • Any investor making a first investment or making an additional contribution on or after February 27, 2012 must exclude the value of the primary residence from the net worth calculation in addition to observing the provisions added by the other final amendments described above.
  • Investors must qualify under the standard in effect at the time of each new investment contribution.

Form PF.  The SEC and the Commodity Futures Trading Commission (“CFTC”) adopted new reporting rules on October 31, 2011.  The new SEC rule under the Advisers Act requires Investment Advisers that advise one or more private funds and have at least $150 million in private fund AUM to file the Form PF with the SEC.  The new CFTC rule requires commodity pool operators (“CPOs”) and commodity trading advisors registered with the CFTC to satisfy specific filing requirements with respect to private funds by filing the Form PF with the SEC in certain circumstances.  The Form PF has quarterly and annual filing requirements based on a number of factors, including amounts and types of assets.

  • Large hedge fund advisers[1] must file the Form PF within 60 days of each fiscal quarter end, with the first filing after the end of the first fiscal quarter ending on or after June 15, 2012.
  • Large liquidity fund advisers[2] must file the Form PF within 15 days of each fiscal quarter end, with the first filing after the end of the first fiscal quarter ending on or after June 15, 2012.
  • All other filers[3] must file the Form PF within 120 days of each fiscal year end, as applicable, on or after December 15, 2012.
  • Under initial compliance, many advisers will not need to file their first Form PF until 2013.

New CFTC Rules.  In a February 9, 2012 Final Rule, the CFTC rescinded Section 4.13(a)(4), which provided private pools with an exemption from registration as a CPO with the CFTC.  Investment Advisers operating 3(c)(7) private funds will no longer be able to claim exemption from CPO registration for funds offered only to institutional qualified eligible purchasers (“QEP”) and natural persons that meet QEP requirements that hold more than a de minimis amount of commodity interests.  The exemption under Section 4.13(a)(3) was retained, which provides exemption from CPO registration in cases where the pool trades minimal amounts of futures such that at all time either (a) the aggregate initial margin and premiums required to establish the fund’s commodity interest positions may not exceed 5% of the fund’s liquidation value or (b) the aggregate notional value of the fund’s commodity interest positions may not exceed 100% of the fund’s liquidation value.  Advisers that had relied on the Section 4.13(a)(4) exemption will either need to avail themselves of the Section 4.13(a)(3) exemption or register as a CPO, i.e., both 3(c)(1) or 3(c)(7) pools will have to comply with the 4.13(a)(3) exemption or register.

Continuing Compliance Areas

Update Form ADV.  An Investment Adviser must file an annual amendment to Form ADV Part 1 and Form ADV Part 2 within 90 days of the end of its fiscal year.  Part 1 and Part 2A of the Form ADV must be filed with the SEC through the electronic IARD system.  Accordingly, if you are SEC-registered adviser whose fiscal year ends on or after December 31, 2011, you must file Part 1A and Part 2A Brochure as part of your annual updating amendment by March 30, 2012.  If you are a state-registered adviser whose fiscal year ends on or after December 31, 2011, you must also file Part 1A, Part 1B, Part 2A Brochure and 2B Brochure Supplement as part of your annual updating amendment by March 30, 2012.

New Form ADV Part 1.  Part 1 of Form ADV has been amended, most importantly, with regard to the calculation of AUM and auditor information.  The Form now contains a uniform method of calculating AUM, and eliminates adviser discretion in including or excluding certain assets from the AUM calculation.

Form ADV Ongoing Updates.  Investment Advisers must amend Part 1 of their Form ADV promptly during the year if certain information becomes materially inaccurate.  The brochure and supplement must also be updated promptly during the year if any information becomes materially inaccurate unless the material inaccuracies result solely from changes in the amount of client assets managed or changes to the fee schedule.

FINRA Entitlement Program.  FINRA implemented changes to its Entitlement Program, which provides access to an Investment Adviser’s IARD account.  Every adviser firm (new and existing) is now required to designate an individual as its Super Account Administrator (SAA).  The SAA must be an authorized employee or officer of the adviser firm.

Fund IARD Account.  An Investment Adviser must ensure that its IARD account is adequately funded to cover payment of all applicable registration renewal fees and notice filing fees.

