Articles Tagged with Rules Regulations

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Written by Jay Gould

Pillsbury’s Investment Funds & Investment Management team has submitted a comment letter to the California Department of Corporations (the “DOC”) on behalf of the California Hedge Fund Association in connection with the DOC’s recently proposed amendments to the California custody rule.

In its letter to the Commissioner, Pillsbury requested that the DOC amend the California custody rule in a manner that balances investor protection and the need for fund managers to maintain confidentiality of certain portfolio positions.  Specifically, the letter requested  that the quarterly reports California-registered advisers to private funds are required to send to their investors be required to disclose only those positions that comprise more than 5% of the fund’s assets, and that the names of short positions not be disclosed at all, but be provided as an aggregate number.  “Implementing our suggestions would be consistent with the quarterly disclosure of schedule of investments based on the FASB’s U.S. financial reporting standards, and would also protect fund investors from short squeezes,” explained Jay Gould, head of the Pillsbury Investment Funds & Investment Management team.

The letter was provided in response to the  DOC Commissioner’s invitation for comment on the proposed changes to the California custody rule that will apply to California-registered investment advisers, including those investment managers that are currently either registered with the Securities and Exchange Commission or are not registered at all.  By February 15, 2012, investment advisers to private funds with less than $100 million under management will need to register with the DOC, if they have not already done so.

“The California Hedge Fund Association expects to provide comments to the DOC in connection with future rulemaking proposals and encourages California-based fund managers to become active in this process,” explains Chris Ainsworth, President of the Association.

A full text of the letter to the Commissioner is available here.

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Written by Jay Gould, Ildiko Duckor and Michael Wu

Effective on September 19, 2011, investors that pay performance fees to an adviser must either have at least $1 million managed by the adviser or a net worth of at least $2 million.

As mandated by the Dodd-Frank Act, the SEC today issued an order that raises two of the thresholds that determine whether an investment adviser can charge its clients performance fees.  As discussed in the article we posted here on May 11, under the current Rule 205-3 of the Investment Advisers Act of 1940, an investment adviser may charge its investors a performance fee if (i) the investor has at least $750,000 under management with the investment adviser (“asset-under-management test”), or (ii) the investment adviser reasonably believes that the investor has a net worth of more than $1.5 million (“net worth test”).  Today’s SEC order adjusted the amounts for the asset-under-management test to $1 million and the net worth test to $2 million.  The SEC order is effective on September 19, 2011.

Accordingly, it is important for investment fund managers to amend their offering materials to comply with the new requirements of Rule 205-3 under the Advisers Act.

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Written by Jay Gould and Michael Wu

On June 22, 2011, the Securities and Exchange Commission (SEC) adopted final rules that implement provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) amending the Investment Advisers Act of 1940 (the “Advisers Act”).   The amendments include:

  • Statutory Threshold for SEC Registration.   The Dodd-Frank Act increases the threshold for SEC registration by creating a new category of advisers called “mid-sized advisers.”  A mid-sized adviser has assets under management between $25 million and $100 million.  If the mid-sized adviser’s principal office and place of business is located in a state that requires it to register as an investment adviser, the adviser must register with the state.  A mid-sized adviser must register with the SEC if it is not required to register in the state where it maintains its principal office and place of business, or if registered with that state, the adviser would not be subject to examination by that state’s securities commissioner.
  • Transition to State Registration, Registration Deadline.

    Existing SEC-registered adviser as of January 1, 2012 – must amend its Form ADV no later than March 30, 2012.Mid-sized adviser no longer eligible for SEC registration – must amend its Form ADV no later than March 30, 2012 to switch to state registration and withdraw its SEC registration by filing Form ADV-W no later than June 28, 2012.

    New Applicants.  Until July 21, 2011 (effective date of the final rules), advisers applying for registration that qualify as mid-sized advisers may register with either the SEC or the appropriate state securities authority.  Thereafter, mid-sized advisers must register with the appropriate state securities authority.