State Notice Filings/Investment Adviser Representatives.  An Investment Adviser should review its advisory activities in the various states in which it conducts business and confirm that all applicable notice filings are made on IARD.  In addition, an Investment Adviser should confirm whether any of its personnel need to be registered as “investment adviser representatives” in any state and, if so, register such persons or renew their registrations with the applicable states.

Brochure Rule.  On an annual basis, an Investment Adviser must provide its clients and separate account client(s) with a copy of its updated Form ADV Part 2A, or provide a summary of material changes and offer to provide an updated Form ADV Part 2A.  An adviser could meet its delivery obligation to a hedge fund client by delivering its brochure to a legal representative of the fund, such as the fund’s general partner.  Delivery is required within 120 days of the end of the adviser’s fiscal year.

Annual Assessment of Compliance Program.  At least annually, an Investment Adviser must review its compliance policies and procedures to assess their effectiveness.  The annual assessment process should be documented and such document(s) should be presented to the Investment Adviser’s chief executive officer or executive committee, as applicable, and maintained in the Investment Adviser’s files.  At a minimum, the annual assessment process should entail a detailed review of:

  • (1)  the compliance issues and any violations of the policies and procedures that arose during the year, changes in the Investment Adviser’s business activities and the effect that changes in applicable law, if any, have had on the Investment Adviser’s policies and procedures;
  • (2)  the Investment Adviser’s Code of Ethics, including an assessment of the effectiveness of its implementation and determination of whether they should be enhanced in light of the Investment Adviser’s current business practices;
  • (3)  the business continuity/disaster recovery plan, which should be “stress tested” and adjusted as necessary;
  • (4)  the Social Media policies and procedures, which the SEC recommends all Investment Advisers should adopt as part of their compliance policies and procedures; Investment Advisers should consider adding such policies and procedures if they have not already done so;
  • (5) review compliance with side letters and other special terms policies and procedures; and,
  • (6)  the Whistleblower policies and procedures, which Investment Advisers should consider adopting or reviewing in light of recent SEC rules that implemented the whistleblower program that became effective in August 2011.  Under the new rules, persons who provide information to the SEC about a violation of any securities law may be eligible in certain situations to receive 10 to 30 percent of amounts recovered by the SEC.  Advisers should consider internal policies that promote employee reporting of violations.

Custody; Annual/Surprise Audit.  Private fund Investment Advisers should have their funds audited by a PCAOB registered independent account and provide audited financial statements of their fund(s), prepared in accordance with U.S. generally accepted accounting principles, to the fund(s)’ investors within 120 days of the end of the fund(s)’ fiscal year.  Investment Advisers that do not have their private funds audited should determine whether they are deemed to have custody of those funds’ assets and therefore are subject to an annual surprise audit and other requirements.

Annual Privacy Notice.  Under SEC Regulation S-P, an Investment Adviser must provide its fund investors or client(s) who are natural persons with a copy of the Investment Adviser’s privacy policy on an annual basis, even if there are no changes to the privacy policy.

New Issues.  Compliance should now address FINRA Rule 5131, which became effective in May 2011 and prohibits quid pro quo and “spinning” allocations of new issues of securities and addresses the book-builiding, new issue pricing, penalty bids, trading and waivers of lock-up agreements by member firms and associated persons.  This new rule must be observed in addition to Rule 5130, whereby an Investment Adviser that acquires “new issue” IPOs for a fund or separately managed client account must obtain written representations every 12 months from the fund or account’s beneficial owners confirming their continued eligibility to participate in new issues.  This annual representation may be obtained through “negative consent” letters.

ERISA.  An Investment Adviser may wish to reconfirm whether its fund(s)’ investors are “benefit plan investors” and whether investments by benefit plan investors result in fund assets being characterized as “plan assets” for purposes of reconfirming its fund(s)’ compliance with the 25% “significant participation” exemption under ERISA.  This is particularly important if a significant amount of a fund’s assets have been withdrawn or redeemed, and some Investment Advisers may need to check compliance procedures with each investment or withdrawal.  The reconfirmation may be obtained through “negative consent” letters.