  • Exempt Reporting Advisers.  These are advisers that rely on either the venture capital exemption or the private fund advisers exemption.  The final rules require these exempt reporting advisers to submit an annual report with the SEC by filing an abbreviated Form ADV Part 1 completing only Items 1 (Identifying Information), 2.B (SEC Reporting by Exempt Reporting Advisers), 3 (Form of Organization), 6 (Other Business Activities), 7 (Financial Industry Affiliations), 10 (Control Persons), 11 (Disclosure Information), and any corresponding section of Schedules A, B, C and D.  There will be fees associated with the filing which will be the same as those for registered advisers.
  • Form ADV.  The SEC is amending Part 1 of Form ADV to require advisers to provide additional information: 1) about private funds they advise, 2) about their advisory business and business practices that may present conflicts of interest, and 3) about their non-advisory activities and financial industry affiliations.
  • Family Office exemption.  By defining “family office,” the SEC is allowing family offices to continue to be exempt from regulation of the Advisers Act.  The final rules expanded the exemption by including additional categories of family members and key employees as family clients.
  • Pay-to-Play Rule.  The final rules permit an adviser to pay a registered municipal advisor, or an SEC registered investment adviser or broker-dealer, to act as placement agent to solicit government entities on its behalf, so long as the municipal advisor is subject to the MSRB-adopted pay-to-play rule, or the SEC registered adviser or broker-dealer is subject to a FINRA-adopted pay-to-play rule, that is at least as stringent as the investment adviser pay-to-play rule.

The SEC also adopted final rules that eliminated the private adviser exemption under the Advisers Act and created three new exemptions from SEC registration for:

  • Advisers solely to venture capital funds (venture capital fund exemption).  The final rules define “venture capital fund” as a private fund that: 1) holds no more than 20% of the fund’s capital commitments in non-qualifying investments (other than short-term holdings); 2) does not borrow or is not leveraged except for a limited short-term borrowing; 3) does not offer redemption or liquidity rights to its investors; 4) represents itself to investors as pursuing a venture capital strategy; and 5) is not registered under the Investment Company Act of 1940 and is not a business development company.The SEC also adopted the grandfathering provision for this exemption provided the following three requirements are met by the fund: (i) represented to investors that it pursues a venture capital strategy; (ii) has sold securities prior to December 31, 2010; and (iii) does not sell securities to, or accept any capital commitments from, any person after July 21, 2011.
  • Advisers solely to private funds with less than $150 million in assets under management in the U.S. (private fund adviser exemption).  The instructions to Form ADV will be revised to provide a uniform method of calculating assets under management for regulatory purposes.
  • Certain foreign advisers without a place of business in the U.S.  A non-U.S. adviser that has no place of business in the U.S. is not required to register with the SEC if it has fewer than total 15 U.S. clients and private fund investors, has less than $25 million in aggregate assets under management from U.S. clients and private fund investors, and does not hold itself out to the public as an investment adviser.
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Written by Michael Wu

The Securities and Exchange Commission (“SEC”) has adopted rules implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act’s (“Dodd-Frank Act”) Whistleblower Program.  The Whistleblower Program requires the SEC to pay awards, under regulations prescribed by the SEC and subject to certain limitations, to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of the federal securities laws, or a rule or regulation promulgated by the SEC, that leads to the successful enforcement of a covered judicial or administrative action, or a related action that results in monetary sanctions of more than $1,000,000.  Dodd-Frank Act also prohibits retaliation by employers against individuals who provide the SEC with information about possible securities violations.

To view a full text of the Final Rule, please click here.

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Written by Michael Wu

The Securities and Exchange Commission (the “SEC”) recently published a notice of its intent to raise the dollar thresholds that would need to be satisfied in order for an investment adviser to charge its investors a performance fee.  Currently, under Rule 205-3 of the Investment Advisers Act of 1940, as amended, an investment adviser may charge its investors a performance fee if (i) the investor has at least $750,000 under management with the investment adviser, or (ii) the investment adviser reasonably believes that the investor has a net worth of more than $1.5 million.  To comply with the Dodd-Frank Act, the SEC must adjust these dollar amounts for inflation by July 21, 2011 and every five years thereafter.

Thus, the SEC intends to issue an order that would revise the dollar amount tests to $1 million for assets under management and $2 million for net worth.  The SEC is also proposing to amend Rule 205-3 to: (i) provide the method for calculating future inflation adjustments of the dollar amount tests, (ii) exclude the value of a person’s primary residence from the net worth test, and (iii) modify the transition provisions of the rule.  The SEC is seeking public comment on the proposed rule.