Anti-Money Laundering.  FinCEN may consider a new round of proposed anti-money laundering regulations for unregistered investment companies, certain investment advisers and commodity trading advisors.  An Investment Adviser is still subject to the economic sanctions programs administered by OFAC and should have an anti-money laundering program in place.  An Investment Adviser should review its anti-money laundering program on an annual basis to determine whether the program is reasonably designed to ensure compliance with applicable law given the business, customer base and geographic footprint of the Investment Adviser.

FBAR Reporting.  A U.S. person is required to file a Report of Foreign Bank and Financial Accounts (“FBAR”) if they have a financial interest in or signature authority over a foreign bank, securities or other financial account (e.g., a prime brokerage account) in another country.  Failure to file this form when required can result in significant penalties.  Financial accounts that may be subject to FBAR reporting include accounts of a mutual fund or similar pooled fund which issues shares available to the general public that have a regular net asset value determination and regular redemptions.  Private offshore funds, such as hedge funds and private equity funds (e.g., a Cayman Island “mutual fund”) are not deemed to be a foreign financial account, and therefore investment advisers are not required to file an FBAR with respect to these funds.  However, if these private funds have either a foreign bank account, foreign prime brokerage account, or other foreign financial account, and the adviser has signature authority over those accounts, then the adviser may have to file an FBAR with respect to those accounts.

“Pay-to-Play”.  The SEC adopted two measures on June 30, 2010 to prevent “pay-to-play” practices by Investment Advisers seeking to manage funds for state and local governments.  The SEC adopted amendments to these rules in 2011.  The amendments cover a multitude of topics, including the prohibition of soliciting or coordinating campaign contributions from others for elected officials in a position to influence the selection of the adviser.  With regard to California, generally employees of “external managers” fall under the definition of “placement agent” requiring lobbyist registration. There are exceptions. Employees (i.e., partners, members, etc.) who spend at least 1/3 of their time during a calendar year managing assets (i.e., securities) will not fall under the “placement agent” definition and may solicit from California state public plans.  This would require a portfolio manager-type to be involved in marketing to covered entities.  The second exception, a 3-prong test requires that the manager be selected through a competitive bidding process, which is rare, so this exception may not be helpful.

Special Purpose Vehicles of Investment Advisers.  In January 2012, the SEC confirmed that, subject to certain conditions, it would not recommend enforcement action to the SEC under the Advisers Act against an Investment Adviser or a related Special Purpose Vehicle established to act as the general partner or managing member of a private fund managed by the Investment Adviser if the Special Purpose Vehicle does not separately register as an Investment Adviser.

Amend Schedule 13G or 13D.  An Investment Adviser whose client or proprietary accounts, separately or in the aggregate are beneficial owners of 5% or more of a registered voting equity security, and who have reported these positions on Schedule 13G, must update these filings annually within 45 days of the end of the calendar year, unless there is no change to any of the information reported in the previous filing (other than the holder’s percentage ownership due solely to a change in the number of outstanding shares).  An Investment Adviser reporting on Schedule 13D is required to amend its filings “promptly” upon the occurrence of any “material changes.”  In addition, an Investment Adviser whose client or proprietary accounts are beneficial owners of 10% or more of a registered voting equity security must determine whether it is subject to any reporting obligations, or potential “short-swing” profit liability or other restrictions, under Section 16 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Section 16 Filings.  Individuals or entities that hold a beneficial ownership of ten percent of any class of equity securities registered under Section 12 of the Exchange Act, if an officer or director of such issuer, may be required to file Form 3, 4, or 5 regarding crossing certain thresholds, reporting certain sales, and making certain annual reports.

Form 13F.  An “institutional investment manager,” whether or not an Investment Adviser, must file a Form 13F with the SEC if it exercises investment discretion with respect to $100 million or more in securities subject to Section 13(f) of the Exchange Act (e.g., exchange-traded securities, shares of closed-end investment companies and certain convertible debt securities), which discloses certain information about such its holdings.  The first filing must occur within 45 days after the end of the calendar year in which the Investment Adviser reaches the $100 million filing threshold and within 45 days of the end of each calendar quarter thereafter, as long as the Investment Adviser meets the $100 million filing threshold.