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Written by Michael Wu

On April 8, 2011, the Associate Director of the SEC stated in a letter to the President of the North American Securities Administrators Association (NASAA) that the SEC may extend certain deadlines imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  Specifically, because the SEC has yet to complete its implementing rulemaking in accordance with the Dodd-Frank Act, the SEC would “consider” extending, to the first quarter of 2012, the date by which (i) advisers must register with the SEC and comply with the rules applicable to SEC-registered advisers and (ii) midsize advisers (i.e., advisers with over $25 million, but under $100 million, assets under management) must transition to state registration.  Please click here to view the letter from the SEC regarding this issue.

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Written by Jay Gould, Ildi Duckor and Michael Wu

On March 18, 2011, the Securities and Exchange Commission released new guidance regarding Form ADV.  The SEC’s Q&As can be found here.  The most significant development pertains to a registered adviser’s obligation to deliver Part 2.  Specifically, Question III.2 reads as follows:

Q: Rule 204-3 requires an adviser to deliver a brochure and one or more brochure supplements to each client or prospective client. Does rule 204-3 require an adviser to a hedge or other private fund to deliver a brochure and supplement(s) to investors in the private fund?

A: Rule 204-3 requires only that brochures be delivered to “clients.” A federal court has stated that a “client” of an investment adviser managing a hedge fund is the hedge fund itself, not an investor in the hedge fund. (Goldstein v. Securities and Exchange Commission, 451 F.3d 873 (D.C. Cir. 2006)). 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, manager or person serving in a similar capacity. (Posted March 18, 2011)

Although the SEC’s response focuses on “hedge funds,” because the term “client” is defined the same way for all “private funds,” we can reasonably conclude that advisers to private equity funds and other private funds can satisfy the delivery obligations by delivering the new Part 2 to the general partners of the private equity funds or private funds that they manage – as opposed to the investors in such funds.  This is a significant change because previously most registered advisers provided Part 2 to all of the investors in the funds that they managed.

Please note that registered advisers are still required to file Part 2 of Form ADV with the SEC.

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Written by Michael Wu

On January 26, 2011, the SEC proposed a rule that would require SEC-registered advisers to hedge funds, private equity funds and other private funds to report information to the Financial Stability Oversight Council (“FSOC”) that would enable it to monitor risk to the U.S. financial system.  The information would be reported to the FSOC on Form PF and the information reported on Form PF would be confidential.

The proposed rule would subject large advisers to hedge funds, “liquidity funds” (i.e., unregistered money market funds) and private equity funds to heightened reporting requirements.  Under the proposed rule, a large adviser is an adviser with $1 billion or more in hedge fund, liquidity fund or private equity fund assets under management.  All other advisers would be regarded as smaller advisers.  The SEC anticipates that most advisers will be smaller advisers, but that the large advisers represent a significant portion of private fund assets.

Smaller advisers would be required to file Form PF once a year and would report only basic information about their hedge funds, private equity funds and/or other private funds, such as information regarding leverage, credit providers, investor concentration, fund performance, fund strategy, counterparty credit risk and the use of trading and clearing mechanisms.

Large advisers would be required to file Form PF quarterly and would provide more detailed information than smaller advisers.  The information reported would depend on the type of private fund that the large adviser manages.

  • Large advisers to hedge funds would report, on an aggregated basis, information regarding exposures by asset class, geographical concentration and turnover.  If a hedge fund has a net asset value of at least $500 million, the adviser would report information regarding the fund’s investments, leverage, risk profile and liquidity.
  • Large advisers to liquidity funds would report the types of assets in their liquidity funds, information relevant to the risks of the funds, and the extent to which the liquidity funds comply with Rule 2a-7 of the Investment Company Act of 1940, as amended.
  • Large advisers to private equity funds would respond to questions regarding the extent of leverage incurred by their funds’ portfolio companies, the use of bridge financing and their funds’ investments in financial institutions.

The SEC’s public comment period on the proposed rule will last 60 days.

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By: Michael Wu

As the new year is upon us, we wanted to take a moment to remind you of some of the annual compliance obligations that you may have as an investment adviser that is registered with the Securities and Exchange Commission (the “SEC”) or with a particular state (“Investment Adviser”).  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.

The following is a summary of the primary annual or periodic compliance-related obligations that may apply to Investment Advisers.  The summary is not intended to be a comprehensive review of an Investment Adviser’s tax, partnership, corporate or other 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.

  • 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.  Effective on January 1, 2011, Investment Advisers must file both Part 1 and Part 2A of the Form ADV with the SEC through the electronic IARD system.  Accordingly, if you are SEC-registered adviser whose fiscal year ends on or after December 31, 2010, you must file Part 1A and Part 2A as part of your annual updating amendment by March 31, 2011.  If you are a state-registered adviser whose fiscal year ends on or after December 31, 2010, you must also file Part 1A, Part 1B and Part 2A as part of your annual updating amendment by March 31, 2011.
  • New FINRA Entitlement Program.  FINRA is implementing 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.  Beginning November 15, 2010, Preliminary Renewal Statements (“PRS”), which list advisers’ renewal fees, are available for printing through the IARD system.  By December 10, 2010, an investment adviser should have submitted to FINRA through the IARD system, its preliminary renewal fee.  Any additional fees that were not included in the PRS will show in the Final Renewal Statements which are available for printing beginning January 3, 2011.  All final renewal fees should be submitted to FINRA through the IARD system by February 3, 2011.
  • 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 private fund investors 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. The 2011 deadline for providing investors with Form ADV Part 2B depends on whether an Investment Adviser is a new or existing SEC-registered adviser and whether the Investment Adviser is providing it to prospective, new or existing investors.
  • Annual Assessment.  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; and

3)      the business continuity/disaster recovery plan, which should be “stress tested” and adjusted as necessary.

  • Annual/Surprise Audit.  Because Investment Advisers are generally deemed to have custody of client assets, they must 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 provide audited financial statements to fund investors should remind their auditors that an annual surprise audit is necessary.
  • 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.  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” 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.  The reconfirmation may be obtained through “negative consent” letters.
  • Anti-money Laundering.  Although FinCEN withdrew its 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.
  • 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”).
  • 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.
  • 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 as of 2009, all Form D filings for continuous offerings will need to be amended 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.

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Written by Michael Wu

The Alternative Investment Fund Managers Directive (the “Directive”) establishes a regulatory regime for all alternative fund managers, such as private equity and hedge fund managers, that are based in the European Union (the “EU”), manage funds based in the EU and market non-EU fund interests in the EU.  A general summary of the Directive is available here.

Although the majority of the Directive’s rules are likely to become effective by January 2013, some of the rules affecting non-EU funds and non-EU fund managers will be deferred until 2015 or later.  Thus, non-EU managers may still actively raise funds in the EU, but will have to comply with a number of additional regulatory requirements beginning in January 2013.

Beginning in January 2013, non-EU managers may actively fund raise in the EU provided that:

  • A regulatory cooperation agreement is in place between all of the relevant regulators (i.e., the regulator in the non-EU manager’s home jurisdiction and the EU country where the fund raising occurs) under which the regulators agree to cooperate on monitoring and managing systemic risk.  In addition, the home jurisdiction must not be designated by the Financial Action Task Force as a non-cooperative country or territory.
  • Non-EU managers comply with the following provisions of the Directive:
    • Transparency and Disclosure: the non-EU manager must prepare an annual fund report for investors in a prescribed format and disclose certain other prescribed information to investors and will be subject to regulatory reporting requirements aimed at monitoring systemic risk.  The European Commission will publish measures specifying the format and content of the reports.
    • Portfolio Company Disclosures: if a private equity fund acquires or disposes of a substantial stake in an EU company, the manager must formally notify the target company, the shareholders and the regulators.  Additional disclosures are required if a controlling stake is acquired.
    • “Asset-Stripping” Restrictions: the Directive restricts certain shareholder distributions for a period of 24 months after acquisition of an EU company (to prevent dividend recapitalizations during the period).
  • Non-EU manager is aware of the securities laws of each EU country in which it intends to raise funds, which may impose more onerous rules.

Beginning in early-2015, non-EU managers may be able to participate in the “passport” regime (i.e., they can fund raise in every EU country without obtaining separate regulatory authorization in each country) if the European Securities and Markets (“ESMA”) Authority decides to make the passport regime available to non-EU managers.  If the passport regime becomes available to non-EU managers, they would become authorized and regulated on the same basis as EU managers with respect to the passporting rights.  However, because the passport regime’s compliance obligations are onerous, non-EU managers may want to forgo the passporting rights and fund raise subject to country-by-country private placement regimes and the minimum directive requirements described above.

Beginning in mid-2018, non-EU managers may be required to operate under the passport regime in order to fund raise in the EU.  The Directive contains provisions that would ultimately terminate the national private placement regimes, leaving full authorization as the only option for non-EU firms that wish to fund raise in the EU.

ESMA and the European Commission have been tasked with issuing extensive implementing measures and guidance.  However, the details of these rules will not become clear for some time.