Form 13H.  The SEC adopted Rule 13h-1 under the Exchange Act which requires “Large Traders” meeting certain definitional thresholds in transactions in NMS securities to identify themselves to the SEC and make certain disclosures to the SEC on Form 13H, effective October 3, 2011.  “Large Traders” are defined as any person that exercises investment discretion over one or more accounts and effects transactions of NMS securities for or on behalf of such accounts, in an aggregate amount of at least $20 million in a day or $200 million in a month.  In addition to an initial filing, all large traders must submit an annual filing on Form 13H within 45 days after the end of the calendar year and submit any amendments promptly after the end of any calendar quarter where information in the form becomes materially inaccurate.

Treasury International Capital System (“TIC”) Forms:

  • TIC Form SLT.  Adopted in 2011, the Form SLT is required to be submitted by entities with consolidated reportable holdings and issuances with a fair market value of at least $1 billion as of the last day of any month.  The first filing was required to be submitted by January 23, 2012 for consolidated data as of December 31, 2011.
  • TIC Form SHC.  The Form SHC is a mandatory survey of the ownership of foreign securities, including selected money market instruments, by U.S. residents as of December 31, 2011.  The form must be submitted by fund managers and other entities required to do so no later than March 2, 2012.

Offering Materials.  As a general securities law disclosure matter, and for purposes of U.S. federal and state anti-fraud laws, including Rule 206(4)-8 of the Advisers Act, an Investment Adviser must continually ensure that each of its fund offering documents is kept up to date, consistent with its other fund offering documents and contains all material disclosures that may be required in order for the fund investor to be able to make an informed investment decision.

Full and accurate disclosure is particularly important in light of Sergeants Benevolent Assn. Annuity Fund v. Renck, 2005 NY Slip op. 04460, a recent New York Appellate Court decision, where the court held that officers of an investment adviser could be personally liable for the losses suffered by a fund that they advised if they breached their implied fiduciary duties to the fund.  The fiduciary nature of an investment advisory relationship and the standard for fiduciaries under the Advisers Act includes an affirmative duty of utmost good faith, and full and fair disclosure of all material facts, and an affirmative obligation to use reasonable care to avoid misleading clients.

Accordingly, it may be an appropriate time for an Investment Adviser to review its offering materials and confirm whether or not any updates or amendments are necessary.  In particular, an Investment Adviser should take into account the impact of the recent turbulent market conditions on its fund(s) and review its fund(s)’ current investment objectives and strategies, valuation practices, performance statistics, redemption or withdrawal policies and risk factors (including disclosures regarding market volatility and counterparty risk), its current personnel, service providers and any relevant legal or regulatory developments.

Blue Sky Filings/Form D.  Many state securities “blue sky” filings expire on a periodic basis and must be renewed.  Accordingly, now may be a good time for an Investment Adviser to review the blue-sky filings for its fund(s) to determine whether any updated filings or additional filings are necessary.  We note that all Form D filings for continuous offerings will need to be amended with the SEC on an annual basis.

Liability Insurance.  Due to an environment of increasing investor lawsuits and regulatory scrutiny of fund managers, an Investment Adviser may want to consider obtaining management liability insurance or review the adequacy of any existing coverage, as applicable.

If you have any questions regarding the summary above, please feel free to contact us.


[1]   Large hedge fund advisers are advisers with at least $1.5 billion under management attributable to hedge funds.

[2]   Large liquidity fund advisers are advisers with at least $1 billion in combined AUM attributable to liquidity funds and registered money market funds.

[3]   This group includes smaller private fund advisers and large private equity fund advisers, which are advisers with at least $2 billion in AUM attributable to private equity funds.  All advisers with at least $150 million in AUM that are not considered large hedge fund advisers, large liquidity fund advisers, or large private equity fund advisers are considered smaller private fund advisers.

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LexisNexis Corporate & Securities Law Center Staff 

Each year, LexisNexis honors a select group of blogs that set the online standard for a given industry. This year, we will once again seek your input in choosing the Top Blogs to our Corporate and Securities Law Community….

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Thursday, October 27, 2011
3:30 – 4:00pm Registration
4:00 – 5:30pm Presentation
5:30 – 6:30pm Reception

Pillsbury’s San Francisco office
50 Fremont Street
San Francisco, CA 94105

How can hedge fund managers that seek more efficient methods for raising capital avail themselves of the public markets?

Now, many private fund managers are finding that a registered fund product can address the needs of certain investors, and with turnkey solutions available, the complexity that has traditionally been associated with registered funds may no longer be a deterrent.

Please join the California Hedge Fund Association, Pillsbury, and JD Clark & Company for a panel discussion on solutions for registered funds. All the questions you have regarding how to organize and operate a registered fund will be addressed at this Managers-Only Event, including:

  • What is the process for registering an alternative investment product?
  • What are the tax, regulatory and operational issues for a registered fund?
  • Interval funds, closed-end funds and open-end funds—why choose one over the other?
  • Who are the investors I will reach with a registered fund?
  • Can I run both hedge funds and registered funds at the same time?
  • How do I minimize regulatory scrutiny and outsource the back office?


Tony Fischer, UMB Fund Services
Paul Kangail, Ernst & Young
Vic Fontana, Registered Fund Solutions
Rachel Minard, Minard Capital
Jay Gould, Pillsbury Winthrop Shaw Pittman LLP


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Written by Jay B. Gould and Michael Wu

On October 9, 2011 Governor Brown signed into law Senate Bill 398 which is intended to clarify the current law regarding placement agents and lobbyist requirements.

In 2009, AB 1584 was enacted.  AB 1584 imposed disclosure requirements for investment placement agents associated with public pension funds in California.  It required public employee pension funds to adopt a disclosure policy requiring the disclosure of fees paid to investment placement agents and contributions and gifts made by placement agents to board and staff members.

In 2010, AB 1743 was passed.  That bill subjected investment managers and placement agents to lobbyist registration.  It also defined “placement agents” and revised the definition of “lobbyist” to include a placement agent.  A placement agent includes employees of an external manager unless the employee spends more than 1/3 of his time managing assets for the external manager.  AB 1743 also exempts from lobbyist registration requirements those advisers and broker-dealers who are registered with the SEC, obtained the business through competitive bidding process, and agreed to the California fiduciary standard imposed on public employee pension fund trustees.

The newly enacted and immediately effective SB 398 changes the current law to this extent:

1.  It revises the definition of “external manager” to mean a person or an investment vehicle managing a portfolio of securities or other assets, or a person managing an investment fund offering an ownership interest in the investment fund to a board or an investment vehicle.

2.  It revises the definition of “placement agent” to include an investment fund managed by an external manager offering investment management services of the external manager and an ownership interest in an investment fund managed by the external manager.

3.  It defines “investment fund” and includes private equity fund, public equity fund, venture capital fund, hedge fund, fixed income fund, real estate fund, infrastructure fund, or similar pooled investment entity.  It excludes an investment company that is registered with the SEC pursuant to the Investment Company Act of 1940 and that makes a public offering of its securities.

4.  It defines “investment vehicle” to mean a “corporation, partnership, limited partnership, limited liability company, association, or other entity, either domestic or foreign, managed by an external manager in which a board is the majority investor and that is organized in order to invest with, or retain the investment management services of, other external managers.”

5.  The exemptions from lobbyist registration for managers of local retirement system funds are extended to include the three exemptions similarly available to managers of state retirement system funds.

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On September 30, 2010, California Governor Arnold Schwarzenegger signed into law AB 1743, which regulates the activities of placement agents who solicit investments from public pensions on behalf of investment managers. The new law:

  • prohibits a person from acting as a placement agent in connection with any potential investment by a state public retirement system unless that person is registered as a lobbyist; and
  • requires placement agents acting in connection with any potential investment by a local public retirement system to file reports with a local government agency and comply with any applicable requirements imposed by such local government agency.

AB 1743 defines a “placement agent” as any person or entity hired, engaged, or retained by an external manager who acts or has acted for compensation as a finder, solicitor, marketer, consultant, broker, or other intermediary in connection with the offer or sale of the securities, assets, or services of an external manager to a California public pension. The definition excludes:

  • employees, officers, directors and equityholders of external managers who spend one-third or more of their time managing the securities or assets of the external manager; and
  • affiliates who manage assets of a California public retirement system if the external manager (i) is registered with the SEC or an appropriate state securities regulator, (ii) is selected by a competitive bidding process and (iii) agrees to a fiduciary standard of care.

AB 1743 is effective as of January 1, 2011.